Johnson & Johnson JNJ and Coca-Cola KO both declared quarterly dividends this week that were unchanged from their previous quarterly payouts.

Please see new analyst updates below from Morningstar Research Services for both firms (two notes for J&J), along with notes for Altria MO, BB&T BBT, BlackRock BLK, Genuine Parts GPC, Omnicom OMC (two separate notes), Philip Morris International PM, and Wells Fargo WFC.

Best wishes,

David Harrell
Editor, Morningstar DividendInvestor

Lowering Our Fair Value for Altria as We Make Assumptions Over iQOS Adoption in the U.S.
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 10-16-19

We are lowering our fair value estimate of Altria to $56 per share from $58 and raising our uncertainty rating to medium from low, after adjusting our revenue and margin forecasts over our five-year forecast period and lowering our fair value estimate of AB InBev. We think the expected rollout of iQOS will be margin dilutive, and we see greater risk from Altria's exposure to vaping, which could face a marketing clampdown in the coming months. Nevertheless, we believe Altria remains significantly undervalued.

The major change to our model is the assumption that iQOS, a technology developed by Philip Morris International and to be distributed in the U.S. by Altria, is rolled out across the U.S. next year. The company began test-marketing the product in 500 stores across Atlanta, Georgia earlier this month and we estimate marketing of the product could move into the broader commercialization phase by second half-2020. We expect adoption to be fairly slow, with the low-income skew of U.S. smokers likely to be a hurdle to selling the $100 devices. The great unknown is the revenue share between Altria and PMI, so we assume a 60/40 split in Altria's favor, given it will assume distribution costs. Our assumption, therefore, is that iQOS achieves 3% share by 2023 This is in line with its progress in some European markets, which we expect will be representative of adoption in the U.S. Offsetting this incremental growth opportunity is the cannibalization of Altria's cigarette portfolio and we now assume premium cigarettes will decline at 5% a year in our forecast period, up from 4.5% previously.

Business Generally Remains Strong for BB&T in Q3 as the Bank Prepares for Merger in Q4
by Eric Compton | Morningstar Research Services LLC | 10-17-19

Narrow-moat rated BB&T reported good third-quarter results, with adjusted return on average assets of 1.5% and adjusted return on average tangible equity of 18.07%. Adjusted EPS was $1.07 for the quarter, up 3.9% while taxable equivalent revenue was up 2.5% year over year. Excluding merger-related and restructuring charges, adjusted expenses increased 1.7%, mainly reflecting higher incentives and commissions. Management reiterated its confidence in expected synergies from the merger with SunTrust, citing approximately $1.6 billion of cost synergies and potential revenue synergies as well, and management continues to expect the merger will close in the fourth quarter of 2019. Management also stated that it is adjusting the balance sheet in preparation for the merger and hopes to be relatively neutral to rates once the merger closes. With an uncertain future rate environment offset by potential merger synergies, we are maintaining our fair value estimate at $52 per share.

BB&T's insurance segment remains impressive as the bank continues to deliver on cost saving synergies from the acquisition of Regions Insurance. New business volume increased 17% this quarter and retention rates remain high as well. This is occurring alongside firming market prices. The margin expansion of over 300 basis points and organic growth of over 8% continues to reflect the strength of the segment. Solid year-over-year fee growth continues to be driven by insurance fees accompanied by strength in investment banking and mortgage banking fees. Net interest margins were down, mainly due to lower rates and a flattening yield curve.

Loan growth remains decent, with average loans up almost 5% year over year, excluding a loan sale. This was due to strong commercial and industrial growth accompanied by growth in credit cards and retail indirect lending. Average deposits grew 3%. While interest bearing deposits were still growing faster than noninterest bearing, we are already starting to see a turn in deposit pricing as the total deposit cost dropped 1 basis point. We would expect this to accelerate into the next quarter. Overall credit quality remains strong for the bank, with key measures of asset quality and credit costs remaining within expected range.

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.

