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More Red Flags for Valeant; Berkshire Battles Headwinds

Shares the beleaguered pharma firm may look cheap, but investors should remain very cautious. Meanwhile, Berkshire pulls off decent results under less-than-ideal circumstances.

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Jason Stipp: I'm Jason Stipp for Morningstar. Welcome to The Friday Five, Morningstar's take on five stories in the market this week.

Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: Healthcare firm Valeant had a tough Monday this week. This follows a spate of poor performance for the beleaguered firm. What's your take on the latest?

Glaser: It was a busy Monday for Valeant. They withdrew their earnings guidance both for the quarter and for the year based on some of the continuing issues they are having, getting away from their relationship with specialty pharmacy Philidor and building up this new relationship with Walgreens. There are a lot of question marks, some accounting issues that they are working through, and how that's going to look in the future.

Their CEO Michael Pearson, who has been on medical leave, came back. But they said he is going to give up his chairman role. They are going to appoint an independent chairman, something that some people had been clamoring for, given the governance questions that have been there.

This definitely has been a challenging time for Valeant. We saw that in the stock price. It fell 18% on Monday. It's off almost two-thirds over the past year. It has been under quite a lot of pressure as it tries to get past some of this murkiness and these short-term issues and show the market its true earnings power.

Michael Waterhouse, who is our Valeant analyst, thinks they do have a stable of drugs that could be very profitable and see good growth over time, but a lot of these short-term issues are truly creating concerns for investors. It is a time to be cautious. Even if on a lot of measures the stock looks pretty cheap, there still is an incredible amount of uncertainty surrounding this name.

Stipp: Berkshire Hathaway reported its full year 2015 and fourth-quarter results last Saturday, and of course that also means a letter from Warren Buffett. What's your take on both of those fronts?

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Glaser: Speaking of a firm that doesn't have a lot of uncertainty to it: Berkshire Hathaway. They are just so big at this point that you don't really see enormous swings in earnings, and we saw that again in 2015. Book value grew, and things looked decent at Berkshire, even given some of the headwinds they are having in their insurance business. Some of the operating businesses, like the railroads, are seeing some issues as well. Even despite all of that, things looked pretty good for Berkshire.

But as you mentioned, one of the things we always look for is that annual letter from Warren Buffett. He hit on a couple of themes, including the idea that America's best days are not behind it, that we still have a lot of potential for economic growth, and that even at a 2% GDP growth rate, we're still going to see much higher standards of living, so we shouldn't be totally doom and gloom about the future of America.

He also talked about how important productivity gains are--that we need to keep driving forward productivity gains and not be afraid to take some short-term pain, to have some short-term cuts, to achieve productivity. We're going to be better off in the long term for that.

And of course, we will be at the Berkshire annual meeting in Omaha at the end of April, and Gregg Warren, our Berkshire analyst, will again be on the panel asking questions of Warren Buffett and Charlie Munger. It should be a good meeting, and for the first time it will be live streamed, so people at home will be able to follow along.

Stipp: We got auto sales data this week. Auto sales have continued to defy expectations. We keep thinking it's going to moderate; it's going to downshift. But auto sales have continued strong.

Glaser: Bob Johnson, our director of economic analysis, joked earlier this week that at the start of every year, we've said, don't get too excited about auto sales; this growth has to slow down. There are only so many cars that can be sold in any given year. But auto sales have really defied that so far. We saw that again in February.

There are some things with the weather year-over-year that make this number a little bit stronger than it truly is on a fundamental basis, but still it was a very good month on a seasonally adjusted annualized rate. It's the best February we've seen since 2000. People really are taking advantage of relatively easy financing to get cars. Low gas prices are moving people into light trucks, and that is showing up in the numbers.

There are some differences between some of the auto firms. Ford had some more rental fleet sales than we usually see, while GM is continuing to pull back from that business. But Ford says that's really just a seasonal mix, and they expect to be flat in terms of fleet sales year-over-year.

Overall, we still think there is some value in these automakers, as we have thought for some time. Ford and GM are in 4-star range, and Fiat Chrysler is in 5-star range right now. So, they could be interesting ideas for investors to take a closer look at.

Stipp: Exchange mergers have been in the news. There has been talk of exchange mergers in the headlines in Europe, and now some U.S. firms are also getting involved in the picture.

Glaser: Last week Deutsche Boerse said they were close to reaching a deal with the London Stock Exchange, and we heard this week that some of the U.S. exchanges might be interested in that London Exchange as well.

Michael Wong, who is our analyst in this space, thinks that ICE, which is the parent of the New York Stock Exchange, is the most logical buyer from the U.S. side given that they have some operations in London already, there are some good synergies, and they would be able to get past regulatory hurdles. CME also has some good strategic rationale for a merger, but it would be much harder from a regulatory standpoint. He thinks they likely would have trouble pursuing it, and he thinks Nasdaq is an unlikely candidate.

We expect to hear more about this deal, but Michael does warn that if we do end up in a bidding war, the winner will probably be the company that's being acquired, and you could easily see the price get out of hand, where all the synergies in the world wouldn't make the deal profitable.

Stipp: Lastly, HR software firm Workday reported solid earnings this week. This is a pure play cloud software firm. Cloud is obviously a hot topic in tech. What's your take on the earnings, and does the stock look like an opportunity?

Glaser: It was another good quarter for Workday, and the stock popped on this news. They are now the second pure cloud-based software company to reach a $1 billion revenue run rate, after Salesforce. That is a good sign that Workday is finding users and has been able to peel customers away from some incumbents in the space, like SAP and Oracle.

But we still think that you shouldn't get too carried away with how well Workday could do. We are seeing signs that they are expanding their economic moat and they are going to get people in, and the switching costs are going to be high. But their competitors also have switching costs, so it's going to take a while to really move people over, and they still haven't shown when they are going to be past this heavy R&D phase when you will really see good profitability. There is still a lot of uncertainty around what's happening there.

We think the shares are fairly valued right now. We don't think the valuation is crazy. But there are other companies that are also competing in the software space, like Adobe and Red Hat, that we think look much more attractive today.

Stipp: Great insights on the news of the week as always, Jeremy. Thanks for joining me.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

Jason Stipp does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.