1 Weekend, 2 Very Different Disasters

On this MarketFoolery podcast, host Chris Hill, Million Dollar Portfolio's Jason Moser, and Stock Advisor Canada's Taylor Muckerman open the week with a pair of discussions of the "How bad is bad?" variety.

Hurricane Irma was still passing through Florida as the Fools went into the studio, when the worst-case scenario had been priced into the markets. But the natural disaster somewhat overshadowed what would otherwise have been bigger news: that big-three credit reporting agency Equifax (EFX 0.25%) had been hacked months ago, putting the personal data of 143 million U.S. consumers at risk.

A full transcript follows the video.

This video was recorded on Sept. 11, 2017.

Chris Hill: It's Monday, September 11th. Welcome to Market Foolery. I'm Chris Hill. Joining me in studio today, from Million Dollar Portfolio, Jason Moser, and from Stock Advisor Canada, Taylor Muckerman. Thanks for being here, guys!

Taylor Muckerman: Hey now!

Jason Moser: Hey hey!

Hill: We're going to dig into the dumpster fire that is Equifax. But first we should talk about Hurricane Irma, which is still going on, but when you look at what's happening with the market and in particular the reinsurance companies, and we'll get to those in a second, again, the hurricane is still going on. We don't know the full extent of the damage, and we won't for some time. But I think it's fair to say that, at this point, it's a weaker storm than we had all feared 48 to 72 hours ago. And that's being reflected in what we're seeing in the market today.

Moser: I think it's less bad than we probably expected. That said, having gone through storms like this, it's still bad. And that's the thing that I don't want anyone to lose sight of. You see some sort of narrative out there like, "Oh, it's not as bad as we thought it was going to be, it's no big deal." It's actually a really big deal. This is an utterly life-changing event for a lot of people, and not in a very good way. But, with that said, it does seem like it's taking it easy. My Mom and Dad are in Southwest Georgia in Moultrie, which is an hour north of Tallahassee. So, they were kind of in that area, and I'll just read the text I got from them this morning. "So far we're good. The generator will work if needed." So, hey, that's pretty good. They still got power. Cousin of mine down in Jackson lost power, I have some family in Charleston, some power on and some power off there. But it sounds like, generally speaking, most people there are OK. I think the concern was, something like Southwest Georgia, you get off the coast and you get into the middle, and it's just a lot of pine trees there. And when a storm with high winds comes through like that, those pine trees just snap in half like matchsticks. And the water, you can't stop the water. When those trees come down, you can't stop that, either. So, any which way you cut it, it can be extremely destructive. It doesn't sound like it's going to be as bad, but it still going to be very bad. And it sounds like there's still some storms developing out there. So this could still be a volatile season.

Muckerman: Stories of up to five million people without power, some maybe for a week or more after the storm finally does make its way through. You're talking about 5% of the U.S. economy. So, it could impact us nationwide for a few extra weeks, just like Harvey did with the infrastructure down there. It doesn't necessarily impact the energy sector nearly as badly as Harvey did, but five million people without access to power is certainly significant.

Hill: And you look at the reinsurance stocks -- Universal Insurance, HCI Group -- they're all popping double digits today, and that's obviously nice for them and their shareholders. I think one more long-term story we're going to see play out over the rest of this calendar year is the day to day businesses, the restaurant groups, all of that. Just thinking of Bojangles, just to pick one name. Anything that's that concentrated in the southeastern United States, I haven't looked at Bojangles stock recently, but I'm assuming they're in for a world of hurt.

