In this Motley Fool Money podcast, host Chris Hill and senior Motley Fool analysts David Kretzmann, Jason Moser, and Aaron Bush review the week in business news, and while there were some interesting (and share-price moving) earnings reports, the lead news in retail completely overshadowed the quarterly release from the company in question: word that home improvement major Lowe's (NYSE: LOW) had lured away J.C. Penney (NYSE: JCP) boss Marvin Ellison to be its new CEO. The Fools consider just how big a deal that is for the company, and what other catalysts are likely to move the needle for it.
They also dissect the latest numbers from Foot Locker (NYSE: FL) (cautiously optimistic), Zoe's Kitchen (NYSE: ZOES) (pretty pessimistic), and Tiffany & Co. (NYSE: TIF) (mighty sparkly). Meanwhile, if you're a little confused about why every company that you ever dealt with online seems to want to talk about your relationship, the guys try to simply explain the EU's new General Data Protection Regulation (GDPR), the new rights it gives you, and how it will impact businesses that are built on knowing their customers. And of course, no MFM podcast would be complete if the gang didn't offer up the stocks on their radar this week.
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A full transcript follows the video.
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This video was recorded on May 25, 2018.
Chris Hill: I'm Chris Hill. Joining me in studio this week: senior analysts Jason Moser, David Kretzmann, and Aaron Bush. Good to see you as always, gentlemen! We'll dig into restaurants, retail, and the sexy world of data regulation. We'll talk boardrooms and box office with Nell Minow, and as always, we'll give you an inside look at the stocks on our radar.
But we begin with some surprising news from the home improvement industry: Lowe's first quarter report took a backseat to the news that J.C. Penney CEO Marvin Ellison is leaving J.C. Penney to take the top spot at Lowe's. Jason, shares of Lowe's up more than 10% this week. And when I look at Marvin Ellison's resume, I understand why there's optimism.
Jason Moser: That guy is grinning so wide, it's like he has a coat hanger in his mouth. I mean, you have to believe he's happy to leave J.C. Penney behind. I don't know that there's anything that fixes that, to be frank. When we look at Lowe's in this market, the home repair and home renovation market, I've been more of a Home Depot (NYSE: HD) guy, I guess, for the longest time. But I think, actually, that looking out over the next three to five years, Lowe's may represent the better opportunity for investors.
There are a couple of really important catalysts that are coming into play here. One is Mr. Ellison taking that CEO role. The other one is an aging home market here in the United States. We talked about this last week with Home Depot's earnings. When we look at 1995, 33% of the U.S. homes were greater than 40 years old. That number is tracking to hit 54% by 2020. I don't need to connect the dots for you, Chris. You know that aging homes require more work.
Hill: Oh, yeah.
Moser: More upgrading, more maintenance, all sorts of stuff like that. That's good for Home Depot and for Lowe's. Lowe's has always played sort of that Pepsi to Home Depot's Coke. But, I think there's a great opportunity to capture some additional share there with Mr. Ellison taking the role.
David Kretzmann: Yeah. It'll be interesting to see where this goes. I think, over the past five to ten years, Home Depot has regularly traded at a slight premium to Lowe's, and that's because they've been the better operator. Lowe's is a quality operator. For instance, their return on invested capital is around 17%. Home Depot's, though, is almost twice that at 32%. So, Home Depot has that leg up as an operator. It'll be interesting to see if this new CEO maybe can help spur Lowe's to catch up to Home Depot and potentially earn a little bit more of a premium valuation in the process.
Hill: And before he got hired to be J.C. Penney's CEO, Ellison spent more than a decade in the executive ranks at Home Depot. I have to believe he's going to be bringing some of those best practices to Lowe's.
Moser: I'm certain he will. He has a reputation for being very service-oriented. Two primary points of focus for him will be on that customer service side, as well as digital sales. Right now, Lowe's digital sales don't represent a whole heck of a lot of the business, only about 5%, so he has a great opportunity to grow that piece of the pie in the coming years.
Hill: Foot Locker's same-store sales fell nearly 3% in the first quarter, and Wall Street stood up and cheered. Shares of Foot Locker up 15% on Friday. All right, David, the comps weren't good, but there have to have been some bright spots in this quarter.
