Friday Five: China's Tricky Gambit for Growth

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 this week, we got news out of China that underscores the delicate balance in that country right now.

Glaser: They really are trying to reach a balance here between having speculative growth and having more stable growth, even if it's a bit slower.

We saw that balance this week with a move that restricts the type of collateral that you could use to borrow money, which is meant to clamp down on risky loan issuance. That obviously is an attempt to bring more stability.

But on the other hand, they also pumped some more money into the system to try to get banks to make more loans. Now, these loans aren't as risky, but this move is the sign that they are also concerned about growth, and they really do want to make sure that they hit those growth targets and don't see a big miss, which is something that at least some analysts are beginning to become concerned about.

What happens in China does matter for the global economy; we saw that very much with oil prices. Supply is a big part of why oil prices have come down so much, but demand is another part of that story. One of the concerns is that a slowing China will demand less oil; that brings prices down, and we see the ramifications that is having everywhere.

It's going to be a challenge for them to manage these goals, and I think it's something we're going to be hearing a lot about and seeing a lot in the coming years.

Stipp: Europe had a tough week. European shares were soft, and Greek shares tumbled. What's the story there.

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Glaser: Greece was very much back in focus, when Parliament moved forward a vote for the Greek president by two months. This position is mainly ceremonial, but if they aren't able to reach a decision on a presidential candidate, it could trigger new national elections. We could see the opposition party, which is polling well, come into power, and that opens up a lot of questions about if they are going to want to renegotiate some of the bailouts or some of the terms that Greece had reached with its creditors in order to keep the crisis under control.

Exactly what happens, we just don't know; there are too many variables. I think the worst-case scenario of a Greek exit from the eurozone still exists, but it's relatively remote. The most likely outcome is that they are going to continue to muddle through this. Even if there are elections, other parties will come to the table and come up with some kind of solution that everybody is able to live with. That doesn't mean that the eurozone is ready for explosive growth, or that they're out of the words in terms of these problems, but I think that the muddling through that we've seen for the past couple of years is likely what's going to continue.

Stipp: In some more positive news, we got U.S. retail sales data this week, and they looked pretty good.

Glaser: These were strong sales. November was up 0.7% from the previous month. October's numbers were revised upward. It does look like lower gas prices are really starting to [relieve] consumers' wallets, and they are out there spending in other categories. Gas station sales were one of the only categories that were down in the month.

Auto sales looked pretty good, and even outside of auto sales, people were spending a lot. Particularly as we head into the holiday season, that could bode well for the U.S. economy. Given some of the other data we saw this week, this is a sign that the U.S. is actually able to continue to perform pretty well, particularly compared to Europe, in the face of some troubles that we are seeing in China and elsewhere. I think that's a good sign for the U.S.

Stipp: In more health-care M&A, Merck is going to be acquiring Cubist. What's our take on the deal?

Glaser: Merck is going to spend $9.5 billion for Cubist, and Damien Conover, our health-care analyst, thinks this is about expanding Merck's presence into the hospital acute-care segment, and he thinks that's something that will help expand Merck's moat.

However, this deal is being done at a pretty hefty valuation, but not a crazy one, according to Damien. He says that there are a lot of synergies that they can get out of this deal. On the top line, the Merck salesforce could be much more productive [for Cubist's drugs]; Merck has many more salespeople. They'll be able to market Cubist drugs better, particularly abroad, and also get some SG&A savings. Merck also has a lower cost of capital, which allows them to pay a bit more than maybe Cubist would be worth as a stand-alone entity.

Stipp: Yum shares sold off this week on more news that relates to their troubles in China.

Glaser: Speaking of slowness in China, Yum is really seeing that.

This is a story we've been following for a while. Some food-safety scares have put pressure on Yum there. They had an update this week, where they said that sales are recovering, but not quite at the pace they had hoped and expected. They now are still expecting a midsingle-digit decline in same-store sales in China.

Yum shares sold off pretty aggressively on this news. But R.J. Hottovy, our Yum analyst, thinks this is an overreaction. If you take a step back and look at the big picture, there are still a lot of things that could go right for Yum. They are still a narrow-moat company with strong brands. They have a very scalable franchise model. They'll be able to continue to expand in a lot of these markets, particularly when they work through some of these issues, and they'll be able to expand margins in particular. R.J. thinks that could happen over the next decade.

For patient investors, the shares do look somewhat undervalued. They are not a screaming buy, but they certainly are in 4-star territory right now.

Stipp: As usual, Jeremy, great insights on the news of the week. Thanks for joining me.

Glaser: You're welcome, Jason.

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