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Can They Deliver?

Christine Benz

Christine Benz: I am Christine Benz from Morningstar and welcome to the Friday Five. I am joined here today by markets editor Jeremy Glaser. Jeremy, thanks for being here.

Jeremy Glaser: Hey, Christine, it's a pleasure.

Benz: Well, Jeremy, you have said that the theme of today's Friday Five is Can They Deliver? So let's talk about what you want to discuss.

Glaser: Yeah, we're going to see if the supercommittee and Congress can deliver? We'll take a look then at Coach, Pfizer, Comcast, and then finally at Kraft.

Benz: So Jeremy, the supercommittee supposedly going to be composed of six Republicans and six Democrats. What are the hurdles facing this group?

Glaser: There are a lot of them.

Benz: So bipartisan, we'll start right there.

Glaser: Yeah, it's a bipartisan hurdle. I think just right there. I think everyone's going to have trouble coming to an agreement. So the committee is really supposed to come up with $1.5 trillion in cuts over 10 years that will correspond with the raise in the debt ceiling, which is around that amount too. And if they don't, there are these triggers that are supposed to come that will cut defense spending or that will cut entitlement spending. So these are things that are supposed to be painful for both Republicans and the Democrats.

But I think that this committee is going to have a lot of trouble coming up with a solution that's going to be able to find these budget cuts and can do it in a way that they're all going to be able to sign-off on. The Republicans still are very strongly against any revenue increases, while the Democrats of the panel, I think really want to have those on the table. I think that we saw these bipartisan commissions before notably with the Simpson-Bowles debt commission earlier…

Benz: They came out with some good stuff, some good recommendations.

Glaser: Yeah, they had a lot of recommendations, but a lot of it was with tax reform. It included raising revenues--about maybe one fourth of the reduction came from revenue raises, and three fourths came from cuts. I don't know if that kind of ratio is going to be acceptable to this committee, but I think that's what a lot of at least some of the centrist members really are looking for. So I think there's going to be a lot of wrangling there. I think their question is if that trigger is really going to be strong enough to focus the committee and really have them go ahead and make these cuts and maybe make some sacrifices on both sides. Or it could be if they're just going to allow these triggers to just to go ahead and happen and just deal with the cuts or maybe create some emergency spending measures to get around the cuts. I think there's going to be a lot of wrangling. I think we saw a lot of political drama over the last couple of weeks before the debt-ceiling raise. I think even after this deal, we're going to see even more wrangling going forward.

Benz: Jeremy, I've been stressing out about how to transition from politics to business news, so let's talk about switching from purse strings to actual purses. Do you want talk about Coach?

Glaser: Yeah, absolutely. Coach had a great quarter, and I think it just shows that the higher-end consumer is still doing pretty well, especially compared with some of the lower-end consumers. And when we think of Coach's customer, it's not necessarily a multimillionaire or multibillionaire who's out there.

Benz: Coach is not Gucci.

Glaser: It's not, right. I mean, it's more of a approachable luxury brand that's really aspirational; people who want to feel like they're doing something special for themselves are going to go into the Coach showroom. They're going to buy themselves a new handbag or are going to buy themselves a new wallet, whatever it might be. And I think it just shows that there are people out there; the people who do still have jobs are spending. That job growth has been anemic would be a very nice way of putting it, but there haven't been a lot of job losses. People, especially professional individuals, are feeling reasonably confident and are out there spending. I think it's a trend we've seen a lot. Last week, we talked about how Whole Foods is doing well, and I think this is kind of a tale of two recoveries, where you have relatively well-off higher end consumers who are feeling pretty good about themselves right now and who are out there spending. And then you have lower-end consumers, who are really struggling still and are facing a lot of problems. I think that this tension is one that's going to play out for another couple of years even. And I think one that's going to be key to see the full recovery is when all consumers are really out there spending again and it could be sometime before that happens.

Benz: Yeah, we're certainly not there yet. So you wanted to talk about Pfizer, Jeremy. I think it's interesting because we've all been looking at the health-care sector during the past couple of years, seeing that maybe this sector isn't quite as recession-resistant as we thought it was. Let's talk about what's going on at Pfizer and the health-care industry more broadly.

