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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.

About the Editor David Photo
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 4/16/21 -- Fair Value Increases for General Dynamics and JPMorgan

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.

Please see new analyst notes and updates below from Morningstar Research Services for Bank of New York Mellon BK, Charles Schwab SCHW, General Dynamics GD, JPMorgan Chase JPM, Microsoft MSFT, PepsiCo PEP, UnitedHealth UNH, and Wells Fargo WFC.

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David Harrell,
Editor, Morningstar StockInvestor

Low Rates Continue to Be a Headwind for Bank of New York Mellon
by Rajiv Bhatia, CFA | Morningstar Research Services LLC | 04-16-21

Low interest rates continue to take a bite out of wide-moat rated Bank of New York Mellon's profits through lower net interest income and higher money market fee waivers. Revenue of $3.92 billion beat the FactSet consensus estimate of $3.84 billion and diluted earnings per share of $0.97 beat the consensus of $0.87. We attribute the EPS beat to equity market appreciation, elevated client activity, and provision releases. We will maintain our fair value estimate of $48 on BNY Mellon's shares.

Revenue was down 5% from the year-ago period, driven by lower net interest income that decreased 4% sequentially and 20% from the prior year. The firm's fully taxable equivalent net interest margin decreased faster to 0.67%, down from 0.72% sequentially and 1.01% in the year-ago period. Fee revenue increased 1%, or 6% excluding money market fee-waivers. Money market waivers had a net impact of $188 million, greater than the $134 million in the previous quarter and $175 million outlook. BNY Mellon expects second-quarter fee waivers to be around a $220 million drag. BNY Mellon expects full-year 2021 net interest income to decline 11%-12%.

The firm's asset servicing business saw revenue decrease 7%, but excluding money market fee waivers and net interest income, fees were up slightly. Assets under custody of $41.7 trillion was up 1% sequentially. In our view, Pershing continues to be a source of strength for the firm. Pershing revenue was down 7% but up 6% excluding fee waivers. The firm is benefiting from higher market levels and higher trading volumes, though management expects the latter to moderate. In addition, consolidation such as LPL Financial buying Pershing client Waddell & Reed's wealth management business will also be a headwind. The firm's investment and wealth management segments performed well given the market backdrop with 20% and 6% respective fee growth excluding money market fee waivers.

Charles Schwab Reports Record Q1 Results as It Benefits From High Trading Activity
by Michael Wong, CFA, CPA | Morningstar Research Services LLC | 04-15-21

Wide-moat Charles Schwab significantly increased its exposure to active traders by merging with TD Ameritrade, and that has bolstered results in the current environment. Charles Schwab reported record net income of $1.48 billion, or $0.73 per diluted share, on $4.7 billion of net revenue. Excluding acquisition-related costs and amortization of intangibles, the company reported non-GAAP net income of $1.6 billion, or $0.84 per diluted share. Net revenue increased $539 million, or 13% sequentially, with $362 million of the increase coming from trading revenue. Trading revenue of $1.2 billion in the quarter is over 500% higher than it was a year ago before the merger with TD Ameritrade. While acknowledging that there has likely been a permanent increase in trading activity from the move to $0 commission equity trades at the end of 2019, annualized trades per active brokerage account of about 70 in the first quarter, according to our calculations, definitely looks like an aberration compared with about 50 trades in the fourth quarter of 2020 and averages in the teens for both Charles Schwab and TD Ameritrade before 2020. We don't anticipate making a material change to our $56 fair value estimate for Charles Schwab.

Client assets at Charles Schwab were a record $7 trillion, up 6% sequentially, which will power long-term asset-based revenue and earnings growth; however, short-term earnings will be driven by trading. Asset management and administration fees increased $29 million, or 3%, while net interest income increased $102 million, or 5.6%, sequentially. The increase in net interest income is more related to the company's trading activity, as interest on margin loans increased $119 million, or 27%, sequentially. Despite an increase in deposits and the company's securities portfolio in its bank, interest from securities decreased $12 million, or 1%, sequentially due to lower yields.

A Fair Value Increase for General Dynamics
by Burkett Huey, CFA | Morningstar Research Services LLC | 04-16-21

We're increasing our fair value estimate for General Dynamics to $185 per share from $182 due to the time value of money. Our fair value implies a price/2021 earnings multiple of 15.8 times and an enterprise value/forward EBITDA multiple of 13.1 times.

