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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.

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.

Oct 21, 2017
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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 10/20/2017 -- An Update on General Electric

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.

An update on General Electric GE from Michael Corty, manager of Morningstar's Tortoise portfolio:

"General Electric's disappointing results in 2017 continued today with its third-quarter earnings and reduced forecasts for 2017 earnings per share. GE clearly needs to improve its financial performance and the new CEO's comments today are just step one in that process. I continue to view GE's shares as undervalued and I still like its risk/reward profile at the current price."

You can also see Michael's trade alert for his recent add-on purchase for GE for his thoughts at the time on the firm.

Below is a new Morningstar Research Services analyst note for GE. Morningstar plans to decrease its fair value estimate for GE by "as much as 10%" from its current estimate of $32 per share. Yet even after a 10% reduction in its fair value estimate, GE would remain undervalued by that measure.

Also below are new Morningstar analyst notes for American Express AXP, Bank of New York Mellon BK, eBay EBAY, Express Scripts ESRX, and Unilever UL.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

After Dismal 3Q Free Cash Flow, GE Retrenches
by Barbara Noverini, CFA | Morningstar Research Services LLC | 10-20-17

We plan to cut our fair value estimate by as much at 10% following General Electric's third-quarter earnings report, which revealed deeper challenges in the power segment than we had anticipated. We now expect industrial free cash flow through 2018 to be lower than our prior projections, with modest growth returning in 2019 and beyond.

Underperformance in the power segment, driven by a lower volume of high-margin services and aeroderivative equipment, weighed heavily on industrial cash from operations, causing new CEO John Flannery to halve management's original 2017 target of $12 billion-$14 billion in industrial cash from operations. With only $7 billion now expected for the year and approximately $3 billion-$4 billion of capital expenditures anticipated, industrial free cash flow will fall far short of GE's $8 billion dividend commitment. More concerning is the suspension of GE Capital dividends, pending actuarial analysis of claims reserves in a long-term care insurance business. Absent these dividends to the parent, and with Flannery positioning 2018 as a trough or "reset" year, we think it would be irrational for GE to maintain its current dividend. Flannery did not explicitly confirm a cut but hinted that GE would be managed for total shareholder return going forward.

When Flannery shares his strategy Nov. 13, we expect he will outline steps to rightsize the power business and drive excess costs out of the entire portfolio. We also anticipate further details on the $20 billion of potential asset sales earmarked Oct. 20 and how that will tie into GE's new capital-allocation philosophy. From a long-term perspective, we think all is not lost. When excluding the power and oil and gas segments, the rest of GE's wide-moat portfolio reported 2% organic revenue growth, 250 basis points of margin expansion, and strong growth in high-margin service orders in the quarter. This is a solid foundation that can produce attractive future returns under better management.

American Express May be Setting the Stage for a Comeback Under New CEO
by Jim Sinegal | Morningstar Research Services LLC | 10-18-17

Wide-moat American Express reported a quarter of solid revenue and EPS growth, increased EPS guidance for 2017, and announced CEO Kenneth Chenault will step down in February to be replaced by Stephen Squeri, a 30-year veteran of the company. In our view, these developments are promising, and we are increasing our fair value estimate to $103 per share as the company begins to address three long-standing problems. First, the company must justify its pricing to its merchant customers. The company’s loss of its acceptance and cobranding relationship with Costco and the Supreme Court’s plans to review an anti-steering case against the company prove that the costs of card acceptance remain an issue for merchants.  Second, the company must improve its value proposition for cardholders--JPMorgan Chase spent hundreds of millions of dollars rolling out a competing card with lucrative rewards, and Amex management admits that it does not have the desire to compete on undifferentiated rewards. Finally, the company must adapt to a changing payment landscape.

Strategic priorities outlined in the earnings conference call were encouraging, if lacking specifics. We think American Express is well-positioned to capitalize on the growing value of data thanks to its closed-loop network and connections between merchants and customers—management echoed these thoughts, and mentioned the possibility of acquisitions on this front. American Express has lagged behind competitors on the M&A front, and past deals were less than successful, resulting in impairment charges this quarter. However, we think the maturing digital payment and data analytics markets provide fertile ground in which to deploy the company’s free cash flow. We also believe American Express’ corporate card business is arguably the crown jewel within the company, and the company plans to extend these advantages further into the small business segment, where card payments still have room to grow share.

Net Interest Margin Gains Combine With Cost Controls to Lift BNY Mellon's Results; No Change to FVE
by Greggory Warren, CFA | Morningstar Research Services LLC | 10-19-17

There was little in wide-moat-rated Bank of New York Mellon's third-quarter results that would alter our long-term view of the company. We're leaving our $53 fair value estimate in place. The third-quarter net interest margin of 1.15% was a decent improvement over the prior-year period (1.05%) but only a slight shift upward from the second quarter (1.14%). We continue to expect the full-year net interest margin to end up closer to the upper end of our 1.10%-1.15% forecast range for 2017.

Assets under custody/administration increased 3.5% sequentially and 5.6% year over year to $32.2 trillion. BNY Mellon had $1.8 trillion directly under management at the end of the third quarter, up 3.0% sequentially and 6.4% on a year-over-year basis. Shifting product mix, ongoing fee compression, and changes in currency left investment management and performance fee revenue up 4.8% year over year (as well as for the first nine months of 2017) when compared with the prior-year period. Total third-quarter (and year-to-date) revenue increased 1.9% (3.2%) to $4.0 billion ($11.8 billion). Effective cost controls once again led to a low-single-digit increase in noninterest expenses during the period, allowing the company to leverage ongoing share repurchases and post an 11.0% year-over-year increase in third-quarter earnings to $0.94 per share.

