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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.

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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.

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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.

Apr 28, 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 4/21/2017 -- It's Earnings Season

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.

It's earnings season and a number of holdings in Morningstar's Tortoise and Hare portfolios reported quarterly results this week. Please see new analyst notes below for American Express AXP, Bank of New York Mellon BK, BlackRock BLK, eBay EBAY, General Electric GE, Unilever UL, and Visa V. Several holdings were also tagged in a general note about Ant Financial's bid for MoneyGram.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

American Express' Cost-Cutting Program Is a Risky Move as Competition Heats Up
by Jim Sinegal | 04-19-17

Wide-moat American Express continued to generate exceptional profitability in the first quarter, producing a return on average equity of 25%, and it returned 91% of capital generated to shareholders, reducing shares outstanding by 6%. We expect 2017 earnings per share to come in just above the midpoint of the company's $5.60-$5.70 guidance, and several datapoints confirm our thesis that the competitive environment is likely to continue pressuring both market share and profitability. We are maintaining our $83 fair value estimate.

The cost to maintain share continued to rise, with card member services expense increasing by 14% and rewards expense--excluding the effects of the Costco cobrand partnership loss--up 20%. Furthermore, although the average discount rate charged to merchants expanded by 1 basis point in part due to the loss of aggressively priced Costco volume, much of the benefit was offset by other pricing pressures, including new regulations in Europe and pricing concessions made through the company's OptBlue third-party acquiring partnerships. We expect American Express to continue experiencing pressure from two sides as issuers compete for its customers and merchants demand lower prices.

American Express' cost-cutting strategy may backfire. The company has long benefited from an intangible asset in the form of its premium brand. Customers see American Express as relatively prestigious and perhaps more importantly, offering exceptional service. Surprisingly, however, Discover has now taken the top honors in JD Power's U.S. Credit Card Satisfaction Survey for three years in a row. JPMorgan is spending aggressively to acquire customers and build its Sapphire brand while American Express cut marketing and promotional spend by 4% over the last 12 months. Furthermore, as mobile payments and other types of digital spending grow, American Express reduced technology spending in the first quarter of 2017. These actions may be cause for concern.

Bank of New York Mellon's 1Q Aided by Improved Net Interest Margin and Fees; No Change to FVE
by Greggory Warren, CFA | 04-20-17

There was little in wide-moat Bank of New York Mellon's first-quarter results that would alter our long-term view of the firm. We are leaving our $49 per share fair value estimate in place. Net interest margin of 1.13% was a step back from the fourth quarter of 2016 (1.16%) but still better than the year-ago period (0.99%), resulting in a 4.1% year-over-year increase in net interest revenue.

Assets under custody/administration increased 2.3% sequentially and 5.2% year over year to $30.6 trillion. BNY Mellon had $1.7 trillion directly under management at the end of the first quarter, with market gains and flows offsetting the effect of adverse currency, and total investment service fees increasing 3.7% year over year. Total first-quarter revenue increased 3.0% to $2.8 billion. Effective cost controls led to a 2.3% decline in noninterest expense during the period, allowing the firm to post first-quarter earnings per share of $0.83, compared with $0.73 during the first quarter of 2016.

BNY Mellon remains fairly well capitalized, with management committed to returning capital to shareholders. The bank's fully loaded common equity Tier 1 ratio at the end of March was 10.0%, up from 9.7% at the end of the fourth quarter and at the upper end of the 9.7%-10.0% range we've seen from the bank during the past year. BNY Mellon's minimum common equity Tier 1 ratio is 8.5%, leaving it with a 150-basis-point buffer at the end of the March quarter.

Management remains committed to returning what capital it can to shareholders. During the first quarter, BNY Mellon repurchased 19 million shares for $879 million and paid out $201 million in dividends. That company maintained its quarterly dividend at $0.19 per share.

Strong Organic Growth and Market Gains Propel BlackRock's 1Q AUM; Raising FVE to $460 per Share
by Greggory Warren, CFA | 04-19-17

We've increased our fair value estimate for wide-moat rated BlackRock to $460 per share from $410 after updating our valuation model for changes in AUM, revenue, and profitability since our last update. The increase also includes an eventual reduction in the statutory U.S. federal income tax rate to 25% (from its current 35%), which accounted for more than three quarters of the change.

BlackRock closed out the March quarter with a record $5.420 trillion in managed assets. This was about $200 billion higher than our own forecast, with more than $50 billion of the difference due to more favorable currency exchange, another $20 billion coming from stronger institutional and iShares flows, and the remainder due to greater market gains than we had forecast.

Long-term net inflows of $80.3 billion were similar to results from the fourth quarter, when BlackRock recorded $87.8 billion in total inflows. While iShares remains the largest driver of BlackRock's inflows, picking up another $64.5 billion in AUM during the first quarter, the firm also saw positive flows from its retail ($4.6 billion) and institutional ($11.2 billion) platforms. BlackRock's organic growth rate of 5.1% over the last four calendar quarters was right in line with management's annual target rate of 5%.