We think top-line growth will slow from the exceptional growth of 2018-19, averaging roughly 3.7% from 2021-25. We think the big growth drivers will be the aerospace and marine segments. In aerospace, we expect long-term growth from the replacement of G450s and G550s with G500
and G600s as well as the introduction of the G700. We see the Columbia-class submarine driving growth in marine. We note that shipbuilding revenue is insensitive to the defense budget.

Reserve Releases Stronger Than Expected; Fee Income Continues Strong Growth for JPMorgan in Q1
by Eric Compton, CFA | Morningstar Research Services LLC | 04-14-21

Wide-moat JPMorgan reported excellent first-quarter earnings, blowing out the FactSet consensus estimate of $2.77 per share with reported EPS of $4.50. This equates to a return on tangible common equity of 29%. The biggest swing factor for the outperformance was the firm's provisioning for credit losses. As we had expected, the bank released a sizable portion of reserves, totaling $5.2 billion. While we had been more bullish than consensus on reserve releases, first-quarter results were even ahead of our own projections. We had expected just under $5 billion in releases for the full year, but the bank released more than $5 billion already during the first quarter of 2021. Going forward, we had expected roughly $3.5 billion in reserve releases from JPMorgan in 2022, but given the accelerated timeline already playing out, some of these releases could be pushed into the current year. Adjusted results, which exclude the reserve releases, had EPS at $3.31 with a ROTCE of 21%. Overall, while the current results largely fit within our existing projections, we are increasing our fair value estimate slightly to $140 per share from $136.

Microsoft Bolstering Healthcare Offerings With Acquisition of Nuance for $16 Billion; FVE Unchanged
by Dan Romanoff, CPA | Morningstar Research Services LLC | 04-12-21

Microsoft announced the acquisition of Nuance Communications, a leader in conversational artificial intelligence (AI), in an all-cash deal for $19.7 billion in enterprise value ($16 billion excluding debt) or $56 per share. We don't believe this deal transforms Microsoft's strategic plans, nor does it move the needle financially. Therefore, we are maintaining our fair value estimate for wide-moat Microsoft of $263 per share.

We view the acquisition as strategic in that it adds conversational AI to the portfolio and aligns Microsoft with Nuance's roster of healthcare solutions and customers. Investors, patients, politicians, care providers, insurance companies, and technology all seem to agree that healthcare is an area where change is needed, but easy solutions have been elusive. Therefore, healthcare is an important vertical for Microsoft to penetrate more deeply. However, we consider this deal as a supplement to Microsoft's larger AI efforts within Azure and do not view it as transformational. More broadly, Microsoft is clearly ramping its deal-making activities after the recently closed ZeniMax deal, the aborted attempt to acquire TikTok, and the recently rumored Discord acquisition.

Financially, even a $16 billion deal does not move the needle for Microsoft as it represents less than 1% of its $1.9 trillion market cap. Similarly, the deal is immaterial to Microsoft's $132 billion cash hoard or Microsoft's future combined financial performance. Nuance has seen its revenue decline in each of the last several years, to $1.48 billion in fiscal 2020, with another decline expected in fiscal 2021 to $1.37 billion, according to FactSet consensus, which we understand has been partly as a result of an ongoing restructuring program. The deal is at a reasonable price at a 23% premium from Nuance's closing share price on Friday, April 9, and represents a takeout price to sales multiple of 11.7 times, as compared with our estimate of the software group median of 11.9 times.

Not Much to Dislike in Pepsi's Q1; Comps Remain Tough, but Enough Portfolio Optionality for Growth
by Nicholas Johnson, CFA | Morningstar Research Services LLC | 04-15-21

With headline performance in 2020 that belied the disruption across the broader economy, investors were seemingly less enamored with wide-moat PepsiCo's value proposition heading into its first-quarter earnings print (as shares have been under pressure in recent months). Still, the firm continued its streak of impressive performance (with top- and bottom-line results ahead of FactSet consensus), dispelling--at least for now--the notion that its growth will be challenged in 2021. To be sure, comps will be toughest in the quarters ahead, but we expect the diversification in the business to allow the firm to maintain its growth algorithm irrespective of how consumer behavior evolves throughout the year. We don't plan to materially change our $145 fair value estimate outside of time value adjustments, and while current trading levels no longer present a compelling margin of safety, we'd be happy buyers on any further pullbacks.

