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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
Quarterly Earnings and a FVE Increase for JPM

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Please see new analyst notes below from Morningstar Research Services for Bank of New York Mellon BK, BlackRock BLK, Charles Schwab SCHW, JPMorgan Chase JPM, Omnicom OMC (two separate notes), Unilever UL, UnitedHealth Group UNH, and Wells Fargo WFC.

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Bank of New York Mellon Continues to Face Industry Headwinds
by Rajiv Bhatia | Morningstar Research Services LLC | 10-16-19

Wide-moat Bank of New York Mellon reported third-quarter results that continue to highlight the challenges custody banks face in growing revenue. Total revenue decreased 5% and net income decreased 7%. Earnings per share increased 1% to $1.07 due to share repurchases. Return on equity was 10.6% and the return on tangible equity finished at 21.4%, up slightly sequentially from 21.2%. Following third-quarter financial results, we maintain our fair value estimate of $48.

Fee revenue, which composed 81% of revenue, was up slightly from the prior quarter but down 1% year over year. Investment services fees were up 3% driven by stronger issuer services fees from higher activity in depository receipts though we expect issuer services fees to be flat in 2019 versus 2018. Asset servicing fees were flat as securities lending softness weighed on growth. Assets under custody or administration increased 4% to $35.8 trillion. Investment management revenue was down 12% due to outflows and tough comps on performance fees. In addition, foreign exchange and other trading revenue was down due to lower volatility.

Net interest revenue of $800 million, excluding a lease-related impairment, was flat from the second quarter and beat expectations of a modest decline. Looking ahead, the company expects net interest revenue to decline 4%-6% in the fourth quarter sequentially. Factors driving the decline include a lower portfolio yield on the asset side and the continued shift from non-interest bearing to interest bearing deposits on the liability side. Average interest earning assets increased 5% and average deposits increased 8%. Excluding the lease related impairment, the firm's net interest margin was 1.09% during the quarter, down a touch from the 1.12% reported last quarter.

Excluding non-recurring items, expenses were roughly flat from the year-ago period. Technology spending increased but this was offset by lower other expense and the impact of a stronger U.S. dollar.

BlackRock's Solid Growth Continues
by Greggory Warren , CFA | Morningstar Research Services LLC | 10-18-19

There was little in wide-moat BlackRock's BLK third-quarter results to alter our long-term view of the company, but we have increased our fair value estimate slightly to account for better assets under management levels and fees than we had forecast.

BlackRock closed the September quarter with a record $6.964 trillion in managed assets, up 1.8% sequentially and 8.1% year over year, with positive flows and market gains contributing to growth in assets under management during the period. Net long-term inflows of $52.3 billion during the third quarter were fueled by $741 million of active inflows (with strong flows from equity and alternatives operations offset by fixed-income outflows), $10.0 billion of inflows from the institutional index business (with the preponderance going into fixed-income strategies), and $41.5 billion in inflows from iShares. BlackRock's annual organic growth rate of 4.7% over the past four calendar quarters is slightly behind management's ongoing annual organic growth target of 5% but still within our long-term forecast of 3%-5% organic AUM growth annually.

BlackRock reported a 3.2% increase in third-quarter revenue compared with the prior-year period, as base management fees increased 3.4% despite a drop in the company's realization rate to 0.173% in the September quarter from 0.180% in the third quarter of 2018. The company's year-to-date top-line decline of 1.9% through the end of September was in line with our expectations for a low-single-digit decline for 2019, which we have increased to nearly flat year over year. While BlackRock reported a 170-basis-point year-over-year increase in third-quarter operating margin to 40.7%, we believe it will close the year with operating profitability of 37%-39% (it was 38% through the first nine months of 2019).

BlackRock reported the following from each of its equity platforms during the third quarter: active, $5.3 billion in inflows; institutional index, $8.5 billion in outflows; and iShares/exchange-traded funds, $13.1 billion in inflows. This was an improvement on the $5.9 billion in equity inflows during the second quarter, but still well off the $13 billion-plus five-year quarterly run rate over the past several years, much of which was driven by BlackRock's iShares/ETF operations. This makes some sense, as we've seen the organic growth rate for equity ETFs overall falling off in anticipation of an eventual sell-off in the equity markets (with a corresponding uptick in flows into fixed-income products), as well as the product itself approaching saturation points in some channels.

