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Friday Five: Some Blue Chips See Red After Earnings

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories in the market.

It was a big earnings week; here with the rundown is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: Up first was McDonald's, which disappointed investors. They are having trouble pretty much all over the world.

Glaser: McDonald's did have a disappointing quarter, and there actually were a few blue-chip companies that disappointed this week. I should mention there were some that also surprised on the upside; Caterpillar and 3M had very upbeat earnings, amongst others. So, you shouldn't look at earnings season as a negative monolith.

But McDonald's definitely stood out as showing some weakness, and some of it we expected. Particularly from Asia, they had problems with some of their Chinese poultry suppliers. So, seeing nearly a 10% decline in same-store sales in the Asia-Pacific/Middle East region shouldn't be a total shock. But the continued weakness in the United States and in Europe does remain a concern.

R.J. Hottovy, our McDonald's analyst, thinks this is a sign that their marketing efforts and their menu efforts really aren't resonating with consumers right now. McDonald's has said that they need to make an effort to turn these things around, to try to cut costs where they can, to add menu items that are going to get people back in the stores. R.J. thinks that this is a sensible plan, but it's one that could take some time to happen.

McDonald's shares have a dividend yield of around 3.5% right now, which is pretty attractive, but they are not trading at a significant discount to their fair value estimate, and they are not looking like a screaming buy right now, even with that pretty nice dividend yield.

Stipp: Not a lot of sparkle in Coke's earnings this week either, but you say investors should keep a long view on this company.

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Glaser: Coke only had 1% year-over-year growth in revenue, and that was driven by weak pricing, by weak volumes, and also some foreign-currency issues.

Coke has seen slow growth for some time as they are adapting to changing consumer tastes. They have currency headwinds: A strong dollar means that the money they are earning outside the United States, which is a lot of their business, is going to translate into fewer U.S. dollars. That's a potential headwind for them.

But Coke thinks that it can hit high-single-digit earnings per share growth in the future through a combination of revenue growth and cost-cutting. Adam Fleck, our Coke analyst, agrees, and thinks that is reasonable and that they will have some short-term issues, but that Coke's long-term story isn't dented.

Stipp: IBM also had a tough week. Not only did they lower their guidance, but there was also an eyebrow-raising transaction.

Glaser: Reportedly, IBM paid $1.5 billion to GlobalFoundries to take their loss-making, highly capital-intensive chip-manufacturing business off their hands.

This is the latest in a series of transactions, as IBM has wanted to focus on their higher-margin software businesses. Pete Wahlstrom, our IBM analyst, thinks this is a sound idea and that higher-return-on-invested-capital businesses is where the company should be versus throwing cash into something that is never going to be a big driver of their profitability.

But that being said, IBM is seeing some weakness in their core software business. They said that they are seeing weak demand from end users. People just don't want to start big software projects, and they are really going to have to invest in more software engineering in order to keep that moving.

We did lower our fair value estimate slightly on some of these concerns. We think IBM will be able to continue to hold its own and it will be able to have higher margins as it gets out of [less-profitable] businesses, but it is going to be a real challenge over time.

The stock is trading in 4-star territory, but investors should definitely be cognizant of those risks, and cognizant that this transition is going on, before diving in.

Stipp: Apple, on the other hand, had a great quarter. Unfortunately for investors, though, this is no secret to the market.

Glaser: We suspected the iPhone 6 launch was going to be very strong, given some of the numbers Apple had already released. With 39 million iPhones sold in the quarter, that certainly was the case, and even their average sales price came up a little bit. Given that the iPhone 6 was available for only a handful of days at the end of the quarter, that's a pretty good sign for that launch.

But perhaps most surprisingly, according to Brian Colello, our Apple analyst, was that Mac sales looked pretty good--up 18%, which is a big gain in a PC category that's not growing very much if at all.

I think it shows that when you get Apple devices into people's hands, be it an iPhone or an iPad, it does potentially drive Mac sales over the long run. If you remember way back when the iPod was popular, there was this talk of a halo effect that would drive Mac sales. I think we are continuing to see that. I think it also creates a good network effect. When you have a Mac laptop and an iPad and an iPhone, it locks you into that ecosystem and makes it that much harder to switch to Android or switch to another platform. That could be good when you come to the next upgrade cycle and could be good for Apple over the long run.

But like you mentioned, the shares do look fully valued right now. It seems like the undervaluation in Apple that we saw just a couple of months ago is gone.

Stipp: So not a lot of upside in Apple's shares right now, but one company that still has some value left in its shares is GM and they also reported this week.

Glaser: GM actually had a pretty good quarter, and it was driven predominantly by North America and China. In North America, their adjusted earnings before interest and taxes were up over 12%, a pretty good result, and China also had good numbers.

Obviously, GM is having some challenges in other areas. Europe in particular looks weak, and recalls and other issues have been very much in the news. But Dave Whiston, our GM analyst, thinks that there still is value in the shares, and they are trading in 5-star territory.

But before diving in, you should be aware that this is a no-moat company. Unlike the other names that we talked about today, GM really doesn't have sustainable competitive advantages, and also there is a high level of uncertainty. There is a big range of outcomes possible. So, there is a little bit more risk than you might see in some other traditional blue-chip stocks. But the shares do look like they are quite a bit undervalued.

Stipp: A big week for earnings. Jeremy, thanks for staying on top of all the reports.

Glaser: You're welcome, Jason.

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