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About the Editor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios invested in accordance with a strategy that seeks to focus on companies with stable or growing competitive advantages. David served in several senior research and product development roles and was part of the editorial team that created and launched He was the co-inventor of Morningstar's first investment advice software.

David joined Morningstar in 1994. He holds a bachelor's degree in biology from Skidmore College and a master's degree in biology from the University of Illinois at Springfield.

Our Portfolio Managers

Matthew Coffina, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Hare strategy. Matt was previously a senior healthcare analyst, covering managed care and pharmaceutical services companies. Matt also developed the discounted cash flow model used by Morningstar analysts to assign fair value estimates to most of the companies in its global coverage universe.

Matt joined Morningstar in 2007. He holds a bachelor's degree in economics from Oberlin College and also holds the Chartered Financial Analyst (CFA) designation.

Michael Corty, CFA, is the portfolio manager for Morningstar Investment Management LLC’s Tortoise strategy. Before focusing his attention on the Tortoise, Michael co-managed five equity strategies offered by Morningstar Investment Management LLC and Morningstar Investment Services LLC since December 2013. Michael was previously a senior equity analyst on Morningstar Inc.’s equity research team covering companies in the media, business services, and consumer industries. Michael also spent several years on Morningstar’s moat committee, which assigns economic moat and moat trend ratings to their global coverage.

Prior to joining Morningstar in 2004, Michael worked at a public accounting firm and in the business lending arm of a major commercial bank. He has an undergraduate accounting degree from Loyola Marymount University, an MBA from Cornell University and is a CFA charterholder.

Feb 25, 2017
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David Harrell
Editor, Morningstar StockInvestor
David Harrell is the editor of the Morningstar StockInvestor, a monthly newsletter that focuses on a wide-moat stock investing strategy. For illustration purposes, issues highlight activities pertaining to Morningstar, Inc. portfolios
Featured Posts
Roundup 2/24/2017 -- A Strategic Review for Unilever

StockInvestorSM focuses on the activities of portfolios of Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies. These portfolios are managed by Morningstar Investment Management LLC, a registered investment adviser, which manages other client portfolios using these strategies.

Kraft Heinz KHC withdrew its bid for Unilever UL over the weekend. The latter opened on Monday at a price that was more than $4 below last Friday's close, but the stock price recovered during the week, as Unilever announced a strategic review, and closed today well above its pre-merger-offer price. Please see a new analyst note for Unilever below, along with a note for Baidu BIDU. Several holdings were also tagged in a note on oil prices.

Also this week: Portfolio manager Matt Coffina established a position in QuintilesIMS Q for Morningstar's Hare portfolio. Please see his trade alert for details.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

Unilever's Strategic Review Likely to Lead to Accelerated Cost Savings, Asset Sales
by Philip Gorham, CFA, FRM | 02-22-17

Unilever announced on Feb. 22 that it is to undergo a strategic review following the recent approach from Kraft Heinz. We believe the company will stop short of a separation of the foods and personal care businesses, but we would not be surprised to see significant asset sales. We are reiterating our wide economic moat rating for the firm and our EUR 40 fair value estimate for the shares traded in Amsterdam. Both of these could change, however, in the event of transformative asset sales.

It is imperative that Unilever accelerates its expense reduction initiatives, in our opinion. Although management expects cost savings this year to be at the higher end of previously revealed guidance, the firm's EBIT margin of around 15% lags well behind the mid-20% margin achieved by its former suitor, Kraft Heinz. We think Unilever must focus on improving margins in order to sustain the financial flexibility to compete with its more profitable competitors.

There may also be some asset sales. The most obvious assets on the block are the spreads brands, which were moved to a separate business in 2014. It is possible that other food assets are sold, with Kraft Heinz likely to be among the bidders. We think Unilever's portfolio transition to personal care and away from food is appropriate, given the higher margin and slightly more attractive growth profile of the category.

We also think it is likely that management will attempt to appease shareholders that would have expected to cash in from the Kraft Heinz acquisition. It is possible that Unilever could allocate more of its EUR 1.5 billion annual free cash flow run rate to dividends or to share repurchases.