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 September was 10.7%, up from the second quarter (10.4%) and the beginning of the year (9.7%). BNY Mellon recently increased its quarterly dividend to $0.24 per share from $0.19, which implies a dividend yield of 1.8% based on today's trading price. BNY Mellon repurchased 12 million (42 million) shares for $650 million ($2.0 billion) during the third quarter (first nine months) of 2017.

EBay Marketplace Acceleration a Positive, but StubHub and Organic Buyer Trends Raise Questions
by R.J. Hottovy, CFA | Morningstar Research Services LLC | 10-19-17

EBay's third-quarter update was a mixed bag, with solid marketplaces GMV growth (up 7% on a currency-neutral basis, driven by a 9% increase in both C2C and international GMV and customer retention), and classifieds revenue (accelerating to 19%) reaffirming the network effect behind our narrow moat rating, but also raising questions about StubHub GMV (up 2%) and organic buyer acquisition trends. We believe structured data/AI efforts and a shift to promoted listing first-party advertising are making eBay a more competitive platform for sellers and buyers, with new innovations like grouped search listings, visual search, guaranteed delivery, and price-matching likely to keep marketplaces GMV growth in the mid- to high single digits over the next few years, slightly ahead of our previous estimates. That said, we still harbor concerns that eBay's new buyer acquisition trends will track below global e-commerce trends, and headwinds facing StubHub (including weaker sporting event attendance) may persist well into 2018.

After taking these moving pieces into consideration, we aren't planning material changes to our $35 fair value estimate and view shares as fairly valued. EBay's updated 2017 guidance--including revenue of $9.53 billion-$9.57 billion (organic growth of 7%), adjusted operating margins of 30%, and adjusted EPS of $1.99-$2.01--strikes us as reasonable. However, we're more focused on baseline top-line and margin trends beyond 2017. After adjusting our marketplaces and StubHub GMV outlook, we anticipate average annual revenue growth of 5% for 2018-22, with adjusted operating margins remaining in the 30%-31% range as a marketing ramp-up offsets some operating leverage. While these assumptions still paint a healthy cash flow generation story--and one that could develop into a more meaningful capital-allocation story in the years to come, beyond the existing $2.6 billion share-repurchase authorization--we'd be cautious putting new money to work at current levels.

Anthem Transitions its PBM Contract to CVS, Express Remains in a Favorable Long-Term Position
by Vishnu Lekraj | Morningstar Research Services LLC | 10-18-17

On Oct. 18, Anthem announced it will officially move its pharmacy benefit manager contract from Express Scripts over to CVS once the current agreement ends in 2020. Anthem will also transition most of the PBM plan management related functions inhouse and service its claims through a segment it will call, IngenioRx. This move was largely expected and upon our initial analysis, we are leaving our moats and fair value ratings intact for Anthem and Express. We plan to leave our moat rating for CVS at wide, but we do expect to modestly increase our fair value for the PBM. The new agreement falls in line with what Aetna and Cigna have established with their own PBM partners and is on par with an insurer the size of Anthem. However, interestingly, Anthem also stated it will also seek to win new PBM business as a third-party servicer--competing for carved-out employer and health plan clients beginning in 2020.

We are uncertain how successful Anthem will be with this strategy. We believe the firm’s current level of prescription volume makes it a midtier PBM player at best and it will likely not have the scale and pricing power to compete with the major three PBMs (CVS, Express, Optum). Thus, we believe this dynamic is why it chose to partner with CVS rather than execute all activities internally. With that said, Anthem will have the opportunity to reap significant savings from the new contract and management stated that it will likely be able to experience $4 billion in annual savings starting in 2021 given. However, we still believe that the firm could have achieved the same level of savings by establishing a new contract with Express and would have not taken on additional member transition risk. From our perspective, this likely points to a strategy where Anthem was looking to diversify its own MCO operations all along and become a third-party PBM servicer. We believe this development and strategy highlights the moaty and critical nature of the PBM business.

Volume Growth Evaporates in 3Q for Unilever, but Operating Changes Should Help
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 10-19-17

We have confidence in Unilever's ability to deliver on its 2020 growth and profitability objectives, but the company's third-quarter update showed that it remains a long way from achieving those targets. Organic growth of 2.6% on 0.2% volume growth just missed our forecast, and we have lowered our full-year growth assumptions to the low end of management's 3%-5% guidance, although the change does not affect our EUR 52 fair value estimate for the Amsterdam-traded shares. Although organic growth remains below historical levels, we believe Unilever's entrenched position in the supply chain of its retailers, the source of its wide economic moat, is intact.

Volume weakness in Europe was the key source of underperformance relative to our forecasts. A 2% volume contraction, on just 0.3% price/mix, was worse than we expected, and it was significantly worse than the 2% regional organic growth reported by Nestle (although there are differences in the geographical footprint of the segments of the two firms). In common with several other consumer staples companies, Unilever's growth engine is Asia, where growth was 6% and healthily balanced between price/mix and volumes.

Given a choice between Nestle's problem of volume growth but very little price/mix, or Unilever's problem of decent pricing but limited volume growth, we would probably take Nestle's situation. The ability to drive volumes in a commoditized portfolio is indicative of a company well entrenched in the supply chain of its customers, the retailers. Expanding the category in an environment of both secular and cyclical headwinds should strengthen the hand of the manufacturer when negotiating for shelf space. Nevertheless, we think Unilever's effort to pass more brand ownership to its regions will improve the effectiveness of customer acquisition spending and support its moat, and we still have conviction in our medium-term assumptions of 4% organic growth and a 19% EBIT margin.


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

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