In this episode of Market Foolery, Chris Hill welcomes Taylor Muckerman and Jason Moser to the show as they dig into the latest news from Fitbit (NYSE:FIT), which just made a steep cut to its sales forecast and announced a round of layofs. They also provide an update on Rite Aid (NYSE:RAD), which saw its buyout bid from Walgreens Boots Alliance (NASDAQ:WBA) drop significantly now that it is clear that regulators will insist on bigger divestitures before they allow the merger to happen.
Finally, the team answers a listener question regarding heavy equipment manufacturer Cummins (NYSE:CMI).
A full transcript follows the video.
This podcast was recorded on January 30, 2017.
Chris Hill: It is Monday, January 30th. Welcome to Market Foolery. I am Chris Hill.
Joining me in studio today from Million Dollar Portfolio, Jason Moser. And from Stock Advisor Canada, Taylor Muckerman.
Good to see you gents.
Jason Moser: What's up dude?
Taylor Muckerman: Good to see you.
Hill: We got a little bit of snow today.
Muckerman: We did
Hill: How about that, you wake up, you look outside and there's snow on the trees
Muckerman: The perfect amount, the roads are perfectly fine and it looks pretty
Moser: I takes the forecast of it to go ahead and just throw the public school system into complete chaos. Just the forecast of it
Moser: I mean school started two hours late today, but it was like . . .
Hill: Where do you live? Not for me, I got to wake my son up, he was like "Is school . . .?" I was like, "No buddy, schools on, chop, chop, let's get moving."
Muckerman: There you go. A little pat on the rear and out to the bus.
We're going to dip into the full mail bag. We are going to start, though, with a pair of stocks that are heading south very quickly.
Fitbit does not report their fourth quarter until late February and today the company confirmed, what some had feared and at least one person in this studio had predicted, which is that this report is going to be ugly.
Fitbit lowered their sales guidance and they are laying off 6% of the work force. Let me just . . . stick with me on the numbers here, because when companies offer guidance, they are offering a range. Which makes perfect sense, they are not going to be able to predict it down to the dollar. The sales guidance range that Fitbit had offered was, "Well, we think sales are going to come in somewhere between $725 and $750 million." They came out today and said, "Actually, it is going to be around $580 million," which is a massive drop and the stock, not surprisingly, down about . . . at one point it was down 16% to 17%. It has come back up a little bit, but it is still down 11% to 12% percent.
Moser: Yeah, I would warn investors who are thinking that maybe this is the opportunity to pick up shares on the cheap to give that notion a lot of thought. You need to be able to identify the catalyst that will turn this thing around, because I don't think there is one personally. I am not trying to be glass half-empty Jason here. It is just the way it is. We have talked about Fitbit a lot since it went public. It's really been a bad investment. I don't like saying that. I like what they stand for, right. I mean they are really trying to do a good thing, I think, in making people more aware of their health and encouraging fitness and what not. At the end of the day, it is a gadget company, it's a one-trick pony, for the most part. Its one trick, it turns out, to kind of suck. It is not very good at what it does.
Muckerman: It has got a class action lawsuit, or did for the heart rate monitoring and then it couldn't measure your steps properly.
Moser: I mean any time you have a situation where you feel like, "Okay, I am wearing this thing for this one reason" and now, it's being brought into question as to whether it actually does it well or is it even doing it correctly.
It is hard to gain that trust back, I think, ever. Most consumers who maybe on the fence in thinking maybe, maybe not. There are plenty of reasons to go ahead and think maybe not now. Like you said, this was a major, major guidance cut. The midpoint of guidance from then to now, that is about a 20% change. This is a company that is going to be very dependent on growing that top line in order to improve its business.
