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Friday Five: Time to Tune In to Media Stocks

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: Up first, media stocks got hit this week. What were the concerns?

Glaser: A lot of media companies reported earnings this week, and a lot of investors are concerned about what's going to happen as people cut the cord from cable.

Disney was a prime example of this. They actually reported a quarter that looked pretty good and was above expectations. All the divisions increased revenue. Their adjusted operating income increased 8%. The quarter looked decent. But concern over what will happen to ESPN, which is the crown jewel of their television empire, as people move away from cable took center stage.

In the earnings call, Disney management was very clear that they think ESPN has a strong position, that people are going to want to watch sports live, and that the money they are investing to carry a lot of these popular sporting events for years into the future will pay off. [Management argued] even if people do cut the cord from traditional cable, they will want to get ESPN in some way. They really tried to defend that position, but it didn't stop the stock from sliding considerably.

Our Disney analyst, Neil Macker, thinks a lot of these fears are overblown and that ESPN is very valuable. He actually raised Disney's fair value after the quarter on the back of the potential strength of the new Star Wars movies, which will begin to come out in the next fiscal year, and the opening of the Shanghai Disneyland Resort. He sees those as potential catalysts for growth for the firm.

Disney is trading in 4-star territory right now, which is a good price for this wide-moat name. So it could be an interesting one to take a look at.

Some of the other media firms, 21st Century Fox and Discovery Communications, also are trading pretty substantially below their fair value estimates right now. These concerns over "cord cutters" aren't going away anytime soon, but they could be opening up some opportunities to own some very high-quality names.

Stipp: We also learned this week that activist investor Bill Ackman has a sweet tooth for Mondelez. What's the attraction?

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Glaser: He is not just buying $5.5 billion worth of Oreos.

Bill Ackman along with some other activist investors have targeted Mondelez over some concerns that the firm has a bloated cost structure compared to its peers. Morningstar analyst Erin Lash, who covers this space for us, does see that to be the case, and looks at Kraft-Heinz as now being the high bar of what you can accomplish out of a consumer packaged goods company and what kind of margins you could expect.

I think Ackman's purchase is going to hold Mondelez management's feet to the fire even more to make cuts, to bring R&D spending down, to bring that profitability. Over the next couple of quarters to next couple of years, there is going to be a laser focus on their ability to do that.

Right now, Mondelez shares are about fairly valued. But if you were to see them have missteps in these quarters to come, you could see the shares sell off, and this could present an interesting opportunity to own this wide-moat company. If management is ultimately able to get back on track and does well, and you see better profitability, that could be a catalyst for a higher stock price. And there is also a floor there, because if things don't go well, clearly there are activists who are willing to do a buyout and make those cuts themselves. Other firms might be interested in getting in there and owning these great brands. So it seems like you have a little bit of protection there.

Shares aren't quite at that point yet, but it's not inconceivable that in the relative near future, we could see that opportunity arrive.

Stipp: Priceline is a company you've talked about on The Friday Five. They reported earnings this week. Their stock had looked quite attractive and undervalued. It's also run up recently, though. Where are we now?

Glaser: We have talked about Priceline a lot because for a while it was one of the few 5-star stocks in our entire coverage universe, and shares have run up considerably since it was in that 5-star territory. But we still think Priceline shares are an attractive proposition right now, and that was really highlighted in their quarterly earnings.

They had a 26% increase in bookings on a constant-currency basis. They are still growing very, very nicely. One metric really brings that home: Outside of the U.S., they had 113 million rooms booked. The number-two player outside of the U.S. in hotels is Expedia. They only had 50 million rooms. You have seen both of them have very similar growth rates over the last two years, but obviously Priceline is off a much bigger base. It's impressive that they are able to continue their dominance particularly in hotel bookings outside the U.S., with their booking.com site looking very, very strong.

So you see the fundamentals of the business looking good. The shares aren't nearly as cheap as they were, but they still look undervalued. I think this is still one that should be on investors' radar screens.

Stipp: Telecom Sprint reported this week, and they made some good progress on their customer churn issues. But is the stock one that we should be considering at this time?

Glaser: In some ways, this was one of the best quarters Sprint has had in years. They were able to get their churn rate to a level they haven't seen in quite some time. They lost only a net of 12,000 phone customers, which for them is pretty good these days. But they still burnt $2 billion of cash in the quarter, and there is still a lot of our concerns about what Sprint is going to look like.

SoftBank's CEO, Masayoshi Son, tried to calm some of these fears. (SoftBank is by far the largest holder, the majority holder, of Sprint.) SoftBank still thinks that Sprint is a good business, is willing to invest more capital in it, and is not going to deprive it of what it needs in order to be successful. SoftBank was really trying to reassure the investor community that they are going to continue to invest in the network and continue to invest in promotions in order to keep existing customers happy, to get new customers, and to be a player in the competitive U.S. market.

That being said, even with all the money in the world, it's still a very, very difficult space. Verizon and AT&T are very strong players; T-Mobile is an increasingly strong player. So, it is going to be a challenge.

Right now Sprint shares are in 4-star territory, but they are pretty risky. This is a no-moat business. We don't think it has a sustainable competitive advantage. It is high uncertainty; it's unclear exactly what's going to happen there. These shares are only for investors who have a very high risk appetite.

Stipp: Lastly, health-care M&A seems to be going strong this week as we heard of a possible deal between Shire and Baxalta. What's the latest news there?

Glaser: It does look like there could be another deal in the works potentially. Shire has made a bid for the rare-disease treatment firm Baxalta. Baxalta was just spun out of Baxter to isolate those rare-disease treatments.

Morningstar analyst Stefan Quenneville, who covers the space for us, thinks this is a pretty good deal from a strategic standpoint. There are a lot of synergies between what Shire does and what Baxalta does. Shire does have the Ireland tax domicile, so there could be some savings there for Baxalta to realize, and he thinks the price they are paying for Baxalta is a nice premium for them. So he thinks that, for Baxalta shareholders, it makes sense. For Baxter, which still owns 20% of Baxalta, the deal makes sense. For Shire, given the price they are paying, it's probably not transformative, but they may be able to wring some synergies out there.

As of now, Baxalta is rebuffing this offer. So we don't know exactly how this one is going to play out. The price might have to go up somewhat to get this deal done. But shareholders should over the long term support a deal like this. It is one that seems to make sense.

Stipp: Great insight on the news of the week, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

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