From All-Day Breakfast to Athleisure Wear: Looking Back at the Top Stories in Consumer and Retail

It's throwback week for Industry Focus, and on this Consumer Goods episode, former host Mark Reeth joins Sean O'Reilly and Vincent Shen to update Fools on some of the major stories from his time covering the industry.

Find out just how far Chipotle Mexican Grill (CMG -0.46%) has fallen from its reign as the darling of fast casual, and what the company is doing to win back customers. In a reversal of fortunes, the team also discusses how McDonald's (MCD -0.03%) has managed to revitalize its business despite being on the wrong side of the health food craze. And to wrap things up, learn about the explosion of the athleisure and sports apparel industry, which may be attracting more competition than smaller players can handle.

A full transcript follows the video.

This podcast was recorded on April 26, 2016.

Sean O'Reilly: We're taking a trip back in time on this throwback consumer goods edition of Industry Focus.

Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginia. It is Tuesday, April 26th, 2016, and joining me in studio is Vincent Sean and ... Mark Reeth?! Who let you in here?

Mark Reeth: Been a long time, my friend!

O'Reilly: What the -- welcome to the studio, thanks for joining us!

Reeth: Thanks for having me. Long time no see.

O'Reilly: For our listeners who don't know you, when did we last do a podcast together?

Reeth: You and I?

O'Reilly: Yeah, it was up in Mackey, in the old studio.

Reeth: It was very old-school, yeah. We were young and naive. It was simpler times.

O'Reilly: We put on blazers like jerks. (laughs) 

Reeth: We tried to look good, and now we just don't even bother. Yeah, it was different times. It was almost a year ago. I'm happy to be back. We got the dynamic duo back together, we get to hang out with Vinny for the first time in a while. It's great.

O'Reilly: Had you met Vince before this show? 

Reeth: You know, I've heard of him, and I've absolutely seen some of the Industry Focus episodes you guys have done, they've been spectacular. So like I said, looking forward to working with you, it'll be fun.

O'Reilly: The theme of the show is, we'll take a trip back in time and update the audience on the stuff that you and I were talking about all the time back in the ... what did we call it back then? I don't even remember.

Reeth: It was Consumer Goods Countdown.

O'Reilly: Consumer Countdown, yeah.

Reeth: There were different names for it. Again, simpler times.

Vincent Shen: All this before I had even joined The Motley Fool.

O'Reilly: Right.

Reeth: You weren't missing much, let's be real.

O'Reilly: How many ... because, we would just throw those up on Yahoo. Our podcast never made it to ...

Reeth: No, I think the majority of the views were my mom.

O'Reilly: That's good.

Reeth: And that was about it. (laughs) 

O'Reilly: "Oh, look at my Mark, he's so cute!"

Reeth: Is that your my mom impersonation? I'm a little offended, but let's keep going. (laughs) 

O'Reilly: Fine, you do an impression of your mom -- I'm just kidding.

Reeth: Nope!

O'Reilly: So, first and foremost, the topic that we always found ourselves talking about was of course restaurants. Specifically, we'll hit up McDonald's here in a second, but Chipotle, and back when we did our little deal, they were ... comps were in the mid-teens.

Reeth: Absolutely. Chipotle was the fast-casual restaurant chain of the future, and everyone wanted to be them. I actually looked up the numbers. It was very easy to see --

O'Reilly: Do you deal with numbers anymore? Just kidding.

Reeth: A little bit, I'm more of a people person now. But, the stock is down 30% since April 26th, 2015, just to give you an idea of how far the mighty have fallen since you and I last talked about Chipotle. And, obviously, we could go over all the different issues that it's had over the last couple of months with the health stuff, the norovirus ...

O'Reilly: The poisoned cilantro. (laughs) 

Reeth: The E. coli. But, you know, it was actually funny, taking this trip back down memory lane, I had forgotten about the fact that for nine months there, Chipotle wasn't selling carnitas. Remember that? No one talks about the carnitas issue anymore, mainly because it seems relatively small compared to E. coli. It's understandable. But when I was thinking about it, I was taking a look back at the charts, and you can see how once Chipotle stopped selling carnitas, there's really only a small dip in the charts, it really didn't affect the company all that much.

O'Reilly: With comps and sales and all that.

Reeth: In terms of sales, in terms of just share price, as well. Which is really weird to me, thinking back on it now. At the time, when we talked about it, we just kind of shrugged it off. But, for three-fourths of a year, the company wasn't selling one of its main food ingredients, and nothing happened to Chipotle. Nothing adverse effect on the stock at all. And I think a large part of that had to do with good will. And I think we always talked about that, too, about how Chipotle, like we said, it was all the way up here. It's the food with integrity. Everyone wants to be Chipotle, everyone wants their food to have integrity. One day Chipotle finds out their carnitas don't have integrity, so they stop selling them. 

