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Weighty Decisions

Jason Stipp

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

A lot of weighty decisions were made in the market this week: Which ones will make an impact and which will sink? Here with me to offer his insight is Morningstar markets editor, Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: Jason, never a tough decision to come down and do The Friday Five.

Stipp: Well, it's always good to see you. And what do you have for The Friday Five this week?

Glaser: Well, this week we're going to take a look at Best Buy, at the Supreme Court, Walgreen, Europe, and finally the first quarter.

Stipp: Best Buy released results this week, and they disappointed investors, but they did say that the firm is going to be making some changes, some pretty big changes. But is it going to be enough to turnaround this struggling retailer?

Glaser: We're going to have to see. Best Buy management is finally making some of those big decisions that they're going to need to really get the company back on track. They've had a string of disappointing quarters, mainly due to increasing competitive pressure. Our analyst R.J. Hottovy has pointed out a number of times, Best Buy has threats from a lot of different areas.

Amazon.com is selling music and movies, and electronics online. There is no need to go and walk down to Best Buy or drive down to the Best Buy to get a CD anymore. Walmart is a making a big push into the consumer electronic space; you don't need to make a special trip [to Best Buy] to buy that digital camera, ... and this has really been hurting Best Buy.

So, they're going to try to cut $800 million out in savings in order to try to turn things around, and they're going to close some underperforming big box stores. They're going to open some smaller stores. They're going to focus on mobile phones, which is an area that has been very successful for them, being able to sell mobile phones from a bunch of different carriers all under one roof.

And I think that this is certainly a step in the right direction. I think it's better than just sitting around and waiting for these competitive threats to disappear. They're not. But these moves in and of themselves are not all of a sudden going to make Best Buy return to really the monolithic, incredibly powerful position they had before. It's still going to be challenging for them. It's good to see them moving in this direction, but certainly it's not a done deal that this is just going to save the company.

Stipp: Consumers who were using Best Buy as an Amazon Showroom, however, may be disappointed by some of those store closures, but we'll have to see.

The second one, Jeremy, the highest court in the land is facing some really big decisions as the health-care debates wrap up this week. I'm going to ask you, what's the outcome?

Glaser: Well, I don't know, and I really don't think that anybody including the Supreme Court justices really know right now.  a little cottage industry has popped up over the last week trying to parse every single phrase and every single word that all of the justices used during oral arguments about the constitutionality of the individual mandate in particular, but also some other issues that they're considering, and I think it certainly is going to be a close case. I think, the constitutional issues are not [clear cut]; there is not some big bright line.

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I think it could really can go 5-4 in either direction, maybe 6-3, if you're looking for a landslide one way or the other there. But really the Supreme Court is going to have to take a long time and go through quite a few deliberations, and we're not going to get an answer until June or later in the summer.

But I think for investors, it's important to keep in mind that no matter which way the Supreme Court rules, chances are, it's not going to have an enormous impact on the investment landscape for health-care firms. We talked to Matt Coffina earlier this week, who is our senior health-care analyst, about what the impact would be, and he really sees that, with the exception of losing the individual mandate maybe bringing volumes down a little bit, which could hurt some of the firms, but for the most part, the investment theses for pharmaceutical firms, for medical device makers, and particularly for ones that have really global exposure, it just doesn’t change that much depending on how this law turns out. And investors should really focus on those long-term fundamentals, instead of trying to handicap exactly what the Supreme Court is going to do.

Stipp: In corporate news, Walgreen made a decision a while ago regarding a former partner that's actually coming back to haunt them now. What's the impact of that choice?

Glaser: Well, Walgreens and Express Scripts, which is a pharmacy benefit manager, parted ways a couple of months ago permanently really because they just couldn't come to terms on payments.

And what Express Scripts does is, it works with insurance companies and works with big groups to make sure that individuals who are being insured by these companies are getting the cheapest drugs that they can. They have the power of group buying that they're able to make sure that they get the generics when they can, and that they are not just using the most expensive branded drug. It really helps keep costs down, and obviously keeping costs down is a huge focus for almost all employers, for almost everyone who is providing insurance. So, [pharmacy benefit managers] have been extremely popular and have been really building up their competitive advantage.

