Thu, 24 Oct 2013
This week: More fuel for Fed stimulus, Netflix shares overshoot, and McDonald's hits the value menu for long-term investors.
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: The numbers we're going to take a closer look at are 148,000, 1.3 million, 0.9%, 12.3%, and finally $1.9 billion.
Stipp: 148,000 jobs were created in September according to a delayed government report. This turned out to be a report really not worth waiting for.
Glaser: That delayed report confirmed what we had been seeing--a slow, plodding recovery in the job market. That was written all over this report. Yes, the unemployment rate ticked down a little bit, but a lot of that is because we're seeing people drop out of the workforce, not that so many people are finding jobs.
I think the big takeaway from this report really comes down to what the Fed is going to do. They've said that employment is the indicator that they're looking at most closely while deciding what to do with monetary policy. Given the relative weakness of this report and the probability that next month is going to be pretty weak because of the government shutdown, it's seems unlikely that the Fed is going to have lot of appetite to taper at the December meeting, to really take their foot off the accelerator of those bond purchases.
Then we're going to get very close into Janet Yellen's tenure as the chair after that December meeting, and I think she's the one who's really going to be in control of when this decision gets made. It will be really a first test to see what kind of chair she's going to be. We'll find out relatively soon. This is a big decision that will need to be made in 2014, which is when the taper is still likely to happen, and it will be a good way to get a preview of what her tenure as the head of the Fed is going to look like.
Stipp: Netflix reported a robust 1.3 million new subscribers in the third quarter. This is very good for the business, but the stock has been overvalued, according to our analyst, for a while. What's the situation now with the company and the stock?
Glaser: It's great for the business. Netflix is doing very, very well. They added 1.3 million subscribers. They'll have domestically more subscribers than HBO. They really are the juggernaut in that streaming space. I think they've cemented, at least for now, their position there.
But the stock has really gone a little bit haywire. Michael Corty, who covers Netflix for us, says that it's just become a pure momentum play at this point. According to his estimates, it's trading for 95 times 2014 earnings. For a business that doesn't really have any sustainable competitive advantages--or even for a business with great sustainable competitive advantages--it just seems like it's much too high, given the potential for growth in this business. It's one of the most overvalued stocks in our universe right now.
I think one of the big things that Michael Corty has pointed out a few times is that there is a misperception that all of these incremental users are just going to drop directly to the bottom line--that there is complete operating leverage there. He just doesn't see that to be the case. It's not that Netflix is a secret anymore. People aren't just discovering that there is this great new service you should check out. People are aware of it, are generally aware of the value proposition. So in order to get more people, either those acquisition costs are going to be high--it's going to cost a lot in advertising, a lot of free-trial promotional spending to get people on board--or it's going to be on the content side, and you're going to see more investment in things like original programming and paying up to the big studios to get some of that really great content. That's expensive, that's going to erode margins.
So really, even if you see big user growth, it could be potentially expensive, and it just doesn't justify the kind of valuation that's on the stock right now.
Stipp: McDonald's also reported this week a very lackluster 0.9% same-store global sales growth. So what's the issue here? A little bit too much value in their value menu?
Glaser: McDonald's has definitely been under pressure for a few quarters now, and this relatively modest growth in the third quarter just underscores that. There really are a lot of pressures hitting McDonald's in a bunch of different areas. Like you mentioned, they've been promoting the value menu, but their franchisees are not thrilled with that. That obviously puts some pressure on them to be selling those lower-priced items. You have issues with the general consumer spending environment, where people are cutting back, and they might see fast food meals as a place that they could cut back.
They're also seeing a lot of competitive pressures from places like Chipotle or other fast-casual restaurants that really eat into their territory. People who maybe have some more money to spend are willing to pay up a little bit for the perception of better quality at one of those restaurants.
Those are some big challenges, but not ones that are insurmountable for the firm. R.J. Hottovy, who is our analyst on McDonald's, still thinks that over the long term, it looks like a pretty compelling stock. It's rated 4 stars right now. He thinks that they can get back to 3%-5% long-term comparable sales growth globally. It's not going to happen overnight. They're going to have to continue to develop new menu items, continue to tweak what the pricing looks like. But if you have a long-term horizon, this wide-moat company should be able to overcome these short-term woes, and hopefully produce economic profits in the future.
Stipp: We also heard from Ford this week, which had a 12.3% rise in revenue, which is very good. Also good for the automotive industry, which has been one of the brighter spots of the recovery recently, as other retail sales have been somewhat soft.
Glaser: It really is good news for Ford this quarter. They saw that 12.3% rise in sales. It was driven by North America. They had volume growth, they had pricing growth, they have products that people want. It's definitely a good sign for Ford.
Like you mentioned, auto sales just absolutely fell off a cliff in the recession, and now that consumers are starting to get back to their normal purchasing habits, the beneficiaries really have been in the auto sector. We've seen that trickle down through a lot of other parts of the economy as well.
Not everything is perfect for Ford. Europe remains a problem. It's getting better, but as our auto analyst Dave Whiston says, it's still a work in progress. They still have to roll out some new products there and still have to refine their message in order to get Europe back on track. But generally, he thinks Ford is attractively valued right now, and that there is still some upside in the shares.
One wildcard here is Alan Mulally, who is the CEO of Ford and very well regarded. It is being rumored that he is going to consider the Microsoft CEO position after Steve Ballmer steps down. This is a persistent rumor for some time now, and there's been some non-denials from Ford and Mulally on this front. Dave Whiston really sees Mulally as, obviously, a key figure there, but if he were to leave, Ford has a strong enough management bench that they'd be able to continue building that value even without him at the helm.
Stipp: $1.9 billion worth of shares were issued by Corning to Samsung to buy out Samsung from a joint venture. These companies are still going to be very closely connected, which underscores some interesting relationships and partnerships in the smartphone space.
Glaser: This was an under-the-radar deal that I think has lot of interesting tidbits to it. Like you mentioned, Corning is issuing these preferred convertible shares to Samsung, $1.9 billion worth. They're also buying out a few other smaller partners to take full control of this one glass venture in Korea. Then Samsung will end up with a pretty sizable stake in Corning.
Corning's big businesses are producing glass panels for things like LCD TVs and smartphones and tablets--the kind of devices that obviously Samsung would like to sell a lot of. The fact that Samsung wanted to shed some of these assets from their balance sheet, but still wanted that tight connection, just speaks to how competitive the consumer electronics industry remains.
It's important for Samsung to keep those deep ties with suppliers, so that if they do need to respond quickly with a new product, they know they can get their hands on those LCD panels, which is something that could [otherwise] potentially be a bottleneck. They're looking at new technology, things like curved displays, higher-quality displays, thinner displays. The R&D work that they'll be doing with Corning is part of this agreement. It will help bring some of those products to the market and give them a cutting edge there.
So it just shows that, even though Samsung has had really incredible success in smartphones and elsewhere over the last few years, they're not resting on their laurels. They want to make sure that they're still putting that money into research in order to make sure that someone doesn't one-up them elsewhere on the technology front.
Stipp: A Congress-free Friday Five was sweet relief for us, Jeremy. Thanks for joining me.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.