This is essentially . . . what is going on right now is like GoPro 2.0, in you're seeing this company has hit its peak and now, I think, what we are going to see here now going forward is a lot of ratcheting back of guidance. They're obviously going to be cutting cost, unfortunately letting some people go, you're going to see margins starting to compress, you are going see cash start to burn, and you're going to start to see these guys try to figure out what do we do here to sort of right the ship. I am not saying that's an easy answer, because I don't know what they do. It is a great example of where you have a company where the co-founders who are leaders there,forward thinking cultures. Those are all great qualities, but they are just that, they are qualities. I think it is important to note that those are things that we like to find in investments, but they don't mean that they will actually be good investments.
Muckerman: This comes at a time when people are spending money. Consumer confidence is as high as it is in January, in the last 12 years. Across any month, a lot of that has to do with the election. People thinking their taxes might get cut and what not. Consumer confidence is up, holiday sales were strong, but this isn't a sticky product. Gartner Research said that in the U.S., U.K., and Australia, 30% of the folks that have a smartwatch or a fitness tracker have stopped using it within a year.
So, if you are not getting people to reup on the newest product in your cycle, and people obviously don't see the benefit of continuing to use it, it is just a dying breed and they are trying to say that maybe they can help save lives by teaming up with healthcare companies. I think they teamed up with Medtronic to allow their Fitbit app to input its data into Medtronic platform to combine the analysis of diabetic's glucose levels with their activity levels to try to monitor that. So maybe there is a future there. It is going to take some proving to do that and this is still a small test with Medtronic and less and less people are using their product in the first place.
Moser: I think it best to just adjust the market opportunity.
Moser: I think initially when this company went public, the perception at least was the market opportunity was as big as the number of people on the face of this planet. Everybody could wear one and that is just turning out to just not be the case.
Hill: You mentioned, Jason, you thought this was GoPro 2.0. I was thinking this morning, when I was reading though the coverage of this. This is reminding me actually of Flip Cam.
Remember Flip Cam? Which was revolutionary until the iPhone came along and Android phones mirroring what the iPhone was doing and then all of a sudden, everybody who has a mobile phone has a camera in it. Then it ends up getting acquired by Cisco Systems and then Cisco Systems quickly writes down that entire thing. I have said this before, I think the likely outcome for Fitbit is an acquisition of some sort and to your point, Taylor, about them partnering up with Medtronic. They ought to be . . . if they are not talking to Medtronic about . . . because Medtronic is a big company . . .
Muckerman: Yes it is, yeah.
Hill: . . . that is very well-established in terms of medical devices. That is one of the things I was trying to think about. Okay, if you think someone's going to buy Fitbit, and I think someone is, I don't know what the price is going to be, but I think someone will buy them. Then the question becomes, "Well, who's the likely candidate?" Any time we talk about potential acquisitions, our mind tend to go toward . . . tend to go broader than what makes sense and they also tend to go to "Well, who has got the money?" So in the tech . . .
Moser: Well at this point, I even think I even have the money.
Hill: But you hear that all of the time. It's like, "Well, you know Apple could buy them." Well yeah, you know, look what Apple has.
Moser: They have a phone, they don't need it.
Hill: They are not going to buy them. But Medtronic actually makes sense to me, as opposed to . . . Jason, one of the companies I was thinking about was . . . well, who's spent money on health fitness app recently? Under Armor. Well, yeah, I don't think Under Armor is going to buy this company.
Muckerman: No, because they will just embed this in their clothes and not have you wear something on your wrist. Maybe an insurance company out there lowering your premiums based on . . . like Progressive has the thing that you plug into your car, so if you drive more safely, your insurance premium goes down. Maybe if you are more active, your insurance premium with this Fitbit. I could see people strapping it to their dog collar and "Get out there and be somebody pup."
Moser: Look at an example of a business where you probably thought acquisition at some point or another. LeapFrog, right? We talked about LeapFrog a lot on the way down and how it was kind of neat what they had, but you could tell more and more that their window for their market opportunity kept on getting smaller and smaller because kids were just making their initial devices like Kindles and iPads and iPods and what not. I look at Fitbit and I think who wants to actually take on that headache.
