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Glasses Half Full

Jason Stipp

Jason Stipp: I'm Jason Stipp from Morningstar, and welcome to the Friday Five. Here at Morningstar, we always like to look at all sides of a situation, and today Morningstar markets editor Jeremy Glaser is here with five half-full glasses, I guess that would give us about 2 1/2 glasses of water. He is here to explain.

Jeremy, thanks for joining me.

Jeremy Glaser: Welcome, Jason.

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

Glaser: Well, this week we're going to take a look at manufacturing, at Apple, at J.C. Penny, AT&T, and finally Roche.

Stipp: So I know manufacturing over the last year has had its ups and downs, it's been a little soft, it's gotten a little bit of momentum. Where are we right now? What's glass half full view of manufacturing?

Glaser: I think manufacturing is doing pretty well. We got a couple of different data points this week that I think point to a continued manufacturing recovery. Durable goods orders looked pretty good. The Chicago Fed came out and said that their National Index of Manufacturing Activity looks decent--the best recording that we've had in five months and also really across a broad swath of the things that the Fed measures.

And also we got results from some industrial companies like Caterpillar and 3M that look decent. Last quarter we were talking about some fears about inventory de-stocking, about the stronger dollar hurting export market, about the European woes that may be tampering demand down in that part of the world. But it doesn’t seem to be having an impact on the bottom-line yet. Those orders are still coming in; I think it's a good sign for the manufacturing community, and I think as that part of economy, that sector, continues to do well, it can help power the broader recovery.

Stipp: Jeremy, in earnings news, Apple reported another blowout quarter. This looks like a full glass to me. How is that glass potentially only half full?

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Glaser: This is a crazy quarter. This is quarter that really no matter which way you slice it, it just looks incredible. Is was one of the biggest quarters ever of an American company to have that much profit come in. They just saw sales go through the roof on the iPhone and iPad, and they are able to increase profitability at the same time. So it wasn’t like they were selling lower-priced models of their products, and that was what boosted demand. The demand was just so high, that they were able to just keep moving those units. They even ran into some supply problems; if they hadn’t had those, results could have been even better.

But the only thing that keeps this glass from being maybe completely full is just that this momentum isn’t sustainable. Just the law of large numbers is going to make it very difficult for Apple to continue to post these kind of numbers year after year after year. Eventually we’re going to see a quarter where the momentum will slow down a little bit.

There is still incredible growth in front of the company. They still have a lot of opportunities, particularly in emerging markets, expanding their PC business, and maybe even some new secret business we don’t even know about yet, like a new Apple TV. But certainly it's going to be difficult to keep growing from a such a large base; that could slow them down a little bit. But really there wasn’t a lot of bad things to be said about that last quarter for Apple.

Stipp: Another potential glass half empty on Apple is valuation; the analyst said it's looking a little bit more fully valued now. There's still some opportunity there, but certainly not as attractive as it was before.

Another company in the news this week, J.C. Penny. They actually had a pretty good day this week. What was that news and what's the glass half full for them?

Glaser: J.C. Penny is not a stock that’s in the news terribly frequently, but going back to Apple, former head of Apple stores, Ron Johnson, has come over to start running J.C. Penny. We talked about this a while back and kind of wondered what it would mean for the department store, how he was going to make some changes. And this week we got the first concrete examples of what he wants to do.

He is going to rationalize pricing, so instead of having a sale every day, they are going to bring that everyday price down around 40% on average, make it easier for consumers to know that this is actually what it costs and not have to do a bunch of calculations or see toppers on every rack that say something's on sale.

They are really going to try to streamline their marketing, renovate their stores so there are areas where people can just relax and hang out, and really get to take a look at the merchandise and not feel like there is just so much bearing down on them when they walk through those aisles.

The company also released some financial guidance that was much better than analysts had expected. They think that they can make a lot of these changes without really killing profitability. The stock really soared on this news as people are expecting that they will be able to execute on this plan. I think time will tell if they are able to completely get people comfortable with the idea of hanging out at their local J.C. Penney, but I think certainly they are trying some new things, they are taking some steps in the right direction. I think it's going to be an interesting story to watch in the coming years.

Stipp: AT&T also reported; what would an optimistic have to say about that earnings news?

Glaser: AT&T sold a lot of iPhones, and this may come as no surprise to anyone as AT&T launched the iPhone, but there was a lot of worry, from myself included, that when other carriers, such as Sprint and Verizon, started to carry the iPhone, that AT&T was really going to lose a lot of momentum there. That’s the device that kind of powered AT&T's earnings for a long time, and powered their subscriber growth, and that once people saw they could get it on some stronger networks that they were just going to leave enmasse, and that’s just not happening.

AT&T activated a record number of iPhones--75% more than Verizon was able to activate, and they have really been able to get people into those profitable post-paid plans. That isn’t to say that everything in AT&T is going absolutely great. Verizon Wireless actually added more customers in total. They have a big lineup of other smartphones like the Galaxy Nexus and other Android devices. So certainly Verizon is doing very well, but AT&T showed that they’re going to be able to hold their own. They are not going to totally fall back, and I think this quarter was just an indicator of that--that they are really in there for the long term even if they haven’t totally overcome some of their network woes yet.

Stipp: Lastly Jeremy in M&A news, Roche making a bid for Illumina, a hostile bid. What's the positive and optimistic side to this story?

Glaser: We have a big pharma giant who is out there shopping, looking at cheap companies, trying to pick up something that they see that could be a good add-on in terms of gene sequencing, could be a good add-on to their business, at what they see as a relatively reasonable valuation. I think this deal itself is probably somewhat interesting for Roche shareholders, but probably doesn’t have a huge impact on the broader market.

But the fact that M&A, and especially these small tuck-in M&A deals, are still on the forefront, and that companies and management teams are willing to make those big investments, are willing to go hostile, really speaks to the idea that there is some confidence in the marketplace. If you weren’t confident in what the future is going to hold, if you're worried about what health care is going to look like five, 10 years down the road, you probably weren’t going to make these investments. You'd really be just trying to close the hatch and just trying to save your money for the rainy day.

It seems like at least Roche believes that the times are going to be good enough in the future that they can spend this money. I think that bodes well for the global economy. I think it bodes well for other M&A deals that could potentially come in throughout 2012. We talked to our analyst Bridget Freas earlier who did a report on M&A. We don’t think that there is going to be a lot of transformational deals this year, but certainly some of these smaller deals are going to be a trend we're going to see throughout the year.

Stipp: Jeremy, always a full glass of insights. Thanks for your reporting. Thanks for joining me on the Friday Five.

Glaser: You're very welcome, Jason.

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