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Friday Five: More Fallout From Valeant Debacle

Two figures are heading toward the exit as the embattled pharma firm's saga continues. Plus, our take on Apple's product tune-up, and more.

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Welcome to The Friday Five. Joining me to discuss five of the top business and market headlines from the past week is Morningstar markets editor Jeremy Glaser.

Jeremy, thank you for being here.

Jeremy Glaser: You're welcome, Christine.

Benz: Let's start with Valeant Pharmaceuticals. It's been on a lot of investors' minds, those who own it perhaps indirectly and those who own it directly. Let's talk about what's been going on at the company, which has been very much in the headlines over the past several months.

Glaser: Valeant is becoming a frequent flyer here on The Friday Five, and this week they're in the news because CEO Michael Pearson has agreed to step down. This doesn't come as an enormous surprise, given the mounting questions about the firm's accounting practices, other business practices, the stock slide that we've seen recently, and their failure to file financials. That's obviously been weighing on the company. It seems like new leadership coming in maybe will help begin the process of restoring confidence, but it is going to be a long road.

And you mentioned a lot of people own Valeant indirectly, and often that was through Sequoia Fund, which had a very concentrated bet on Valeant. We had some news there this week as Bob Goldfarb, who is a longtime co-manager of Sequoia, stepped down because of that or at least partially because of that, as the board was looking to put some new risk-management practices into place and to try to prevent something like what happened to Valeant to happen again at that fund. So another interesting story, an interesting departure, surrounding that pharmaceutical company.

Benz: Apple did a big reveal this week. Let's talk about the products that it is bringing to market shortly.

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Glaser: Apple had a press conference that did not generate maybe the kind of headlines that you usually expect from events like this. Part of that was because it was really more of a tune-up of their product line than anything radically different. They introduced a new iPhone, the SE, that is a very similar to a product from a couple of years ago, just with updated internals, a new iPad, and they also lowered the price on the Apple Watch.

I think the iPhone SE is probably the bigger story, and Brian Colello, our Apple analyst, agrees with that. He sees two major markets for this phone: People who like that smaller form factor who might have been holding off on upgrading to the bigger phones--they might find this attractive. Also in emerging markets where that lower price point makes an Apple device more approachable for the first time, makes it more accessible--that could be another positive for this phone. But he thinks that any volume growth you're going to see from it is going to be mitigated somewhat from a financial standpoint because of its lower margin, because of the lower selling price. So he doesn't see a huge financial impact to Apple over the long term. We still see the shares as trading below their fair value estimate. It's not a screaming discount, but Apple does look like a decent value today.

Benz: Let's talk about Nike. They'd been on a little bit of a roll recently, but very recently, not so much.

Glaser: Nike has had a lot of very strong performance. But this quarter, the market was a little bit disappointed, and that mostly came from the guidance, which was seeing as quite conservative and below views, including Morningstar's views.

A couple of things are driving this. The performance of Converse remains a little bit muted, particularly compared to some of the Nike-branded footwear and apparel and other things that they're making. And also there are some question marks about the Rio Olympics sponsorships, seeing what the exact impact of that going is to be. That led to the conservative guidance.

But Paul Swinand, Morningstar's Nike analyst, thinks that you need to be focused on the long term. He still sees the long-term picture as bright for Nike. You can even see some bright spots this quarter, as they performed well in places like China and Eastern Europe, despite some concerns about what's happening with the economies there. That's a good sign for Nike over the long term. Unfortunately, shares still look pretty rich--not a great entry point right now--but still a lot of positive things, we think, over the long haul for Nike.

Benz: Some big news in the paint industry over the past week. Let's talk about that.

Glaser: That's not a phrase you hear terribly often, but we did have some M&A in paint with Sherwin-Williams agreeing to buy Valspar for a little bit over $9 billion. We think, strategically, this deal makes a lot of sense. Sherwin-Williams has a big focus in the United States; Valspar has more overseas exposure. You bring that together, that gives you more geographic diversification, and also there are potential synergies to take some costs out of the business. Morningstar analyst David Wang thinks Sherwin-Williams is paying about a fair price; when you take into account the synergies, the premium they paid is reasonable. So we're leaving our Sherwin-Williams fair value estimate unchanged.

Overall, at this point in the long bull market, even after some of the pullback and then subsequent rise we've seen, the fact that people aren't overpaying for lots of big deals like this is somewhat of a heartening sign for investors.

Benz: Last story, from the paint market to the cereal market, let's talk about what's been going on at General Mills.

Glaser: General Mills has had some struggles in the sales department due to competition, and we saw that again this quarter, where sales remained under pressure there.

But the real story and the real question mark over time with General Mills is going to be more on the cost structure. We are seeing some good signs of progress; gross margins actually rose about 160 basis points in the quarter, despite the fall in sales. That's a good sign that management is having success in their cost-cutting efforts.

But the real question mark is, will they be forced to do even more in order to keep in the market's good graces? You see Kraft Heinz out there with some very aggressive cost-cutting targets, and given that management team's history, it seems like it's possible that they're going to be able to meet those, and if they do, it's really going to put pressure on a lot of other firms in this space, including General Mills, to continue to put downward pressure on costs, and to continue to improve profitability.

So if Kraft Heinz missed those targets, Erin Lash, our General Mills analyst, thinks that they're going to be under a lot of pressure to that as well or face the ire of shareholders. So I think we're certainly going to be hearing a lot more about that cost structure, both at General Mills and a lot of other consumer packaged goods firms in the quarters and years to come.

Benz: Jeremy, always great to hear you insights. Thank you so much for being here.

Glaser: You're welcome, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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