Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Josh Peters. He is the editor of Morningstar DividendInvestor newsletter and also our director of equity income strategy. Some of his portfolio companies have reported earnings recently, and we're here for his take on if they are still on track. Josh, thanks for joining me.
Josh Peters: Good to be here, Jeremy.
Glaser: Let's start with McDonald's (MCD). This was certainly one of the more disappointing reports we've seen recently. They are under a lot of pressure. Could you talk a bit about what kinds of headwinds McDonald's is facing now and if it has really changed your investment thesis at all in the company?
Peters: Well, like a lot of big multinational companies, you do have exposure to a lot of economies that are now weaker than the United States, especially Europe. You've also got the effect of the strong dollar on results, which is negative from the standpoint of a U.S. company and its U.S. shareholders. But McDonald's just seems to have lost that magic touch.
They had such a terrific run there from 2003 or 2004 until about 2011 or 2012. It happens I bought right at the end of that run. One of the things they did during that period was become much better at capital allocation, stepping up the dividend dramatically, creating what is now a very attractive dividend yield that I think is quite secure. But earnings are not growing.
In fact, with some of the specific challenges that they've had here this year, including the food-safety scare in Asia, earnings are down. And some of these things will just wash out. They will lap the comparisons with the food-safety scare. That will go away. McDonald's has changed its supply chain. There is no reason to think that needs to recur. So, it will get those customers back. But how do you engage with customers in the United States and in Europe where you didn't have a specific issue, but your comparable store sales are still falling? What's going to bring those people back?
I frankly don't know. And at this point, to continue owning McDonald's is really expressing a lot of faith in the dividend, which I think is secure, and also what we think is still a wide economic moat. They just have such strong competitive advantages relative to other large restaurant operators. But there is some sense that maybe that moat is under attack, and maybe some other chains, like a Chipotle, have come up with ways of getting people good food fast that McDonald's has not figured out how to replicate or compete with yet. So, that one is kind of a tough one.
And I think that it's still a buy--a stock that you can own for income at this point--but I think you also have to have in mind that they need to start to showing some kind of progress here in, let's call it, another 12-month type of window or you're really going to have some real strong questions that could be very difficult to answer about the company's competitive position going forward.Read Full Transcript
Glaser: Let's take a look at Coca-Cola (KO), another multinational. Many investors were disappointed by those results. What's your take on them?
Peters: It's kind of curious. McDonald's results I thought were legitimately terrible, but it was Coke whose stock price fell much farther after the report. And I think what you have here are a couple of things in play.
One is that the stock had been performing very well since earlier this year when people were in a real funk around Coke. And they had a couple of decent earnings reports--turns out Coke isn't going out of business in a hurry after all. The stock outperforms the market and then--boom--here comes a report that doesn't surprise to the upside and shows some pressures and some weaknesses for the business globally, and the stock gets thrown for a loop. So, there is an expectations mismatch.
In the case of McDonald's, people had very low expectations. So, it was kind of hard for the company to dramatically underperform relative to just how sour the sentiment is around that name. The biggest problem I think Coke has right now is one that it has absolutely no control over, which is the strong dollar. Most of Coke's earnings come from overseas countries, and most of those currencies that they are earning their profits in, when they are translated back into dollars, it's a big headwind. It was a 6-percentage-point headwind for their earnings per share in the third quarter alone; that they managed to keep earnings per share kind of flat against that headwind, I think, is a decent result. It's not as good as, I think, the company should be able to do longer term. But most of the criticism is that the company is too bloated, it's not executing well, they haven't innovated enough, they've got the wrong products, people don't like sugar or artificial sweeteners anymore.
This one, frankly, I'm much more comfortable owning long term than McDonald's because Coke is a packaged-beverage company. It doesn't need to be sugar soda in the red can. As long as people are drinking anything that comes in ready-to-drink fashion, chances are Coke is going to be the dominant supplier of those beverages. It's not going to always be a fast-growing business, but with the dividend yield here back at 3%, even if you only think this is a 5% or 6% [earnings per share] growth business long term, which is quite a bit less now than what Coke itself is targeting for high-single-digit earnings per share growth, then I think you are still looking at a decent total return, given the fact that this is not a very risky business. It has a very wide economic moat, generates lots of cash, and is recession-resistant. So, I don't think that there is the same level of questioning, when you really think about it, around their execution. They could do a little bit better than you have with McDonald's.
Glaser: And finally, can you give us your take on GE's (GE) earnings?
Peters: GE was a positive surprise. It came at a good time for the market, which had been sagging. It gave the whole market a lift when they talked about the U.S. economy being the strongest that they've seen since the recession ended. They had terrific growth in orders. They are continuing to execute this reshuffling of their portfolio away from the finance earnings--that business got them into a lot of trouble back in 2008-09--and into those industrial and infrastructure segments where we think their moat is the widest and where they are going to generate the best returns over the long run. I find very little to complain about, and I think the stock is still fairly attractive here.
Now, again, as with all of these companies, it's a global business. You've got exposure to lots of different economies that aren't performing as well as the United States. You've got some currency headwinds as well associated with all that overseas exposure. But these things have a natural ebb and flow. I think, over the long run, it's a net positive to have some of that foreign exposure and some of that nondollar exposure as a part of your portfolio. It's not always going to be the ideal bet, if you're thinking about a short-term bet. But with GE offering a dividend yield here in the mid-3% range, I think we're looking at another good dividend increase to be announced by them in December, which would immediately add to your realized yield if you're buying at this price. I think this one is a core holding.
In fact, I'd regard Coke as a core holding, too. McDonald's, I think, we've got to keep an eye on that business. We may not want to give them as long of a leash as we would to GE or Coke.
Glaser: Josh, thanks for your thoughts today.
Peters: Thank you, too, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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