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Moats in Action

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to the Friday Five.

As any regular reader of Morningstar knows, we spend a lot of time talking about economic moats, and this week we saw a several signs of moats in action in the market. Here with me to offer the details is Morningstar markets editor, Jeremy Glaser.

Jeremy, thanks for joining me.

Jeremy Glaser: You're quite welcome, Jason.

Stipp: What do you have for the Friday Five this week?

Glaser: We're going to take a look at the moats of the iPhone, at the United States, General Electric, PIMCO, and McDonald's.

Stipp: Morningstar Apple analyst Joe Beaulieu said that they "crushed it" this quarter. Can you tell a little bit about what we know about the moat from the results we're seeing for Apple?

Glaser: Apple had a fantastic quarter. We're used to them having a fantastic quarter, but this really just was completely beyond, I think, anyone's even wildest expectations of how well the company was going to do.

One of the big drivers of that growth was the iPhone, along with the Mac business and the iPad, and other things that have been successful for them. But what's really striking is the iPhone was not only just successful for Apple, which we would expect, but also for Verizon and AT&T.

There was a lot of concern that when the iPhone launched on Verizon, AT&T which was going to implode, that everybody was going to leave, and they weren't going to be able to activate any new customers. But that just wasn't the case, as we saw earnings from those two companies as well this week.

Verizon had some nice subscriber growth, powered by having the iPhone available on their network for the first time, while AT&T only saw a modest loss of people leaving their network, and they still activated a really fair number of new iPhones--where people were choosing AT&T for the first time.

So I think that it shows how powerful the iPhone ecosystem is, that people across different networks want to buy it. They are out there buying it, and it shows how powerful of a franchise Apple has there.

Stipp: So, looking at moats at a higher level, you could say that the United States government, with its AAA credit rating, has a moat, but news out of the S&P this week might indicate that moat is eroding?

Glaser: Standard & Poor's certainly thinks that the United States' moat is starting to narrow a little bit. They think the likelihood of a default potentially could increase if political actors aren't able to tackle the deficit and aren't able to tackle the debt.

Now, I think the idea of a United States' default is still incredibly far-fetched. I think it's still a solid AAA credit. I think, we've seen political actors are willing to work together when they absolutely need to on things like the government shutdown and other important issues. And there's going to be a lot of talk and a lot of bluster on both sides. We're starting in a presidential campaign. We're going to hear a lot of it.

But I think that we're not going to risk the entire national balance sheet. We're not going to risk our credit rating just because we're unable to come to terms immediately. So, it's going to be long, it might not be a perfect solution, but I think the United States will be able to keep that AAA rating, and I think this is really just a warning shot and not one that investors need to be terribly worried about right now.

Stipp: Swinging back to earnings, we heard from GE on their first quarter on Thursday, they had a pretty good results for that first quarter period. Does this show that their moat is still really working for them?

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Glaser: I think it is. GE has really gone out of their way to try to strengthen their moat. They've gotten rid of businesses that don't have a lot of competitive advantage or that wouldn't have competitive advantages within GE. Selling NBC Universal, a great example of that. They're able to get cash that they can reinvest in industrial businesses, where they do have the moat, and not have to worry about the ratings of the next big NBC sitcom.

They've been using this cash to make some acquisitions, which seem to be boosting their bottom line. GE Capital has started to turn the corner and really could start actually contributing to earnings in the next couple of years.

I think General Electric had a good quarter. They are showing strength across their businesses and showing that when they're really focused, they can create a portfolio that makes a lot of sense for them, and that's really where their moat comes from.

Stipp: So, looking at the fund industry the moat surrounding Bill Gross is obviously a very powerful one. He was our Manager of the Decade. PIMCO made a move this week that might underscore the power of their moat, though. Give me details on that one.

Glaser: We certainly saw that this week because Bill Gross and PIMCO announced that they're going to launch a Total Return, which is their flagship fund, but in an ETF form.

I think this really tells us a couple of things. The first is it shows the incredible power of the ETF structure and how it's been gaining popularity for a long time. PIMCO has waded into the ETF space before, but really having the Total Return could be a real game-changer in terms of the way people think about bond funds and think about how they're going to get their assets.

We don't know too much about expenses yet, but conceivably expenses will be lower than the open-end fund that individual investors can access now--will give people a cheap way to access Bill Gross, to access the expertise of PIMCO in the bond market. I think that that's going to be very interesting to a lot of investors. It underscores the importance of ETFs and fixed income, and also helps PIMCO solidify their space, so that another provider who is able to make it work in an ETF won't come in there and maybe steal some of those assets that people are looking for that structure.

Stipp: It certainly will solidify the legitimacy of active ETFs if PIMCO can make this work out.

So, lastly Jeremy, we heard from McDonald's, we got their results on Thursday. Some headwinds among restaurants in general with commodity costs. Is their moat helping them out there?

Glaser: Absolutely, McDonald's had a great quarter. It wasn't so much the top line, which was also very good, but they managed to actually increase operating margins, which is unbelievable considering that food prices have been going up at such a steady clip.

It just shows their power--that they are able to negotiate with their suppliers and negotiate with people that they work with to keep costs down, and that they have enough pricy power to raise prices modestly on consumers across the globe to make up for some of that shortfall.

So, it shows that businesses with competitive advantages can really help pass those inflationary costs along, and they are going to do a lot better than businesses that just have to take a price and will end up seeing margins erode as inflation increases.

Stipp: Well, Jeremy, thanks for helping to widen the Friday Five's moat today and have a good weekend.

Glaser: You're very welcome, Jason.

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