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The Friday Five

Thu, 30 May 2013

Five stats from the market and the stories behind them. This week: Berkshire's buy, a boost for Costco, and more.


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 Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

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

Glaser: Well, we'll look at the numbers $49.1 billion, $4.7 billion, 4, 5, and 7%.

Stipp: $49.1 billion refers to the amount of cash on Berkshire Hathaway's balance sheet at the end of the first quarter. They're putting some of that money to work, in news we found out this week.

Glaser: They are. Berkshire announced that its unit MidAmerican Energy will be buying NV Energy, which is a regulated utility in Nevada. I think this is a good example of something that we talked about at the Berkshire meeting, and Buffett talked about, [which is] this idea of paying up for quality. Instead of being focused on finding the absolute cheapest company, the cheapest securities you can find, Warren Buffett is willing to pay a little bit more if he thinks that it's a well-run company, if he thinks it's going to have good prospects in the future, if it's going to work well with some of his other units. And I think that's what's happening here.

They're paying a fairly rich valuation, both a premium to our intrinsic value of NV Energy, and also to what it was trading at in the marketplace beforehand. In return, they're getting a narrow-moat business, one that our utilities analysts think is pretty well-run, and also one that's going to have a lot of opportunities to soak up capital and to have other capital-intensive projects in the coming years. And that's something Warren Buffett is really looking for. They're sitting on all this cash. They don't necessarily have a ton of uses for it, and it's earning 0% right now. Putting it into some of these businesses, even if it's not … going to be an incredible return, it's generally still better than where they were before, and Buffett is willing to pay up a little bit in order to get a deal like this done.

Stipp: $4.7 billion is the amount that Chinese firm Shuanghui is going to pay for Smithfield. This is one of the largest takeovers of a U.S.-based firm by a Chinese firm, and you're saying that you're going to keep an eye on the regulators here.

Glaser: Absolutely. I think that's the most interesting part of the story for most investors--those that aren't already [invested] in Smithfield or interested in the pork industry or in the food industry more specifically.

Over the last couple of years, there's been a lot of resistance from U.S. regulators to big Chinese takeovers of U.S. firms. Be it investments, be it complete takeovers, … either the deal got scuttled or has to get reshuffled or restructured in some way. Generally [regulators] cite that there are some state secrets that they don't want to be passed into Chinese hands. They're worried about sensitive areas; they're worried about intellectual property. There is always a laundry list of reasons that keep deals from getting done. And I think this will be a real test if regulators are willing to allow the Chinese capital to flow into the United States, to take over some of these bigger businesses.

It's not immediately apparent that pork processing and raising pigs is going to rise to national security level, like [deals] in telecom or in wind power or in oil or other areas, where there have been some problems in the past.

So this will be fascinating to watch from that standpoint. Smithfield says there may be some other bidders in the wings, so we might see that emerge and we won't get to see that regulatory battle potentially play out. But it's one that's worth keeping an eye on.

Stipp: The number four refers to the fourth season of "Arrested Development" that was released exclusively on Netflix. Some mixed reviews recently, though, dinged the stock. Is this really a content problem, or is this just an excuse for worried Netflix shareholders to take some profits?

Glaser: This could be a case of live by the content sword, die by the content sword.

Michael Corty, who is our media analyst, has talked, and we've talked, before about content being king. Consumers are interested in high-quality content, and they don't really care how it's delivered to them. Be it through Amazon or Comcast or Netflix or Apple, they just want to see this really good content. And Netflix has embraced this and is trying to produce this original exclusive content--things like "House of Cards" and now this new season of Arrested Development--to try to drive subscribers.

So far it seems to have been working. "House of Cards" is very critically acclaimed, and they saw that uptick in subscribers in the next quarter. But with "Arrested Development" maybe not having quite the glowing reviews that they may have hoped, we did see the stock get dinged a little bit, and it could be that the investment community is understanding that creating good content is challenging. A lot of the big media conglomerates have a lot of different irons in the fire at any different point, and potentially one of them works, one of them doesn't, [which is why] you have that portfolio. With Netflix producing so few shows and having so few new pieces of content, really each one has to do really well.

But beyond that, I think that some of the sell-off could have just been valuation based, like you mentioned. The Netflix shows have become fairly pricey. There's been a big runup. It gets ahead of the valuation, and maybe this is just an opportunity for some people to take some money off the table, to take some of those games. It could be a combination of the two as well. It's obviously hard to ascribe a stock drop to any certain event, but it definitely seems like the poor reviews of the content did weigh on Netflix.

Stipp: Five refers to the five-year high that consumer confidence hit this week. People are still out there buying despite some bad news?

Glaser: Consumers are in a pretty good mood. I think over the first quarter, it seemed like there are lot of things that were conspiring to make consumers a little bit gloomy. You look at things like the payroll tax cut expiring, so you're dealing with a little bit less take-home pay. The uncertainty around the fiscal cliff got solved--that was an overhang.

Despite all of this, despite unemployment coming down, but still being relatively elevated, consumers have a pretty cheery outlook--the highest in five years. The outlook over the next couple of months remained pretty high. According to this Conference Board data, [consumers] are expecting things to get better, and for the employment market to get better.

I think that's a good sign for the economy; a confident consumer is someone who is going to go out and actually buy, and make that big purchase, going to buy that car. We see the housing market continuing to improve: They're going to be potentially buying a house, willing to trade-up that house. Those are decisions that keep the recovery going, and I think that it's good to see that confirmed in this data.

Stipp: A 7% boost in same-store sales in the recent quarter for Costco. Is this is a good name for folks looking for some decent growth right now?

Glaser: It could be, or if not growth, looking for a solid, fairly valued stock in a market that's starting to look slightly overvalued.

Costco had a really great quarter. R.J. Hottovy, who covers Costco for us, said there wasn't much more you could ask for in terms of the results. They had that 7% same-store sales growth. They were able to increase the operating margins with more efficiencies. [They had a] big boost in traffic, a lot more people coming in through the stores. These were all good signs for Costco.

Despite what we just said about consumers being confident, they're still looking for a deal. They're still not necessarily completely free spending, and they see a value proposition at Costco, that it's worth paying that annual membership for what they see as better prices, and they're willing to buy in bulk in order to get that lower unit cost. That bodes well for Costco. If there is an economic slowdown, if the recovery remains somewhat middling, people are going to still go to Costco and continue to push up those sales, and you have an excellent operator who is able to push out those operating efficiencies.

So it's not screaming cheap by any stretch of the imagination right now, but given some of the other options in the equity space, it could still be a solid name for folks to look at.

Stipp: Another five notable numbers in the market this week. Jeremy, thanks for the insights.

Glaser: You're welcome, Jason.

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

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