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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 Morningstar.com. 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.

 
Nov 19, 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 11/17/2017 -- Michael Corty's Current Thoughts 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 Tortoise portfolio manager Michael Corty:

General Electric's investor event on Nov. 13 did not appease investors, and the stock traded down roughly 11% this week. The Tortoise roundup section in the November StockInvestor newsletter included my thoughts on the stock as of Oct. 31, including discussion of what has gone wrong with this investment. At its investor event, the company announced a 50% reduction to its dividend and issued disappointing adjusted EPS guidance of $1.00-$1.07 for 2018, which implies a slight decline from the $1.05-$1.10 EPS range forecast for 2017. CEO John Flannery also announced the potential for $20 billion of asset value transactions, as the company looks to further simplify the business and focus on its core segments: aviation, healthcare, and power.

For now, my plan is to hold the stock in the Tortoise. GE's current price is lower than my current view of intrinsic value, which I peg in the low to mid-$20s. This is less than the Morningstar, Inc. published fair value estimate of $26 per share. The stock does not appear undervalued if one applies a market P/E multiple to management's forecast EPS in 2018. In making my assessment of GE, I am looking out over the next 10 years, not just next year. I view 2018 as a trough year in earnings, and the company should grow from that 2018 base level; however, there is more uncertainty (both positive and negative) about the growth rate because of the headwinds facing the power segment. I also expect the cash conversion from earnings to improve, although that picture remains cloudy given the near-term restructuring charges flowing through the income statement. The power business has been very disappointing, but taking a bigger-picture view, GE's aviation and healthcare franchises are strong and have solid growth potential over the next decade.

Unfortunately, the reality is that GE has become a deep turnaround story, and I don't see a quick fix on the horizon. This investment will take patience, as earnings growth won't resume until 2019. Given more uncertainty around intrinsic value, I'm not inclined to add to the position at the current price. Looking ahead, I will treat GE like any other Tortoise holding, as I regularly reassess the risk versus reward. No portfolio management decisions are permanent; I could elect to sell or trim the stock if I think it makes sense at a later date. There is no clock or timetable on making decisions on any stock in the Tortoise -- portfolio management is an ongoing process. The investment result for General Electric has been terrible so far, there's no sugarcoating it.

One can take a glass-half-empty or half-full viewpoint when assessing GE corporate governance. The glass-half-empty view is that the new CEO's explanation of what went wrong in the power business is essentially a lack of common sense and honesty by managers about the current reality of that business until the third quarter of 2017. It's baffling how former CEO Jeff Immelt could not have a better handle on the situation. The glass-half-full view is that new CEO John Flannery appears to be taking steps to improve corporate governance. GE will reduce its bloated board from 18 to 12 directors, including three new directors in 2018. Counting Flannery and Ed Garden from Trian Fund Management, five of 12 board members will be new as of April 2018. Given the issues in the power business, at least one new board member should have relevant experience in the utilities or power industry, a gaping hole in the current board. I am taking the glass-half-full view that improvement is coming, but management clearly needs to build back its credibility with results, not just words.

I've spent a great deal of time writing about GE for subscribers, which is warranted given the drop in the stock price. However, GE is just one position in the Tortoise, and I continue to monitor the portfolio and research new potential ideas. I've spent considerable time looking back at what I missed with GE and trying to get a better handle on its future long-term earnings power, but my portfolio management duties don't hang on one stock.

Please see analyst notes from Morningstar Research Services* for Berkshire Hathaway BRK.B (two separate notes) and General Electric below.

Best wishes,

David Harrell,
Editor, Morningstar StockInvestor

Berkshire's Diversification and Prudent Valuation of Insurance Business Add Stability to Our FVE
by Greggory Warren, CFA | Morningstar Research Services LLC | 11-16-17

Despite a difficult third quarter, in which wide-moat-rated Berkshire Hathaway's insurance operations were affected by $2.8 billion in catastrophe-related losses, our fair value estimate is unchanged at $290,000 ($193) per Class A (B) share. The more broadly diversified nature of Berkshire's portfolio generally allows the company to offset losses in any one segment, which was the case in the third quarter, as strong results from its insurance equity portfolio and railroad operations, as well as solid results from the rest of its businesses, helped offset the insurer's underwriting losses. From a valuation perspective, it helped that our modeling of Berkshire's insurance operations had already included the possibility of large natural catastrophe losses, even though the exact timing of these events was unknown.

We use a sum-of-the-parts methodology to derive our fair value estimate for Berkshire. Following our updates to the different models we use to value the company, our valuation of the insurance operations decreased 3% to $94,200 ($63) per Class A (B) share, primarily because of the impact of this year's large catastrophe losses. Our estimate for Kraft Heinz, which we value separately from the insurance operations, is $14,900 ($10) per Class A (B) share.

Following a strong recovery in rail volume (especially for coal) during 2017, our estimate for BNSF increased 3% to $63,100 ($42) per Class A (B) share. As for the company's utilities and energy division, our fair value estimate increased slightly to $26,000 ($17) per Class A (B) share after we backed out assumptions for the Oncor acquisition and adjusted the model for year-to-date results. While our value for Berkshire's manufacturing, service, and retail operations increased slightly to $82,600 ($55) per Class A (B) share, our estimate for the finance and financial products division remains in place at $9,200 ($6) per Class A (B) share.

