Underlying Trends in U.S. Tobacco Improve in Q2; Altria Still Undervalued
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 07-29-20

Altria reported a resilient second-quarter performance, with revenue slightly above our expectations, although smokeless margins were a little light. Underlying trends in the U.S. cigarette industry improved during the lockdown period, and we expect some degree of mean reversion next year. We are modestly raising our forecasts for this year, but retain our $54 fair value estimate and wide moat rating. Altria, like the rest of the tobacco group, remains undervalued relative to our estimate of its intrinsic value.

Reported cigarette shipment volume was down by almost 9% in the second quarter, offset by 6% pricing. After adjusting for inventory trade movements, however, the underlying smokeable volumes fell by just 2%, a significant improvement from the 4% to 5% decline of recent years. We think this is for two reasons. The first is the temporary effect of smokers staying at home and having more time, social freedom and discretionary income to spend on smoking. The second is the structural effect of nicotine consumers switching back to smoking from vaping, following the clampdown on flavored nicotine liquids by the Food and Drug Administration, or FDA. While it is difficult to quantify the impact of these factors, and management has refrained from reinstating medium-term guidance, we believe our medium-term estimate of a 3.5% annual volume decline in a normalized environment remains realistic, and assumes a material contraction in the vaping category.

Maintaining Our $219 FVE for Amgen Ahead of Significant Second-Half 2020 Pipeline Catalysts
by Karen Andersen, CFA | Morningstar Research Services LLC | 07-29-20

Amgen reported second-quarter results that were in line with our expectations, and we're maintaining our $219 per share fair value estimate. Shares continue to look slightly overvalued, although several potential pipeline catalysts in the second half of the year could lead us to increase our assumed probabilities of approval if data are positive. Overall, demand for Amgen's newer products like immunology drug Otezla are countering the temporary headwind from COVID-19 (lower use of hospital and doctor's office-administered therapies, like bone-strengthening drug Prolia) and the expected continuing headwinds from generic Sensipar and biosimilar versions of neutropenia drug Neulasta and anemia drug Epogen. Amgen's diversified portfolio and solid pipeline continue to support a wide moat.

We expect Amgen to continue to face pricing pressure for migraine drug Aimovig, particularly as oral competitors begin to reach the market, but pricing headwinds for cholesterol-lowering drug Repatha should abate in the second half of the year as the firm reaches the anniversary of past price drops. While the loss of the CVS national formulary positioning for Repatha reduces coverage, Amgen still has coverage for 75% of the market, and we think its dominance over Regeneron/Sanofi's Praluent and solid cardiovascular outcomes data will allow it to continue to see strong growth despite incoming competition from Novartis' inclisiran.

Cautious Dealers Pare Inventories, but No Major Surprises in Caterpillar's 2Q
by Scott Pope, CFA | Morningstar Research Services LLC | 07-31-20

As the pandemic impeded commerce across the globe and spooked dealers, Caterpillar's revenue declined 31% in the second quarter to $10 billion. Caterpillar's independent dealer base reduced inventories by $1.4 billion in the quarter compared with a $500 million increase in the second quarter of 2019. This $1.9 billion change was a major factor in the $4.4 billion year-over-year sales decline. Caterpillar's retail sales decline was a less severe 23% with Asia-Pacific the sole geography that grew at the retail level (+7%). Despite significant rationalization of its manufacturing footprint in the past decade, Caterpillar has significant fixed costs. We were modestly impressed that operating margin was 7.8% in the quarter, which was a major improvement over the 1.9% it experienced in 2009 during the financial crisis. Adjusted EPS plummeted to $1.03 from $2.83 in second-quarter 2019. Our fair value estimate of $148 remains unchanged.