While BlackRock's quarterly average AUM was up 15.3% year over year, first-quarter revenue increased just 7.6% due to mix shift and reduced fees. With BlackRock's AUM likely to increase at a low-double-digit rate this year, we continue to forecast a mid- to high-single-digit increase in revenue for 2017. With regards to profitability, the firm reported a 180-basis-point increase in adjusted operating margins (to 41.4% of revenue) when compared with the first quarter of 2016. We expect full-year adjusted operating margins in the 41%-43% range, with free cash flow exceeding $3 billion this year.

Solid Start and Back-Half Tailwinds Make eBay 2017 Outlook More Feasible; Long-Term Questions Linger
by R.J. Hottovy, CFA | 04-20-17

EBay parlayed new platform enhancements into first-quarter momentum, though not quite enough to shake concerns about growth trends lagging industry peers. To be sure, there was a lot to like from the quarter, including modest acceleration in active users (up 4% to 169 million), constant-currency marketplace GMV growth of 5% (including contribution from both B2C and C2C transactions, the latter of which underpins our narrow moat rating), and constant-currency revenue growth of 7%. We attribute these trends to new user experiences backed by new structured data/AI investments, mobile platform upgrades, and reactivation/new user adoption (skewing more toward women and younger consumers). We believe this momentum will carry into the back half of the year, owing to a new home page, a more aggressive brand campaign, new delivery speed search functionality, and adoption of promoted listing advertising on the platform for sellers, not to mention easier comparisons for StubHub and classifieds.

With the solid start to the year and the back-half tailwinds, we're buying more into eBay's 2017 outlook. We plan to adjust our model to the high end of its organic revenue growth guidance of 6%-8% (implying $9.3 billion-$9.5 billion), just above the midpoint of its operating margin (29%-31%) and adjusted EPS forecasts ($1.98-$2.03) due to technology investments, brand marketing, and promotional activity. Over the next five years, we assume average annual revenue growth of 4% and operating margins of 32%, though site enhancements coupled with traditional retailers looking for greater online distribution and new international opportunities (including the Flipkart partnership in India) could set the stage for upside.

Based on greater near-term optimism and tax reform adjustments, we're planning to add a few dollars to our $30 fair value estimate. While we find eBay to be an attractive capital-allocation story, we'd prefer a wider margin of safety before adding to positions.

Despite Weak Industrial Cash Flow in the Quarter, We Believe GE's Longer-Term Story Is Intact
by Barbara Noverini | 04-21-17

Shares of wide-moat General Electric slumped April 21 as investors reacted to negative industrial cash flow in the first quarter, which largely overshadowed healthy 7% year-over-year growth in organic sales and a solid 130 basis points of operating margin expansion in the industrial segment. We do not intend to alter our $32 fair value estimate based on the quarter's operating results.

Industrial cash flow from operating activities was a $1.6 billion use of cash, mostly due to higher-than-anticipated working capital in the quarter and lower cash payments collected from GE's long-term service contracts. We're satisfied that these are all largely timing issues and believe the company's 2017 goal of $12 billion-$14 billion of industrial cash flow from operating activities is still reasonable.

Otherwise, GE reported solid year-over-year gains in industrial revenue after excluding the impact of M&A and foreign exchange. Six out of seven segments achieved positive organic revenue growth, led by the power, renewables, and aviation segments. This was GE's strongest quarter of organic revenue growth in nearly two years. Orders also showed positive momentum, up 7% organically, with equipment orders increasing 5% and services 9%. This included a 9% organic increase in oil and gas segment orders, which, while off a low base, is a step in the right direction. With broad-based strength in backlog growth, we're more confident that GE's near- to medium-term goal of 3%-5% annual organic revenue growth is achievable.

Industrial operating margins expanded 130 basis points to 12.6% in the quarter, with equipment margins increasing 30 basis points and service margins growing 140 basis points year over year. All told, we believe the company is on track, and we urge investors to focus less on quarterly cash flow ebbs and flows and more on the sustainable changes GE has made to its portfolio, which we believe will lead to stronger, higher-quality cash flow over time.

Unilever's 1Q Good Enough in Low-Growth Environment; Shares Fairly Valued
by Philip Gorham, CFA, FRM | 04-20-17

Unilever reported 2.9% underlying sales growth in first-quarter 2017, a rate that exceeded consensus estimates and keeps the firm on track to meet our full-year estimate of 3% organic growth. We reiterate our EUR 50 and GBX 4,200 respective fair value estimates for the Amsterdam- and London-traded share classes, as well as our wide economic moat rating. It is a sign of the times that an organic growth rate of under 3% is exceeding investors' expectations. In Unilever's case, it is volumes that are underperforming, down 0.1% in the quarter, while pricing was up 3%. This underlines, however, the sensitivity of consumers to above-inflation price rises.