Exercise of Bank of America Warrants and IBM Sale Biggest Standouts in Berkshire's 3Q Equity Filing
by Greggory Warren, CFA | Morningstar Research Services LLC | 11-14-17

Wide-moat Berkshire Hathaway's second-quarter 13-F filing offered some insight into changes in the insurer's common stock holdings since the end of the second quarter. While we'd known about the insurer's exercise of warrants to acquire 700 million shares of Bank of America common stock for $7.14 per share, which was the biggest move for the equity investment portfolio during the third quarter, it does look like Berkshire sold off 21 million shares of the bank's common stock during the quarter (raising an estimated $520 million).

We expect that the capital raised by the Bank of America sale, as well as the other sales that took place during the period (which we believe raised another $3.1 billion) was used to fund the purchase of 3.9 million additional Apple shares (for an estimated $580 million), 3.3 million additional shares of Synchrony (for an estimated $100 million), and 0.8 million shares of Monsanto (for an estimated $100 million). That said, we are curious about what the firm plans to do with the $2.8 billion in sale proceeds that were left over after the all of these transactions were done.

As for the sales, the company sold off close to a third of its stake in IBM, raising an estimated $2.5 billion through the sale of 17.1 million shares during the period. This marks the third straight quarter of sales of IBM, reducing Berkshire's stake in the technology firm by more than 50% since the start of the year. The insurer seems to be willing to settle for lower prices each time it sells, with the third quarter's average estimated price per share of $150 comparing unfavorably with $164 during the second quarter and $171 during the first quarter. It was also below our own fair value estimate of $158 per share.

Berkshire also sold off 3.8 million shares of Wells Fargo (which is tied more to its ownership threshold in the bank than that firm's fundamentals), and 1.0 million shares of Charter Communications, while eliminating its stake in Wabco Holdings.

GE Cuts Dividend and Resets 2018 Earnings; We Think Point of Maximum Pessimism Finally Reached
by Barbara Noverini, CFA | Morningstar Research Services LLC | 11-13-17

We expect to cut our fair value estimate to about $26 from $29, chiefly by reducing our expectations for midcycle margins after GE's long-anticipated investor update, in which new CEO John Flannery reset expectations to reflect the harsh realities of what we believe will likely be a multiyear turnaround. With the dividend cut by half to $0.48 per share, significant restructuring planned for the power segment, and no imminent breakup of the industrial conglomerate on the table, we believe maximum pessimism has been reached. Following today's sharp sell-off, GE shares are trading at a level that implies that the portfolio is incapable of returning to meaningful earnings growth; however, we do not believe this reflects the company's longer-term potential, considering that 70% of GE's revenue and 85% of its earnings come from businesses that dominate their markets. While we acknowledge that 2018 will be messy, and that 2018 earnings will exhibit a lot of accounting and restructuring noise, we assert that GE's collection of assets can return to healthy free cash flow generation over the long run under today's better management.

In these early days of Flannery's tenure, we like that his messaging repeatedly addresses questions we consider most important to investors: How will GE improve its free cash flow, and how will the company allocate that cash going forward? Cutting the dividend is painful, but it frees capital to allocate toward restructuring sorely needed to rightsize the power segment. Flannery also highlighted $20 billion of assets earmarked for divestiture over the next two years, including transportation, lighting, and up to 10 other smaller businesses, a sign of purposeful redirection of capital and management attention toward businesses with strong potential for secular growth. Finally, management incentives will be pegged to free cash flow performance, a change we welcome to better align the company's interests with shareholders'.

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*Investment research is produced and issued by subsidiaries of Morningstar, Inc. including, but not limited to, Morningstar Research Services LLC, registered with and governed by the U.S. Securities and Exchange Commission. Analyst ratings are subjective in nature and should not be used as the sole basis for investment decisions. Analyst ratings are based on Morningstar’s analysts’ current expectations about future events and therefore involve unknown risks and uncertainties that may cause such expectations not to occur or to differ significantly from what was expected. Analyst ratings are not guarantees nor should they be viewed as an assessment of a stock's creditworthiness. Ratings, analysis, and other analyst thoughts are provided for informational purposes only; references to securities should not be considered an offer or solicitation to buy or sell the securities.

©2017 Morningstar, Inc. All rights reserved. The Morningstar name and logo are registered marks of Morningstar, Inc. The information contained in this document is the proprietary material of Morningstar, Inc. Reproduction, transcription, or other use, by any means, in whole or in part, without the prior written consent of Morningstar, Inc., is prohibited. All data presented is based on the most recent information available to Morningstar, Inc. as of the release date and may or may not be an accurate reflection of current data.  There is no assurance that the data will remain the same.

Disclosure:
The commentary, analysis, references to, and performance information contained within Morningstar® StockInvestorSM, except where explicitly noted, reflects that of portfolios owned by Morningstar, Inc. that are invested in accordance with the Tortoise and Hare strategies managed by Morningstar Investment Management LLC, a registered investment adviser and subsidiary of Morningstar, Inc. References to "Morningstar" refer to Morningstar, Inc.

Opinions expressed are as of the current date and are subject to change without notice. Morningstar, Inc. and Morningstar Investment Management LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only and has not been tailored to suit any individual.

The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

Investments in securities are subject to investment risk, including possible loss of principal.  Prices of securities may fluctuate from time to time and may even become valueless.  Securities in this report are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information. Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

Common stocks are typically subject to greater fluctuations in market value than other asset classes as a result of factors such as a company's business performance, investor perceptions, stock market trends and general economic conditions.

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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