Even before COVID-19 hit, conservatism was pervasive across many end markets after a long period of economic growth. We believe recent dealer and end-user spending patterns could be an overreaction as much of the markets served are essential industries that haven't been directly impacted by the pandemic. That said, equipment purchases are often influenced by operational cost trends that are driven by fuel prices and labor shortages that aren't pressing now. Regardless, we believe Caterpillar's strategy of manufacturing premium equipment with lowest total cost of ownership equipment is optimal regardless of economic conditions. The recent pandemic highlighted unanticipated benefits of Caterpillar's leading autonomous and telematics solutions that reduce person-to-person interaction, which could lead to share gains in the long run. Moreover, increased gold and copper prices could boost adoption of Caterpillar's autonomous mining solutions as these miners have historically been strong adopters of such technology.

Broadband Shines Again in Comcast's Second-Quarter Results as the Pandemic Hits Media
by Michael Hodel, CFA | Morningstar Research Services LLC | 07-30-20

Despite several challenges, Comcast produced exceptional broadband customer growth during the second quarter, and cash flow generation was similarly impressive. On a consolidated basis, revenue declined 12% and EBITDA dropped 9% versus a year ago. Free cash flow, however, increased sharply thanks to shifts in working capital and minimal cash tax payments. As expected, results in theme parks and film were poor, and weak ad revenue weighed on the television business. Sky also struggled during the quarter, and management expects earnings will decline 60% in the second half of the year as revenue slowly recovers and sports rights fees spike. Overall, we believe Comcast is managing well through the pandemic and we don't expect to materially change our $47 fair value estimate. With the shares grinding higher in recent weeks, we believe the stock is approaching fair value.

The broadband business was again a key beneficiary of the pandemic, coupled with Comcast's strong position in this market. Net customer additions during the quarter were up sharply versus a year ago (323,000 versus 209,000) and were the strongest second-quarter figure in more than a decade. Also, broadband customer additions exclude about 600,000 Internet Essential and “high-risk” customers. The television business was predictably weak given the lack of live sports, shedding 477,000 customers. Total cable segment revenue (about 60% of the consolidated total) declined 0.2% but would have grown 1.4% absent an accrual for fees that Comcast expects regional sports networks will return and it will rebate to customers. While this accrued rebate is small ($10-$11 per television customer), it is a step in the right direction toward improving customers' perception of the value of live television.

Compass Shares Rally as Salt Profits Continue to Be Restored
by Seth Goldstein, CFA | Morningstar Research Services LLC | 08-05-20

Compass Minerals' profit restoration was evident in its second-quarter results as adjusted EBITDA was up 44% year on year, primarily driven by improved performance in the salt business. With our long-term outlook intact, we maintain our $81 fair value estimate. Our wide moat rating is also unchanged.

The low-cost Goderich mine struggled with issues from 2016 to 2018, but our thesis was that profits in the salt business would be restored. This long-term outlook has driven our view that Compass shares have been undervalued. On the news of improving salt profits, shares were up nearly 7% at the time of writing. However, we continue to view Compass shares as undervalued, still trading in 4-star territory.

In the salt business, operating earnings during the second quarter were roughly double from a year ago. The increase was driven by higher volumes and a 9% year-on-year decrease in unit production costs. Operating margins were over 24% during the second quarter, compared with a mere 13% a year ago. Margins were in line with our long-term outlook for the salt business in the mid- to high 20s.

Dominion Energy Reports Solid Q2 Results as COVID-19 Impact Diminishes
by Charles Fishman, CFA | Morningstar Research Services LLC | 07-31-20

We are reaffirming our fair value estimate of $80 per share after wide-moat Dominion Energy reported solid 2020 second-quarter operating earnings per share of $0.82 versus $0.77 in the same period in 2019, discussed the impact of COVID-19 on electric sales, and fine-tuned its planned equity capital market financing activities over the next five years. The second-quarter results were not adjusted for the recently announced sale of most of the assets in the gas, storage, and transmission segment.

We are also reaffirming our 2020 EPS estimate of $3.50, the midpoint of Dominion's unchanged guidance range of $3.37-$3.63. Strong residential and data center demand continued to support electricity sales for Dominion Energy Virginia, and weather-normalized sales are actually slightly higher than the two-year average since the pandemic began in March.