Moser: Yeah, that's a really good point there. You can use Starbucks as an example. While they're certainly not nearly as tied to that area because they're so widespread everywhere around the world, where is Bojangles is certainly very concentrated in that part of the country. And Bojangles has not been a terribly good investment since its gone public. I mean, hey, I love the biscuits, but it doesn't necessarily translate to an attractive stock. So, I think that's really the most difficult part of it for anyone in that area, when any of these storms ever go through, it's the small businesses, it's the businesses that rely on the day-to-day activity. As we said before, you can't get that activity back, you can only try to figure out a way to go forward. And when we talk about the insurers, we talked about insurance a lot, probably not as many people out there think about or know about how reinsurance works, but yeah, that's the insurers for the insurers. So, it's like, pass the buck along, almost perpetually. And somewhere down the line, someone takes care of it, and that's part of the benefit of having a strong economy, with the taxpayer, at the end of the day, you see a lot of that stuff get lumped into tax bills in some way, shape or form at the end of the year. But, yeah, whenever you consider an insurance company, you want to look at exactly how they're dealing with that risk. What are they covering and how are they dealing with that? We see Buffett talk about it all the time, you're going to have plenty of years where these insures don't really witness a whole heck of a lot of activity, but then all of the sudden you hit an active hurricane season and the tide goes out and you kind of see who's exposed.

Hill: Yeah. You mentioned Starbucks. Obviously the smaller businesses, in some ways, because they're not as diversified, they're not as spread out all over the United States or around the world, that kind of thing. That being said, I think when you take what's happening with Florida and the southeast with Hurricane Irma, we're still surveying the damage of Hurricane Harvey in Houston, and the port there, and how much shipping goes through the Port of Houston. These larger businesses, and you can throw apparel retailers in there as well, a lot of them are running their businesses so close to the margin that it doesn't take a big disruption, they don't need a nationwide disruption to really crush them in one single quarter or a couple quarters in a row.

Muckerman: Yeah, you're not going to want to be holding onto a ton of inventory, so if you're missing a few trucks or a few rail cars of inventory, you're really strapped there. And you definitely saw that with the storm in Houston. And speaking of retailers, you've got a number of fairly large retailers with significant exposure to the Florida region and Irma's path. Abercrombie & Fitch, almost 8% of their total stores were in Irma's path. L Brands, 6.5%. So, certainly some retailers out there, especially with the back-to-school season that's still kind of in session, so some worries there for some retailers that haven't been doing all that well lately.

Hill: Let's move on to Equifax, because it's easy to have missed this story with so much of the coverage, and rightly so, on the storms recently. Equifax, which is the credit reporting agency, late last week revealed an enormous data breach that exposed personal information of up to 145 million consumers.

Muckerman: Basically every adult with a credit card in the United States.

Hill: Pretty much, yeah. [laughs] As we talked about on Motley Fool Money, Ron Gross found out that he was one of them.

Moser: [laughs] I guess, I just think, I'm not laughing at his misfortune, because technically we all kind of got screwed here. But, over the weekend, I think I saw some stuff where, if you register for Equifax's year-long monitoring, apparently you're foregoing your rights to a class action lawsuits. Have we advised Ron of this? I feel like maybe we need to catch him after we get done taping here.

Muckerman: That and the auto-renewal, where they charge your credit card at the year's up for a new year of this service.

Hill: Yeah, the way that Equifax has handled this, they appear to have made every mistake possible. This is a data breach that happened in late July. There were three executives who sold stock before this information became public.

Muckerman: Over $1 million worth, I believe.

Hill: Right, before the stock tanked 17% in the last two days, which is what has been going on here. Yeah. They, I use this word in air quotes, "magnanimously" offer a free year of credit reporting, but as you mentioned, Jason, people very quickly found out that in the small print was, "Oh, and, by the way, you can't sue us if you sign on for this." They've got the data breach, and part of their solution is to say, "Give us your social security number, and we'll check to see if ... "

Moser: Yeah, I feel really good about including my social security number on your website at this point in time.

Hill: And I'm waiting for some sort of Uncle Sam knocking on the door moment here, because part of my thought would Equifax is something, and I forget who made this point earlier in the last couple of weeks when we were talking about Wells Fargo, when Wells Fargo came out and said, "Oh, by the way, it's not two million fake accounts be created, it's three and a half million." And someone made the point --

Muckerman: Hold my beer. [laughs] 

Hill: Yeah. Someone made the point, if this wasn't Wells Fargo, and instead it was a small community bank, the authorities would be kicking the door in and shutting them down. And I feel that Equifax is kind of on that level here, too. I'm waiting for someone from the federal government to knock on their door and be like, "We'd like to have a conversation with you."

