On this episode of Market Foolery, host Chris Hill is joined by Motley Fool analysts David Kretzmann and Aaron Bush to discuss some of the many companies releasing earnings reports this week.
A full transcript follows the video.
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This video was recorded on April 26, 2017.
Chris Hill: It's Wednesday, April 26th. Welcome to Market Foolery! I'm Chris Hill, joining me in studio today from Rule Breakers and Supernova, David Kretzmann and Aaron Bush. Happy Wednesday, gents!
David Kretzmann: Hey, Chris!
Aaron Bush: Happy Wednesday.
Hill: This is one of those days when we have three companies we're going to talk about today. We could easily talk about ten other companies. That's how many companies are reporting today. But, we have to choose, because we're not doing an hour long show.
Kretzmann: We could. I don't know if anyone would listen. [laughs]
Hill: Two things would happen if we did an hour long show. Long-time listeners, to your point, would just cut out, they would just be like, I'm done. Once they hit the 35 minute mark, they'd pull the plug. The other thing is, Kristine Harjes is coming in in a little bit to host Industry Focus, and we don't want to incur the wrath of Kristine Harjes and the Industry Focus crew.
Bush: She'll boot us out.
Hill: So, let's start with signs of life -- I can't believe I'm saying this -- signs of life from Twitter. Shares are up 11% this morning after a first quarter report that included, Aaron, a rise in monthly active users. The revenue fell, for those of you who actually pay attention to money. The revenue fell, but that seems to matter less than the fact that monthly active users are on the rise.
Bush: Yeah, I think the 10% pop in the stock today is a little misplaced, in my opinion. I don't really think it was that great of a quarter, to be honest with you, Chris. I think you could say it was a mixed bag. Revenue was down, margins and cash flow were up, users were up. But ultimately, I do think, when you piece it all together, the news is more bad than it is good.
Hill: Wow, really?
Bush: I think so. On one hand, it's clear that Twitter is slowly making changes. They're slow, they're ungodly slow when it comes to handling user issues like abuse and improving the actual timeline. But they are improving their cost, free cash flow is growing, the user base is growing, daily active users was up 14% year over year, which is actually pretty great. And I do think that's because of some of these efforts they put in place from the product perspective.
That said, revenue, you can't just ignore that. That's huge. It's down 8% over the last year, and this is the 11th quarter in a row of a deceleration. The first quarter that it's down. That's pretty bad. I think the moral of the story here is pretty simple. Twitter's ads are currently not competitive with Facebook and Google, not even close. And it's a huge undertaking for them to become competitive. So, you can celebrate all these other wins, but at the end of the day, this is the business. Turning the ship around is still a multi-year process, and the slower they move, the higher the odds of them getting whacked.
Hill: So, the people who are on Twitter itself, but also reporting in the media, etc, who are saying, among other things that CEO Jack Dorsey has bought himself some time, this was a good quarter, let's quiet down the drumbeat of, he needs to choose between being CEO of Twitter and being the CEO of Square. You're saying "No".
Bush: I think this is beyond him. This is beyond what any one person can change at this point. I do think a lot of the changes that he has put into place have been positive, but revenue, you can't overlook that.
Kretzmann: Yeah, Aaron mentioned the competition from Google and Facebook. As far as digital sales go, those are definitely the big giants in the room. But then, as Twitter is doubling down on its live video strategy, they're starting to compete more with Snap, which has a very engaged user base. The growth there has slowed a little bit, it'll be interesting to see what Snap's metrics look like, and how those compare to Twitter, as far as ad engagement and user growth. But, yeah, it's not a good combination when you have users going up, but ad revenue going down. And Twitter said they expect that disconnect to continue for the rest of the year. This probably won't be the last quarter that revenue goes down. In the meantime, their pace of stock-based compensation has receded a little bit, but their diluted share count increased over 1% just from the last quarter. So, in the process, as revenue has completely decelerated and now is declining, their share count has climbed up. So I went back and looked, if Twitter wanted to bring its share count back to the same level it was in 2014, a few months after it went public, they would have to spend $1.9 billion just to get back to that break even level with the share count. What that shows is, the bar that they have to cross at some point to reward shareholders is perpetually getting higher as they continue to dilute shareholders. So, that's not a good trend to have when your revenue is dropping.