Kretzmann: Low expectations are a beautiful thing, Chris. Foot Locker had guided for weak first quarter results, but they continue to expect those comps to become flat and eventually positive through the remainder of the year. You have to give the company credit. They have nearly 3,400 stores worldwide. Most of those are company-owned. But the balance sheet is still strong, $900 million in net cash, producing about $600 million in free cash flow a year. So, they have some flexibility to reinvest in the stores, try to bring more experiences to those retail stores, invest in digital, try to make sure they're bringing in the latest and greatest sneaker trends and apparel trends. I think a lot of people assume that Amazon would eat Foot Locker's lunch, Zappos would eat their lunch. But so far, the company has been resilient, and it looks like it'll improve the rest of the year.
Aaron Bush: In my opinion, this was not a great quarter, at all. I don't think closing stores and falling foot traffic make for much excitement. I mean, they can say they'll do better, but in my opinion, they sort of have to prove it before I get excited. I agree that they might become more Amazon-proof than others think, but I think their largest threat isn't Amazon, it's Nike (NYSE: NKE), it's adidas, it's them going more direct-to-consumer and really accelerating that effort. The more Foot Locker and stores like Foot Locker continue to suffer, the more it just motivates those big brands to push even harder to get those customer relationships directly.
Hill: Am I the only one who actually likes to buy footwear in person? In all honesty, that's one of the mental leaps I'm trying to make here. I buy a few pair of sneakers every year. I'm never buying them online.
Bush: I haven't bought shoes in stores in probably six or seven years.
Moser: I was going to say, man, once you stop growing, you know what your size is. I don't understand what your hang-up is, Chris.
Kretzmann: Maybe Chris is still growing.
Moser: Zappos for the win, right?
Hill: I'm trying out different brands, all that sort of thing.
Kretzmann: And I don't know how much experience you can really bring to buying shoes. At the end of the day, you're still going into the store to buy shoes. I think their focus has been really trying to be at the forefront of any new and emerging trends within the shoe category. Maybe that helps attract people into the stores. But I think they do have an uphill battle compared to some other concepts, when it comes to creating compelling experiences.
Hill: Let me go back to Nike for a second, Aaron. When Sports Authority went under, one of the things we saw that was, Nike was on the hook for a lot of inventory. I mean, it's a little bit of a balancing act that Nike and Adidas and Under Armour have to pull off here. They're, in some ways, rooting for Foot Locker to do well, until that tipping point where they really get their e-commerce operations going.
Bush: Yeah. At the end of the day, they just want to sell shoes. And it's more, wherever the consumers are going to go to buy those shoes is where those companies need to be. So, it's just playing that dance of where the customer is going. Are they going to stores less? Are they going online more? Therefore, how do you position your business for that?
Moser: Yeah. I think Foot Locker is certainly pulling for Nike to do well. Nike was mentioned 17 times in this earnings call, so they're obviously hoping that Nike sticks around. I think you're probably looking at a situation where Foot Locker needs Nike more than the other way around, and that goes back to your point about that direct-to-consumer model. Nike and Under Armour and even Adidas are growing out those capabilities.
Bush: I think so. What this is, it's a new law that lets EU citizens gain more control of their data, and it forces companies who operate and serve those EU citizens to be more responsible with that data. That's the biggest picture of what that means. So, all of these companies that have worked with EU citizens, whether they're European companies or North American, U.S.-based companies, they've had to work incredibly hard to improve their data processes, update them, and invest in the teams to make that happen. I do think it's ultimately a good thing for individuals.
A couple things that it gives new rights to users for: It gives rights to access what data companies have on you. You can see what all these companies have tracked for you. You can ask to rectify data or delete data or withdraw consent from different things. It's one step closer toward individuals truly owning their data. It's not all the way there yet, but starting in the EU, it's a big step.
Kretzmann: I don't know if Aaron mentioned this, but the fine for companies that don't comply with these new regulations would be up to 4% of your annual global revenue. Not profit, but revenue. This clearly going after the tech incumbents who have been skirting over ways to pay taxes in Europe. At the same time, that means a lot of smaller companies, it's going to be even more challenging and expensive to comply with regulations in the EU. Just speaking for our teams here at The Motley Fool, we're a company with several hundred employees, but we've had a pretty big team spending months working on getting compliant with these new rules. And you even have some companies that basically suspended their websites in Europe until they can figure this out, and whether it's viable for them to be there -- including Tronc, the publisher of the LA Times and New York Daily News. Tronc, at this point, you cannot access it in Europe. This is obviously going after the tech incumbents. But at the same time, they're the companies that have the resources and the time to make sure they are compliant.