And people, instead of punishing the stock for losing sales because it's not selling carnitas, they praise the stock because the goodwill is so thoroughly embedded in that company. Food with integrity, they're sticking with their guns, they're not selling carnitas, it's for the benefit of everybody, and then E. coli struck, and now we're down 30% in the last 12 months.

O'Reilly: They're trying to make good on it. We went a couple weeks later, because they were giving away free burritos. But, they actually closed every store for a day so they could have a companywide meeting. And now, I was preparing the notes for this show, I don't have a ton, but, they said, "We're going to lose about $1 per share this quarter." It is staggering, the difference that's happened here.

Shen: And, a big part of the swing, too, is, the carnitas thing that you mentioned, that's pre-emptive. And that's something they basically had control over. 

O'Reilly: So they got rewarded.

Shen: They decided to no longer offer that. In this case, with the E. coli outbreak, they had no control over that. Once the sicknesses started being reported, and the CDC got involved, the press will take that and gladly run with it. And once the CDC wrapped up their investigation, they could never even found the source, because Chipotle, frankly, has a lot more fresh ingredients than your average express --

O'Reilly: It's actually harder to control, yeah.

Shen: So, combine that fact. But once the CDC did end their investigation, it's not like it was on the front page of these different media websites like, "Oh, it's OK again." Chipotle, now, what you mentioned with Town Hall, when they closed for five hours on that day in February, now they're trying to lure everybody back in. They mentioned, actually, they had 5.3 million requested free burritos, because they gave that rain check offer. 

O'Reilly: I would think that 300,000 of those were actual, legitimate ruined lunch plans, and the rest ... (laughs) 

Shen: I would say, probably a quarter of those distinct people, and a lot of the others were people doubling up.

O'Reilly: Did you get one?

Reeth: Of course I did! What are you crazy? Think E. coli will scare me away from free Chipotle burritos?

O'Reilly: (laughs) I don't think anyone at this table stop going there.

Reeth: Heck no, absolutely not.

Shen: It was nice, because for once, I didn't have to wait in line.

O'Reilly: A shorter line, it's great. And, these people in my building, I ran into a friend of mine in the lobby, and he was like, "Oh, did you hear they're closing all the Chipotles forever because of E.coli?" I'm like, "The company's fine." (laughs)

Reeth: Well, the company is fine. I think deep down, the long-term growth of the company is still pretty assured. Chipotle reports earnings, I think, today, actually.

Shen: Yes they do, after the close.

Reeth: Later today, yeah. So, there's going to be a lot to watch there. Analysts are expecting huge drops in revenue, and smaller ones in EPS. I think the main thing to watch, and you both touched on it with the free burritos, Chipotle is doing everything in its power to lure customers back to its stores. We might be joking around about how E. coli isn't scaring us off from our burritos, but it scared a lot of people off. And they've been spending so much money to bring those people back, with free burrito days, and think about how much money you lose countrywide if you close all of your stores for five hours. You think, five hours, that's nothing; but that adds up. 

I think, this quarter, we're going to see a lot of drops. I really just want to see, like I said before, the goodwill return to this company. I think once it regains customer trust, then you'll see the numbers tick back up. I think Chipotle still has a lot of long-term growth ahead of it. I think people will trust it once more sometime in the future. Probably not tomorrow, probably not until the CDC gives it the all-clear one last time. But, I'm not worried about Chipotle over the long term.

O'Reilly: I'm also curious to see, before we move on to talking about the golden arches, if they'll keep buying back their stock. They actually bought back $787 million worth of shares between November 1st and March 14th, at an average price of $493 a share, so not quite profitable yet. They're at $440.

Shen: But, keep in mind, during their peak, I think in August of last year, they were trading over $750. 

O'Reilly: This is a bargain, yeah, it's great.

Shen: For them, that could be seen as a very wise allocation of their resources. Those vouchers, by the way, which, my brother managed to collect 15 in his apartment building, and he's gradually going through them. They sent out 21 million of those in stages.

O'Reilly: Wow!

Shen: The direct mailers only see a redemption rate of about 30%, call it.

O'Reilly: That's it?! Really?

Shen: Yeah. Whereas, the digital one, the 5.3 million rainchecks during the Town Hall, they see a 60-70% redemption rate. So, a lot of money being spent on promotions, for sure. But, how much to lose, it's not like they're giving away 26 million free burritos.