At Dominion Energy South Carolina, sales have for the most part recovered and month to date in July are only 1% below normal demand. Through June 30, Dominion estimates COVID-19 has negatively affected operating EPS by $0.04, which has been largely offset by cost reductions, giving us a high level of confidence in our earnings estimate.

Dominion plans to issue slightly more equity than we had assumed in 2021-24. However, the recent strength in the share price more than offset the modest increase in equity with respect to our estimate of weighted average shares outstanding for 2023-24. Thus, our EPS growth rate increased 40 basis points for 2020-24, to 7.9%, but there was no material impact on our fair value estimate.

Dominion also announced that Robert Blue will become CEO on Oct. 1. Tom Farrell, who has been CEO since 2006, will continue to serve as executive chair. Blue, currently executive vice president and co-chief operating officer, previously held positions at Dominion that included responsibility for regulation and public policy. Before joining Dominion in 2005, he served as a counselor to the governor and director of policy for Virginia Gov. Mark Warner. With the majority of Dominion's projected investment in renewable energy in Virginia over the next decade, we think Blue's selection to replace Farrell, who recently turned 65, is a great choice.

Duke Energy Reaches Partial Rate Case Settlement with North Carolina Commission Staff
by Andrew Bischof, CFA, CPA | Morningstar Research Services LLC | 07-31-20

We are reaffirming our $92 per share fair value estimate for Duke Energy after the company's Duke Energy Carolinas and Duke Energy Progress subsidiaries reached a partial settlement agreement with the North Carolina Utilities Commission in connection to the subsidiaries' general rate case. Our narrow moat and stable moat trend ratings remain unchanged.

Duke Energy's combined rate request at the subsidiaries filed late last year was for a $755 million revenue increase and 10.3% allowed return of equity. Under the proposed settlement agreement, the utilities will be granted a 9.6% allowed return on equity and a capital structure with 52% equity and 48% debt. The allowed return on equity was slightly lower than our expectations. Incorporating the lower proposed rates does not have a material effect on our fair value estimate. The proposed capital structure is in line with our expectations.

Additional components of the settlement include an agreement on deferral treatment for a portion of planned grid improvement projects, including an appropriate return. An agreement for the inclusion of plant in service and other updates as of May 31 is a positive. However, the staff and Duke Energy have not reached a settlement on two key matters, the most contentious likely being the recovery for coal ash basin expenditures. Annual depreciation expense on some of Duke's coal fired generation plants also remains open. The settlement is subject to commission review.

Enbridge Beats Expectations Again
by Joe Gemino, CPA | Morningstar Research Services LLC | 07-29-20

Enbridge reported another strong quarter that surpassed our expectations along with Cap IQ consensus expectations as of July 27. The company reported second-quarter adjusted EBITDA of CAD 3.31 billion, which was up from CAD 3.21 billion in the year-ago quarter. Distributable cash flow of CAD 2.44 billion was also up from the second quarter of 2019 when DCF was CAD 2.31 billion. The better-than-expected results were driven by higher-than-expected utilization on gas pipelines, increased earnings from rate case settlements, and increased energy services earnings from storage opportunities. Results were

partially offset by lower Mainline throughput related to lower oil demand from the coronavirus.

Despite the better-than-expected results, we don't see any material changes to our long-term outlook. As such, we are maintaining our CAD 57 fair value estimate, but increasing our U.S. estimate to $43 (from $40) based on movement in foreign exchange rates.

Enterprise's Results Show Its Resilience to Brutal Environment
by Stephen Ellis | Morningstar Research Services LLC | 07-29-20

Enterprise Products Partners reported a solid second quarter in a brutal energy environment. After updating our model, we will maintain our $25.50 fair value estimate and wide moat rating. The diversity of Enterprise's operations across basins, hydrocarbons, and the midstream value chain helped cushion the partnership's results, as gross operating margin fell only $50 million sequentially to $2 billion. Similarly, EBITDA fell by a bit more -- over $100 million -- to $1.96 billion, but this was within our expectations, as our full-year forecast of $7.75 billion remains unchanged after our updates.

