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The Friday Five

Thu, 28 Feb 2013

Five stats from the market and the stories behind them. This week: the $85 billion sequester, two divergent same-store sales stories, 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: You're welcome, Jason.

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

Glaser: Well, the five numbers we're going to look at are 3, $85 billion, minus 32%, plus 7% and 50.

Stipp: 3 is the number of political parties that seem to rise through the mist of the election going on over there [in Italy]. What's the deal with those three parties? It caused some consternation in the market [this week]?

Glaser: The Italian election really was a bit of a mess. Before going into the election, there was some thought that the center-left coalition was going to be able to win outright--they were going to form a stable government, be able to continue on some of the reforms that Mario Monti had been working on. And that just didn't happen.

Three parties got over 20% of the vote: that center-left coalition, Berlusconi's center-right coalition, and also a protest party that's run by an Italian comedian got a surprisingly large share of the vote. And these parties do not want to form coalitions with each other, and that means that we're probably going to have another election.

This just adds more uncertainty to the Italian situation. Italy's big problem is getting back to long-term growth. They don't have the kind of budget deficits that some of the other European countries have right now that need to be dealt with immediately, but they do need to make some of those structural reforms in order to get that growth before they run into some of those deficit problems that could be a major issue for them.

Without a strong Italy, the eurozone crisis becomes incredibly difficult to solve. Italy is a much more important economy than, say, Greece or Spain. This is why the market, I think, was so upset about these election results, and we're going to have to go through this probably all over again in just a few months from now.

Stipp: Here at home, $85 billion is the size of the "sequester" that's going to go into effect if Congress doesn't take some action very soon here. What's your take on that number? The market doesn't seem as concerned about that right now as it did about the Italy situation.

<TRANSCRIPT>

Glaser: It's sequester day in America. These cuts that were never designed to be implemented look like they're going to be implemented now. And I think that it's difficult to assess exactly what impact this is going to have on the economy for a few reasons.

The first is that it wasn't really designed to be implemented. We don't really know how these cuts are going to happen. The executive has been very tightlipped about precisely who's going to have to be furloughed, how much of a cut they're going to see early on. There's been some discussion, maybe cuts in the air traffic control for the TSA. Ray LaHood has been talking a lot about impacts to travel. The USDA has been talking about the impact to meat inspections. We've gotten little bits and pieces, but we just don't know what the full impact is going to be there. So that's one big question mark--implementation.

But the bigger one is what's going to happen when Congress has to pass a budget at the end of March that's going to fund us for the rest of the year, and if they don't do that, we'll see a full government shutdown like you may remember from the '90s. And I think there's a good chance that in those budget discussions, a lot of these sequester cuts will end up getting rolled back or changed in some way. So they might only be implemented for a couple of weeks before either some of that funding is restored or the cuts are moved to different parts of the government. And because of that, it's hard to extrapolate exactly what that $85 billion will mean, if only a small fraction of that is actually cut.

I think everyone agrees that there needs to be some spending cuts, that we can't tax our way out of the deficit problems that we have. But almost everyone on both sides of the aisle think that these cuts are not the way to do it, that there are better ways to cut that spending, so I think that they will try to create more targeted cuts--ones that maybe are spread out over a longer period of time. And over the next few weeks, I think we're going to be hearing a ton about that.

Stipp: Your third and fourth stats from the market are a tale of two retailers; the first one, negative 32% is obviously not a good tale. That's J.C. Penney same-store sales results. What's going on with the struggling retailer?

Glaser: J.C. Penney did not a have a good holiday quarter. The problems that the retailer is having have been pretty well-publicized. When the former Apple Store's chief Ron Johnson came in as the CEO, he made a lot of big changes. He got rid of coupons. He got rid of discounts. He wanted to build these "stores within the stores" and really make the brand a little bit more upscale. And that's something that hasn't been particularly well received yet. Customers have been fleeing, and that 32% fall in sales, I think, is a pretty clear sign of that.

Now, this doesn't mean that J.C. Penney won't be able to execute on this turnaround. They still have a decent amount of liquidity, and they will be able to really use 2013 to stabilize the business before turning around.

There are a few green shoots there, if you will: Some of the "stores within the stores," these new boutiques within J.C. Penney, are performing pretty well, according to the company. They are starting to bring back some coupons and discounts. They are backing away from their absolutely no-discounting strategy, which I think is a sign that they're willing to adapt to the market conditions.

But it's not going to be easy. If we don't see stabilization this year, if we don't see more cash or that cash[doesn't] stop getting burned, that means they might not have the capital to really invest to make all of these changes that they'll need to improve the business.

It could happen. It's not a lost cause. You see these huge declines, and it's easy to write the company off. I think it's too early to do that, but this is going to be an absolutely pivotal year--if we don't see stabilization soon, then they really could be in trouble.

Stipp: On the flipside, 7% is Home Depot's same-store sales number. That's a pretty good number for the home industry, which for a long, long time throughout the recovery hadn't been doing so well.

Glaser: This is what I like to call our "wide moat in action" series. You see these companies that have great competitive advantages, and in these environments you can really see it happening.

Home Depot had a really good quarter. Like you said, they had 7% same-store sales growth. That was on top of last year's quarter that had over 5% same-store sales growth, so it's not like it's coming off of a low base. They were able to increase operating margins, really get that leverage there, and keep their costs from expanding too much.

Some of this is weather-related. It's Sandy cleanup-related, so there are more people in the stores. But part of it is that the housing market is starting to come back in a real way. People are spending money on renovating their homes. They are spending money on maybe getting things ready to sell or renovating a home that they just bought, and that's a good sign for Home Depot that they have that competitive advantage to really take advantage of it.

Stipp: 50 is the number of grounded planes for Boeing--the Dreamliner 787 is still having some trouble. What's the latest on that drama?

Glaser: A lot of news on the Dreamliner this week. Boeing said they think that they're close to a fix; they think that the battery just needs a different kind of casing around it, that they need to separate the different cells, and put some monitors in it to make sure that it's not overheating, and they want to start testing this fix as soon as possible.

The regulators are a little bit more skeptical. They want to make absolutely sure that they know what caused some of these fires in the batteries, and then make sure that whatever these fixes are, that it keeps those fires from ever happening again. And they are apparently going to be extremely cautious in allowing the plane to test again and in allowing it to actually go back into service. We're even hearing that different regulatory agencies around the world probably of different standards of what that means. It's going to be a bit of a mess to get the Dreamliner back into service.

But I think what's important for Boeing investors is to see that even if this grounding continues for months and months to come, it's still a relatively small portion of Boeing's operating income. They have a diverse business with defense and with a lot of other commercial aircraft. They're still bringing in a lot of cash. They will be able to ride this out for some time. And it does seem like the planes will eventually get back in the air. There haven't been a lot of order cancellations. The benefits of the plane are still apparent to their customers and they'll be able to ride this out, but it's going to be a messy road until those planes are back in the air.

Stipp: Jeremy, great insights as always. Thanks for taking us behind the numbers.

Glaser: You're welcome, Jason.

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

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