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US tech stocks pricey, retailers too cheap

Brian Colello  |  09 Jan 2018Text size  Decrease  Increase  |  
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The US tech sector is overvalued, but there are investment opportunities in retail stocks unfairly punished by the market, writes Brian Colello from Morningstar US.

After stunning gains in recent years, Morningstar analysts believe valuations across technology are painting overly optimistic scenarios for new and emerging technologies around artificial intelligence.

Technology bellwethers Apple (APPL), Facebook (FB) and Intel (INTC) all appear modestly overvalued to us. Google parent company Alphabet (GOOG) appears fairly valued.

But new trends such as the shift towards cloud computing will have dramatic implications for the stocks in the technology sector, and could create opportunities for existing tech giants.

Both startups and existing enterprises, in an effort to reduce the high fixed costs associated with running IT hardware and software, are shifting more of their workloads to companies such as Amazon (AMZN) Web Services, Microsoft (MSFT) Azure, and Google.

Although we think Apple iPhone unit sales – split this year among the iPhone 8 series and the high-end iPhone X – will be relatively flat against sales last Christmas, higher prices associated with the iPhone X should drive nice revenue growth for Apple.

Focusing on a better customer experience

Moving into 2018, we think companies will focus on faster product development and delivery to enhance the customer experience.

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We believe Amazon has essentially won the battle with retailers in categories such as electronics, office products, and toys, and is now turning to categories with potential subscription opportunities, such as groceries, clothes, pharmaceuticals and beauty products.

The web giant is also moving into categories which have complicated logistics, such as home furnishings and car parts.

Amazon's dominance of existing and new sectors is likely to continue to pressure profit margins for incumbent firms.

But we still believe there are a handful of traditional retailers offering some combination of product specialisation, convenience, and experience that have been excessively punished by the market. A better customer experience could help those companies not involved in ecommerce to offer a more individualised, experiential environment - such as in restaurants and cruise ships.

Global cruise operator Royal Caribbean (RCL), for example, is investing $400 million in its "Celebrity Revolution" update to enhance its fleet of ships. The company's shares rose 45 per cent in 2017, while rival Carnival (CCL) rose 27 per cent last year.

These types of efforts tend to improve brand awareness through customer satisfaction and retention, leading to stable repeat business - something Amazon has done well across its Prime user base.

Cost-cutting in the food and drink sector

Following the Kraft Heinz (KHC) tie-up more than two and a half years ago, many packaged-food firms and drinks firms such as Coca-Cola (KO) have been slashing costs. Several more are slashing ineffective advertising expenses, with Procter & Gamble (PG) one of a number of companies hoping to reduce social media spending in the short term. Cornflakes maker Kellogg's (K) has actually increased spending on its brands, while at the same time reducing the complexity of its warehouse operations.

However, efforts to extract costs do not alter the sluggish growth environment across the industry and the pressure on prices. The growth of the discounters are lowering barriers to entry and intensifying price competition in the sector. The consumer is also looking for alternatives to the big brands, either seeking better value from unbranded alternatives, or trading up to more niche, artisan products such as craft beer.

 

Brian Colello, CPA, is a senior equity analyst for Morningstar, based in the US.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is a senior equity analyst with Morningstar, based in the US.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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