O'Reilly: If any of you listeners out there have an unredeemed coupon, please mail to Fool Headquarters in Alexandria, Virginia.

Reeth: Just pass them along.

O'Reilly: Care of Sean O'Reilly. (laughs) 

Reeth: Start stacking them all up. 15?!

Shen: Yeah.

Reeth: Oh my gosh, that's great.

Shen: People just throw them away!

O'Reilly: 30% redemption rate ...

Reeth: That's five days of meals, three square Chipotle meals a day.

Shen: Exactly.

O'Reilly: In fact, if you get the loaded bowl, you could make two meals out of that.

Reeth: Makes a lot of sense. Thrifty.

O'Reilly: So, a couple days ago, on April 22nd, I tweeted -- and I'm paraphrasing here, "I feel like I blinked and McDonald's shares went through $100 to $125 without my knowledge." They were hanging out at $100 for like a year for a long time, back when we were ... and we were like, "I don't know, they're not as cool as Chipotle, they're just hanging out." Then, they introduced all-day breakfast!

Reeth: Revolutionary.

O'Reilly: Is that the reason for the 25% gain? (laughs) 

Reeth: I think that's absolutely part of the conversation. Again, I took a look at the numbers. Shares are up 33% in the last 12 months, which is pretty darn impressive. And to your point earlier, whenever we talked about McDonald's, it was ... it was very much ...

O'Reilly: It was boring, say it.

Reeth: Pooh-pooh, it's McDonald's. It's old-school. We've got Chipotle up here, we've got McDonald's down here. That's been the conversation for a long time. To a certain extent, it's still the conversation. But to their credit, McDonald's has done a lot to turn around their business. And like you said, I think a large part of it has to do with the all-day breakfast. That's one thing that Chipotle doesn't have, a breakfast menu. And I think McDonald's does breakfast better than a lot of its competitors out there. It's also been benefiting from the McPick 2, where you get two menu items for something like $5, which is good value, a good bargain for that customer base that McDonald's is looking for. Yeah, it's been a heck of a turnaround. 

Honestly, and this is just my opinion, I think the turnaround has a lot to do with Steve Easterbrook, the CEO who came in in March of 2015, almost a year ago, when it was still, as you said, down at $100 or so per share. Now it's way up.

O'Reilly: We were just hanging out, talking about it as a dividend stock, and that was it, yeah.

Reeth: It just meandered for a long time there. And then Steve Easterbrook came in. He's been great. He's been at McDonald's since the '90s. He actually left for a short period of time and got some fast casual dining experience over in England, then came back as the chief brand officer, and eventually became CEO. And, almost as soon as he steps in, things start turning around. They start revolutionizing their menu with the all-day breakfast, with the McPick 2s, they start revamping stores. 

I think most importantly, and people always forget about this, out of McDonald's 36,000 around the world locations, 30,000 of them are owned by franchisees. You have to keep those franchisees happy. When your stock price and sales are just meandering along for years, you're not going to be happy. People aren't going to be lining up to own these stores for you. Now, suddenly, Steve comes in, shares start going up, stores get revitalized, they bring in new menu items, you start seeing sales go up at those franchisees. Now they're happy. Now people are starting to line up again for those McDonald's franchises. So, again, I think a large part of this turnaround has to go to Steve Easterbrook. I think he's been a huge part of this.

O'Reilly: Did either of you hear those rumors that the franchisees were actually fighting the all-day breakfast move?

Reeth: No, tell me more.

O'Reilly: I suspect it was because of supply chain Inventory management, like, OK, how many Egg McMuffins do we keep on the shelf at 4:00 p.m.? What are we going to do here? But, I bet they're happy now. (laughs) 

Shen: Well, it comes down to the fact that, when you add, basically, a whole day part to the menu, and you have to serve that all day, you only have so much grill space. And when you add those products, it makes it much more complicated. That's absolutely what happened with the franchisees being frustrated. But, once they saw the benefit of the increased foot traffic, and the fact that, the McPick 2 promotion, for example, they hit that on two tiers. They had the one for $2 for the super value-conscious, and they had the one for $5, McPick 2 for 5. And management is talking about how they're seeing that being able to essentially appeal to two groups where, some people go in and split that, so it's still a really great value for them, but it's still in-step essentially with very similar promotions from Wendy's and Burger King, where they're doing these value meals again. And I think that's perfect for McDonald's, because they're returning to their roots, where, in the end, I think most people recognize the fact that, it's not the best food you're getting there.

Reeth: Wait, what?! Oh my god.

