Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to The Friday Five, Morningstar's take on five stories in the market this week.
Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser. Jeremy, thanks for being here.
Jeremy Glaser: You're welcome, Jason.
Stipp: Lots of retail news this week. Let's start with Macy's. They were under some pressure after they released results this week. What's the story with the department store?
Glaser: We expected that Macy's was not going to have a great third quarter, but it was even worse than we expected and worse than the market expected. It also looks like their fourth quarter is going to be pretty weak as well. They have too much inventory. They haven't been able to get rid of it, and that probably means there's going to be some significant discounting going into the holiday season in order to move merchandise off the shelf. That doesn't bode well for profitability.
One of the other things I wanted to flag in the results is that Macy's did say they aren't going to spin off their real estate into a separate company, into a REIT, and try to maximize value that way. They are going to do a few things to get some of the real estate that's not being utilized at its fullest potential working a little bit better for them--but no big spin-off.
This comes on the heels of McDonald's making an announcement this week that they also aren't going to be pursuing a REIT. It seems like the strategy of spinning off real estate has fallen out of favor across the market. This had been a favorite of activist investors as a way to unlock value in a lot of these chains. However, given that the IRS may look at these transactions more skeptically, and management also wants to keep the flexibility of having the real estate, the tide seems to be turning against this strategy. It's an interesting trend that we saw this week, and I think we'll probably continue to see.
Stipp: Nordstrom also reported, and if expectations for Macy's weren't that high, they were certainly higher for Nordstrom, which had been doing pretty well. But they really disappointed this time around.
Glaser: In The Week Ahead last week, we said that we were going to look at Nordstrom's earnings to see if they could continue this trend of outperforming their peers, and they really weren't able to.
Same-store sales were up only 1%; that's a pretty sharp deceleration from where they were in the previous quarters. Bridget Weishaar, who covers Nordstrom for Morningstar, thinks this really isn't a sign that Nordstrom the concept is failing, or that people don't like Nordstrom anymore. Rather, it's a sign of broader consumer weakness in the quarter. Given how evenly spread the weakness was across all of Nordstrom's different businesses and different geographies, it seems like it really was a broader consumer issue.
She did point out that management did a good job of discounting in order to get inventory under control, so they don't have this big amount of inventory they're going to have to discount through the holidays, which bodes well for them.
Nordstrom shares were off considerably on this news. They're under review right now as Bridget reviews these results, but she thinks that the sell-off may possibly be a bit overdone.
Stipp: We also got broader economic data--retail sales for October. They were pretty anemic at 0.1% growth. What's your take?
Glaser: That number was well below expectations on the headline, and even when you strip out gas and autos and building materials--things that can be pretty volatile--the numbers didn't look that great, and were also below expectations.
I don't think one bad report is a reason to panic about the state of the consumer. This is a very volatile series, something we've talked about in the past. It's too difficult to read much into any one month about the state of the consumer.
When you look at the data on a year-over-year basis, we're not seeing a huge deceleration from where we were in the previous quarter. Research group Capital Economics says that this is supportive of around 3% real consumption growth in the fourth quarter, down from 3.2% in the third quarter. So yes, it's moving down, but not to a place where there's really a worry about the consumer totally going home. However, we still have not seen any signs of acceleration and aren't expecting to see any signs of acceleration any time soon.
Stipp: Another stock under pressure this week was Priceline. We've recommended Priceline shares in the past because we felt they were undervalued. Well, they're even lower now. What is our opinion at this point?
Glaser: Priceline had a decent quarter, but what really got Priceline shares this week and really got investors concerned was management's guidance about U.S. bookings. They said bookings were going to be down considerably to a disappointing level.
The U.S. is actually a relatively small portion of Priceline's business, but still when you see it decelerating, that's something that people aren't exactly excited about. But we think that some of that is transitory. There aren't a lot of empty hotel rooms out there, so the name-your-price type of product that's popular in the U.S. just isn't as valuable for the hotels. They don't need to put a lot of inventory through that, because they're able to sell it through traditional channels at higher prices. That puts some pressure on Priceline. And airfares have come down a little bit, which hurts revenue as well.
But when you look at the bigger picture, Priceline's network advantage, which is really the core of its narrow moat, is still very much in place. They still have a lot of properties in Booking.com, which is their biggest property, that aren't available anywhere else. Priceline should be able to continue to grow their international markets at a very nice clip for years and years to come, if you look past some of the noise, issues with currency, and these little blips in the United States. Dan Wasiolek, who covers Priceline for Morningstar, does see the shares as still attractively priced.
Stipp: And lastly, in deal news this week, the Miller-Budweiser merger took a big step forward. What are the details?
Glaser: This week, Molson Coors, which is currently in a joint venture with SABMiller (the Miller Coors joint venture), is paying about $12 billion to buy out their partner. This was seen as a crucial part of the deal, because in order to have any chance of passing regulatory muster in the U.S., they were going to have to divest these assets. And Molson Coors was the only logical buyer for them, given that they already are so entrenched in that joint venture.
The $12 billion price tag is actually a little bit less than we thought the entire entity was worth, which could offer some upside for Molson Coors, but they expect to actually have less synergies than we originally thought--only about $200 million in cost savings, so that weighs the other way. We did increase our fair value estimate for Molson Coors a little bit, but not a lot.
Turning to the SABMiller-Anheuser Busch combination, even without these assets, we still think they're going to end up with one of the widest moats in the consumer defensive space, but they're still going to have to pass a lot more regulatory hurdles in order for this deal to actually close. Maybe they've solved some of that problem in the U.S., but there might be more divestitures happening elsewhere around the world. There's going to be a lot of different entities looking at this. It's going to be sometime before they're able to close. But if they are able to make all of the math work and get together, there is quite a strong possibility they're going to be able to cut a substantial amount of cost out of their businesses, even more than we think they're projecting now. As Phil Gorham--who covers these companies for Morningstar--has said, it really will be one of the widest moats in consumer defensive when all is said and done.
Stipp: Great updates on the retail sector and more, Jeremy. Thanks for joining me this week.
Glaser: You're welcome, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.