Charles Schwab Reports Record Quarterly Earnings Per Share Right Before Revenue Headwinds Manifest
by Michael Wong, CFA, CPA | Morningstar Research Services LLC | 10-15-19

Wide-moat Charles Schwab reported record diluted earnings per share of $0.70 in the third quarter, but we expect revenue headwinds to more prominently show up in results next quarter. While the company reported record quarterly earnings per share, it was attributable to a lower share count, as total net revenue and operating income were modestly below first-quarter 2019 results. We are maintaining our $44.50 fair value estimate for Charles Schwab, which we recently decreased from $47 after the company announced trading commission pricing cuts in early October.

We see multiple revenue headwinds manifesting soon. A definite headwind is the announced commission pricing cut that was implemented earlier in October and that management said would decrease net revenue $90 to $100 per quarter, or 3% to 4%. Another headwind is the interest rate environment. The Federal Reserve decreased its target federal-funds rate in two meetings in the third quarter to a target range of 1.75% to 2% that affects interest-earning assets tied to short-term interest rates. The 10-year treasury yield has also been below 1.5% on several days in the third quarter compared with around 2.7% in early 2019, which is indicative of pressure on securities tied to long-term interest rates. The pressure on gross interest income can already be seen with the yield on interest earning assets decreasing for each of the previous two quarters to 2.82% in the third quarter from a high of 2.92% in the first quarter. Quarterly net interest income is also down 3% from the first quarter of 2019. Net interest income was up 1% from the second quarter from less interest paid on deposits more than offsetting the decline in gross interest income, but this dynamic can't hold up indefinitely.

JPMorgan Turns in Another Solid Quarter; Raising Our Fair Value Estimate
by Eric Compton | Morningstar Research Services LLC | 10-15-19

Wide-moat JPMorgan Chase reported solid third-quarter results that were well ahead of consensus, with net income of $9.1 billion, or $2.68 per diluted share. The quarter's return on tangible common equity was 18%, coming down a bit after several one-time items from the last quarter boosted previous results, although 18% is still above the bank's through-the-cycle goal of 17%. Revenue was up 8% year over year, while expenses were only up 5%, leading to solid operating leverage. The bank continued its share repurchases, with average diluted shares down 52.5 million shares (down 2% compared with the second quarter), and year-over-year EPS growth was 15%. Management gave more details around its expectations for net interest income as the forward curve has changed over the quarter; it now expects managed net interest income of less than $57.5 billion. Given the fact that multiple rate cuts have already occurred, with the possibility for more, this was not surprising. Management also nailed down its expense guidance a bit more, coming in at roughly $65.5 billion, whereas before the guidance was simply for less than $66 billion. After incorporating these and other changes, we are increasing our fair value estimate to $114 per share from $110.

The managed overhead ratio stayed steady at 55%, and the bank continues to support massive investments in technology and expansion initiatives, as marketing, occupancy, and technology expense climbed. Average core loans were up 1%; however, excluding certain mortgage loan sales, loan growth was closer to 3%. This was matched by deposit growth of roughly 5%. Credit costs remained range-bound and generally below normal for JPMorgan, with charge-offs on almost all portfolios coming in below historical norms with no obvious signs of stress. While we wait for credit to normalize, credit costs remain low, and the banks are well capitalized this time around. JPMorgan ended the quarter with an advanced common equity Tier 1 ratio of 13.1%.

Mixed Q3 for Omnicom, but Organic Growth and Margin Expansion Stand Out
by Ali Mogharabi | Morningstar Research Services LLC | 10-15-19

While Omnicom reported mixed third-quarter results, we remain bullish on the name as its organic revenue growth continues to demonstrate demand by its clients for its creative, media, and digital offerings. In our view, organic revenue growth during the quarter outweighs headwinds of the stronger U.S. dollar and sales of underperforming agencies, which resulted in an overall year-over-year revenue decline. With some account wins during the quarter and the addition of more U.S. Disney accounts recently, we think Omnicom can maintain organic growth through 2020. The firm also demonstrated further margin expansion during the quarter, driving the bottom line above consensus expectations. We did not make significant adjustments to our model and are maintaining our $85 fair value estimate. While the shares are up slightly in reaction to quarterly results, we still view them as attractive, given the 13% upside in price (based on our fair value estimate) and a 3%-plus dividend yield.