Moser: Yeah, I think that's distinctly possible. I'm not sure how that impacts them at the end of the day. What Equifax does, they have a fairly diverse business. We know them for basically credit reporting purposes. It's a fairly diverse business with their biggest customer accounting for about 3% of total revenue. So, they provide a lot of different services for a lot of different things. With that said, this is in the U.S. Information Services segment of the business, which is responsible for somewhere in the neighborhood of 40% of revenue, but even more than half of the company's operating profits. So, this does matter to the business. But with that said, I feel like I'm about to turn my nose up even thinking about this, but the fact of the matter is, you have to ask the question, is this an opportunity for investors? I mean, that's what we're here to do.

Hill: Shares of Equifax are on sale.

Moser: They are. Is this something where, can you hold your nose and actually buy shares of this company and feel good about it? Can you recognize that perhaps there's an opportunity here? Because, I'll tell you what, we went back through the financial crisis, and boy, I tell you, a lot of people looked at Moody's and were thinking the same thing. We were thinking, "Man, this business was complicit, and they need to fix something because something obviously went wrong," and you know what? That company has made it through relatively unscathed. It has rewarded shareholders. And we actually own Moody's today in Million Dollar Portfolio, and part of that is because it holds a very enviable position in what it does as a ratings agency, and it has not been displaced. If the financial crisis didn't knock this thing out, I don't know what does. So, with Equifax, it still does something that is needed, but its business isn't solely based on that, so when you look at the business itself, there's some attractive parts of the business. I mean, it's a nice top line that's growing at a reasonable rate, it produces very high margins, cash flow rich, decent enough balance sheet. Sure, there's some leadership issues --

Hill: I was going to say, how's the management? How are we feeling about the management?

Moser: Leadership is very fixable. You just get a few guys out, you bring another team in there, and who knows? I think this is something that investors at least have to take a look at, particularly if you're a value investor. I see some similar traits as to something like Moody's. I don't think it holds that same enviable position as Moody's, but it's similar. And I don't know that it's necessarily going to be displaced by this. I think we're going to have a very long trail of litigation. It's going to go on for who knows how long, it'll be quite some time. But one thing I am very sure of, data breaches will continue to happen. It just happened to be Equifax this time. It's going to be someone else next time. It just happens. If these are man-made systems, they're hackable. So, you have to look at it from that perspective, and from the investor's perspective, the stock has obviously gotten throttled in the past few days, and rightly so. And there might be more to come here. But I think you have to be at least looking at this and thinking, maybe there's an opportunity to make a little money.

Muckerman: And a year from now, they might have a lot of recurring revenue suddenly jumping onto their income statements with all these folks signing up for this free service, and still having to give their credit card number.

Hill: We have to get Ron Gross. [laughs] We have to talk to Ron.

Muckerman: We have to pipe him in.

Moser: Given his penchant for value investing, I think this would be right up his alley. I think we need to have --

Hill: You know what? That's absolutely the question. Ron is a value guy. He got hit. Is he going to be --

Moser: He could at least break even.

Hill: He could. Or he could just be so angry that he's like, "No."

Muckerman: You have to leave the bias aside.

Moser: I tell you, the other thing that's really fascinating here is, you sort of see this other narrative in that the IRS could be facing a big problem here, too, just from the perspective of fraudulent tax returns. And that's where I start to get a little bit worked up, because I'm not the biggest fan of doing my taxes, and I've just passed that on to someone else to do for me because I loathe the process from start to finish. But, if it's that easy for someone to go out there and file a fraudulent tax return, and the IRS just cuts them a check, or better yet, direct deposits that money into their account, I mean, that could be something else that really lasts for years and years. I think the IRS is another example of an institution that is really going to have to take a look at their policies, their procedures, their process, and try to figure out how they're going to overcome something like this, because I think that could be a real threat. Not just this year, not next year. Five, ten years, this is going to be something that probably is ongoing for them.

