Ivanna Hampton: Here’s what’s ahead on this week’s Investing Insights. The holiday travel season is taking off. Why you may want to skip airline stocks and look for opportunities somewhere else. Plus, earnings season score cards are out for Uber, Roblox, and Kellanova. What Morningstar’s analysts think about the companies’ ups, downs, and stock worth. And inflation cooled in October. What’s driving it lower, and what should investors watch for? This is Investing Insights.
Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.
Uber’s Profits and Demand Cruised Ahead
Uber’s profits and demand cruised ahead in the third quarter. The ride-hailing and delivery platform reported a second-straight quarter of profitability. Gross bookings, or what a customer pays for rides and deliveries, rose 21% year over year. Meanwhile, the company’s freight segment struggled. Revenue soared to $9.3 billion. It would have climbed higher if not for business model changes in some markets. Advertising revenue, cost cuts, and efficiency improvements helped expand margins. Morningstar is impressed that the company has gained traction in more markets. Uber has reported an increase in users, orders, and order frequency. The number of drivers has also hit a record 6.5 million. Morningstar thinks Uber’s stock is worth $68 and undervalued.
Roblox Reported Rise in Global Growth
Roblox reported an uptick in global growth in the third quarter. The online gaming platform says bookings rose in most regions compared with the same period last year. The number of daily active users was up, while quarterly spending per user was flat. Engagement remains strong, topping more than 16 billion hours. Users who are older than 13 are gaming longer. Roblox became available on PlayStation in October. That’s expected to strengthen growth in the fourth quarter. The company has slowed the pace of hiring this year. That’s kept personnel costs flat outside of growing stock-based compensation. Morningstar maintains that Roblox’s value sits at $60 per share and is undervalued.
Kellanova Benefited From Higher Prices
Snack giant Kellanova’s third-quarter results marked its final quarter linked to the North American cereal business. It completed the spinoff from newly formed WK Kellogg in October. Including the domestic cereal segment, sales increased 4%. Kellanova benefited from higher prices, but a drop in volumes diminished results. Morningstar believes this partly has to do with replenishing inventories at the retail level last year. And shoppers under financial strain are buying less. Kellanova should see profits rise over time with outsize exposure within the snacking category and faster-growing emerging markets. It’s expected to prioritize investments in innovation and marketing. Morningstar thinks Kellanova’s stock is worth $75 and undervalued.
Holiday Travel Season and North American Airlines
The holiday travel season has arrived, and it’s game time for major airlines. Southwest took reputational and financial hits from its holiday travel meltdown last year. So, what’s the low-cost carriers plan for this year? Nick Owens covers major North American airlines. He’s an industrials equity analyst for Morningstar Research Services. Thanks for being here, Nick.
Nicolas Owens: Thanks for having me, Ivanna.
How Southwest Airlines is Preparing for the Holidays
Hampton: So, let’s talk. It’s been almost a year since Southwest canceled more than 16,000 flights around Christmas. How is Southwest using what they learned then to prepare for now?
Owens: Yeah, well, I’ll say they definitely are interested in living that down, and I think it’s also fair to say it was kind of a perfect storm—literally, it was a storm system that covered almost the entire U.S. from Dec. 21 to Dec. 26. And Southwest had an antiquated scheduling system that was vulnerable to that kind of disruption. They couldn’t match their crews to where the empty planes were, and as the cancellations cascaded through, it fell apart, like you were saying. Another feature of Southwest is compared to the other big airlines is they have a different route system. Instead of hub-and-spoke, they fly what I might call like a spiderweb or even a cobweb, point-to-point network. And so at the beginning of a day, their crews and their planes aren’t necessarily all in the same place. So again, just some things that made it harder for them.
What they’ve been doing is investing in new de-icing machines, new scheduling, new processes, some weather tech, and other things that’ll make it easier for them to respond and plan for this. I would say if history repeats itself and there’s a similar storm, it will definitely still disrupt Southwest and the airlines, but I’m guessing it would be not quite as bad.
Hampton: So we wouldn’t have a perfect storm two years in a row.
Owens: One would think. Also the holiday, Christmas, is on a Monday. And so even if there’s probably more travelers this year, my guess, I would estimate their schedules will spread out a little more. So again, this idea of everyone trying to get somewhere on the same day is less likely.
What We Can Expect From Travel Demand and Ticket Prices
Hampton: All right. Let’s talk about travel demand and ticket prices. What are the major airlines’ expectations for the rest of this year, maybe early into next year?
Owens: Right now, the airlines are pretty much lapping the amount of seats and miles that they’re flying that they did in 2019, before the pandemic. That’s about 15% more than last year. So even though the economy is ticking over pretty well, and there is still, I think, some pent-up demand for travel among people, I don’t think there’s going to be 15% more demand. And also, fuel prices are a little lower, and that influences ticket prices, too. I’m expecting, and the airlines have forecast, that their revenue will grow a little slower than 15%. So, ticket prices will be a little lower this season.
Will a Low-Cost Airline Fail in 2024?
Hampton: All right. That’s good to know, for anyone still looking for a ticket. United CEO predicted that, because of higher expenses, that at least one low-cost airline may fail next year. Talk about that.
Owens: It was interesting to hear that. They didn’t say it in so many words. One CEO said there will be a new equilibrium, and the other one said he thinks a shakeout might happen. What they’re really talking about is the scenario that because all the airlines, whether full-service or low-cost, have been adding to their costs. They’ve been renegotiating labor deals, wages have been going up, service contracts, all kinds of costs have been going up separate from fuel, which just kind of comes and goes. And what’s happened is the comparison between the cost that a low-cost airline has and the cost that a full-service, or high-cost airline has, the difference is not as great.
