US Outlook: Tech Stocks Pricey, Retailers Too Cheap

Morningstar equity analysts believe the US tech sector is overvalued, but there are investment opportunities in retail stocks unfairly punished by the market

Brian Colello, CPA 4 January, 2018 | 3:07PM Jaime M. Katz, CFA
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Amazon Prime

Morningstar equity analysts believe the US technology sector is now overvalued after stunning gains in recent years. We believe valuations across tech are painting overly optimistic scenarios for new and emerging technologies around artificial intelligence. 

Tech 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.

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% in 2017, while rival Carnival (CCL) rose 27% 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.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Alphabet Inc Class A175.60 USD-1.27Rating
Alphabet Inc Class C177.19 USD-1.31Rating
Amazon.com Inc183.05 USD-0.05Rating
Apple Inc191.13 USD-0.63Rating
Carnival Corp15.85 USD-2.19Rating
Coca-Cola Co62.91 USD-0.01Rating
Intel Corp31.67 USD-0.24Rating
Kellogg Co61.91 USD-0.55Rating
Meta Platforms Inc Class A470.29 USD1.22Rating
Microsoft Corp429.90 USD0.20Rating
Procter & Gamble Co168.01 USD-0.20Rating
Royal Caribbean Group148.98 USD-1.17Rating
The Kraft Heinz Co36.17 USD0.68Rating

About Author

Brian Colello, CPA  is a senior stock analyst with Morningstar.

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