Hill: Couple of housekeeping notes before we wrap up. I had mentioned, I think this was a month ago or so, it was probably on one of these episodes, because Jason, you had mentioned that Roku was coming out with an S-1. And without telling Dylan Lewis at Industry Focus, I volunteered Dylan to do an S-1 episode of Industry Focus. And, in fact, he did that last Friday.

Muckerman: On Roku.

Hill: On Roku, yeah. Dylan loves really digging into the S-1. For those unfamiliar, the S-1 is the paperwork a company files when they are going public. A lot of people out there have the Roku device. Interesting to hear Dylan and Evan Niu break down the business of Roku. I'm not going to spoil anything, I will simply say this, and we talk about this from time to time, when a company files to go public, one of the things they are doing with that document is, they want that document to look as good as it possibly can. They want the numbers to look as good as they possibly can. So, just know that anytime a company goes public. And that's what's just a tiny bit sad about Roku's S-1. There are a couple of numbers that, when you look at them year over year, you're like, ooh.

Muckerman: That's the best?

Hill: That's probably not as great as you were hoping for.

Moser: It's like interviewing management. I know it seems, on the surface, like "Oh, wow, you're going to go interview the CEO or CFO! Wow, that's great!" Isn't their job to make this thing look as good as possible? I mean, I'm not going to go, "Hey, tell me about the state of your business." "Well, Jason, let me tell you, it really sucks right now, but we're looking up for next year, I'll tell you, we've got some plans to turn this thing around." No! That's the tough one there with interviewing management, it's not an easily answered question. You want to do it, but by the same token, you have to go in knowing that they're trying to paint the best picture possible.

Hill: I agree with you. That's why I think some of the more interesting things that show up on conference calls, when management is doing quarterly conference calls, is the tone. That's where we can all, as investors, look at any company's numbers, we can look at their balance sheet and their income statement, and those are objective. But part of this process is evaluating human beings. And sometimes it just comes down to your gut, and what is the tone of voice of a CEO or any executive when they're talking about a challenge that they faced, or an opportunity that they see? And do you believe them? And that's where a little bit of guesswork has to come in.

Moser: Yeah.

Muckerman: It'll be interesting if video makes a bigger presence in conference calls, or if it's pure audio. I know Zillow is --

Moser: Well, when you're seeing companies, I mean, Netflix has obviously done that, Twitter has done that before. I like that, I think it's pretty cool to actually see how the management team is acting, how they're carrying themselves. I don't think most will do it because it's extremely transparent, and they'll at least want to have some wall up there to keep from being too transparent. But, generally speaking, I like it. Whenever I see a management team that does that, it's encouraging to me, at least.

Hill: I think it was about a year before Yahoo got bought by Verizon, do you remember, they did a conference call and the body language of Marissa Mayer was so telling and not in a good way.

Muckerman: Sell, sell, sell. 

Hill: Yeah. To your point, Jason, that's why I think most companies, there's no great incentive for them to do it, because if you say, "We're going to do it for this quarter because we know we're going to crush this quarter ... "

Muckerman: That's right, you can't back out.

Hill: It's kind of like guidance. If you're going to give guidance, that's fine. But, just know, if someday you decide, "Well, we're going to stop giving guidance," you're going to take a hit for that. Tomorrow's episode on Market Foolery, Jim Gillies back in the house. Been a long time since --

Moser: From the great white North.

Muckerman: Yeah, I think since November.

Hill: The great white North, he made it over the border.

Moser: He said he's just here for a couple of days.

Muckerman: Today and tomorrow, yeah.

Hill: Yeah. So, he'll be in studio tomorrow, and maybe I'll ask him why he hasn't been here in so long, and what, if anything, does that say about his personal security profile with the United States border patrol? But maybe not. Anyway. Taylor Muckerman, Jason Moser, thanks for being here, guys.

Moser: Thank you.

Muckerman: Thanks.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow.