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The Friday Five

Thu, 8 May 2014

Draghi drops a hint, Whole Foods takes a hit, and Alibaba's impending IPO raises questions for Yahoo.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five: five stories from the market this week and Morningstar's take. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: Glad to be here, Jason.

Stipp: Up first, the ECB kept rates the same, but what's more interesting is what might happen next month.

Glaser: We got one of the most direct comments from ECB head Mario Draghi this week at his press conference saying that the whole board is feeling comfortable and ready to act to keep inflation from becoming too low and to bring it closer to that 2% goal that they have for the eurozone.

Now, what we don't know is what form this is going to take. It could be as simple as taking rates from 0.25% down to 0%, a more conventional move. It could be more unconventional, such as quantitative easing or something along those lines. We're not clear exactly what he meant by that, but it does look like the ECB is ready to act, ready to try to get some stimulus into the eurozone, and we'll have to wait and see what the impact of that is going to be.

Stipp: The big Alibaba IPO was in headlines this week. What does this mean for U.S. investors, though?

Glaser: U.S. investors probably have two big questions about Alibaba, which will be listing their shares in the United States. The first is, what exactly is Alibaba? R.J. Hottovy, who will be covering it for us, describes the company as a mix between eBay, PayPal, and Amazon. It's a big e-commerce platform that has really gained a lot of market share in China, and that's created a lot of interest. It could be one of the largest Internet IPOs of all time.

But also Yahoo shareholders are very interested in what this valuation looks like, given how much of a stake Yahoo has in Alibaba. Of our $35 fair value estimate for Yahoo, a full $17 comes from the Alibaba stake. Depending on where Alibaba prices, and where it trades afterward, that could have a huge impact on the valuation of Yahoo shares.

But our Yahoo analyst Rick Summer does put a note of caution in there. First, there's a lot of volatility in these Internet stocks. You look at Twitter and Facebook and how those can move pretty quickly, and that potentially introduces some volatility into Yahoo [if Alibaba is similarly volatile].

Also, if they do sell a big part of the stake, what are they going to do with that capital? Are they going to make intelligent decisions? Is management going to deploy it correctly or in a way that's going to increase shareholder value? That's very much an open question. So I think that will be a big part of the Alibaba IPO, at least from many U.S. investors' perspective.

Stipp: Merck and Bayer announced a deal this week, the latest in a string of health-care deals. What's the story with this one?

Glaser: This is, as you mentioned, the latest in many deals. Health-care companies are really trying to focus on what their core business is and get rid of some of these ancillary businesses, and that's what's happening here. Merck is getting about $14 billion for their consumer business--which includes things like Claritin, Coppertone, and Dr. Scholl's foot insoles--and sending them over to Bayer.

Damien Conover, our health-care analyst, thinks this is a good deal for both sides. Merck is getting a good price for these businesses right now, and they can focus on their core pharmaceutical lines. Meanwhile Bayer, although they are paying a pretty good premium for it, will be able to deploy their capital back into that health-care business, which is their more profitable segment, instead of some of the other parts of Bayer's businesses. He sees it as really making sense for both sides.

Stipp: Disney reported earnings this week and became the latest chapter in your "moats in action" series. So why were the results so good?

Glaser: It's really interesting to see these companies that have carved out wide economic moats and have great competitive advantages, and how that really comes into play quarter-after-quarter in earnings. With a 10% rise in revenue and a pretty good quarter for Disney, you can see how they're able to take these franchises, film franchises or other ones, and continue to monetize them across so many different channels and in so many different ways for years, and how successful that can be. They had lot of success with Frozen, with the merchandising, and really the only thing that was holding them back was that they ran out of merchandise in a lot of channels.

At the same time you see theme park attendance doing well, as they continue to build properties, say, with Pixar's cars, which was released years ago, and which is still generating profit for them. They were able to do that better than almost anybody else. A lot of that is the basis for their economic moat, and you could really see it this quarter.

Stipp: There was a cleanup on aisle 5 for Whole Foods this week after they reported a lackluster quarter and a disappointing forecast. What's the story here?

Glaser: Whole Foods really did have a tough week, down over 20% at one point. What happened, as you mentioned, was that the forecast was really disappointing to a lot of investors. It seems like they are facing quite a bit more competition in that core natural and organic niche. The stock sold off as investors were worried that they were not going to be able to drive that kind of same-store sales growth, that they're not going to be able to increase margins, and that they're going to have to lower prices in order to keep that traffic coming and to keep people in the stores. And that obviously takes a hit on profitability.

But we don't think the story is completely over yet. Ken Perkins, who covers Whole Foods for us, thinks there are a few things behind that. The first is that there's still room for lot of store growth. If they go from 400 to a 1,000 stores, that gives them a much bigger base to spread some costs behind. That could help with profitability.

And their model is not that easily replicated. Walmart can come in and start selling organic foods, other stores can start selling these kinds of product categories, but it's very difficult to recreate that entire in-store experience. There will always be consumers who are looking for that and are willing to pay a premium for it. It doesn't mean Whole Foods is not going to face a ton of challenges, but given the sell-off, the shares are starting to look somewhat undervalued.

Stipp: Jeremy, The Friday Five is always worth checking out. Thanks for joining me again.

Glaser: You're welcome, Jason.

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

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