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The Friday Five

Thu, 7 Feb 2013

Five stats from the market and the stories behind them. This week: a steep 41% dividend cut, a surprising 12% sales gain, and more.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five: five stats from the market and the stories behind them.

Joining me, as always, with the numbers is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: My pleasure, Jason.

Stipp: So what do you have for the Friday Five this week?

Glaser: We are going to look at $5 billion, minus 25%, minus 41%, 12%, and finally zero.

Stipp: $5 billion refers to the potential size of a lawsuit over mortgage-backed security ratings for S&P. What's the story? It's a pretty big number.

Glaser: The U.S. Department of Justice has filed a civil lawsuit against McGraw-Hill unit S&P alleging that S&P, during the run-up to the financial crisis, basically gave more favorable ratings than they should have to different securities in order to win that rating business, in order to compete against some of the other agencies that were also being fairly lenient during this time.

The fact that this lawsuit came, and that it's such a big number, doesn't come as an enormous surprise, really. A ton of ink has been spilled about the run-up to the crisis and the role that rating agencies may have played in stoking investment demand and saying these securities really are as safe as Treasuries--even though it turns out that they weren't, as many of them ended up going from AAA to junk status in pretty short order.

What is a little bit surprising about this lawsuit is that S&P didn't settle. There were reports that they were looking at about $1 billion settlement, admitting that they had some wrongdoing, and it seems like settlement is the way that most of these financial crisis lawsuits have been settled. There doesn't seem to be a lot of appetite for taking this to trial, but S&P is going to try their luck there. Who knows exactly how that's going to work out for them?

But overall, it just shows that even though we are few years away from the financial crisis now, we are still doing with some of these issues, that we still haven't really figured out what the regulatory regime should look like, exactly who was responsible, who is going to be held legally or who is going to have to pay money for the responsibility for what happened during the financial crisis. And it could still be some time before we really have totally cleared all of those issues and [won't] have to be keep looking back over our shoulders to 2008.

Stipp: 25% refers to a decline in same-store sales for a restaurant chain in China, of all places. Does this say more about China or some problems with this restaurant chain?

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Glaser: Yum Brands certainly looks like they are going to be under an incredible amount of pressure in China over the short term. They've had some problems with their chicken supply chain, primarily for their KFC restaurants, where there have been some reports that they have had too many antibiotics and worries about product safety, and Yum expects that this is going to have a big negative effect, potentially 25% decline in same-store sales in China, as consumers stay away from the restaurants due to these concerns.

And this is a big deal for Yum. 42% of their operating income comes from China. This isn't just a side project for them; it's a huge part of their business, and it's going to take some time for them to recover from this.

Our analyst,  R. J. Hottovy thinks that they will be able to--there is some marketing, there is some products innovation--so they will be able to get people back in the doors, into the restaurants. They have enough of a presence [in China] that this isn't going to be a game-ender for them. But it's going to take a while.

But R. J. points out that there still are some other good things going on with Yum Brands. Their U.S. division is doing better than many had expected--that turnaround is happening. Elsewhere in the world, outside of China, they're seeing pretty good results

So, even though there is going to be some short-term noise there, over the long term, that story and that thesis remain intact.

Stipp: 41% refers to the steep drop in dividend for a big utility company this week. This was not really unexpected. What does it mean for the stock?

Glaser: Exelon made that big dividend cut so that they would be able to keep their investment-grade credit rating and that they would be able to have more cash to invest in the business in areas that they think will be a high return for shareholders.

Even after the cut, which won't happen until the middle of this year, the shares would still have about a 4% yield at today's prices. So it's certainly not a paltry yield compared to the rest of the market. But they felt that they had to do this. A lot of the reason is that energy prices are pretty low right now. So, on the generation side of their business, when you have the high fixed costs, those low prices really put a big hamper on earnings. It makes it difficult to produce all that cash that you need to both service your debt and pay out the big dividend. One of those things had to give. So, like you said, it wasn't an enormous surprise that the dividend was the one that had to give there.

But I think investors still need to look out over the long term. Travis Miller, who covers Exelon for us, still sees it as a wide-moat company. These generation facilities, these nuclear power plants that they have, are irreplaceable assets. They aren't building a lot of new ones right now due to regulatory and safety concerns. So, they have these relatively low-cost centers. They operate at very high utilization rates. They are one of the best operators of these plants in the country, and that's a big advantage for them, and one that's going to be there for decades to come.

So even though we're looking at low energy prices right now, and that's putting some pressure on the dividend and forced them to cut the dividend now, when you look out over the long term, the company still has those great competitive advantages and should be able to produce an economic profit over time.

Stipp: 12% seems like a pretty good same-store sales rate for any retailer, but especially so for an older line department store.

Glaser: Macy's had a great January, along with a lot of other retailers. The retailers that still report monthly same-store sales numbers, those came out this week, and they were generally much better than expected.

Macy's had a big surprise with their 12% [same-store sales] gain [for January], but we also saw Kohl's did very well, moving upscale a little bit. Nordstrom had a very good month.

It seemed like consumers really felt comfortable spending in January. It could be that after the fiscal cliff discussions were over, people saw that the world wasn't going to collapse, that the economy was going to continue on its recovery path at least for the time being, and that gave them permission to go out and spend, made the merchandising enticing to them, and they were out there spending money, and that's good for the economy.

Stipp: Zero is the change in interest rates from the ECB this week. What does that say about what's going on over there? Is it more of the same?

Glaser: No one expected any big changes from the ECB. Their benchmark rate is probably as low as it's ever going to get. It's already at a record low and has been for some time.

But people really were interested in what Mario Draghi was going to say. The commentary around it is more important than the actual rate decision. And Mario Draghi said that he thinks the eurozone will see some sort of recovery at the end of this year, but there are still a lot of risks, and those risks are weighted toward the downside. There still are a lot of places where things could get derailed. We see the euro strengthening quite a bit. That could hurt exports; that's one potential vector. There are still a lot of other issues that just haven't been solved yet.

We saw an agreement with Ireland on the Irish banks and the bailout for the Irish banks, restructuring that a little bit. That had been a long time coming. Cyprus is going to become a big issue fairly quickly. They are going to require some even more significant bailouts in order to keep that country's economy going as a member of the euro.

So there are still a lot of potential land mines on the path for Europe. And Draghi has said, and the ECB has said, that they are going to do whatever it takes to keep everything together, and so far that hasn't really been tested. It's calmed the market down enough so that we've been able to have this relatively quiet period in the European crisis, and I think that we could see in the next couple of months what's going to happen if that's tested. Will they really go out and buy those bonds? In what quantities? Will that be enough to calm the market? And I think that's going to be the big question for Europe throughout 2013.

Stipp: Jeremy, great insights. Thanks for taking us behind the numbers again this week.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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