Shen: But, it comes out of the fact that they want that value, and they want that consistency. Just a quote I saw recently, from Easterbrook, actually, where he talks about simplified menu boards, new crew training procedures, they're looking to every single detail, like font size on the printers, the receipts. And he says things like, "The primary driver of customer satisfaction, getting it right, hot, fresh food, friendly service." Just hearing management mention these things again in their calls is like, OK, they're refocused on the right things, and this is a really nice trajectory that I think can be long-term for them.

O'Reilly: Did you guys see they're making a movie about Ray Kroc?

Reeth: I did see that, yes.

O'Reilly: It's starring Batman. (laughs) 

Reeth: I think it'll be a pretty good story.

O'Reilly: And starring Michael Keaton.

Reeth: It's about how he took away the power of McDonald's from the McDonald's brothers. I think it's actually going to be a pretty fascinating movie.

O'Reilly: I want to see it.

Shen: Wait, you're telling me Ben Affleck's going to play that role? (laughs) 

Reeth: Oh, god, this is why we don't work together Vinnie.

O'Reilly: Michael Keaton will always be Batman.

Before we move on, I wanted to point any listeners out who are hungry for more Foolish content to focus.fool.com, where all Industry Focus listeners have access to a special discount on the Motley Fool's Stock Advisor newsletter. The discount works out to $129 for a full two-year subscription. Once again, that is focus.fool.com.

All right, so. Mark, you get to pick. We're going to talk about clothing now.

Reeth: Clothing!

O'Reilly: Do you want to talk about everybody's favorite yoga-wear retailer, Lululemon Athletica (LULU 1.33%), or Under Armour (UAA 0.23%) first?

Reeth: That's a good question. I guess we'll start with Lululemon. Again, I took a look back at the share prices a year ago. Lululemon's only up 2% since we last spoke about it. And the conversation, for a long time, with Lululemon was trouble with the management.

O'Reilly: Pilling.

Reeth: Pilling, for instance, was also a problem a year or go or so. Those problems have kind of been pushed to the side, and Lululemon was still doing what they usually do. And to their credit, revenues are up 15%, net income is up 11% as of their last quarterly filings. They're still firing on all cylinders.

O'Reilly: It does seem like, operationally, they're turning the ship finally.

Reeth: Exactly. And that's very good. There's nothing wrong with that. My problem is, it's going to be tougher and tougher for Lululemon to sell these $80 capris and $110 hoodies.

O'Reilly: Do you remember the company's gross margins? It's like 50%! That's insane!

Reeth: Yeah, and that's something I was going to mention -- they've started guiding gross margins down, very slowly. I think yeah, gross margins last quarter were something like 51.4%. They guided for gross margins to come down to 47%.

O'Reilly: This year?

Reeth: Yeah, this quarter, year-over-year. That's a small amount, in the long-term scheme of things. And like you said, 51%, that's pretty good. But it's indicative to me that their gross margins are going to start to, at least in my mind, slowly come down as more and more competitors enter this market. A year ago, if we talked about athleisure or whatever the kids are calling it these days, we probably just talked about Lululemon. Maybe Gap, with their athletic stores, sure.

O'Reilly: You're absolutely right.

Reeth: Now, if we're going to have a conversation about Lululemon, a lot of other companies have to enter that conversation. Nike is coming at the athleisure wear space from the sports angle. Excuse me, Under Armour, which we'll talk about in just a second, same thing.

O'Reilly: I was just thinking, since we did our last show together, a mall in my hometown in the Midwest, huge Under Armour store just opened up. Shoes, yoga pants, shirts, huge store. And I'm like ... there's only so many consumer dollars out there.

Reeth: That's true, but you have to admit, a lot of those consumer dollars are going to Under Armour right now. If you look at their last quarterly report, I mean, my god! What is it, revenue growth of over 20% for the last 24 consecutive quarters? You can't deny they're doing something right over there. But, again, Under Armour is almost in the same position as Lululemon. I think Lululemon is a little bit worse-off, because their niche is so much more niche-y, that it's not just leisure wear, it's also mainly women's leisurewear, whereas Under Armour can expand out of its niche a little bit easier, I think. 

But again, there's just so much competition coming in to this market now, where we're starting to see a lot of saturation. If you look, actually, at Under Armour's pricing over the last couple of quarters, a Morgan Stanley analyst named Jay Sole pointed out in a report recently that Under Armour has seen declines in the average selling price of the company's apparel for the last six quarters. Again, it's almost like that Lululemon guiding down their gross margins just a little bit. Everyone's focused on the big numbers. The revenue is outstanding, the EPS is great. 