The focus remains on protecting the balance sheet, while prudently allocating capital. Current liquidity is $7.3 billion, made up of a $6 billion credit facility and $1.3 billion in cash on hand, and adjusted debt/EBITDA is about 3.4 times, which we consider prudent. Capital spending forecasts continued to decline for 2021 and 2022, falling to $3.3 billion from $4 billion in the prior quarter, as projects are deferred and canceled due to weak economics. The bulk of the spending is just three projects: PDH 2, Midland-to-ECHO 4, and a natural gas pipeline. We still consider the units to be deeply undervalued and note that Enterprise has expressed a willingness to devote more than 2% of its operating cash flow to buybacks this year if opportunities arise. Eighty-eight percent of the business remains fee-based.

Exxon Reports Q2 Loss, but Dividend Looks Safe After Management Reiterates Commitment
by Allen Good, CFA | Morningstar Research Services LLC | 08-03-20

Exxon reported its second consecutive loss during the second quarter as the fallout from the coronavirus pandemic likely reached its peak. Second-quarter earnings fell to a loss of $1.1 billion from earnings of $3.1 billion last year. Operating results were actually worse, as earnings benefited from a $1.9 billion noncash inventory valuation adjustment because of rising commodity prices. Adjusted earnings were a loss of $3.0 billion compared with earnings of $2.6 billion last year.

Cash burn intensified during the quarter as free cash flow was negative $5.1 billion as Exxon generated only $1.5 billion in operating cash flow during the quarter, excluding changes in working capital, falling well short of covering capital spending and the dividend. Debt increased by $10 billion during the quarter, bringing its net debt/capital ratio to 25%, which remains manageable. Also, management does not expect to raise any more additional debt given current conditions. It is also working on identifying additional operating cost reductions beyond the targeted 15% reduction this year. Reductions in 2020 capital spending to reach $23 billion are ahead of schedule, so that fourth-quarter spending will fall to an annual run rate of $19 billion and be below that level in 2021. Management also reiterated its commitment to the dividend, which likely means the payout will not be cut, assuming macroeconomic conditions continue to improve. Exxon currently yields more than 8%.

Raising Genuine Parts' Fair Value Estimate
by Zain Akbari, CFA | Morningstar Research Services LLC | 08-03-20

Largely reflecting the time value of money after it reported on-track second-quarter earnings (5% first-half sales decline, excluding divestitures, across the automotive and industrial units), we are lifting our valuation of Genuine Parts to $90 per share from $89, implying forward fiscal 2021 enterprise value/adjusted EBITDA of 12 times and adjusted forward P/E of 17, incorporating 4% organic revenue growth and a 7% operating margin, on average, over the next decade.

The pandemic's dramatic reduction in economic activity should hit both segments. Unlike the sub-2% pullback under recessionary conditions in 2009, we expect the large numbers of cars and trucks pulled off the road as a result of shelter-in-place orders (exacerbated by a mild winter) will lead to a low- to mid-single-digit percentage revenue slide for the automotive unit in 2020, including an emergence into a more conventional recession in the second-half. Longer-term conditions are sound, with rising vehicle age and benefits to come from larger, post-financial-crisis sales cohorts aging into retailers' sweet spot. We still expect 4% average organic segment sales growth long term, outpacing low-single-digit industry expansion as scaled sellers assert their advantages. Focus on more profitable DIY customers as well as rising infrastructure and inventory leverage should lead segment margins to approach 10% long term from 7.6% in 2019.

Boosting Hanesbrands' Fair Value Estimate
by David Swartz | Morningstar Research Services LLC | 08-04-20

We are raising our fair value estimate on Hanesbrands to $24 from $23 after the company reported adjusted EPS of $0.60 in the second quarter of 2020. While this gain was greatly influenced by nonrecurring sales of personal protective equipment, it had a big impact on our 2020 estimates. We are raising our 2020 adjusted EPS and sales estimates to $1.38 from $0.71 and to $6.3 billion from $5.6 billion, respectively. Moreover, we are lifting our adjusted operating margin forecast to 12.3% from 8.7%. Our fair value estimate implies the following 2020 valuation ratios: adjusted price/earnings of 17, enterprise value/adjusted EBITDA of 13, and free cash flow yield of 6%.

