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Friday Five: Buffett's Batteries, Net Neutrality Realities

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories from the market this week.

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

Jeremy, thanks for joining me.

Jeremy Glaser: You're welcome, Jason.

Stipp: Up first this week, Berkshire Hathaway announced that it is buying P&G's Duracell business for $4.7 billion. What's your take on the deal?

Glaser: This is a bit of an unusual deal. For various tax reasons, it's actually going to be a swap where Warren Buffett's Berkshire Hathaway, which owns quite a few Procter & Gamble shares, is going to send those shares over to Procter & Gamble in exchange for the battery business. Procter & Gamble is also going to kick in $1.8 billion to help recapitalize the battery business.

This makes sense from P&G's standpoint. They have been trying to sell Duracell for quite some time. They want to focus on fewer brands that are going to be growing faster, and Duracell definitely is not a fast-growing business anymore. With the rise of a lot of electronics that don't take replaceable batteries, it's a business--although it has decent sales now--that probably isn't going to see a lot of growth.

Warren Buffett is often attracted to well-known consumer brands, so you could see why he might like to do it. But Gregg Warren, our Berkshire Hathaway analyst, thinks that one of the other reasons could be that this is a tax-efficient way to exit his P&G stake. He may be trying to simplify his portfolio, get rid of some of these legacy holdings to make it easier for his successors to handle that investment portfolio. This could be a good way to do that, and that could be a driver of this deal as well.

Stipp: Cable stocks this week fell after President Obama came out in support of net neutrality. How should investors think about this?

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Glaser: They should probably be levelheaded, according to Mike Hodel, our telecom analyst. The stocks did sell off, in some cases pretty substantially, on this announcement that Obama wants the FCC to regulate Internet services providers more like utilities, so that they have to basically treat all traffic on their networks the same and can't favor traffic from some sources over others.

There is some concern that this is either going to reduce profit opportunities for the ISPs or maybe lead to even more regulation down the road. But this is a debate and a discussion that will be going on for a while. This is hardly a final ruling. The FCC still hasn't decided if they are going to reclassify ISPs like this, and Mike Hodel thinks that even if they do make these changes, it's not going to dramatically change the competitive dynamics of the industry, and not really going to change the competitive advantages of these firms. There may be more of a missed opportunity, maybe some missed revenue, but it isn't going to create a huge dislocation for these businesses.

Stipp: Walmart for the first time in nearly two years reported an increase in same-store sales, but you say there is still some work for the retailer to do to right the ship?

Glaser: There is, but they did have a decent quarter, with 0.5% same-store sales growth in the United States, which is, like you mentioned, the first increase in quite some time. Their earnings were a little bit better than expected.

But they do still have some issues to take care of. They've been squeezed a couple of different ways. First off, their consumer has been under a lot of pressure. Wage growth has been low, particularly for lower-income people, and that's been a challenge for them to get people to spend. There have also been some self-inflicted wounds, issues with stores not being stocked appropriately, not being staffed appropriately, making it hard for people who do want to shop there even to buy things.

It seems like they are trying to turn all of that around, and coming up with some initiatives like matching prices from online retailers during the holiday season, which is something they had unofficially done before, but now they are doing that officially. It seems like they are starting to move in the right direction, but it's going to be a slow process. This isn't something that's going to turn around right away, particularly unless wage growth starts to pick up among their core consumers. The shares do look about fully valued.

Stipp: Speaking of companies breaking a streak, Cisco also finally reported this week that they are getting some traction with revenue growth.

Glaser: They are. Cisco is still being weighed down a lot by slowness in emerging markets and really seeing some challenges there. But even despite those issues, they were able to see product growth of 0.4% of revenue, and their services were up 4.5%, and that emerging-market story really remains core there.

Outside of some of their main markets, some smaller emerging markets are starting to look a little bit better. India looked a little bit better in the quarter. But China is still weighing very heavily, down 33%, which obviously is a challenge for them.

U.S. corporate orders were also down. The big telecom companies weren't ordering quite as much. Government actually looked like a bit of a bright spot. The U.S. federal government looked better, and even the European governments started to look a bit better, which helped boost results a bit.

Profitability also was very good. Gross margins were at the highest level in three years. Operating expenses ticked up somewhat, but it looks like their restructuring program and reducing their headcount and rightsizing their organization is on track.

Cisco shares are about fairly valued. So maybe this is not a great opportunity right now, but certainly it's a business that is on the right track.

Stipp: Big banks were under the microscope again this week as they had to agree to a deal with regulators around some foreign-exchange allegations.

Glaser: U.S., U.K., and Swiss regulators had alleged that several big banks were manipulating the foreign-exchange markets in order to create more profits for themselves, and the banks agreed to an over $4 billion fine to settle a lot of these claims.

I think what's interesting about this particular fine is that it covers some activity that was very recent, up into 2013. This is not a fine for wrongdoings from the pre-crisis world or during the crisis. It's something that's happened since regulatory scrutiny has ramped up considerably.

Investors who are considering any of these big banks need to be aware that these fines probably aren't going away. These banks are under heightened scrutiny. Regulators are going to be looking for any kind of misconduct and going after them pretty aggressively, so you probably do want to look for a bigger margin of safety than you would have before to account for these relatively large fines. Even if they don't imperil the financial position of these banks, they are going to continue, or could continue, to be weighing on earnings.

Stipp: From batteries to banks, another great update for investors. Jeremy, thanks for joining me.

Glaser: Thanks Jason.

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