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Friday Five: Economy Walking a Fine Line

This week's retail sales report was not so hot to stoke fears of Fed tightening, but not so cold to raise recession fears. Plus, Williams follows Kinder's lead, and more.

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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: In a surprise move this week, Verizon announced it was buying AOL. What's the rationale behind this deal?

Glaser: Verizon is picking up AOL for $4.4 billion. This is not about AOL's 2 million dial-up Internet subscribers, even though that is probably the first thing that comes to mind. This is really about AOL's ability to serve ads on mobile video. Verizon is getting ready to launch a mobile video service that will feature a lot of different types of programming, and they are looking for an advertising platform that would let them monetize that and serve targeted ads to people.

But Mike Hodel, our Verizon analyst, thinks the success of this deal is going on hinge on if Verizon is able to convince consumers to use their video service. There are plenty of competitors out there, from Google's YouTube to all of the networks. There are lots of people who want to serve mobile video and see it as a growing market. But it's not clear that Verizon itself will be in a position to become a major player there.

Time will tell if this deal is successful, but given its relatively small size compared to the behemoth that is Verizon, the deal doesn't change our fair value estimate; it doesn't make us think about the business any differently. But this is an interesting capstone on what was one of the most interesting stories in American business--the rise and fall of AOL. It's interesting to see it end up in Verizon's hands.

Stipp: In economic news, we got retail sales data this week, and it feels like consumers are still being thrifty.


Glaser: That seems to very much be the case, as sales were flat from the previous month, and expectations were that sales would pick up a little bit--that some of these factors like weather, which had been holding things back, were finally going to come out of the data.

It's exactly what you said--consumers are taking some of the savings that they've had from lower gas prices and other things, and are saving it, or they are using it to pay down debt. They are still being very cautious about what they are purchasing.

In many ways, this report is similar to the jobs report. Bob Johnson, our director of economic analysis, has described is as "Goldilocks, " where it's not too hot, and it's not too cold. It's not so hot that it concerns the market that the Fed is going to act sooner than they would have expected and feel like they really need to tighten. But it's not so terrible, or showing signs of the economy falling apart, that we're at risk of another recession or a big slowdown. This is another one of those middle-of-the-road reports.

That is a very fine line to walk, and it will be very interesting to see in the coming months, as we get more data and see how the second quarter is shaping up, to see if the economy will able to shake off the issues of the first quarter, like in 2014, or if we're in for what may be a disappointing year.

Stipp: One of those affected by the low level of retail sales was Macy's. They reported disappointing results. What are the factors there?

Glaser: It's a lot of the issues that were holding back retail sales generally. Macy's in the quarter said that they had flat same-store sales, and they actually saw a total revenue decline because they had some store closings.

Management cited a lot of different issues--everything from weather holding people back, to issues with the ports on the West Coast making it difficult for them to get inventory, and even a stronger dollar hurting some of their stores in big markets like New York, where they generally have international tourists buying [merchandise], but with the euro so weak, maybe they were less excited about spending in U.S. dollars.

Macy's still has a plan to jumpstart growth again, and Paul Swinand, our Macy's analyst, thinks that a lot of them are probably reasonable moves, such as opening up some low-cost stores or going upscale in some of their other stores. They are trying to find the right merchandise at the right price points for the right markets. But given that shares are trading at about his fair value estimate, he thinks that it doesn't make sense to buy them today; it's better to wait for a margin of safety given some of the question marks.

Stipp: Over in the energy sector, Williams announced that it's making a deal similar to a previous feel that Kinder Morgan made. We liked that Kinder move; what's our take on the Williams move?

Glaser: We like it as well. Like you mentioned, in the footsteps of Kinder Morgan, Williams is purchasing Williams Partners, rolling up the companies into one, and there are a couple of advantages to this.

First, you get rid of these incentive payments, the GP payments, that they had to make. That frees up some cash flow. Jason Stevens, our analyst on the company, thinks that will enable the company to have more excess return over time and lowers their hurdle rate for new projects, which could make a lot of sense in the long term.

There are also some tax savings, estimated at about $2 billion over the next 15 years. Jason thinks that could help boost dividend growth for investors.

Overall, we think it's a deal that does make sense for Williams. We raised our fair value estimate modestly for Williams Companies. We think this is a transaction that made sense for Kinder Morgan, and it makes sense here as well.

Stipp: Lastly, DuPont scored a victory over activist investor Nelson Peltz this week. What's the latest on that story?

Glaser: This has been an ongoing saga, and this week DuPont did score a narrow proxy victory over Peltz in his search for getting some board seats to try to shake up DuPont, potentially break it up, in order to, as he would say, unlock shareholder value.

DuPont was able to convince enough of its investors to stay with them, to stay with the current board, and that they are going to be able to overcome some of the challenges that the company has been facing recently. They are going to have to show they are able to do that now that they've rebuffed Peltz.

This was interesting because in recent history, we've seen that a lot of activists, as they build up ownership stakes and threaten these proxy battles, have forced management teams to acquiesce and try to come to some settlement, either giving up a board seat or implementing some of the things that the activist wants. But DuPont really stood firm.

It will be interesting to see if this changes how activists are treated by boards in the future, if they are going to feel like they have a chance of winning at the ballot box and will keep doing that. And for activists, too, it will be interesting to see if they want to still go after some of these much bigger names than they are used to going after generally. Will they think that they actually can be successful, or are they going to stick to some of the smaller companies where they feel like they can have more sway and potentially make changes a little bit faster?

Stipp: Great update as always, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

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

Jason Stipp does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.