We anticipate that Hanes will begin to recover from COVID-19 next year and generate about $6.9 billion in sales and $1 billion in operating profit by 2023. Further, we estimate the firm will generate approximately $3.4 billion in free cash flow to equity over the next five years. Given uncertain timing, our estimates do not include any contributions from acquisitions.

Lloyds' First Half Shows Loss After Sizable but Expected Loan-Loss Provisions
by Niklas Kammer | Morningstar Research Services LLC | 07-30-20

Narrow-moat Lloyds reported an underlying loss before taxes of GBP 281 million in the first half of the year after setting aside GBP 3.8 billion for potential future loan losses. We maintain our fair value estimate of GBX 62 per share. Income declined across the board for the group, down 16% versus the same period a year ago, as economic activity slowed during the coronavirus-induced lockdown. Net interest income of GBP 5.5 billion versus GBP 6.1 billion in the year-ago period was weak as a result of a declining net interest margin to 2.6% from 2.9% a year ago without the typical tailwind from higher volume supporting income. Operating expenses showed a good performance (down 5%), but this was not enough to offset the overall decline in income (down 16%).

Loan-loss provisions were large at GBP 3.8 billion, although this did not really come as much of a surprise as IFRS 9 models are intended to be forward-looking, forcing banks to take provisions now for losses that could materialize in the future. In the first half of the year, Lloyds experienced about GBP 0.8 billion in loan losses in a normalized or pre-COVID-19 environment, which is up GBP 0.2 billion versus the same time a year ago but coming off a low base. Overlaying this with current estimates of the economy's downward trajectory and subsequent recovery results in the remaining charges. However, an important takeaway is that unless the outlook for or actual pathway of the economy differs from Lloyds' current assumptions, provisions for the remainder of the year should sit somewhere in the vicinity of GBP 0.8 billion. Lloyds itself provided guidance of GBP 4.5 billion-5.5 billion. Our full-year assumption of GBP 4.3 billion therefore is on the light side, which we plan to amend, but which should not have a material impact on our fair value estimate.

Magellan's Refined Product Network Takes an Expected Hit in the Second Quarter
by Stephen Ellis | Morningstar Research Services LLC | 07-30-20

Magellan's second-quarter results reflected the sharp drop in refined product demand, given travel and economic restrictions in place during the quarter. Distributable cash flow for the quarter fell to $210 million compared with $315 million last year, as both refined product volumes and crude-oil pipeline volumes declined 20% and 41%, respectively, due to weaker economic activity and unfavorable differentials limiting crude-oil spot market shipments. Management trimmed its 2020 distributable cash flow guidance to a midpoint of $1.025 billion compared with $1.0375 billion last quarter, given the uncertainty over the demand recovery in the second half of the year. The refined product assumptions include a 6% decline in gasoline, 12% for distillate, and 40% for aviation fuel in the second half for volumes, which will be roughly flat once the impact of expansion projects is included. The change in guidance is not material enough to affect our $55 fair value estimate or wide moat rating.

Industry Uncertainty Looms, but Marketing War Chest and Drive-Thrus Offer McDonald's Advantages
by R.J. Hottovy, CFA | Morningstar Research Services LLC | 07-28-20

Comp trends have continued to improve since wide-moat McDonald's mid-June update, but the key question coming out of the second quarter is whether this is sustainable. June consolidated comps decreased 12.3%, up from a 20.9% decline in May, and July comps appear to be on pace for a mid- to high-single-digit decline (with U.S. running slightly positive, international operated markets running at mid- to high-single-digit declines, and international developmental licensed markets likely running at high teens declines).

On one hand, macro pressures (including elevated unemployment, which has historically been a leading indicator for quick-service restaurant sales trends, and uncertainty regarding future government assistance), a potential return of restaurant operating restrictions in several markets, an uptick in industry promotional activity, and softer breakfast trends due to the reduction in morning commuters will likely result in uneven month-to-month sales trends in the back half of 2020.