Hill: Yeah. So, in terms of Facebook and Alphabet and the advertising business, as David said, they have the resources to deal with it. I'm not necessarily worried about their ability to make more money. But I'm wondering if, long-term, the ripple effect here is that, if there's a lowered ability to target ads, then those ads, in theory, becomes less effective, marketing becomes more of a challenge, and maybe the ROI isn't as great.
Bush: I think that's probably directionally accurate. I also think there could be regional differences in how you target people in different regions. If I'm starting a newspaper in the U.S., for example, I don't know if I would want to open access to EU citizens, because it could completely change the way I have to build my team, work with the data. I don't know enough about it to say that that's true, but I know a lot of companies right now are going through issues like that. So, it definitely is like, how well can you target, but it's also, how well can you keep on doing what you're doing.
Hill: Zoe's Kitchen has more than 200 locations across America, and that number may be going down soon. Shares of Zoe's Kitchen fell more than 35% on Friday after a first quarter report that, David, it was just a train wreck. They lost money, they cut guidance.
Kretzmann: Yeah, this was a really ugly quarter. Same-store sales were down 2.3%. Margins are being pressured, expenses are going up. And I get the feeling here that management is just throwing a lot of stuff against the wall at this point and hoping, praying, that something sticks. They're reducing their future store opening plans, they're looking at letting some existing leases expire with their current locations. They're increasing the amount of money they're spending on marketing, they're looking at franchising. And the board of directors even formed a committee to consider strategic alternatives.
So, presumably looking to sell the company or find some sort of saving grace. Zoe's has really backed themselves into a corner here. For a long time, they've relied on debt to open new locations. At this point, they only have a few million dollars of cash on the balance sheet, over $45 million in debt, and they're still generating negative free cash flow. They need to find something quick to turn this ship around.
Moser: This is sounding more like Zoe's Kitchenette.
Hill: I've never been to one of these. This is fast casual Mediterranean cuisine. It seems like something I would like. I should probably go soon, because, I mean ...
When you hear about a restaurant stock dropping this much in a single day, absent any other news, my mind immediately goes to some sort of outbreak of some sort. So, I guess the good news is, this is not an outbreak of some sort. The bad news is, they are mismanaging this business to the point where it can drop this much in a single day.
Kretzmann: And I think the other challenge for Zoe's is that the restaurant category as a whole has actually been improving so far this year. When you're generating such poor results when the rest of the restaurant landscape is improving, that's just extra cause for concern.
Bush: The yellow flag investors should have seen coming years ago at this point was the fact that they couldn't fund expansion out of their operations, out of their cash flows, and they had to rely on debt. That's really risky, because when they're going from a regional to a national play, a lot of companies don't make that leap. So, if you end up struggling while doing that, and you have a ton of debt, and you can't really fund out of your operations, you're in a really tough spot to maneuver. So, I'm not surprised by all of this.
Moser: Recent troubles notwithstanding, that's something that Chipotle (NYSE: CMG) did very well early on. When they needed to make that leap, they had the balance sheet and the business model that enabled them to do it without having any real obligations hanging out there. And even today, I mean, still, a pristine balance sheet, plenty of cash flows. If they can rebrand and create more interest, I think there's still a chance for them to grow.
Kretzmann: Yeah. Whenever you're looking at smaller restaurants that are potentially trying to expand nationally, I think the primary thing you want to look for is, is this company capable of expanding out of the cash they're generating from the business, as Aaron and Jason highlighted. If not, if you're relying on debt or issuing stock to fund that expansion, that really dramatically increases the amount of risk you're taking as an investor.
Hill: I'm glad you mentioned Chipotle, Jason. Last year, executives at Chipotle said that they were going to be testing a drive-thru concept. And they've begun to do that in a few locations. But it's not drive-thru in the sense that you can pull up to the window and order. It's something they're calling mobile drive-thru pick up. You actually have to order ahead of time, then go and pick it up. Any time I've been in a Chipotle, it's been a pretty fast experience. Why wouldn't they just go for straight drive-thru?
