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Friday Five: Two Big Turnarounds on Track

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 this week. Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: It was a big earnings week. Let's start with P&G. They reported results, and there are some signs that they are starting to get traction with their turnaround, and the shares also might be worth a look.

Glaser: We can see signs that P&G's competitive position is stabilizing. The top line is still weak. It had about 1% growth, and that excludes all the foreign-currency headwinds; when you add those in, they had a pretty big decline in sales. There were some weak spots, particularly in beauty.

But there were also some spots that looked a bit better--things like laundry detergent in the U.S. and diapers--that were showing signs of gaining share. Erin Lash, our P&G analyst, thinks that's a good sign, that when Procter & Gamble is able to put a focused marketing push behind products, they still are able to gain share. That's heartening for the future, as they focus on their core brands.

There are also signs that their cost-cutting measures really are starting to bear fruit as well, and that showed up in the profitability numbers.

As you mentioned, Procter & Gamble shares look relatively attractive. In a sector that does not have many values, Procter & Gamble is the wide-moat firm that looks the most interesting for investors. It's certainly worth a closer look.

Stipp: Coke also reported this week. They have warned and asked for patience as they are in the midst of a transition, but they turned in pretty decent results.

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Glaser: Coke was very clear that 2015 was going to be a year of transition for the firm, as they tried to get the business back on track and get back to the long-term target that they had missed for a few years.

We saw a strong start to this year as they moved toward those goals. Some of the strong numbers are due to timing issues. There were some extra selling days, and the mix of concentrate sales and when those happened. So we think the kind of growth we saw in the first quarter isn't sustainable over the rest of the year.

But still, there were positive signs. Things in emerging markets were looking a little bit better. Pricing looked good in North America. They were able to charge more by selling smaller containers at higher prices, versus just going after volume. That's certainly a good sign. Also, their cost-cutting measures and some of the commodity headwinds are fading, and that's looking good for the firm.

Adam Fleck, our Coke analyst, thinks the shares are about fairly valued right now, but there definitely are signs that Coke's turnaround is going to plan, and that they will be able to get back to those long-term growth rates in the years to come.

Stipp: Social media giant Facebook reported, and we saw expenses tick up there, but investors really need to keep the long-term picture, the full picture, in mind here.

Glaser: We've talked about this a few times with respect to Facebook. Their expenses are going to look high as they continue to invest in their incubator platforms, like WhatsApp, Oculus, and even Instagram--places where they haven't seen big advertising growth or have very limited ads, but that they want to keep investing behind, because Facebook thinks they are important growth drivers.

Rick Summer, our Facebook analyst, agrees that these are prudent investments. It makes sense to go slow and not rush a bunch of ads when you don't know how they are going to perform for a short-term gain, versus thinking about the long-term future of these products.

When you look at their more mature product, Facebook, you see really good advertising and engagement growth, which shows that management really understands what they are doing, and that this isn't just some kind of pie-in-the-sky idea. They are going to be able to monetize these other platforms, and this isn't just money they are throwing away.

So investors shouldn't be scared off by these higher expenses. They should see them as prudent investments and focus on the good metrics that are coming out of the core Facebook business.

Rick Summer raised his fair value estimate after the positive results from last quarter. The shares look about fairly valued right now, but Facebook is one to keep on the radar screen if you are interested in owning it, because if we do see another quarter where it sells off because of these higher expenses, that could be a buying opportunity.

Stipp: Another stock to keep on the radar is Chipotle. The restaurant chain reported disappointing sales, but in this case you really have to look beyond that, because there is potential here.

Glaser: This is another case where a firm is making a long-term investment in its competitive advantage and in its future at the expense of short-term sales. Yes, same-store sales were lower than expected, and that was being driven by weather-related issues. When the weather is really bad, people don't go out to eat, and that's business that can't be made up later. If it's a durable purchase, you might go and make it later, but for food, you missed that opportunity. Chipotle also has had some issues with its carnitas supplier. They weren't able to get enough pork that was raised to their standards, and they've had what they call "rolling carnitas blackouts" across the country, where it hasn't been available in some stores, and that's hurt sales as well.

But RJ Hottovy, our Chipotle analyst, thinks this is a good investment in their long-term future. Chipotle sells its sustainably farmed meat as a differentiator from some of the other fast-casual restaurants. That makes people feel good about eating there. By sticking to those principles, they are going to be able to keep that competitive advantage over the long term, so it's worth taking the short-term pain now.

Even with the issues they are having in this quarter, they are still growing much faster than the industry. They are still taking share. They are still showing that they have pricing power, and that they do have an economic moat.

Shares don't look particularly cheap right now, but they are a little bit tastier after the sell-off than they were before.

Stipp: We also had news in telecom/wireless, a couple of earnings reports. And Google may be coming in. Anything to report there? Is this a game-changer?

Glaser: This was an interesting week in wireless. Let's start with the earnings.

It's been very competitive with Sprint and T-Mobile ratcheting up by their promotions and their promotional spending, and that's obviously had an impact on AT&T and Verizon, the two largest players. But both of them reported earnings that show they're doing pretty good. Verizon is showing that they have pretty good consumer loyalty. So, even though they are losing some customers and they are seeing some pressure in terms of the average revenue per customer, their profitability continues to look strong, and generally speaking they are weathering this competitive storm pretty well.

AT&T also had a much better first quarter then they did in the fourth quarter. They lost more customers than Verizon, but not dramatically so, and they also seem to be a doing OK in this environment.

As you mentioned, Google also came into the marketplace this week with Project Fi. They're going to offer a low-cost service currently just to customers of one of their phones, but it's potentially a program that's going to expand over time. This is a network that runs on a combination of the Sprint network, the T-Mobile network, and also Wi-Fi hotspots in order to provide broader coverage.

Right now we think this is probably just too small to really be a game-changer. Rick Summer, who covers Google for us, doesn't think it factors into the Google valuation, but it definitely could have a long-term impact as Google potentially tries to bring down the cost of wireless services. That could have an impact on the prices that some of the major players are able to charge.

Remember that Google's goal is not to necessarily make a lot of money selling you wireless services; it's to get you to use more wireless data. When you're on your phone, you're probably using Google services that can serve you more ads. That's really the core of the business for them. They are probably willing to sell you wireless service at a much lower price in order to get that advertising business that is their bread-and-butter.

Right now, Fi is too small to really make a big difference, and obviously they are running on the networks of the competitors; that's not going to go away. It's not an existential threat to the incumbent wireless players, but definitely it could have an impact on the landscape in the years to come.

Stipp: Thanks for keeping a close eye on the earnings and all the news of the week, Jeremy.

Glaser: Thanks, Jason.

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