I have always been somewhat critical of Apple on the Apple Watch side because I felt like they built a device that tries to do to much as opposed to something where, given their resources, the technology, the brand power, I think Apple could actually develop a Fitbit style, truly dedicated fitness device that could completely wipe Fitbit out. Without even thinking twice, because of everything I just said there, the finances, the resources, the brand power, what not. I don't even know that I would look Fitbit ultimately as an acquisition at this point because you got to figure, who really needs it, right? I don't know that anybody actually needs it, because what they're doing isn't necessarily so special.
Muckerman: You could develop it for cheaper than you can buy it.
Hill: Let's move on to Rite Aid. If there is a stock that's making Fitbit feel better itself today, it is Rite Aid. Shares are hitting their lowest point since 2014 after Walgreens lowered the buyout price by nearly $2 billion. And just to refresh everyone's memory, October of last year they agreed to a buyout at $9 a share, today that gets lowered to $6.50, maybe as much as $7.00 a share, which is a pretty big haircut.
Muckerman: Yeah it is. It is really dependent on the amount of stores that they would have to divest in order to make this deal happen. If they have to divest 1,000 or less, they will probably get $7, if they have to divest up to 1,200, which is what many people are thinking, likely $6.50 per share. But when you are looking at it, you see Fred's, I think was a Tennessee-based pharmaceutical store that said they would originally buy the stores when the deal was thought to be approved. But now the FTC is coming out and saying that there is still some question marks here. Maybe having to divest more than the original 867 stores, so seeing that haircut immediately . . . and shares weren't even trading up to the $9 level to begin with.
Muckerman: Some uncertainty right from the very get go.
Hill: Just to be clear, what is driving this is that Walgreens is looking, "How do we get this deal done?" If there is a silver lining for the shareholders of Rite Aid, it's that Walgreens is committed to getting this deal done. It is going to be at a lower price.
Muckerman: They extended the deadline. I think the deadline was this past Friday. They extended it out to July 31st. There has been a private equity firm, Cerberus, that has come out and said that they would like to potentially buy these stores if Fred's can't make it happen. There is some action on that side of things to help get the deal done, but you are still looking at what price Walgreens is going to pay and what price Rite Aid shareholders are willing to accept.
Hill: Isn't Cerberus the mythical three-headed dog who guards the gates of hell?
Muckerman: That is their logo, I think, as well.
Hill: If you're a business, and a company called Cerberus is calling you up and wants to do a deal. You're in trouble.
Muckerman: Scratching your head.
Hill: Either run the other way or you're in trouble.
Muckerman: They have the money though.
Moser: What's going on right now shows you that Rite Aid is in a position of total weakness. They are at the mercy of a suitor and it needs the suitor more than the suitor needs them. We are seeing a lot of consolidation in this sector. Walgreens buying Rite Aid, CVS buying Target's pharmaceutical division. You go back and you read the 8-K that the press release that came out when this deal was initially announced, I think back in late 2015, it was really interesting to see more or less the termination fees here involved. It basically all falls on Rite Aid's shoulders.
I think Walgreens knew going into this, that there were going to be some antitrust concerns at least or some questions. So that initial price was one where they set that mark and said "Okay, we may have to divest some here and if that is the case, we will be able to make all of this stuff happen." In most cases, the onus really fell on Rite Aid's shoulders to make sure this deal happened. If it doesn't happen, most scenarios result in Rite Aid actually having to pay Walgreen a termination fee regardless. So when you think about it from that perspective.
Muckerman: Wow, that's kind of backwards.
Moser: Walgreens is a much bigger company. It has close to three times as many stores, a much bigger market gap, more financial resources. At the end of the day, this is a deal that is going to happen. They are going to divest what they need to divest. If you are a Rite Aid shareholder, there is light at the end of the tunnel from that perspective. It goes to show you, Rite Aid has been in a position of weakness for some time.