On the other hand, we share management's view that the second quarter is likely to be the sales trough for the year. First, with McDonald's choosing to conserve its resources until COVID-19 containment efforts stabilize, it has amassed a significant "marketing war chest" (including a commitment for $200 million in marketing support in the U.S. and international operated markets), which gives it multiple ways to stimulate growth, including greater emphasis on value. Second, we see increasing contribution from McDonald's drive-thrus due to efficiency improvements (15-20 seconds of per-order improvement in major markets) and Dynamic Yield's suggested ordering technologies, which should drive average check sizes higher. Lastly, we expect menu innovation across all dayparts in the back half of the year, including new value and chicken products. Taken together, we don't plan a material change to our $205 fair value estimate, and we see the shares as modestly undervalued.

Omnicom Q2 Revenue Battered by the Pandemic, with Less Impact on Margins
by Ali Mogharabi | Morningstar Research Services LLC | 07-28-20

Omnicom's second-quarter revenue beat our projection, but it came in lower than the FactSet consensus. In our view, while the firm may have benefited from some clients returning to ad spending in late second quarter, questions about the possibility of a second wave of the coronavirus pandemic and the return of business lockdowns in the U.S. remain. Some cost control, mainly on the headcount, resulted in Omnicom's adjusted bottom line beating our expectations and the FactSet consensus. Management issued guidance for a continuing year-over-year decline in revenue during the second half this year, similar to what we have assumed; although it believes the decline has decelerated since March. We did not make significant adjustments to our model and are maintaining our $79 fair value estimate. While the pandemic continues to pose risk in the near term, we think this narrow-moat name can withstand the current downturn and will quickly react favorably to any indication of an economic recovery post the pandemic. With continuing profitability and no debt coming due until May 2022, we are confident Omnicom can maintain its quarterly dividend, which is currently yielding nearly 5%.

Pfizer Posts Slightly Better-Than-Expected Q2 as COVID-19 Pressures and Generics Weigh on Results
by Damien Conover, CFA | Morningstar Research Services LLC | 07-28-20

Pfizer reported second-quarter results slightly ahead of our and consensus expectations, but we don't expect any significant fair value estimate changes based on the minor outperformance. We continue to view the stock as undervalued, with the market likely underappreciating the firm's strong immunology pipeline and entrenchment in vaccines. Pfizer's recent stock appreciation appears partly driven by the firm's progress with a COVID-19 vaccine along with its partner BioNTech, but we would urge caution in ascribing significant value related to the COVID-19 vaccine; a long duration of COVID-19 vaccine cash flows seems unlikely due to the probable entry of competitive, not-for-profit vaccines and potentially less demand following the pandemic period. Nevertheless, Pfizer's remarkable ability to potentially bring a vaccine to the market in late 2020 shows the strength of the firm's ability to develop innovative treatments, a core element supporting its wide moat rating.

Plains Remains Deeply Undervalued After Challenging Quarter; Boosts Outlook
by Stephen Ellis | Morningstar Research Services LLC | 08-05-20

During a challenging environment, Plains reported a solid quarter, in our view. Overall adjusted EBITDA fell to $524 million from $784 million last year, mainly due to the loss of nearly $200 million in supply and logistics EBITDA contributions. We will maintain our $18 fair value estimate and narrow moat rating. Adjusted 2020 EBITDA is now expected to be around $2.5 billion, up around $75 million due to slight improvements across all areas of its business, while capital spending has been trimmed $100 million to $1.45 billion over 2020-21. Beyond 2021, growth capital spending will be in the $350 million to $450 million range, by our estimates. Broadly, Plains expects more Permian completions activity in the second half of the year tempered by demand and production declines, as well as producer capital discipline. The firm also expects to repay its $600 million 2021 maturity in the fourth quarter, and after a $750 million note issuance in June, it does not expect to need to access the capital markets for the time being.

