Nike Looks Expensive; Some REITs Look Cheap

In this podcast, Motley Fool senior analyst Matt Argersinger discusses:

• Nike beating Wall Street's low expectations in the third quarter.
• Why being a higher-end discretionary consumer business puts Nike at risk.
• How the banking drama is putting some commercial real estate businesses in peril, while four REITs appear to have been oversold.

Motley Fool analysts Kirsten Guerra and Tim Beyers face off in the semifinals of our stock investing bracket!

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 22, 2023.

Chris Hill: We've gotten Nike, real estate, and two analysts going head-to-head over two different stocks. Motley Fool Money starts now.

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I'm Chris Hill. Joining me today: Motley Fool Senior Analyst Matt Argersinger. Thanks for being here.

Matt Argersinger: Hey, thanks for having me.

Chris Hill: Let me timestamp this. We are recording late morning on Wednesday. This is before the announcement from the Fed and whatever comments Jay Powell makes. On tomorrow's show, Andy Cross is going to be here. We'll be talking about all of that. For right now, let's you and me start with Nike.

Matt Argersinger: Is that your nice way of saying whatever we talk about now is really not going to matter by this afternoon?

Chris Hill: I don't know. I'm a Nike shareholder. I feel like what we're going to talk about matters to me.

Matt Argersinger: Good.

Chris Hill: We've got some other stuff to get to as well. For anyone who is listening, this will come out after the comments. Why aren't they talking about the Fed? It's the morning. The Fed stuff hasn't happened yet.

I think it's fair to say that Wall Street's expectations for the holidays were pretty low in terms of Nike, and not without reason, but third-quarter profits and revenue beat those low expectations.

Where do you want to start? Because it seems like inventory is getting better, but they still have work to do.

Matt Argersinger: I think that's where you have to start, because that's been the issue, I think, overhanging the business and the stock price for most of the past, say six to nine months. When inventory is going one way and sales are going the other, it only leads to one thing, which is lower-profit margins and lower earnings. That's what they're seeing, even though, as you mentioned, the expectations were better. Global revenue was up 14%. Their direct channel looked pretty strong. Digital sales there were up 20%.

But again, I think it's the earnings that's really the story. Net income was down 11% year over year. Gross margin was lower. They're working on the glut, but inventories were still up 16% in the quarter, and that's faster than sales are growing.

I still think they're in that situation they're going to have to continue to mark down, continue to liquidate inventory. That's going to keep gross margins pretty low. They're only seeing revenue growth of high-single-digit percentages for the remainder of the fiscal year.

To me, the inventory is one thing, but I think the bigger risk with Nike right now is that they're in that uncomfortable, higher-end discretionary category that I think is susceptible to a slowdown in consumer spending. If we see that, and we know that credit is getting a little tight, consumer credit card balances are high, the job market is strong but maybe teetering. They've got this inventory issue. If sales then start to slow down, that could portend some serious problems. It's not as if Nike shares are cheap at the moment.

Chris Hill: Even though the stock is treading water today, you look over the last six months, it's up 25%. It has definitely rebounded from the low. I do like the fact that John Donahoe, the CEO at Nike, I feel like he's about as transparent as you would want to see in terms of talking about the business. You go back to last quarter, he said, "We're past the worst of the inventory problems, but margins are going to take a hit during the holidays," and he was right about that.

Matt Argersinger: He was. Spot on. I think you're right. I think they're working through it as aggressively as they can. If you look at last quarter, inventory was up 43% year over year. They've done a good job. That growth has come way down.

You mentioned the stock being up 25%. I just feel like the stock isn't really reflecting, I think, some of the issues that they're going to have with margins and a slower growth rate. If you look at what they're expecting to make for earnings this year, that means the stock is trading roughly 38 times those earnings. Now, maybe that's a depressed earnings state and earnings are going to bounce back in fiscal 2024. But I just think you're paying a high price for... It's probably going to be a tepid next few quarters.

