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The Friday Five

Thu, 17 Oct 2013

Five stats from the market and the stories behind them. This week: three wide-moat names worth a look, an 89-day deal in Washington, 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 an eventful week in 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: We're going to look at the numbers 89, 14.1%, 4%, $1.1 billion, and 9%.

Stipp: 89 is the number of days until this budget deal runs out. I was hoping that maybe I would have one day where I wouldn't have to think about all the wrangling in Washington, but apparently not.

Glaser: I really think we'd be remiss not to start with the budget deal. Obviously, it has overshadowed everything else this week, overshadowed earnings.

Congress finally came together, passed a relative clean bill, didn't end up debating a lot of the little provisions that we had talked a lot about beforehand. They sent it to the president, the government reopened, the debt ceiling has been delayed for a bit.

But it really only buys us about three months, 89 days, until the government would potentially shut down again, and a little bit longer until the debt ceiling would come up.

In the meantime, a budget conference is going to get together; they're going to try to reconcile that Senate bill and that House bill and see if there is any common ground there. Likely they'll [discuss] the sequestration, the next round that's supposed to hit Jan. 15, and maybe have some horse trading to swap some spending from one area to another while keeping the general level of cuts relatively the same. I think that's a potential deal.

I doubt there will be a grand bargain for reasons that we've discussed before--the divide is just too big. But it's good to see that this is taken care of for now. The next 90 days will be very instructive to see if we'll just have a repeat, or if we're really going to be able to have some constructive discussions about some of our long-term fiscal issues.

Stipp: We saw more than 14% growth in Marketplace users at eBay. That's pretty strong growth for what, at least in tech terms, is a pretty mature business line for eBay, and the stock looks interesting, too.

Glaser: eBay is doing really well right now. They had another strong quarter, and it's really being driven across all of their businesses. They had 14.1% user growth in Marketplace. They're seeing PayPal continue to do very well. Mobile is growing very strongly for them, obviously off of a smaller base, but still growing. People are wanting to do these kind of transactions on their mobile phones, and that's been a bright spot for them.

Also, any type of competition, particularly in the PayPal space, doesn't seem to really be having a huge impact yet. A lot of different companies are out there trying to get into this online payment space. It's a hot place for startups and for some more established players, and it's been hard to displace PayPal. People don't want to re-enter their bank account information or their credit card [into a new payment system], and that really helps PayPal's moat.

Now, eBay management did guide toward the lower end of where they thought the year-end guidance would be. This caused the stock to trade off some, to drop a little bit. Our analyst for eBay, R. J. Hottovy, thinks that this represents a pretty good buying opportunity, and says the risk-reward looks great, and that eBay is a wide-moat firm that should be on investors' radars right now.

Stipp: Also in earnings news, we saw a 4% decline in IBM's third-quarter revenue. This is a tough quarter, obviously, for IBM, but there is some good news for investors.

Glaser: IBM did not post good results. You're right. We saw that 4% decline in revenue, and even though earnings grew, that was really driven by some one-time factors and didn't represent any core earnings growth.

They're seeing weakness in a lot of places, in software, in hardware in particular. They're really feeling the crunch of lower government spending, lower corporate spending, an emerging-markets slowdown (particularly in China), the commoditization of a lot of their products, competition. All of these forces are really bearing down on IBM and are producing these less-than-stellar results.

But I think investors need to look over the long term and think about what kind of assumptions and what kind of numbers IBM needs to put up in order for it to be a compelling story. Our analyst Grady Burkett, who follows IBM closely, his projections are for 3% growth in operating income in the coming years. You don't need heroic numbers out of IBM in order to really justify the stock looking like a pretty attractive bargain right now.

As long as some of these pressures ease up a little bit … maybe some of this corporate spending, even if it happens a year or two from now, as long as it does happen, as long as those cycles continue, IBM could be well positioned there. And I think it's another stock investors may want to be keeping an eye on right now.

Stipp: $1.1 billion was the litigation cost that we learned Bank of America will face. Are these kinds of costs are just basically business-as-usual, costs of doing business, for the banks now?

Glaser: It's funny to see a big bank post a litigation loss of over $1 billion, and say, well that's nothing compared to JPMorgan's over $9 billion litigation charge that they had just last week.

But I think it does represent a key risk for Bank of America, along with other things with their business. This wasn't a terrible quarter for the bank. Their wealth investment management unit looked pretty good. Their cost-cutting measures are starting to bear some fruit; they are seeing some good cost controls. They really turned in some decent numbers. But still a lot of the underlying problems, like that regulatory litigation risk, like some of the other legacy problems that they have, continue to weigh on the company and will continue to create an uneven earnings environment.

Jim Sinegal, who covers Bank of America for Morningstar, thinks that means it's unlikely to see a big return of capital, at least for another year. It makes it difficult, with uneven earnings, to know when those dividends can come back, and it just makes it a very uncertain enterprise, even more or so than some of their other big bank peers.

Stipp: 9% represents a drop in coal hauling revenue at CSX. Railroads were recently upgraded to wide moat, so a lot of Morningstar readers might be looking at the railroad results. How should they interpret these?

Glaser: You're right that coal really did hurt CSX again in the third quarter. They had a 9% decline in coal revenue, but things like intermodal and merchandise are helping pick up the slack, and are really helping CSX results not look too bad, even with those coal problems. Particularly with operations, too, they're able to keep the cost structure in line, which helps CSX as well.

I think when you look at CSX over the long term, it looks like a pretty compelling investment right now. Keith Schoonmaker, our analyst, really sees it as a compelling investment. A lot of that is because of that wide moat--these are new wide moats in North America in railroads--and we upgraded it because we really do believe that they're going to be able to earn an economic profit over of course of the next 20 years. It might not be a huge profit--railroads are going to always have the capital expenditures, they're never going to see runaway earnings growth--but they will be able to consistently have solid returns on invested capital above their cost of capital into the system. And even if we have some short-term worries about coal volumes or anything like that, over the long term, they're going to continue to generate this economic profit. That's what investors need to be interested in, and for people with that longer-term focus, it could be a really interesting name right now.

Stipp: Jeremy, after a Washington-dominated week, it's great to get back to some of these fundamentals. Thanks for joining me.

Glaser: You're welcome, Jason.

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

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