As a result, Plains' balance sheet looks healthy, in our view. Liquidity is about $2.9 billion, and long-term debt to adjusted trailing EBITDA is about 3.2 times. We expect leverage to increase to around 3.6 times by the end of the year, but as capital spending declines, Plains will quickly fall below 3 times by 2022. Plains has also started to emphasize free cash flow after distributions, and while it is currently not generating adjusted free cash flow, we think this is a good step toward improving capital allocation.

P&G Continues to Clean Up, but Valuation Is Far from a Bargain
by Erin Lash, CFA | Morningstar Research Services LLC | 07-30-20

It wasn't that long ago when wide-moat Procter & Gamble was dogged quarter-after-quarter for boasting lackluster revenue growth; however, with the company posting its eighth consecutive quarter and second consecutive year of mid-single-digit organic revenue growth, we don't think these concerns are top of mind for investors at this juncture (with shares up more than 2% on the print). We attribute this staunch performance to its radical decision six years ago to materially prune its brand mix (cutting more than 100, leaving it with just 65) and focus its resources on its highest return opportunities as a means to more nimbly respond to evolving consumer trends.

But the firm hasn't gone headfirst into boosting its sales trajectory. Rather, it has astutely balanced driving profitable top-line improvement. This was again evidenced in the fourth quarter, as adjusted gross and operating margins expanded 210 and 140 basis points, respectively, to 50.9% and 21.0%. And we don't expect the firm will prioritize margin gains to the detriment of its leading brand mix and its entrenched retail relationships. As such, our forecast continues to call for P&G to expend 3% and 11% of sales to research and development and marketing, respectively, up from less than 3% and 10.5% on average the past few years.

Although uncertainty abounds (and is unlikely to wane over the near term), we think P&G maintains the wherewithal to withstand impending macro and competitive pressures. We will likely bump up our $109 fair value estimate by a low- to mid-single-digit percentage to reflect the firm's full-year performance and the time value of money but don't expect to materially amend our longer-term outlook (nearly 4% average annual sales growth and a 200-basis-point bump in operating margins relative to fiscal 2020, to more than 24%, by fiscal 2029). However, shares fail to offer an attractive risk/reward opportunity at present, trading about 20% above our valuation.

Starbucks Poised for Post-COVID-19 Growth Acceleration Via Access
by R.J. Hottovy, CFA | Morningstar Research Services LLC | 07-29-20

We expect investor sentiment on wide-moat Starbucks will start to shift away from the pace of its COVID-19-related recovery and instead focus on its post-pandemic growth potential following third-quarter results that matched its mid-June update and a relatively upbeat outlook for the fourth quarter and fiscal 2021. While it still lags many QSR chains due to morning commute disruptions and its experience-focused formats, we see several ways that Starbucks is positioned to take market share in a specialty coffee category that will likely be hit harder than many other restaurant subcategories.

First, it is finding ways to give consumers greater access. In the past, we've been constructive on plans to increase drive-thru and pickup locations in several key markets, but strategic initiatives such as digitally enabled curbside pick-up at 700-1,000 locations by the end of the fourth quarter will give consumers even greater access to the brand. Second, digital capabilities (mobile ordering, loyalty program, and delivery capabilities) have kept sales trends ahead of most small specialty coffee chains, a trend we expect to accelerate in fiscal 2021. Finally, because Starbucks continues to invest more heavily in its business than peers (employee wages and benefits, other COVID-19-related safety measures), we expect it will face fewer operating issues over the near term (even if profits lag sales in fiscal 2021, as CFO Pat Grismer pointed out).

UPS' B2B Volumes Anemic, but B2C Package Spike a Nice Offset, and Margins Stabilizing
by Matthew Young, CFA | Morningstar Research Services LLC | 07-30-20

Small-package delivery giant UPS' second-quarter revenue increased 13% year over year, surprisingly better than the 5% growth posted last quarter and ahead of our forecast. The pandemic has materially accelerated the broader shift to e-commerce sales for large retailers, driving another spike in residential deliveries across the U.S. and Europe. Also, strong airfreight demand out of Asia benefited the international package and global forwarding units. Overall, solid Asia outbound demand and robust B2C package growth more than offset depressed B2B package activity and a pullback in demand for the truckload brokerage and less-than-truckload trucking divisions.