Coke Continues to Execute and Deliver on Strategic Priorities; Growth Vectors Already Priced In
by Nicholas Johnson | Morningstar Research Services LLC | 10-18-19

Wide-moat Coca-Cola reported solid third-quarter results that were largely in line with consensus as well as our expectations. Management's key strategic initiatives, predicated on innovation, revenue growth management, and digitization, continue to bear fruit and drive strong organic growth. We plan to increase our $53 fair value estimate by a low-single-digit percentage, reflecting primarily the time value of money as well as modestly lower guidance for capital outlays. Still, we see the current valuation as fully reflective of Coke's unparalleled competitive positioning and prospects, and we would advise investors to await a wider margin of safety.

Coke's results continue to be somewhat obfuscated by various structural changes, such as Coca-Cola Beverages Africa and the refranchising of Canadian bottling operations, but underlying performance looks strong. Reported revenue of $9.5 billion represented an 8% increase year over year, with growth across all segments and particularly robust contributions (high single digits) from global ventures (housing Costa, 2% of revenue) and bottling investments (11% of revenue). Price/mix contributed the preponderance of organic revenue growth (5% in the quarter), as concentrate volumes declined 2%. However, this is more a function of shipment timing, as unit cases across the system were up 2%, and we still expect volumes to be a marginally stronger contributor (roughly 2.5% on average) to the top line longer term, owing to Coke's leadership position in numerous emerging markets.

Gross and adjusted operating margins of 60.4% and 28.1% compressed 250 and 470 basis points year over year, respectively, reflecting currency headwinds, outperformance of lower-margin finished-goods businesses, timing of certain marketing investments, and a litany of other structural items. Still, we expect many of these to be transitory, and continue to expect meaningful expansion, particularly at the operating margin line (32% by 2023).

With Genuine Parts' Third Quarter Consistent With Our Targets, Our Long-Term Outlook Remains Intact
by Zain Akbari, CFA | Morningstar Research Services LLC | 10-17-19

Our $98 per share valuation for narrow-moat Genuine Parts should not change much after it posted third-quarter earnings that leave it poised to meet our full-year targets. We still call for roughly 4% organic annual revenue growth and 7% adjusted operating margins, on average, over the next 10 years. Although we have a favorable view of Genuine Parts' core automotive and industrial efforts, we suggest investors await a greater margin of safety before building a position.

Sales rose 6% on 5% and 10% growth for the automotive and industrial groups, respectively, and a 1% dip for business products (about 55%, 35%, and 10% of overall revenue, respectively) against a 7.6% operating margin. Management cut its 2019 adjusted diluted EPS target to reflect its recent sale of EIS, now calling for $5.60 to $5.68 (from $5.65 to $5.75), with the divestiture accounting for most of the $0.05 to $0.07 change and the difference between the revised range and our $5.72 pre-announcement mark.

Although near-term European automotive market conditions remain difficult (due to weather), we are encouraged that comparable sales improved sequentially, down a mid-single-digit percentage rather than the second quarter's high-single-digit swoon. We are not surprised that its British unit was particularly sluggish, with Brexit-related uncertainty depressing economic activity. Similarly, while the industrial economy is slowing, we view that unit's nearly 1% increase in comparable sales favorably, reflecting its skew toward mission-critical components. While both units' top-line pressures are exogenous and transitory in our view, we are encouraged by Genuine Parts' continued efforts to deliver $100 million in annualized cost savings by the end of 2020. As it integrates recent acquisitions and capitalizes on longer-term initiatives (including the introduction of higher margin NAPA-branded items in Europe), we believe it can boost operating margins toward the high single digits from 6.1% in 2018.

J&J Posts Solid Third Quarter, Despite Increasing Litigation Concerns That We View as Manageable
by Damien Conover, CFA | Morningstar Research Services LLC | 10-15-19

Johnson & Johnson reported third-quarter results that were slightly ahead of both our and consensus expectations, but we don't see any major impact to our fair value estimate based on the outperformance. We continue to view the stock as fairly valued. Also, the firm's wide moat looks intact, as shown by the steady results across J&J's key divisions.

While the fundamentals in the quarter look solid, J&J continues to face increasing litigation concerns, but we see these lawsuits as manageable. We have factored in over $5 billion of costs related to litigation over the next five years. In particular, we believe the litigation around the side effects of opioids and talc will represent the larger settlements, with legal challenges to neuroscience drug Risperdal and the company's pelvic mesh likely to lead to smaller settlements. Overall, our projected legal costs over the next five years are similar to those of the previous five years. Both from a discounted cash flow valuation perspective and a market sentiment perspective, the actual payouts on legal challenges in the past haven't significantly affected J&J's stock price over the long term. However, we expect continued short-term volatility surrounding legal cases, especially where initial rulings are significant.