Chris Hill: We have talked so much over the last few weeks about Silicon Valley Bank, First Republic, Credit Suisse, and a bunch of the ripple effects from what we're all seeing in the banking industry. But one thing we haven't really talked about is the fallout for real estate stocks and REITs. I'm curious what you are seeing and what your reaction is to what you're seeing.

Matt Argersinger: It's been something to behold, Chris. The fallout in REITs and real estate-related stocks in just the past few weeks. I think the initial reaction to the Silicon Valley Bank fallout was well, OK, overexposed to technology, venture capital, that part of the market.

I think what now investors are waking up to is that, well, the fallout of SVB and this small to mid-size regional banking crisis that has ensued, it's heightening awareness about the role that commercial real estate plays on the loan books of many of these banks. These smaller regional banks, they tend to be the lifeblood of commercial real estate lending in many markets. You take away that liquidity, and a lot of commercial real estate is not going to be able to refinance or roll over debt this year and probably the next few years.

You've got to remember in commercial real estate, especially office, was already facing a lot of fissures. Tenants aren't coming back to the office, they're not renewing leases, so you have a slew of office landlords sitting on millions of square feet of empty office space. Leasing activity is nonexistent, and the debt is coming due.

Remember in commercial real estate, unlike the residential market, debt tends to have much shorter maturities -- three years, five years, maybe seven years at the high end -- and those interest rates are almost always floating. There isn't like a 30-year fixed rate that you'll find that we have in the home market. That debt is coming due. Interest rates are higher. Now with Silicon Valley Bank and a lot of banks not in a position to lend, it's creating a real challenge for commercial real estate.

Chris Hill: Do you think the opportunity in commercial real estate is attractive enough, that the economics are attractive enough, that larger banks start to step in and essentially, among other things, take market share from the smaller regional banks?

Matt Argersinger: I think so. I worry about the smaller to mid-size areas of the real estate market, because unfortunately the bigger banks like your JPMorgans, your Bank of Americas, it doesn't move the needle enough for them to get involved. They'll get involved in some of the bigger deals, and they will take market share for sure. It's that lower part of the market.

But I do think the damage to the REIT market has just been way overdone. Especially when it comes to large real estate investment trusts that have great assets, great balance sheets, plenty of access to the capital markets.

A few that come to mind are Mid-America Apartment Communities, which is the second-largest apartment owner; Alexandria Real Estate, which is a blue chip technology and life sciences, office REIT; Realty Income, which is just a wonderful, diversified, very low-risk net-lease REIT; and Prologis, leading industrial. These stocks have been killed, and they're trading at some of the lowest valuations in years with dividend yields that are also at multiyear highs.

If you look at the overall REIT picture, REITs are trading, by most estimates, at least 10% if not 20% below their net asset value. I'm not saying all REITs are created equal, but that I think presents a really interesting opportunity for investors that can take a long-term view because the damage has just been pretty severe. I really think, at this point, it's overdone.

Chris Hill: Matt Argersinger, always great talking to you. Thanks for being here.

Matt Argersinger: Thanks, Chris.

Chris Hill: While the real March Madness gears up for the Sweet 16, our investing version moves on to the semifinals. Today, we've got Kirsten Guerra facing off against Tim Beyers.

Ricky Mulvey: Welcome to the semifinals of Stock Market Madness. This is going to work a little bit differently because there's going to be some rebuttals now that we know what the stocks are. In this semifinal matchup, we have Kirsten Guerra and Tim Beyers. Kirsten, talking about General Motors. Kirsten, good to see you as always.

Kirsten Guerra: Thanks for having me on, Ricky.

Ricky Mulvey: Tim Beyers, coming in to defend Monday.com. Tim, appreciate you being here.

Tim Beyers: Thanks, Ricky. Ready to go.

Ricky Mulvey: The way this will work is that Tim Beyers has elected to defer, meaning that he will kick off and end the discussion. He'll get two minutes at the start to recap the case on Monday, then Kirsten will have five minutes to offer her rebuttal and recap her case for General Motors, then Tim Beyers gets three minutes to the end to make his rebuttal. I will be watching the stopwatch.