Hill: And share-based compensation, that's one of those things that, if you're the average investor, it's understandable if your eyes gloss over, and it's easy to dismiss it and focus on the more headline-oriented things like revenue and monthly active users. But when we talk about some of these tech companies potentially putting themselves up for sale, you need to recognize that share based compensation is a huge factor in that, the fact that they're going out and hiring people and convincing them to stay on board and not jump ship, a lot of that has to do with, "Look, we're going to give you more shares." Go back and look at LinkedIn being acquired by Microsoft. As much as anything, it was the share-based compensation within LinkedIn that made the leaders of that company go, "We have to figure something out quick."
Kretzmann: Yeah, because that's one of the main currencies they have for paying their employees. And competition between employers in Silicon Valley is not going to disappear. I think that's a dangerous thing for Twitter shareholders and something to watch. At first glance, on the balance sheet, it does look pretty strong. We have net cash of $2.2 billion, as Aaron mentioned, you have free cash flow, which is going up, but stock based compensation is still a huge component for that positive cash flow production. So, the balance sheet, to me, is not as strong as it looks on the surface, because $1.9 billion just to break even with your share count two years ago, that takes up most of their net cash today. The investments that they've been making up to this point are not paying off. At some point, that trend has to reverse for shareholders to be rewarded.
Bush: One other thing that David and I were talking about earlier today is how slow they move, and what that really means when you look long term. I think it's easy to look at these incremental changes and think about where things should go. But the pace that they move, these larger tech companies like Facebook and Google, they could do it at the snap of a finger, what these guys take six months to do.
Hill: I was going to ask you about that. It's, in some ways, an unfair question because unless you're spying on headquarters at Twitter, there's no way for you to have the information to answer this question, but I'm going to ask it anyway. Why do you think that is? I've seen you write about this, I've seen other people touch on it. The popular image that we have of Silicon Valley is, among other things, it's a fast culture, it's a nimble culture. The way things move at Twitter, they might as well be the U.S. Department of whatever. When you think of bureaucracy, you think of Washington D.C. When you think of fast and nimble and cutting-edge, you think of Silicon Valley. Twitter's lack of speed is really astonishing.
Bush: I do think I know one big reason behind it. I think a lot of it stems from the very early days of the company. They never had to struggle to reach product/market fit. So, never in their journey to figure out how to improve what they're doing, they never had an issue. They just threw something out there and it worked. So then, they just kept on capitalizing on what worked, but never really changed the product itself. Now that they're up competing against these companies that have been changing their platform at pretty innovative speeds for years now, they're finding that gap so much larger that it's just, in comparison, it takes so much more time to get out of.
Kretzmann: Yeah, it seems like Twitter just doesn't have near the focus on the actual product. What is their platform, fundamentally, compared to Snap or Facebook, where you have leaders that are so product-driven, and it drives everything they do. From there, you find the business model that fits. But with Twitter, it seems like they're very scattered trying to figure out the direction of the company and what their actual product is.
Hill: All right, let's move on to Chipotle. First quarter profits came in higher than expected. Same store sales were up 18%. I realize that is off of, go back a year in time, off a terrible quarter a year ago. Still, it's nice to see that it's up 18%. Stock up a little bit, not amazing, although it has risen about 30% in the last six months. So, I don't know, maybe we shouldn't expect too much of a pop off of this.
Kretzmann: Yeah, I think the key for investors is, the metrics are moving in the right direction. I think you can safely say the turnaround has begun. As long as they can keep moving at this pace, I think good things are ahead for shareholders. But, it will still take time. It'll probably be at least a year and a half, I think, before we get back to those pre-crisis levels, as far as metrics go. But, yeah, same-store sales up about 18%, their restaurant level operating margins are trending up. This quarter was almost at 18%, but that's still quite a bit lower than the 28% restaurant level operating margin we saw right before the crisis hit in 2015. All those metrics like restaurant sales, sales as a whole across the company, margins, they're moving in the right direction, it's a definitive turnaround from where the company has been going for the past year and a half but still some work to do to get back to those pre-crisis levels.