Glaser: I think the conventional wisdom has been for a long time that health care is a very defensive sector. No matter what people are going to be spending on health care, and over time that's been pretty accurate. Spending on health care continues to grow as percentage of gross domestic product, and almost any way you look at it, people keep spending more on health care. But as we saw again this quarter, Pfizer didn't have a great quarter. It has a lot of drugs that are coming off-patent, and it is really seeing those revenues fall. Pfizer has a pipeline of drugs, but it's not really clear whether that pipeline could to take over all of that lost revenue. I think the question is, "Can Pfizer deliver on this promise if it is going to be able to continue growing its branded-drug business even with the patent cliff, even with a lot of its new trials and new drugs not working in quite the way that the firm had expected or expanding in quite the way the firm had originally expected?" I think you are absolutely right that in the recession, people are cutting back on some of their health expenditures. They're making cuts where they need to.

Benz: People are not taking tests and not taking the medicines that they've been prescribed?

Glaser: Yeah, absolutely. And I think that's putting some pressure on some of the Big Pharma companies. It's a trend we've seen for a little bit. Certainly, it's not a completely dire situation, and we think there's actually some value in some of these stocks that people should take a look at. But it shows that health care might not have those defensive characteristics that people are absolutely expecting--or that people have expected in the past--and I think it could be a different landscape for health-care providers in the future.

Benz: So you want to talk about Comcast, as well. That's another company that I think a lot of people were watching, seeing if it could deliver on its acquisition of NBCUniversal. What's the news so far on that front?

Glaser: Yes, we were very skeptical. Our analyst Mike Hodel was very skeptical of the NBCUniversal acquisition. A lot of times, people have tried to combine the distribution and the content together hoping that it would create kind of these great synergies, if you will, that would help drive the business forward. NBC has not been doing great recently, I mean especially compared with some of its peers; the firm has really fallen behind. But Comcast had some cash sitting around and had the balance sheet strength in order to take on this acquisition. At least for this quarter it seems to actually be playing out pretty well for the firm. NBC is improving, ratings are going up, advertising rates are going up, and the Universal movie business is doing fine. I mean really a lot of these disparate parts of the business are actually starting to come together. They're trying to find some synergies, and they're trying to do cross promotion across different channels or across the brand and try to strengthen it. I still think the journey is out on if this is going to be long-term and if it's going to create a lot of shareholder value. Comcast did spend quite a bit of money on this acquisition. It could take some time to see if it really makes sense, but it certainly has not been a complete train-wreck, which compared with some other media mergers in recent memory, that's a big plus.

So I think the fact Comcast is managing the business pretty well so far and that things are improving is a good sign. So we'll see if the firm can really finally deliver on that shareholder promise.

Benz: Lastly, you want to talk about Kraft. It's going in the other direction, splitting itself apart. Let's discuss what the firm is doing and your early take on that news.

Glaser: Yeah, I mean this was one of the big pieces of corporate news this week was that Kraft is deciding to split itself into two businesses. One will focus on the firm's traditional grocery business, so that includes the cheeses of the world. And the other is going to focus on the faster-growing snack business, so the Cadbury acquisition is a big part of that as well as some of the other snack items. I think it's kind of an interesting play. I think certainly Kraft has been a little bit frustrated that it hasn't been given a higher multiple after it acquired that Cadbury business. Kraft got Cadbury for the growth and wanted to get out of what's a high-margin, but very low-growth grocery business and move into emerging markets where people are buying a lot more candy and where people are willing to spend money on these confectionery goods.

Certainly, the market didn't really agree with that. I think that a lot of people, Warren Buffet notably was one of the most outspoken critics, thought Kraft was spending too much money on the deal and that getting rid of the frozen pizza business and divesting of some other businesses that had decent growth prospects didn't make a lot of sense. Kraft hasn't really been rewarded with the same earnings multiple as, say, Nestle, a competitor that is in that fast-growing confectionary business.

I think Kraft is hoping that by splitting into two, the firm will be able to get a higher margin on the candy business. The firm also likely hopes it can maintain about the same multiple on its grocery business and will be able to deliver the incredible shareholder value from it. We'll have to wait and see if this actually happens and what exactly these businesses look like. Again, if they'll actually be able to deliver on this promise is an open question. I think it's probably good that they're trying to unlock shareholder value, but we'll have to see if it's successful.

Benz: So Jeremy, lots of interesting stories that I know, we'll both be watching over the coming months. Thanks for sharing your insights.

Glaser: You're welcome Christine.

Benz: Thanks for watching, I'm Christine Benz for