Revenue of $14.8 billion represented a 6.8% year-over-year increase. Though 5 points of this bump was due to recent strategic acquisitions (chiefly Be & Cheery in China, Pioneer in Africa, and Rockstar in the U.S.), over 2% organic growth is still commendable given tough comps faced from March 2020 pantry loading. In snack foods, Frito Lay remained vibrant, and Quaker brands in the U.S. continued to benefit from elevated at-home occasions (specifically around breakfast and side dishes). Beverages had several bright spots, with the North America business up 1.5% organically. Energy remains a key strategic focus in this unit, revolving around Rockstar and Mountain Dew (with its Bang partnership likely sitting ignominiously on the sidelines). The firm signed NBA superstar LeBron James as the marquee ambassador for its new Mountain Dew energy drink (Rise); this is no small feat, and likely required a nontrivial financial commitment, but signals to us management's determination to compete more aggressively in this high growth, high margin category.

UnitedHealth Raises 2021 Outlook in Line With Our Estimates
by Julie Utterback, CFA | Morningstar Research Services LLC | 04-15-21

Narrow-moat UnitedHealth Group released first-quarter operating results that beat market consensus, and management raised its guidance a bit. However, our estimates remain within management's new outlook range, so we are not changing our $329 fair value estimate materially on this news. Shares appear slightly rich to us.

In the first quarter, the firm beat consensus expectations and raised its outlook for the year, but our estimates remain within management's new guidance range. In the quarter, UnitedHealth turned in $70.2 billion of revenue, or higher than FactSet consensus of $69.2 billion. Also, its adjusted EPS of $5.31 significantly beat consensus of $4.37. Based on that strong performance, management raised guidance for 2021 to $18.10 to $18.60 from $17.75 to $18.25 previously. Our estimate for 2021 ($18.42) was already above management's previous guidance and within its current outlook range, so we are not changing our assumptions for UnitedHealth materially. However, we recognize there may be upside to UnitedHealth's outlook for 2021, as the firm has highlighted $1.80 of potential coronavirus constraints on its 2021 EPS guidance, such as higher acuity patients increasingly accessing healthcare services primarily in the second half of the year, that may not fully materialize.

Digging in deeper to the first quarter, the medical insurance business (8% revenue growth and 42% operating earnings growth on a weak comparable) and the Optum franchises (11% revenue growth and 25% operating earnings growth) performed well. In medical insurance, the firm's government-sponsored plans, particularly Medicare Advantage and Medicaid, offset constraints in its commercial operations related to weak employment conditions. In the Optum franchises, OptumHealth (35% revenue growth) and OptumInsight (14% revenue growth) led the pack while OptumRx was merely flat year over year. While strong, Optum's results largely reflect management's expectations given in early 2021.

Wells Fargo Releases Sizable Reserves in Q1, Sticks to Previous Guidance for Net Interest Income
by Eric Compton, CFA | Morningstar Research Services LLC | 04-14-21

Wide-moat Wells Fargo reported excellent first-quarter earnings, easily exceeding FactSet consensus of $0.72 with reported EPS of $1.05. This equates to a return on tangible common equity of 12.7%. The biggest swing factor was provisioning for credit losses.

As we had expected, the bank released a sizable portion of reserves, totaling roughly $1.6 billion. We had been more bullish than consensus on reserve releases, and we expect Wells could have even more reserve releases ahead. If we assume provisioning would have been closer to the 2019 run rate of roughly $670 million, EPS would have been closer to $0.66 and ROTCE would have been closer to 8%. In other words, the bank still has a long way to go.

That said, management stuck to its previous net interest income and expense guidance ranges. If anything, management seemed to suggest net interest income would end up in the middle to upper end of its previous guidance. We think this was an important symbolic victory. In the past, for example, net interest income guidance was often missed and then adjusted downward. With management able to stand its ground, and even imply optimism, we think an important, subtle shift has taken place.

Overall, current results largely fit within our existing projections, and we are maintaining our fair value estimate of $52 per share. Wells remains our top pick among the traditional U.S. banks, and we think it has unique, idiosyncratic upside compared with peers.


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

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