Walgreens kind of didn't like that dynamic. They really wanted to be able to control a lot of the pricing themselves, and they walked away from that relationship. I think they knew they were going to lose some sales, and they certainly have, and that really played out in the lackluster earnings that they reported this week.

But I think certainly for the long-term investor, it's important to look at how much bigger these pharmacy benefit managers are going to get and does that really provide a big challenge to Walgreens over time as more and more people are in these programs.

Express Scripts just looks poised to get bigger. They're going to probably buy their rival Medco, pending regulatory approval, which could come in the next couple of weeks. It just makes it that much more difficult for Walgreens to really push those pharmacy sales, which are important for the bottom line for them, and also [pharmacy sales] get people in the store to buy all the other goods. So, it's important for the bottom line. So, I think that this might not be an existential crisis for Walgreens yet, but certainly that decision to really go on their own there is going to play out in their results for years to come.

Stipp: On the international stage, it certainly seems like, when you look at news flow, that the immediate threat in Europe has subsided somewhat, but there's still a lot of weighty decisions to be made there, right?

Glaser: Absolutely. We've seen stabilization in Europe. I think, one of the big stories of the first quarter was that lending from the European Central Bank to European banks really stabilized that sector. The Greece voluntary write-down of their bonds and also that second bailout really got rid of that tail risk of a disorderly default for now. But certainly a lot of the underlying issues aren't gone. I think, we saw that pop up a few times this week.

The first was that bond yields for Spain and Italy started to peak up a little bit again particularly after a national strike in Spain highlighted that maybe the austerity measures aren't going to go down as easy there as maybe some had initially predicted. And also the OECD, which is a think tank based in Europe, came out with a report saying that they really see the growth path in the United States and some other developed countries in the eurozone really diverging, and that the eurozone is going to have to make some really important decisions.

On one hand, the austerity measures that are helping keep budget deficits in check and help pay back all of that huge debt they have are really slowing growth in a lot of countries, and without growth it's very difficult to really pay down this debt, and to really get back on stable footing. So, they're going to have to find a way to cut their budget in order to get to some sort of fiscal stability, while still having the growth there and still having the support for growth that will allow for long-term stability in those countries.

So I think that those are some very difficult decisions. I think we're going to see a lot of mistakes along the way, I think particularly when elections come up this year at a number of European countries that could change the way that they approach these problems. It's certainly going to be an important one. It's certainly one that's going to impact growth for Europe, and potentially for the rest of the world.

Stipp: You mentioned in the first quarter, Europe was one of the big stories there, and the stabilization. It seems like investors potentially have made some decisions about the market, given first-quarter performance. Is it safe to go back in the water now?

Glaser: Despite the uncertainty that we've talked about a lot on The Friday Five, particularly in Europe, but also with economic recovery in the United States that, [although] looking better ... obviously still has some weak points, investors seemed to shrug all that off in the first quarter. Really the performance was just incredible. Particularly after coming off of a fourth quarter of 2011 that was really strong, we even accelerated in terms of stock performance into 2012. I mean, just across categories, across sectors, it was really very difficult to slice the equity market in a way that you would have lost money, and generally you were making over 10%, 11%, 12% in broad-based index funds, which is really an incredible run, given that we are so far off of that bottom that we reached over three years ago now. So certainly stocks are now much more fully valued than they were before. I think that's something that we've talked about.

It seems like it'll be really challenging to repeat that kind of blistering performance, quarter after quarter after quarter; the fundamentals just don't necessarily support that. But I think the way that a lot of this uncertainty and a lot of these open questions play out throughout 2012 will [decide] if the market really backtracks somewhat or if we're able to maintain these more lofty levels.

Stipp: Jeremy, always a good decision to tune in to The Friday Five. Thanks for joining me again this week.

Glaser: You're welcome, Jason.

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