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This Week's Learnings From Earnings

Fri, 25 Jul 2014

Facebook makes the most of mobile, focus pivots to Apple's pipeline, Chipotle may be moat-worthy, and more.


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: You're welcome, Jason.

Stipp: It was a big week of earnings. The first one we're going to talk about is Facebook. They had very strong results, driven by mobile. This shows that mobile continues to be a great area for them to invest.

Glaser: It really does. Going into Facebook's IPO, one of the big question marks was, could they monetize mobile? Would people be willing to look at ads on their mobile phone? And after a couple of good quarters, I think the answer is clearly yes. Facebook grew revenue overall by 61%, but mobile was up 151%, which is a pretty big increase off of what's already becoming a substantial base. And you also see the leverage really inherent in their model, with those GAAP operating margins coming in at 48% in the quarter--a very hefty margin.

Rick Summer, who covers Facebook for us, says mobile is an area that we're going to continue to see Facebook invest in, that they have been investing in, and it's a prudent place for them to be putting some of their capital to work.

Stipp: Apple, another tech giant, also reported this week. They had a decent quarter, but the more important thing for investors to focus on is the potential for that product pipeline.

Glaser: You're right. The quarter was fine. Revenues came in a little bit light, and there were some other bright spots: sales in China looked pretty good. But as Brian Colello, our Apple analyst, pointed out, the real action is happening in the pipeline, on products that we just don't know about yet.

For a while, management (Tim Cook and others) have been hinting that they're very bullish on these new products. They think they're going to be great. But we haven't seen them yet. I think one of the big questions is going to be, will the iPhone 6, will the new iPad, will the new iWatch (if it does materialize), move the needle on sales? Will people be excited about them? Does Apple still have that magic? I think we're going to find out sooner rather than later, as some of these products come to market before the holiday.

Stipp: Restaurant chain Chipotle reported, and they had very strong results. Are they building a moat out of all those burrito bowls?

Glaser: They might be. R.J. Hottovy, our Chipotle analyst, thinks that they could be digging out a narrow moat right now.

Chipotle had a 17.3% increase in same-restaurant sales, which is impressive against a restaurant backdrop that just isn't terribly robust right now. These results show that their brand and their operations are really resonating with consumers and they're offering a product that people want. They're even able to maintain profitability with higher commodity prices; that's a pretty impressive feat. So it looks like Chipotle could be on the track for a moat, but they're not quite there yet.

But one thing to keep in mind is valuation. Even if they have this great growth and they're building this great brand, it's not worth paying any price for it. You need to be very focused on getting in at a decent bargain or even at a fair price, and not at maybe some of the more lofty levels we're at today.

Stipp: Chipotle is firing on all burritos, but not so for McDonald's, whose results show that they're still having some trouble in the U.S.. And also this week, there was a mcnugget of bad news.

Glaser: Let's start with earnings. In the U.S. same-store sales were down 1.5% and traffic was down 3%. That's a continuation of a trend here in the U.S. that McDonald's just isn't doing as well.

R.J. Hottovy, who also covers McDonald's for us, thinks management is focused on this issue, they're going to roll out new menu innovations, try to deal with some staffing issues to make sure that those peak waits aren't as long. But it's going to be a challenge, and they're going to have to execute that very well.

They had another nugget of bad news this week, which was that one of their suppliers in China was selling expired meat to McDonald's and also to Yum Brands and to some other chains in China, and that's going to have a detrimental effect in the short term, as consumers maybe shy away from it over food-safety concerns.

In the past, brands have been able to bounce back from this. With some investments in advertising about food safety and some changes in the supply chain, they got people back into the restaurants. So it should just be a short-term dislocation, but something to keep on the radar.

Stipp: In a last bit of interesting news this week, Herbalife got a bump after Bill Ackman, who has a short interest in the stock, gave a very negative presentation on the firm. So what is driving the stock price here?

Glaser: Ahead of this presentation on Tuesday, Ackman said it was going to be a "death blow" for Herbalife, that it was going to be so damaging that the regulators will be forced to step in. The market just didn't buy that after the presentation. The stock was up 25% at one point during his talk, in which he laid out why he thinks that Herbalife is a pyramid scheme, and he presented these nutrition clubs that have been expanding as a sign that they're aren't real customers, they're just people recruiting other people into the pyramid.

Obviously, the management team of Herbalife vigorously denies this, and says that they're a legitimate multi-level marketing business. But I think it's clear either way that the stock price is not being driven by fundamentals, it's being driven by these very public debates right now.

I think, as an investor, you can go ahead and read about it, it might be interesting to watch, but it probably isn't a place to be making a big bet right now. It's just hard to say what the outcome of this is going to be.

Stipp: Jeremy, no smart investor would take a short interest in the Friday Five. Thanks for joining me again.

Glaser: You're welcome, Jason.

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

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