And with that out of the way, Tim Beyers, two minutes is yours to recap your case.

Tim Beyers: Monday.com. For those who don't remember, Monday is a low-code productivity software. I consider it one of the innovators here, born in 2012. I would say its primary closest competitor would be Airtable. They were born in 2013. The company it wants to be as Atlassian. I'm going to come back to that in the final here.

But what I want to point out: two things about Monday in the minute and a half I've got left here. It meets all six signs of a Rule Breaker. That is very important, because companies that meet all six signs of a Rule Breaker tend to be exceptional growth companies.

And to recap what that is: The six signs of a rule breaker are the top dog and first mover. They have sustainable advantage, they have past price appreciation. They have good management, smart backing, they have strong consumer appeal, and they are overvalued according to the media.

In my last case, I went through each of those six, so I'm not going to go through that right now. But what I will say is that this company has two very big things going it. It is operationally efficient and growing more so with every passing quarter. I'm going to point out how that is in just a second. Then secondarily, the valuation, considering the growth here, is actually pretty darn attractive.

First things first: operationally efficient. One of the arguments over companies like Monday.com because it's a cloud company, is that there's far too much stock-based compensation here. You can make that argument... except not really, not anymore. Because in the latest quarter, even if you take out every bit of the stock-based compensation, it's still a cash generator: $5.3 million worth. This company has generated increasingly improved operating margins.

We're out of time.

Ricky Mulvey: Yes, we are.

Tim Beyers: I'm going to have to come back to that.

Ricky Mulvey: Kirsten Guerra, you get the full five minutes to offer your case and offer rebuttal to Monday.com in Tim Beyers's case. Five minutes is yours.

Kirsten Guerra: Thank you. As I mentioned last time, automakers right now, I think, are a more interesting space than maybe they have been for decades, given a few catalysts that are changing the industry overall. Because GM specifically is, in my opinion, price to reflect automakers of the past and not necessarily the near future.

I like GM for a few reasons: market share, margin story, and unpriced optionality.

I'll start with market share. GM is pushing harder than any other OEM I've seen into segment coverage. It plans to produce EVs covering 75% of U.S. segment volume by 2025. Together with the overall industry shifts to EVs, this is a really strong opportunity for them to gain market share above their historical average around 16%.

But even if I'm wrong there, GM has a compelling margin improvement story as well. EVs as a whole are generally viewed as having far fewer parts and being easier to manufacture at lower costs. GM's EBITDA-adjusted margins, which now sit around 8% to 10%, management expects to improve that to 12% to 14% by 2030. Now, management has been very clear that it will not achieve Tesla-like margins just by virtue of producing vehicles that cover so many more segments than Tesla does. But that's fine. A 4-percentage-point average margin improvement for a company with revenues as large as GM's is a very meaningful improvement.

Finally, that unpriced optionality that I mentioned is Cruise, GM's autonomous ride-hailing subsidiary. GM believes Cruise can reach $50 billion in revenue by 2030. If we assume that that's correct, and then we assume an average of $25 per ride, which is taken from an average Uber ride.

That would imply that Cruise in 2030 will facilitate 2 billion rides annually. For comparison, Uber facilitated nearly 7 billion in 2019. That seems very much within the realm of possibility. If that $50 billion estimate was spot on, it would place Cruise at around 18% of the company's revenues in 2030, which just makes it a far more appealing business model and margin profile than it stands at today.

But enough about GM. Let's talk about why Tim's pick is trash. Here's what's tough about these two businesses, honestly. Monday.com and GM, they're very different. They could be, honestly, both great businesses and serve very different roles in the same portfolio, I think. Sorry to be a pacifist here in Madness, but that's just the truth, I think.

But I'll tell you why I personally feel more comfortable with GM compared to Monday.com. That's because in my mind, Monday.com feels a bit like a commodity. I'm sure that sounds very rich from someone who just pitched an automaker, but hear me out here.