Bush: Yeah, when I was reading through the call, and what they've been doing to move back to the levels that they were, I think I was pretty impressed with what they were doing. If you look, for example, at the online sales, that increased 54% over the past year. I know that's something in the past we've talked about. Chipotle is not very good at that compared to others. So, it seems like they're moving in the right direction. Still have room to improve. They're revamping their restaurant tour program, which also was a pain point.
Hill: Is this the management program?
Bush: Yes, this was their management program. Chipotle has always promoted internally. But, if you grow too fast and promote too quickly, that can lead to problems, especially if you incentivize poorly. So, they've been doing a lot of work around figuring out what metrics are best to incentivize their managers and field team leaders. It looks like that is improving. Just, how they're interacting with consumers and turnover of their leaders. That's good. They also just closed, this quarter, 15 ShopHouse locations. So, they're moving past that --
Kretzmann: Still sad about that, though.
Bush: Yeah, it's unfortunate for those of us, in the past, who were optimistic at some point. But it's good that they are diverting those resources, now, to higher-impact endeavors.
Hill: I'm a Chipotle shareholder. I'm glad they decided to pull the plug on ShopHouse, because I got tired of wondering when they were going to roll it out. The first couple of years, what you heard was a lot of, "They're taking their time, they're not going to rush it." But at some point, you move so slowly that it's natural to ask the question, "What is wrong with this concept?" Either it's ready to be rolled out or it's not. The fact that they said, "We're packing it in on that, we're going to focus on the main brand locations and go from there," I'm glad.
Kretzmann: Yeah, and on top of everything else Chipotle was dealing with for the past year, I think trying to work out issues at ShopHouse, it was just becoming a distraction. To me, that really was the theme of this quarter, it was very clear that Chipotle is refocusing. And I think part of that is boosted by Steve Ells taking over the sole leadership role as CEO. Monty Moran, who was co-CEO for a while, retired late last year. So I think you're seeing that focus from Steve Ells. And in the call, he mentioned revamping that restaurant tour program, as Aaron mentioned. But the focus of that is a "relentless focus on customer experience." So, sort of a Jeff Bezos-esque comment there, really trying to figure out what the priority is there for their management program. And they mentioned that they now have the lowest turnover with general managers in more than eight years.
Hill: That's great.
Kretzmann: Yeah. A lot of things moving in the right direction. I think you're seeing, internally, a refocus on prioritizing the guest experience. As they get traffic into the stores, their throughput should really be able to increase with digital orders, because they're starting to launch kitchens in the back of the restaurants specifically for digital. That should theoretically take people out of that front line, more people can go through that front line. The restaurant, in other words, will be able to pump out more burritos, more orders. If they can get that traffic back to pre-crisis levels and hopefully beyond that, these stores could be much more profitable than they were a few years ago, and they were incredibly profitable then.
Hill: Yeah. And that is, in some ways, the promise of this investment, if you're a shareholder or a potential shareholder. Because the headlines have been so bad, and rightly so, for the last couple years. But you go back to 2013 and 2014, and they were putting up these type of same-store sales numbers, not off of a low base, off of a pretty high base. So, when they would come in with double-digit comp increases, that's just breathtaking. So, the idea that they're looking at what Panera has been doing and saying, "How can we do that? How can we up the people walking in and picking up their food and walking out? If we can get our throughput even higher, that's great."
Bush: I think the biggest news out of all of this is they're going to start testing two new desserts.
Hill: [laughs] Is that the big news? What are the desserts they're testing?
Bush: They only announced one of them. It's called buñuelos. It's these fried tortilla strips with honey, cinnamon, and sugar. So, super healthy.
Kretzmann: Fits right with their healthy ingredients theme.
Hill: I hear that honey is supposed to be healthy, I've heard that from time to time.
Kretzmann: Cinnamon, I think.
Hill: Cinnamon is a spice.
Kretzmann: Sugar ...
Bush: Just ignore that it's fried.
Hill: You know, it's dessert, it's not supposed to be healthy if it's dessert.
iRobot shares hitting an all-time high today after first quarter profit more than doubled expectations. Aaron, this is not a beat by a penny type situation, they crushed it. They also raised their guidance for the whole fiscal year. Holy cow.