Moser: Baby steps, Chris, baby steps. You have to try something and iterate. I think one of the problems, maybe, with Chipotle right now is, that entire restaurant model has been built without any consideration to a drive-thru. Even when I think about some of the Chipotles in our area that I visit, I don't know where you would put a drive-thru. I think Starbucks ran into that position or that situation, as well. Part of it is trying to figure out the actual logistics. I have a feeling, if you throw a drive-thru in a restaurant, it's going to bring some traffic in, and that's really what Chipotle needs right now.
Kretzmann: I think this actually makes sense for Chipotle. A traditional drive-thru, I think, would be very clunky with Chipotle, because they don't have a Big Mac or 7-Layer Burrito. You have to really build your own each time you go to the store, and order that way. So, I think the traditional drive-thru would just get clunky and held up if you're rolling that out to Chipotle, because they don't have any predefined menu items.
But, this mobile drive-thru, I think, is interesting, because it's really just pushing people to use the app or the online experience. That's just a way to increase the volume or the throughput going through the restaurants. So, for Chipotle, I think this actually makes sense.
Moser: You know who's mastered the drive-thru? I'll tell you, our Chick-fil-A by our house, oh my God. They have two windows for two lines, and that line will continually back up out of the parking lot. So, then, they get two employees from the store that are out there on, like, iPads with payment swipes. They're taking orders by hand to keep the traffic moving, and it works. It's unbelievable how they have that down. But, man, it's a nice problem to have, I guess. They can't keep the customers away.
Hill: Shares of Tiffany up nearly 25% this week. Tiffany's first quarter profits came in higher than expected. Jason, did you help with that?
Moser: I like to think maybe I did. I got my lovely wife a bracelet for her birthday. Unfortunately, the bracelet was purchased in the current quarter, so I didn't play out in the first quarter results. But, maybe the sentiment is there. Listen, I think Tiffany is a good business. I think the most important thing that management can do is protect their brand. Tiffany is actual luxury. It's not affordable luxury like we would talk about with something like Coach or Michael Kors. There's sort of this sense of accomplishment, almost, with getting something from Tiffany.
The company has done a very good job in growing at a measured pace. They have 314 stores now versus around 250 about five years ago. Gross margin is ticking up a little bit as prices on wholesale diamonds are coming back to reality and store traffic is growing. They do a very good job of managing this brand and not resorting to fire sales to try to move product. As long as they can do that... They have a new CEO in the chair there, Alessandro Bogliolo. I hope I'm pronouncing that correctly. His first year with the company, and I think he's feeling very good about things. They just raised the dividend, continuing to buy back shares. So, it's working out.
Hill: All right, we have about a minute left. As we kick off the summer and people are looking to unwind with a book at the beach, let's just go around the table. Aaron Bush, what do you have for a book recommendation?
Bush: I think the best genre for investors is actually really good sci-fi. So, Stories of Your Life and Others, by Ted Chiang, is a good collection of sci-fi short stories.
Hill: Nice. Jason?
Moser: I'm not even done with the book yet, but I really do like it. The Space Barons: Elon Musk, Jeff Bezos, and the Quest to Colonize the Cosmos, by Christian Davenport. Very fun read.
Kretzmann: I'm looking at Hit Makers, by Derek Thompson. He's someone that you interviewed last year, actually. Looking at the science of how things become popular and go viral. I really enjoyed it.
Hill: I haven't gotten it yet, but the new book about Theranos from John Carreyrou at the Wall Street Journal -- Bad Blood: Secrets and Lies in a Silicon Valley Startup. That is definitely on my list.
Moser: New Stephen King book out, The Outsider. I just bought it, I need to start it.
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Let's get to the stocks on our radar. Our man behind the glass, Steve Broido, will hit you with a question. David Kretzmann, what are you looking at?