Turning to the quarter, the drug division continues to lead overall growth, but the device and consumer groups are improving. Despite generic competition, the drug group's recent launches continue to offset the patent losses (especially in oncology and immunology) and we expect continued steady growth for the drug unit over the next five years. We expect steady growth in the device segment, with potential room for upside based on new robotic devices that should reach the market over the next two years. In consumer, we don't expect much acceleration of growth based on the more competitive Internet distribution channel, where brand strength looks less powerful.

J&J's Decision to Recall a Single Lot of Talc Powder Doesn't Affect Our Fair Value Estimate
by Damien Conover, CFA | Morningstar Research Services LLC | 10-18-19

Johnson & Johnson has announced a voluntary recall of a single lot of baby powder after a trace amount of asbestos was found in a bottle that was purchased online, but we don't expect an impact to our fair value estimate. With more than 15,000 plaintiffs claiming that J&J's talc powder caused cancer, potentially due to asbestos contamination, this latest recall gives plaintiffs more fuel for their legal cases. However, the amount of asbestos found (less than 0.00002%) in a test by the U.S. Food and Drug Administration is very low, and several confounding variables cannot be ruled out, including sample testing errors or counterfeit product. We believe J&J is being very cautious in recalling the product.

Further, beyond J&J's rigorous product safety tests, clinical studies, the FDA, and the Cosmetic Ingredient Review Expert Panel have all said that talc is safe. Also, the National Cancer Institute's Physician Data Query Editorial Board concluded that perineal talc exposure doesn't increase the risk of ovarian cancer, a key cancer in several plaintiff cases. Nevertheless, the recall increases the uncertainty around J&J's product governance. We continue to factor in $2 billion in litigation costs related to the talc powder side effects. Further, while the media headlines could damage the company's brand power, we don't expect this litigation to have a major impact on the company's moat. With 17% of J&J's sales derived from consumer products, the majority of its moat source is driven by intellectual property and patents in its devices and drug groups. Additionally, many of the company's brands are marketed under different names, so any brand damage done to baby powder is unlikely to transfer to other company brands. Also, we expect J&J to pull out all stops to support the baby powder brand, which should limit brand damage as the firm has a successful track record of defending brands.

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.

Minor Disruptions Fail to Derail PMI's Momentum in Q3
by Philip Gorham, CFA, FRM | Morningstar Research Services LLC | 10-17-19

Philip Morris International missed our forecasts narrowly in the third quarter as a result of weak volumes in the south and southeast Asia segment, but the business continues to demonstrate reasonable underlying momentum. We have lowered our short-term estimates for a one-time charge in Russia and lower organic growth in Indonesia, but neither of these adjustments impact our $102 fair value estimate and wide moat rating. We consider PMI, our quality pick in multinational tobacco, to be materially undervalued.

Third-quarter cigarette volumes in south and southeast Asia undershot our flat forecast, and fell by 7.6%. Management pointed to two issues, neither of which appear to be headwinds that will be sustained for any material period of time. Perhaps the most structural issue was a loss of share in Indonesia, where trading down to lower price segments lead to some share loss by PMI, in spite of overall market growth. The company can either manage the share loss through activating marketing at the lower end, or by managing the price gaps with its premium portfolio, while any tax-driven increase in the minimum price could also close the price gap and stabilize share. It seems likely, however, that either price/mix or volumes will be lower than our forecasts in the near-future. The second issue was in Pakistan, where the market declined 50% year over year, which reflects the timing of excise tax increases last year and associated price hikes. We expect the market to normalize within the next three quarters.

PMI took a one-time charge of around $374 million relating to an excise and VAT audit of its Russian affiliate. While this will lower earnings per share by $0.20 this year, it has little impact on our estimate of intrinsic value.

The good news in the report was the continued momentum of iQOS in Europe, where volumes beat our estimates. This is encouraging for the launch of iQOS in the U.S., which we think will follow a similar adoption path to Europe.

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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