Bush: Roombas are taking over the world. That's all you can really say. Yeah, they crushed expectations. I think what we're seeing right now is they're witnessing an inflection in demand of their Roombas, which is very impressive. Believe it or not, the Roomba last year was the most sold vacuum cleaner in the U.S., in terms of dollars spent. Yeah, wow. To me, that almost feels like the rise of the Roomba occurred somewhat stealthily. Looking at the product compared to past iterations, you really do see the improvements that have been coming through. They work better, they have more connected features, which will play a role more so as the connected homes inevitably start popping up more and more. The Roomba itself, obviously, is killing it.
But, beyond the Roomba, there are other products and moves the company has made that also excites investors. The Braava, for one, that's iRobot's hardwood cleaner, right now, that's still a tiny fragment of revenue, but it's selling well. It also has these wipe consumables that consumers need to buy, so it adds a form of recurring revenue for the company, too, which is always good to see. iRobot just bought back its Asian distributors, which gives it more control in how it sells in that continent. That's actually a pretty huge deal. I think later this year, we should expect Japan's growth to accelerate. We'll see them significantly ramp up business in China. That should be a huge deal. The Braava in particular could sell particularly well because hardwood floors are more of a norm over there. So, really giving that second product they have a huge boost. Then, lastly, the innovation machine that they have just keeps on running. They're just as much as software company at this point as a vacuum cleaning robot company. So, new robots that perform new tasks, like lawn mowing, whatever else they have in store, should be expected. As time rolls on, these robots are going to do their jobs better and better. I think investors should expect more beats going forward. This is impressive.
Hill: I was on their website and saw they also have a robot pool cleaner. I don't have a pool, but I thought, I would 100% buy one. There are some people who actually enjoy mowing their lawn. I'm not one of them, but there are some people who are like, "It's relaxing, I'm outside in nature," that kind of thing. I can't imagine anyone owning a pool and saying, "Oh, I'm looking forward to a day of Zen and relaxation of cleaning my pool." No. Buy that thing, set it loose on the bottom of your pool, and you're done.
Kretzmann: I think our digital age has made people lazy enough that iRobot is hitting the inflection point, finally, where people just want to automate everything they can.
Hill: Is 100% of their business just consumer? Do they have any sort of business-to-business relationship where they're going to a hotel chain or something like that and selling them en masse?
Kretzmann: I think now that they're entirely a consumer goods, consumer-facing company. Last year they divested a defense or security division. I think they're primarily selling to the U.S. military at that point. I think that makes sense, because the consumer market is sizable. In the U.S. alone, robot vacuum cleaners are about 20% of the total vacuum market. Just that robot vacuum cleaner portion, which is growing, is about $6 billion or so. So, there's a sizable market there. And iRobot really is the dominant brand in the U.S., Europe, and Asia. So, I think doubling down and really focusing on that consumer market makes sense for them. Since they divested that security division last year, the stock has done really well. I don't follow this closely enough I know if those two are completely related, or one caused the other. But to me, it makes sense for them to focus on that consumer market, because I think that's where the majority of the growth is.
Hill: Aaron, the stock is up about 15% today. We love it when a stock hits an all time high. But I have to ask, how expensive is this stock? When you look at it, do you think, "OK, this is great for shareholders, but right now, today, this is kind of a pricey stock?"
Bush: It is a pretty pricey stock. I think it's definitely earned it. Just seeing, today, the stock go up 15%, I think if this company continues to execute the way it has, and if this inflection point is real, then I don't think it is as pricey as it may seem to a lot of investors.
Kretzmann: Yeah, it's still just a $2 billion company. I could see that bumping up, especially if they could maintain that brand leadership position, which they seem to have carved out pretty nicely.
Hill: Before we get out of here, I should mention that Rule Breakers, the service started by David Gardner that both David and Aaron work on, the new issue of Rule Breakers comes out today with two new stock recommendations from David Gardner and the team. You can check it out by going to podcasts.fool.com. Just scroll down to the bottom of the page, and you can kick the tires on Motley Fool Rule Breakers. Check out the new issue. Thanks for being here, guys.
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!