Kretzmann: I'm going with Stitch Fix (NASDAQ: SFIX), ticker SFIX. This is a recent IPO. It went public in November. This is really a data-driven online apparel retailer. You sign up, you enter your preferences when it comes to clothing styles and brands. One of their 3,500 stylists will work on it and really personalize an experience for you and send you a box with five different items. You pick what you want, you keep what you want, and then you send back everything else. You only get charged for the stuff you keep. I think this is a really interesting look at, potentially, the future of retail. They have so much data compared to your brick and mortar retailers when it comes to consumer preferences. So, one that I'm keeping an eye on.
Hill: Steve, question about Stitch Fix?
Steve Broido: In five years, are more men or more women using Stitch Fix?
Kretzmann: Probably women. They started with women, and I bet they'll be their dominant category for a while.
Hill: Jason Moser, what are you looking at this week?
Moser: Sure. Taking a look at PayPal (NASDAQ: PYPL), ticker PYPL. I was thinking about this earlier today, I think that PayPal's acquisition of Braintree back in 2013, I don't think it's hyperbole to say that that is on par with Facebook's acquisition of Instagram. I think it's that important to the business. And I think we're starting to really see the results play out here. If you look at the most recent quarter, PayPal's total payments volume was $132 billion, up 27%. Venmo, now, which is part of PayPal, is on a run rate to generate over $50 billion in total payments volume in 2018. So, it's becoming a very important part of the business. I do think that over the next ten years, PayPal and Square are going to be the two companies that really help define this payments space.
Hill: Steve, question about PayPal?
Broido: I still struggle on how to use PayPal to get money from point A to point B. Is that just me?
Moser: I do think that's just you, Steve. I mean, I figured it out, and if I can do it, then I think anybody can do it. We'll talk after the show.
Hill: Aaron Bush, what are you looking at this week?
Bush: The company I'm looking at is SendGrid (NYSE: SEND), ticker SEND. This is also another recent IPO, it IPO-ed about six months ago. They are a cloud-based email services platform. As we all know, email is still a super relevant platform for advertising and reaching consumers, getting conversions, that type of thing. And their expertise as a platform is using algorithms to help target ads, get people to take action, and to work through spam filters. They sell an API to companies that they can work with in whatever development framework that they use, and they can help run marketing campaigns, that type of thing. This is still a pretty small company, about a billion dollars, but they're growing super fast, they have a really strong culture, strong leadership team. I think it's pretty interesting.
Hill: Steve, question about SendGrid?
Broido: Do I have a SendGrid email address? Is that how this works? Or, are they behind the scenes, hosting other people's email addresses?
Bush: They work with companies to help them use algorithms to better get through spam filters, and to ensure that when they send us an email, it's going to be more relevant to us, so that we open it and take action.
Hill: Do you have one you want to add to your watchlist, Steve?
Broido: I'm looking at Stitch Fix.
Kretzmann: All right! Thank you, Steve!
Hill: All right. David Kretzmann, Jason Moser, Aaron Bush, guys, thanks for being here!
Kretzmann: Thank you!
Bush: Thanks, Chris!
Hill: That's going to do it for this week's edition of Motley Fool Money. Our engineer is Steve Broido. Our producer is Mac Greer. I'm Chris Hill. Thanks for listening! We'll see you next week!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Alphabet (C shares), Amazon, Chipotle Mexican Grill, Facebook, PayPal Holdings, Square, Starbucks, Under Armour (A Shares), and Under Armour (C Shares). Chris Hill owns shares of Amazon, PayPal Holdings, Starbucks, Under Armour (A Shares), and Under Armour (C Shares). David Kretzmann owns shares of Alphabet (C shares), Amazon, Chipotle Mexican Grill, Facebook, Home Depot, Nike, PayPal Holdings, Square, Starbucks, Under Armour (A Shares), Under Armour (C Shares), and Zoe's Kitchen. Jason Moser owns shares of Chipotle Mexican Grill, Nike, PayPal Holdings, Square, Starbucks, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Chipotle Mexican Grill, Facebook, PayPal Holdings, Square, Starbucks, Stitch Fix, Tapestry, Under Armour (A Shares), Under Armour (C Shares), and Zoe's Kitchen. The Motley Fool owns shares of Michael Kors Holdings and has the following options: short February 2019 $185 calls on Home Depot, long January 2020 $110 calls on Home Depot, and short September 2018 $80 calls on Square. The Motley Fool recommends Home Depot, Lowe's, and Nike. The Motley Fool has a disclosure policy.