First off, a commodity, for anyone unfamiliar, is essentially just a product that's undifferentiated. You can think oil or minerals, those are commodities. There's nothing distinct about the product itself. In terms of a quality investment, it's all about how efficient the business itself is, and Tim has made a compelling case that Monday.com is a very efficient business. Clearly, Monday.com is not a true commodity.

But for me, it's just that if you imagine a spectrum, and on one end of that spectrum, you have really highly differentiated vertical-market software that requires like niche industry knowledge, and there's maybe also not a lot of competition because the total addressable market is smaller. Then on the other end of the spectrum, you have like pure commodity.

I would place Monday.com and all of its task-management peers maybe leaning a bit more toward commodity, a bit less differentiated than a lot of other software plays out there. I'm not a software developer, never have been. I could be totally wrong here. But to me, task-management-type software like Monday just seems to have one of the lowest barriers to entry in software, and that could be OK as long as it's a large and growing market and everyone can grow their slice.

But I do worry that there are some big expectations baked in. It trades around 140 to 160 times free cash flow, depending on whether you're factoring in leverage.

In comparing the two companies, GM, I just see us trading with lower expectations, but ,in my opinion, a lot of upside. If I'm right, that's a big win for me. If I'm wrong, I see it as not a huge loss. Whereas Monday, I worry, is the opposite. If I'm wrong and it lives up to these big expectations then I missed out on some upside. But if I'm right, I fear it would be a far bigger loss than GM could be for me.

Ricky Mulvey: That is your time, Kirsten Guerra. Five minutes is up. And we can all get along, but only one person is going to make it to the finals of Stock Market Madness. Making his case that he should be the one, Tim Beyers, three minutes is yours for a rebuttal to Kirsten's case.

Tim Beyers: Let me tell you why Kirsten's is wrong. It's interesting. GM is never going to not only hit the margins of Tesla, it's going to have a hard time hitting the margins that it's going for. The reason for that is it's a disaggregated business. GM doesn't have control over a lot of that supply chain that would grant those margins. That's a problem. It's going to be very difficult to overcome. I would not overbet on those margins.

In the case of Monday, they are very vertically integrated. They are integrated all the way down. While it's true that low-code productivity software, there are a number of entrants in that, it is a big market. It is growing fast, and there is a differentiation for Monday. It is around how they make that software customizable for anyone that wants to use it.

The number of use cases, it gets used for software development, it gets used for task management, it gets used for support, it gets used for customer relationship management. It is a highly flexible piece of software, and that shows up in the financials.

But let me hit the valuation for a minute here, because this is really important. The argument for GM versus Monday is that you are getting GM at a crazy low price and that you're going to get a high return as a result of that. But here's what's true about Monday when you look at the model: If it were to grow at 42% over the next 10 years, annualized -- which is a high hurdle. I understand that. But if it were to do it, and it's already growing much faster than that right now, then that would be a 20% annualized return.

Think about that for a minute. That's a 6x in 10 years. Now, I would say that's unlikely. But the hurdle to a 10% return, which is probably what you're going to get from GM if you're lucky, over the next 10 years, is 30%. That's about half of where Monday is right now. This is a business that's growing at an exceptional rate. It is getting more efficient. It is not firing people while its competitors are.

Let me bank a little time and end on this. Can you imagine Monday becoming the business it wants to be, which is Atlassian? Because if you can, given all of its advantages, given how it's growing, then that would make it a $35 billion company. Atlassian today is over $40 billion. It's a misunderstanding to think of the high hurdle here. It's not really as high as it looks, and that's why I really love Monday.com here.

Ricky Mulvey: Tim Beyers, thank you for the case on Monday.com. Kirsten Guerra, thank you for the case on General Motors.

Now it's up to you to decide who won. We're going to have a poll up at Motley Fool Money on Twitter. You can decide who made the better argument. More importantly, who's moving on to the finals of Stock Market Madness? Thank you both.

Chris Hill: As always, people on the program may have interest 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. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.