The food segment was particularly vulnerable to price elasticity, with volumes down 2.1% on 2.2% price increases. Only the home care segment showed any resilience to price increases, with 1.4% volume growth in spite of a 2.6% increase in prices.This subdued level of growth is partly cyclical. A 2.1% decline in volumes in Latin America weighed heavily on organic growth in the quarter, but volumes are likely to improve as economies in the region move out of recession. There is also likely to be a macroeconomic element to the high price elasticity, and pricing is likely to become more robust in the near term, particularly if global inflationary pressures return. However, there is also a structural element at play, with fragmenting demand and emerging channels presenting long-term challenges to the large-cap manufacturers of big consumer brands.

While Nestle appears to be moving very slowly, we like Unilever's reaction to the evolution in the industry. Its efforts to streamline its cost structure should allow management to channel funds to the areas of the business that will drive growth, including improving its pipeline of new product innovation, and more effective marketing. In this low-growth environment, it is the lean and nimble manufacturers that will achieve better balance between pricing and volumes.

European Integration Cannot Slow Visa's Momentum in 2Q
by Jim Sinegal | 04-20-17

As we expected, the integration of Visa Europe is progressing well, and the firm remains a growth juggernaut in the financial-services industry. Visa is guiding to net revenue growth approaching 18% for its full fiscal 2017 year, including 2.0% to 2.5% of negative impact from the strong U.S. dollar. At the same time, its minimal reinvestment needs--the company had only $317 million in capital expenditures over the last six months--ensure that its owners share in the rewards. The payment network returned cash in the form of dividends and repurchases at an annualized rate of just below 4% of market capitalization during the quarter, and just authorized an additional $5 billion in repurchases. The wide moat company's stock price is approaching our $101 fair value estimate as it continues to benefit from its excellent competitive position and growth of the electronic payment market.

The quarter's results were impacted by two charges produced by the acquisition of Visa Europe--a $1.5 billion income tax provision and a $192 million expense related to the establishment of the Visa Foundation. Excluding these items, adjusted EPS expanded at an impressive 27%. We expect earnings to continue growing at a healthy rate for the foreseeable future thanks to the company's dominant status in the payment industry.

Although large customers continue to demand a share of revenue, client incentives totaled 18.7%, with management guiding toward the bottom of a 20.5%-21.5% range for the full year. We believe customers will continue to demand a larger share of revenue in exchange for volume, but expect that underlying market growth will offset the impact of slight pricing pressure.

Visa's highly profitable cross-border transaction volume expanded by 11% over the past 12 months, including Europe and ignoring currency movements. We think these solid results in a period of moderate geopolitical turmoil bode well for cross-border volume growth over time.

Ant Financial's Bid for MoneyGram Highlights Chinese Payment Ambitions
by Jim Sinegal | 04-19-17

Ant Financial's $1.2 billion bid for international remittances firm MoneyGram highlights the competitive threats in payments and other financial services emerging from the Chinese market.  Though we believe the growth prospects and competitive position of firms like Visa and MasterCard remain favorable, we currently forecast that major networks will lose a small amount of international share to such competitors over time.

The deal would provide Ant Financial, a financial services affiliate of e-commerce giant Alibaba, access to MoneyGram's expertise in cross-border payments, while potentially expanding MoneyGram's digital reach. It also gives Ant Financial access to a network of agents and customers around the globe. Many of these customers are not part of the traditional banking system, providing plenty of opportunities for Ant Financial to expand its presence in the financial-services industry.

Ant Financial already offers a variety of financial products, including payments (via Alipay and other subsidiaries), money market funds (via Yu'e Bao), and online banking (via MYbank). The firm clearly aspires to become a diversified global player, and MoneyGram will expand its reach across both emerging and developed markets. The company's close ties to Alibaba also open doors to the combination of banking and commerce and control of a much larger value chain. While U.S. competitors have ambitions in this arena, both the regulatory environment and intense rivalries among firms like Wal-Mart, Amazon, Alphabet, and JPMorgan Chase make this a more difficult proposition. We therefore expect the competitive status quo to persist in the developed markets for some time, while high-growth emerging markets have the potential to leapfrog traditional financial services firms in favor of newer offerings provided by global competitors like Ant Financial and PayPal, and local players like Kenya's mPesa.


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All Morningstar Stock Analyst Notes were published by Morningstar, Inc. The Weekly Roundup contains all Analyst Notes that relate to holdings in Morningstar, Inc.'s Tortoise and Hare Portfolios. Morningstar's analysts are employed by Morningstar, Inc. or its subsidiaries.  In the United States, that subsidiary is Morningstar Research Services LLC, which is registered with and governed by the U.S. Securities and Exchange Commission.

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

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