Omnicom's total revenue came in at $3.6 billion, down 2.4% from last year as 2.2% organic growth was more than offset by the negative 3.1% and negative 1.5% impact of net divestiture and foreign exchange rates, respectively. Unlike some of its peers, Omnicom continues to perform well in the North America region as it posted 2.7% organic growth (with 2.7% in the United States) for the quarter. This increase was driven by higher demand for the firm's core advertising, customer relationship management consumer experience, and healthcare offerings, while public relations and CRM execution and support remained weak. Management says the firm remains focused on turning around CRM execution and support, but we don't see any improvements in the short to medium term. The firm's relatively low exposure to consumer packaged goods clients also helped maintain organic growth in North America.

Various Reports Indicate Disney Has Chosen Publicis and Omnicom as Its Media Agencies
by Ali Mogharabi | Morningstar Research Services LLC | 10-14-19

According to Campaign and Ad Age, Disney has decided to work with both Publicis and Omnicom media agencies. In our view, the winners in this are not only Publicis and Omnicom, but also WPP, which maintained Disney's Star India as a client. WPP declined Disney's request for the global pitch, as it feared it may create a conflict with one of its current clients, Comcast. It appears that Omnicom not only kept its Fox clients and Disney's various studios in the North America market but also landed that region's Disney channels (including Fox), while Publicis got those in the international markets. Publicis was also awarded Disney+ and the Disney parks, which were previously being handled by Carat, a Dentsu agency. The channels won by Omnicom were accounts of the independent agency Horizon Media.

These wins will likely lessen the impact of client losses on organic revenue growth for both Omnicom and Publicis beginning next year. We view narrow-moat WPP, Omnicom, Publicis, and IPG stocks attractive, but continue to recommend the 5-star WPP and the 4-star Omnicom over the other two. As we noted last week, indications of WPP's turnaround are apparent. Plus, we continue to applaud WPP and Omnicom for maintaining a balanced mix of investments in creativity, and data and technology, which we think advertisers are looking for.

The Campaign article said that Publicis' Epsilon may have given the firm an edge and helped win part of the Disney account. This supports our view that Epsilon helps Publicis enhance its media services to U.S. clients. As we said in our note published on Oct. 11, we believe Epsilon's data analytics capabilities allow clients to monitor and adjust campaigns across various channels in real time, which we think is what Disney and its new streaming service, Disney+, were seeking.

Underlying Trends Intact in Unilever's 3Q; Shares Valued Appropriately
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 10-17-19

Unilever appears on track to beat our full-year sales growth estimate of 1.5%, thanks to support from foreign exchange. Third-quarter sales figures revealed little change in underlying business performance, but currency was a slightly stronger tailwind than we had estimated, so we are nudging our growth forecast slightly higher. We make no changes to our longer-term forecasts, our EUR 52 fair value estimate for the Amsterdam-traded shares, or our wide moat rating. We believe the shares are currently fairly valued.

Underlying sales growth remains subdued, and was just 2.9% in the third quarter. The headline data show a good balance between price/mix and volumes, but growth is coming from some quite concentrated drivers. Home-care sales grew by 5.4% in the third quarter, driven by laundry in Brazil, China and India. The value of Unilever's strong presence in emerging markets is clear: these markets offer opportunities to benefit from category growth, premiumization, and pricing. Foods and refreshment remains the laggard, however, with 1.7% organic growth weighed down by a slight volume decline, which management blamed on weather. Within beauty and personal care, skin care remains the standout, with hair-care growth in the low-single digits. We expect spending behind customer acquisition to increase in that category.

Geographically, Asia remains the growth engine, with 5.6% underlying sales growth, thanks mainly to the emerging markets. Europe remains stubbornly deflationary, with negative third-quarter price/mix of almost 1%. Although we believe this is somewhat cyclical, it also reflects our belief that many of Unilever's categories lack the pricing power that will be a key growth differentiator in the medium term.

UnitedHealth Turns In Strong 3Q, but Cautious on 2020 Outlook
by Julie Utterback, CFA | Morningstar Research Services LLC | 10-15-19

Wide-moat-rated UnitedHealth Group reported third-quarter results that beat consensus on the top and bottom lines. Positive trends continued in all major business lines, and the firm increased its adjusted earnings outlook for 2019 based on those trends. While we appreciate UnitedHealth's momentum, we do not expect to change our fair value estimate on the basis of these announcements.