And sure, that's all fine. But there are little hints here that the saturation is starting to affect these companies. Under Armour is bringing prices down, Lululemon's gross margins are starting to get hit just a little bit. These businesses aren't going to collapse tomorrow, by any stretch of the imagination. But again, when you have so many competitors coming in from every single angle into this market, whether it's low-end with Wal-Mart and Target, or high-end with Victoria's Secret or Tory Burch ... Beyonce has her own athleisure line. For god's sake, people, Beyonce. 

O'Reilly: Do you know what she charges? (laughs) 

Reeth: No, I don't, I'd have to check the price tag on everything in my closet. But, again, I think both of these companies are pretty sound. But I think the market as a whole is starting to get really crowded.

O'Reilly: Not only that, but Lululemon's having to go to different segments for growth. The best, fastest-growing segment for Lululemon in the quarter they just reported was men's wear. So, my question was, does anybody here own a shirt from Lululemon? No?

Reeth: No ...

O'Reilly: Didn't think so.

Reeth: And that kind of goes to the point I was trying to make earlier, though, how Lululemon is kind of backed into this corner with their niche. It is very much a women's brand for leisure wear. And you're right, they are trying to grow out of that into men's wear. And again, to their credit, their online sales have been ticking up pretty consistently over the last couple of quarters. Like, they're doing things right. But it's tough to have that conversation. I'm not going to walk into a Lululemon on my own and buy sweatpants there.

O'Reilly: Girlfriend's going to have to drag you in there. (laughs) 

Reeth: It's not my brand, it is my girlfriend's brand, or your wife's brand, or your daughter's brand, whatever. And, as for Under Armour, they don't really have that. They have that leisure wear as a sports wear kind of market. And they actually have so much more room to grow in several markets, like their footwear, which has been outstanding for Under Armour in these last couple quarters. We've got Stephen Curry, who's just been phenomenal, and he's been their biggest brand ambassador, his footwear line is selling hand over foot. Their footwear segment grew 64% year-over-year this past year. They have new launches, smart running shoes, new running shoes with Jordan Spieth as their spokesperson. So, I think Under Armour, like I said before, has a lot of different directions it can grow. Lululemon, not nearly as many. And that worries me.

O'Reilly: Yeah. In their latest report, Vince, I'd love to get your thoughts on this, they said they wanted to double sales by 2020. My eyebrows popped at that, Mark here is not buying it. I mean, maybe they can sell to a bunch of men? Is this possible? They want to double sales by opening stores and stuff ...

Shen: Yeah, but keeping in mind what you guys said in terms of the market being really crowded, I will not deny that, especially in the athleisure segment, within, we'll call it sporting apparel overall, definitely getting very crowded. I understand that. But, Lululemon's footprint is still quite small, 350 stores. And mostly concentrated in the U.S., at that. You mentioned men's growth as being a big driver for them, but also international growth is a big driver for them. So, I think that's very ambitious on their part. But at the same time, there's also some longer-term trends in terms of demographics that are benefiting them as well.

Morgan Stanley, again, had this report talking about sporting retail, about the fact that in North America, for example, high school sports participation is up from 25% to 35% over the past 35 years, especially with girls, which benefits Lululemon. Participation doubled from 17% to 32% over the same period. Then, keep in mind the fact that U.S. professional sports leagues, their studies say that interest in their product, their sports, is very much tied to the fact that the consumers participated when they were younger. That doubles up as it goes through time.

Latin America, super low penetration. Does that benefit an Under Armour more so? Probably, because the premium prices aren't going to work as well in some of these emerging markets. But, overall, I think that, with China, for example, another big growth area for both of these companies, and the fact that the government there is actually pushing its citizens into healthier lifestyles, to be active, because they basically want a next generation of highly competitive athletes to participate--

O'Reilly: Are they actually telling them to work out? 

Shen: They're very much pushing them.

O'Reilly: That's scary. (laughs) Big Brother is telling you to work out. (laughs) 

Shen: I don't think that's the worst thing in the world. 

O'Reilly: Yeah.

Shen: So, that's a nice push to have. Basically, think about basketball. The number of people who play basketball in China is absurd per day, it's hundreds of millions. So, when you have a market that size, I see the competition, of course, just being the fact that the market is so strong that people want to get into this business.

O'Reilly: Cool. Alright. Mark, thank you for joining us, we'll have to have you back.

Reeth: Yeah, I knocked it out of the park. You guys should definitely have me back.

O'Reilly: And he's so humble, ladies and gentlemen. (laughs) 

Reeth: I was happy to be here. Thank you guys.

O'Reilly: If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Again, that's [email protected]. 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 those stocks, so don't buy or sell anything based solely on what you hear on this program. For Vincent Shen and Mark Reeth, I am Sean O'Reilly. Thanks for listening and Fool on!