Hill: Our email address is firstname.lastname@example.org. You can also hit us up on Twitter @marketfoolery is our Twitter handle.
From Todd Whitcomb in Utah, "I am attempting to value Cummins Incorporated and I was curious to get your expert opinion. Thanks. Love the Show."
Taylor, Cummins for those unfamiliar, this is a heavy equipment maker. Engines, power generation, turbo technologies, big stuff.
Muckerman: Yeah, we're talking 15 liter, 12 liter engines. A company that has had a good run. We talked right before the show. It is up about 60% over the last year. That makes me wonder if the valuation might be a little to rich. If you look at some of the metrics that it is trading at, like a price to earnings, just north 21 times. The five year average has been right around 15. The price to book, not as bad, right around 3.5 times. Price to book historically over the last five years around 3.2.
You are looking at a lot of these areas where this company does business: mining . . . its mining business is down about 45% from its all-time high. Its marine business is down about 40%. Oil and gas is still down 80%. There is some upside there, but they're not expecting the bottom to flatten until at least the middle of 2017, maybe even later into the year. You might be able to get a better price, especially because we have seen this run up, when results really haven't caught up to that share price performance.
Hill: I was going to say, that's surprising to hear you tic off the various percentages of how their business units have fallen. I can see a six . . . I mean this is a $25 billion company. I could see a 60% run up like that if they were flat out crushing it.
Muckerman: They're not.
Hill: They're not.
Muckerman: In the U.S., revenues are still falling. They are looking at China to be a stronger segment, because obviously heavy machinery companies, you're not going to succeed on a global basis unless China is helping you out. So they do have a favorable outlook for China, more near-term than North America. The balance sheet is there, they have some time to wait it out, maybe some M&A on the technology side. If not, you could certainly see some share buybacks or an increase in the dividend as a likely possibility. There is some upside there, in term of where it is at now, I don't have a price target or anything like that. It does appear a little richly valued based on the last five years worth of multiples.
Hill: So this is one of those companies we get questions about from time to time and the name pops up, in part because it is one of those spaces that I think certainly over the last few years when you think of Caterpillar and sort of the ups and downs that Caterpillar has gone through. This type of industry becomes more interesting to watch. It is not the sexiest industry in the world.
Hill: But it becomes more interesting.
Muckerman: One thing that you will look at with these cyclical industries that rely on oil and gas and commodities. If the price to earnings, or the pork value is a little high, maybe it is because earnings have been depressed, so it might be toward the bottom of the cycle. You always want to look a little deeper than just these multiples. If you look at enterprise value to revenue, the spread between its five year average and where it is at right now isn't necessarily as high those other two that I mentioned. You really want to dive in a little bit closer, because earnings could be depressed based on cyclicality.
Hill: So I looked up the origins of this company. Started by a man named Clessie Lyle Cummins. Clessie, there is a name that I've never heard in my life before.
Muckerman: Bring it back.
Hill: Grew up in rural Indiana. Never had formal education past the eighth grade. Is just one of those people that just makes you shake your head in wonder at what he is able to do once he starts working and innovating. He was awarded 33 patents for his various inventions. Set five world records for endurance and speed for trucks, buses and race cars. Really amazing.
I love stories like that. There are the people that are highly educated and do amazing things, and there are people who have the brains, don't get the formal education and do them anyway.
Muckerman: Roll their sleeves up and get it done.
Moser: Yeah, and you hear about that stuff and you think about financial implications there and how much money ends up making and yada, yada, yada. It is natural to think about, wow, it would be so great to make all of that kind of money. Those are the people that just do it, because they love it. That is just what they love doing. For them, the money is like one of those things that just comes from building really great products and ideas.
Muckerman: Really fast cars apparently.
Muckerman: Or trucks and buses.
Hill: Thanks for being here guys.
Moser: Thank you.
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 solely on what you hear.
That is going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I am Chris Hill, thanks for listening. We will see you tomorrow.