And so the United and Delta CEOs basically are saying that they can now offer their service, and they can’t be as undercut as much by a low-cost airline and the low-cost airlines can’t charge as much for the no-frills service. And so the prediction is that one of these smaller, ultra-low-cost airlines might be under pressure and lose profitability and might fail. And what they were saying is that would actually take some supply out of the system and would be better for the airlines overall. So stay tuned.
Travel Stocks to Consider This Holiday Season
Hampton: Yeah, something definitely to watch. Where can investors find opportunities in consumer travel?
Owens: OK, I think there’s two parts to that question. One, I would just contextualize that the winter holiday is not really a make-or-break for the airlines. They have way more peak demand in summer. And the way the industry defines summer is everything from April to October.
Hampton: It’s a long summer.
Owens: And peak to peak, it’s 30% less traffic in the winter. So they have a harder time making money over the winter. So I wouldn’t use that as an investing thesis really. And I would add that airlines are super competitive over the long term. They don’t make a profit as an industry. And so I wouldn’t actually look there for a way to invest to get exposure into consumer travel. Look through our coverage list. And there’s a handful of more moaty, narrow-moat companies, less risky than airlines, I would say, that are exposed to consumer travel. You could look at Expedia that makes a little fee every time someone uses their system. There’s also a handful of global hotel chains that are trading in 4-star territory, narrow-moat, like Accor and Hyatt, and you could look at some moaty casino stocks, if that’s your thing.
Hampton: All right. Nick, thank you for your time today and your insights.
Owens: Thank you very much.
Inflation News: Cooler Report Opens Door to Interest-Rate Cuts in 2024
Hampton: Lower than expected numbers show: Inflation is cooling. The Labor Department reported some consumer prices like gas and airfares declined in October. That’s lifting hopes that the Federal Reserve is done with raising interest rates. Morningstar Research Services Senior U.S. Economist Preston Caldwell has reviewed the report, and he’s here to talk about it. Thanks for being here, Preston.
Preston Caldwell: Thanks for having me, Ivanna.
Hampton: What trends stood out to you as inflation appears to loosen his grip on the economy?
Caldwell: I would say that core inflation, first off, is holding about steady. Core inflation strips out volatile food and energy prices, and so, we did see markets react very positively to the fact that core inflation was 0.2% month-over-month in October compared to expectations of 0.3%. But from our vantage point, the three-month annualized growth rate in core inflation has been consistent in the 3% area—it was 3.4% annualized in October, a small uptick from 3.1% a month ago. And that small uptick is driven largely by an uptick in healthcare inflation, which actually won’t replicate in the PCE index, which is a separate inflation index, which will be released later this month and is the main one we focus on.
So all that’s to say that core inflation is holding steady at fairly low levels, not quite back to the Fed’s 2% target. Shelter’s the main component to core inflation—that still remains high. But we think a drop in shelter inflation is around the corner.
Hampton: Now, Fed Chair Jerome Powell has recently said inflation has given them “a few head fakes.” Did you see any potential head fakes in today’s report?
Caldwell: Yeah, it’s a good question. What I would say is, again, we had one month where inflation was quite low, almost back to the Fed’s 2% target. But we want to see additional months of that playing out in the data. One thing that’s bringing inflation down right now is durables prices, which are actually deflating, prices are falling. So there’s concern that that might not repeat in the future by the Fed, and if that ceases, that could cause the overall inflation rate to rise. I happen to think that durables prices will continue deflating because of supply chain relief, but the Fed will want to see that play out in the data. And importantly, it will want to focus on the least volatile components of inflation, sometimes called super core inflation, which is, we could say, core services excluding housing. And that component of inflation still has yet to come down to 2%. In terms of the PCE index, that super core inflation is still running at about 4% year over year.
And so in order to bring that down, we’ll probably have to see further cooling off of the labor market as well as further just general dissipation of inflation momentum. So that’s one thing the Fed will be keying in on, and I will as well.
Hampton: All right. And Morningstar believes that interest-rate hikes are over. The Fed is scheduled to unveil their next interest-rate decision in December. What else should investors watch for that will support holding rates steady?
Caldwell: Well, I think they’ve gotten enough evidence already, really, barring any disastrous news. I would say that they’re going to hold steady in December, not high rates. The question really turns to when could they start cutting rates. I would say today’s report, in conjunction with the news of recent months in terms of inflation and other data points, suggest that we will see the Fed cut at some point in 2024. I still think as early as March because I believe that inflation will be back to the Fed’s 2% target in the first quarter of 2024, and also GDP growth will substantially weaken in that first quarter and that will induce the Fed to do one cut in March and then another cut in June and every meeting after that. But regardless of the exact timing, I do think we have aggressive cutting from the Fed in store in the second half of 2024 throughout 2025 in response to normalizing inflation and weakening growth. And that will be needed to sustain a rebound in GDP growth.
Hampton: Thanks, Preston, for your insights into today’s inflation report.
Caldwell: Thanks for having me, Ivanna.
Hampton: That wraps up this week’s episode. Subscribe to Morningstar’s YouTube channel to see new videos from our team. You can hear market trends and analyst insights from Morningstar on your Alexa devices. Say “Play Morningstar.” Thanks to senior video producer, Jake VanKersen, and lead technical producer, Scott Halver. And thank you for watching Investing Insights. I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.
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