Baidu Is Betting on AI-Enabled Businesses, but We Think the Uncertainty of Monetization Is Very High
by Marie Sun | 02-24-17

Baidu's fourth-quarter top line is largely in line with our estimates, but its operating income is less than our estimates, mainly due to increased content cost. Revenue excluding Qunar's impact is flattish year on year as a result of the decrease in active online marketing customers in an environment of stricter verification. The operating margin is continuously depressed by iQiyi and online-to-offline services, and came in at 12% in the fourth quarter, versus 15.3% in the previous quarter and 17.6% in the year-ago quarter. The company guided a soft recovery of 4.2%-7.6% year-on-year growth for total revenue in first-quarter 2017.

We retain our fair value estimate of $180 per ADR for wide-moat Baidu and believe the stock lacks a near-term catalyst. Investors should be aware that our fair value estimate has embedded the scenario of iQiyi's divestment in 2019, which results in an improvement in operating margin to over 30% from 2019 onwards. Including iQiyi, the operating margin would be dragged down due to content cost. We believe that the next one to two years will be a critical period for Tier 1 players to consolidate their leadership in the online video market, and Baidu's iQiyi, as one of the largest online video platforms, could be divested and listed. On Feb. 23, iQiyi announced another round of funding amounting to $1.5 billion through convertible bonds. Management has showed strong willingness to win the battle in online video, and the firm plans to double its spending on content in 2017.

Baidu will discontinue the disclosure of key metrics such as monthly active users and gross merchandise value. The company has emphasized that artificial intelligence, or AI, is its foundation for future growth, and management believes Baidu is well positioned to lead the AI wave in China. However, as search-related advertising is still the core revenue generator (contributing over 90% of revenue), we think the lower transparency will result in less confidence in the market. We appreciate Baidu's early movement in AI investment, which will protect its leading position in technology, but we think it is still too early to predict its monetization model.

Baidu started News Feed at Mobile Baidu App in May 2016. This is an AI-enabled business to distribute content to targeted users. The company also invested in “Baijiahao”, the content platform embedded in Baidu Search and News Feed, to differentiate its content. Management said the ads load at News Feed is relatively low and the click-through rate for News Feed is about half that of search. We agree that News Feed can leverage Baidu Search's large user base and its marketing customers, but we think competition is already fierce in the news-related field. Baidu's News Feed needs to compete with dozens of news apps as well as social networking and media apps. Therefore, we don't forecast a large increase in advertising revenue from News Feed in the coming years.

In 2016, Baidu restructured its internal organization after the Wei Zexi incident, and the firm appointed Qi Lu as its new president and COO on Jan. 16, 2017. Lu is a veteran in the technology field and served as Microsoft's Global Executive Vice President before joining Baidu. He will focus on realizing Baidu's visionary AI strategy.

Danger Zone: Coming Shale Growth Poses Major Risks to Oil Prices
by Stephen Simko, CFA | 02-22-17

OPEC's production cuts and strong demand growth have 2017 crude fundamentals in their best shape since oil prices crashed two years ago. The consensus outlook is that fundamentals are now strong enough to remain healthy even after OPEC's cuts lapse. This might have been possible a few months ago, but the odds of this scenario playing out have markedly worsened since. The reason is that major increases in shale activity now have U.S. production firmly on a path of rapid growth, even if rig counts don't increase further. This growth plus the eventual supply increases from OPEC is likely more than enough to erase any market tightness and throw crude markets back into oversupply.

What's obvious by now is that current oil prices provide economics that are very attractive to the major U.S. shale producers. This has created the conditions that will allow tight oil to grow rapidly and is a reality that even looming cost inflation will not change. Unless shale producers become more disciplined or OPEC resigns itself to permanently ceding share to the U.S., oil markets have major problems looming. Neither of these is likely to occur.

Nonetheless, there remains a good chance that oil prices could rise in the coming months if OPEC compliance remains high or production cuts are extended. Because surging shale output won't truly begin to move the supply needle until the second half of the year, these would allow for further inventory draws. This could bolster the perception that oil market fundamentals are improving. In reality, oil prices above current levels at any point in the coming months would in fact be pouring gasoline on the flames since it would certainly encourage even higher levels of U.S. shale investment. Nothing is certain in the world of oil, but clouds appear to be gathering on the horizon. We our maintaining our forecast for strong oil prices in 2017, with West Texas Intermediate averaging $58 per barrel, followed by a meaningful pullback to $45 in 2018.


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David Harrell may own stocks from the Tortoise and Hare Portfolios in his personal accounts.

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