U.S. domestic package revenue rose 17% year over year, as the B2C package spike (up 65%) offset 22% lower commercial B2B deliveries, which were hit by pandemic lockdowns and soft industrial end markets. Domestic average daily volume increased 23%. International package sales grew 7% (adjusted for FX) as outbound demand from Asia and higher cross-border e-commerce shipments in Europe offset anemic B2B activity. International volume expanded 10%.

The drastic mix shift to B2C (which carry lower margins), COVID-19 expenses, pension costs, and higher employee incentive payments pushed adjusted U.S. domestic EBIT margins down 170 basis points to 9.3%. That said, margins showed excellent sequential improvement. International package margins increased on solid utilization management, but supply chain profitability contracted, likely due to lower brokerage gross margins and soft LTL volumes. Total adjusted EBIT margin fell 60 basis points to 11.4% but was well ahead of our expected run rate.

We are raising our fair value estimate to $112, from $107 due to boosting our 2020 and 2021 revenue and margin forecasts, as domestic and international package trends came in well ahead of our forecasts. Even so, we still see elevated downside risk to our estimates given the threat of incremental pandemic

disruption.

The Massive Decline in Senior Housing Fundamentals Was in Line with Our Q2 Expectations for Ventas
by Kevin Brown | Morningstar Research Services LLC | 08-07-20

Despite a significant drop in senior housing operations, we maintain our $50 fair value estimate for no-moat Ventas as the company performed relatively in line with our expectations for the second quarter. Occupancy in the same-store senior housing portfolio sequentially fell 470 basis points to 82.2%. With rate growth declining 0.5% year over year, same-store revenue fell 8.1%. However, additional cleaning costs caused operating expenses to rise 83%, causing same-store net operating income to fall 42.7% in the quarter. While senior housing saw a massive drop, the other segments held up in the quarter, with NOI growth of 1.4% for the triple-net senior housing portfolio, 14.4% growth for life science, and only a 0.4% decline for the medical office portfolio. Combined, the total same-store NOI growth for the company was a 13.9% decline in the second quarter. This drop in operating income led to a 21.1% year-over-year decline in Ventas' normalized funds from operations with a $0.77 figure for the second quarter, which was only $0.03 below our $0.80 estimate for the quarter.

Senior Housing Declines Drag Down Results for Welltower in the Second Quarter
by Kevin Brown | Morningstar Research Services LLC | 08-06-20

Welltower reported second-quarter results that were slightly worse than we had anticipated, though we don't see anything in the quarter that will have a material impact on our $73 fair value estimate for the no-moat company. Welltower's same-store net operating income fell 10.5% as the senior housing operating portfolio, which represents more than 40% of Welltower's total NOI, fell 24.5% in the quarter. Occupancy in the same-store sequentially fell 410 basis points to 82.7% in the second quarter, better than the 77.2% occupancy we had assumed. Rate growth declined 20 basis points year over year, leading to same-store revenue falling 4.6%. However, same-store expenses were up 4.5%, leading to the 24.5% same-store NOI decline that was worse than our estimate of a 16.3% decline. The other segments fared better with 1.4% growth for the triple-net senior housing portfolio, 1.8% for medical office, 1.4% for health systems, and 2.1% for skilled nursing, though all of those were slightly below our estimates. As a result, normalized funds from operations came in at $0.86 in the second quarter, below the $1.02 mark the company reported in the first quarter.

It appears that our fears of senior housing occupancy declines might have been conservative. The spot occupancy for the portfolio by month shows that April saw a 220-basis-point decline and May saw a 180-basis-point decline, but the decline slowed in June and July with just 90-basis-point and 70-basis-point declines, respectively. Management stated that 95% of its centers are currently accepting new residents and, while move-out activity is likely to continue to exceed move-in activity, it predicts that occupancy losses are expected to range between only 125 and 175 basis points in the third quarter. Therefore, while we had predicted that the situation would continue to worsen for the senior housing portfolio over the course of the year, it appears that the second quarter might be as bad as it gets for the company.

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