During the quarter, revenue grew 7% year over year to $60.4 billion, operating profits grew 9% to $5.0 billion, and adjusted earnings per share grew 13% to $3.88. UnitedHealthcare, the leading U.S. health insurer, grew 5% year over year to $48.1 billion in revenue while operating profits grew 4% during the same period to $2.7 billion. This business continues to benefit from the expansion of Medicare Advantage plans, and the recent executive order bolstering that program may reinforce those positive trends.

The Optum businesses delivered 13% consolidated revenue growth to $28.8 billion and operating profit growth of 16% to $2.4 billion. By business line, OptumHealth, which recently closed on the acquisition of DaVita Medical Group, increased revenue 34% to $8.1 billion. OptumInsight, the company's healthcare-focused information technology group, grew 16% year over year to $2.6 billion while its backlog grew 21% to $19.0 billion, which bodes well for future growth. OptumRx grew 6% to $18.5 billion, despite the ongoing transition of Cigna's business after the latter's acquisition of top-tier pharmacy benefit manager Express Scripts.

With these strong trends, the firm now expects to generate adjusted EPS of $14.90-$15.00 in 2019, up about 16% year over year and up from its $14.40-$14.70 original guidance. The company plans to give 2020 expectations at its Dec. 3 analyst day. However, management expects its core earnings outlook to be on the low end of its typical 13%-16% growth goal and may be further influenced negatively by the reinstatement of the health insurance tax.

Wells Fargo Takes $1.6 Billion Legal Charge in the Quarter, Net Interest Income Under Pressure
by Eric Compton | Morningstar Research Services LLC | 10-15-19

Wide-moat Wells Fargo reported OK third-quarter results. The bank reported a $1.6 billion legal charge in the quarter. While we didn't necessarily know the exact amount, given movements in legal reserve estimates last quarter, we had predicted that several outsize legal charges were likely on their way, which is exactly what is happening. We would not be surprised if the bank has one or several more of these charges left. On the positive side, the bank stuck to its updated net interest income guidance of negative 6% for the year. The bank also stuck to its expense guidance of hitting the upper end of its $52 billion-$53 billion range. We'll note that this is adjusted for excess operating losses and deferred compensation expenses, therefore the GAAP expense amount will come in above this range. However, this was still a good sign, as the bank had been forced to increase its expense guidance in the past due to ballooning risk and compliance related spending. This may indicate that the bank has a better grasp of the true cost of what it will take to reform and rebuild its internal systems. After making several adjustments to our projections, including giving the bank slightly less credit for net interest margin expansion in the future, we are lowering our fair value estimate to $57 per share from $58.

With Wells having found its next CEO (Scharf will start on Oct. 21), the asset cap will be the next big obstacle for Wells. We currently predict it will stay on until sometime in 2021. Management commented on the cap during the earnings call and said it is having a minimal impact on profitability, and that they still have room to maneuver, even while growing core loans and deposits.

There were a few ups and downs during the quarter. Due to a MSR (mortgage servicing rights) revaluation, the bank did not hit the mortgage revenue numbers we were expecting. But we would not expect a similar revaluation to occur in the fourth quarter, so we would expect mortgage-related revenue to bounce back in the fourth quarter. The bank also recorded a $1.1 billion gain from the sale of its Institutional Retirement and Trust, or IRT, business and a $302 million gain from another sale of Pick-a-Pay loans. At this point, the PCI Pick-A-Pay loan portfolio only has roughly $500 million in balances left, enough for roughly one more sale.

The biggest hit to revenues came from declining net interest income. Management's updated guidance from a conference roughly a month before the end of the quarter largely telegraphed this. After making updates to our model based on commentary from the call, we now expect net interest income to be down again in 2020, and to only gradually recover for the next several years, as we expect minimal net interest margin, or NIM, expansion from 2020 forward. This slightly worsened NIM outlook was the biggest change to our model.

Period end loans were up 1%, while deposit balances were up 3%. The community banking segment continues to see growth in digital and mobile customers, primary checking account customers, and credit card accounts. Loyalty and satisfaction scores have also continued to increase. While consumer and small business deposit growth isn't amazing, at only 1%, we still don't see a segment that's fundamentally broken. The wholesale segment had a rather average quarter, with lower net interest income being the primary driver of lower net income. Finally, the wealth and investment management segment remains in turn around mode, as the unit is still seeing net outflows for assets, as well as negative growth for financial advisors. Normalizing for the gain on the sale of the IRT business, the unit is still struggling to grow fees, something which may take a while to turn around.


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