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Fed Decision: When Good News Is Bad News

Jason Stipp
Jeremy Glaser

Jason Stipp: I'm Jason Stipp for Morningstar. 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, of course, is the big Fed decision. They decided to keep rates the same. Overseas issues definitely were weighing on the Fed.

Glaser: They certainly were. Going into this meeting, one of the big question marks was: How would the potential impact of slowing global growth weigh on the Fed? It turns out that was the decisive factor. They said the U.S. economy is basically ready for a rate increase, but given that these overseas concerns could really weigh on the U.S. economy, they decided to hold pat for now.

The really interesting thing is looking at their projections for what's going to happen going forward. Most of the governors still think they are going to have a rate increase some time in 2015 but with slightly less confidence than they did the last time they gave us projections. If we look at the path of where they see rates going for the next couple of years, they still expect a very, very gradual increase in rates over time when they actually do start to have lift-off.

It still seems possible there's going to be a rate increase in December this year. That is very much on the table, but they are going to be watching that data carefully.

It's been interesting to watch the market reaction to this. U.S. stocks ended lower on Thursday. They continued to be lower on Friday. European stocks sold off. Asian shares were mixed. I think this shows that the market--instead of being jubilant that this easy money was here to stay at least for a couple of more months--was actually concerned that the Fed was concerned about growth. I think that's weighing on markets right now. It'll be interesting to see how this plays out in the weeks and months to come as we continue in this uncertain guessing-game period until the Fed acts.

Stipp: Last week, you talked about some beer deals, but this week we got the mother of all beer deals. Two beer giants, Budweiser and Miller, are in talks potentially to merge.

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Glaser: This would create an enormous company, by far the largest in the beer business. Anheuser-Busch already is the largest.

AB Inbev and SABMiller have been talking, and there have been rumors of this deal for quite some time. This week we got confirmation that they are in talks. We don't have any details on pricing yet. There's no guarantee that any deal like this would get done or pass regulatory muster, but certainly it's interesting to think about the competitive advantages this firm would have.

Phil Gorham, who's our beer analyst, thinks the combined firm would have one of the widest moats in the consumer defensive sector and would be a very strong company, given how powerful and important economies of scale are in this business.

But that regulatory issue is going to be the challenge. They'll have such a big share, regulators probably are going to be somewhat skeptical. Chances are they're going to have to sell off some brands and businesses in order to get a deal like this done. Depending on how big those are, that's going to have an impact. So this is one deal that is not going to be done anytime soon.

Stipp: Oracle reported results this week. The wide-moat firm has big cloud aspirations. How's it going?

Glaser: They do. Rick Summer, our Oracle analyst, said that this quarter provided more hope than evidence that they're seeing a ton of success in cloud.

If you look at their overall picture, it actually looks pretty good. Excluding some currency impacts, Oracle's revenue was up 7%. About 9% of that is coming from the cloud right now, and that's up 30% year over year. It's growing very, very quickly, but it's off somewhat of a small base. Rick Summer thinks that's OK. Even though we don't exactly see how the cloud is going to totally overtake Oracle's legacy business ... as people obviously have a preference for the cloud over time, he thinks that the strength of Oracle's core business [is still intact, because of] high switching costs. … Customers are very skeptical about moving mission-critical databases into the cloud just now, or they're going to do so very, very cautiously, which gives Oracle a lot of runway in order to grow this over time.

He thinks the market isn't appreciating the power of that effect. He sees shares as looking pretty attractive right now. For investors who can ride out some bumpiness with this cloud transition, it could be an interesting name.

Stipp: HP had an analyst day this week ahead of the split that company is going to undergo soon. What's the take on the job cuts they announced?

Glaser: The big news was that they're going to cut 25,000-30,000 jobs out of their business, and this is on the back of a lot of pretty big cuts that they've been making for years now as they try to bring their cost structure in line. Pete Wahlstrom, who covers HP for us, thinks that generally these are prudent cuts. They do need to get their cost structures down in order to be competitive.

Even after they do this, though, when you look at both businesses, they still are no-moat businesses, and they're going to take a while to find their footing when they are separated.

On the Enterprise side, certainly they'll have scale, but that's really not enough in order to drive excess returns over time, and I think investors in that part of the business would have to be very patient as HP works through some of those new clients and tries to prove themselves even more in that business.

On the HP Incorporated side, which is the consumer business, they said they want to stay away from commodity printer and PC businesses. That's easier said than done. They must continue to be innovative in order to get their hardware sales looking up again, given some of their competitors and given some of the issues with the strong dollar, at least in the short term. That could be a challenge for them.

So the strategy on both sides, we think, makes sense, but it's still not going to be an easy thing to execute. We think for the moment, it's probably better for investors to watch this split-up from the sidelines.

Stipp: Lastly, FedEx reported results this week and lowered their guidance, which disappointed investors. What's our take?

Glaser: The lower guidance certainly was disappointing, and that was on the back of a couple of things. Their less-than-truckload freight shipping business is looking weaker than they expected, and higher costs in their ground segment weighed as well.

But when we look at the quarterly results, Keith Schoonmaker, who's our FedEx analyst, really thinks there still are some signs that FedEx is doing very well right now. Their express business continues to rebound, their profitability in that segment is looking much stronger, which is something that's important for them. And if you look at their competitive positioning, they really have a strong moat in the United States. As they continue to grow globally, this is a business that does look attractive for the long term, and shares do look undervalued.

That doesn't mean there's not going to be some challenges in the near term, when you look at things like currency and slowing trade and global growth. But it does seem like a much more interesting long-term story.

 

Stipp: From the Fed to FedEx, more great insights on the news of the week, Jeremy. Thanks for joining me.

Glaser: Thanks, Jason.

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