On this episode of Market Foolery, host Mac Greer is joined by Motley Fool analysts Ron Gross and Jason Moser as they dig into a handful of last week's quarterly earnings reports.
Under Armour (NYSE:UA) (NYSE:UAA) came through with a smaller than expected loss; Domino's (NYSE:DPZ) continues to outperform; Buffalo Wild Wings (NASDAQ:BWLD) is struggling to satisfy an activist investor; and Southwest (NYSE:LUV) saw profitability sink as expenses jumped.
A full transcript follows the video.
This video was recorded on April 27, 2017.
Mac Greer: It's Thursday, April 27th. Welcome to Market Foolery! I'm Mac Greer and I'm joined by Ron Gross from Motley Fool Total Income and Jason Moser from Million Dollar Portfolio. Gentlemen, welcome!
Ron Gross: Hey, Mac! How are you?
Greer: Guys, I'm good. We're going to talk some pizza, we're going to talk some wings, and we're going to talk some Southwest Airlines.
Jason Moser: You had me at pizza.
Gross: What doesn't fit there? [laughs]
Greer: But, guys, let's begin with Under Armour. Shares up big on Thursday after the company reported a smaller than expected loss. Jason, I still hear the word loss in there, so why are investors so giddy?
Moser: You have to love it when it's less bad than folks were expecting. A lot of what Wall Street focus is on quarter in and quarter out is just an expectations thing. I think this was a good report for Under Armour, if for nothing else that they set reasonable expectations. They did not go in there and raise guidance for the year based on, perhaps, any optimism they may feel for this coming year. I think management took a bit of a tone of humility based on the last couple quarters. These last couple of quarters really socked it to them. I think they needed to really get back to resetting expectations, focusing on getting the task done, and less on this hype cycle. Every quarter, quarter in and quarter out, a new record they were setting, and you could tell they were falling in love with themselves, they were falling for their own hype. I think there's a level of humility that needs to be entertained here, when you're in management with a public company. I think this has helped reset that bar for them.
Gross: Is there still a lot of talk about Sports Authority and the impact that that has had on the industry? Or have they let that go?
Moser: I think this quarter, 2016 put a bow on that. We've seen that's now in the rearview mirror, and it's really looking forward and figuring out new distribution channels. They did fairly well in the wholesale side. The direct-to-consumer business grew a little bit more, it looked like. I think footwear is where they had a little bit of weakness there, and that was also on top of a pretty tough comp from last year. A lot of questions there in regard to connected fitness movement, and I think those questions are fair, given the amount of money they spent on these apps. The connected fitness business on its own grew 2% for the quarter. That's obviously not very impressive. But, management was very clear, they said in the call, these investments in connected fitness are all about having a better understanding of their consumers. So, I suspect in 10 years, we're not going to really be talking as much about connected fitness, I think we'll be looking back at the data that connected fitness provides for companies like Under Armour and Nike and whoever decides to use it. It's just a very obvious target right now because they paid so much for those businesses.
Greer: You just mentioned Nike. Nike is the big dog in this space. What's the case for investing in Under Armour as opposed to Nike?
Moser: I think it's just a matter of growth. With Under Armour, you have a company that's still very small, comparatively speaking. The bet is, ultimately, do you feel like Under Armour still represents that type of growth opportunity? Mac, we were talking before taping here, looking at those charts of Under Armour shares and where they fall. If you've been owning the shares for the past year as opposed to two years as opposed to the past five years -- if you bought Under Armour two years ago, you're clearly not very happy with the direction the stock has gone and the direction the company has gone. But if you look at it over the past five, 10, 15, the longer that timeline goes out, the better that story looks.
And generally speaking, when you want to do well as an individual investor in the stock market, you want to buy shares of good businesses when they're having some temporary hiccups. And honestly, I do feel like Under Armour is a very good business with a smart, proven leader. They hit a big stumbling block here. But let's remember, those can be very great learning opportunities. Reed Hastings, I think, is a good example. Good business there in Netflix, hit a big stumbling block there with the Qwikster debacle. I think he learned a few lessons there, perhaps on the humility front, reset expectations, got back down to brass tacks, and they are where they are today. I expect the same things for management here with Under Armour, but only time will tell.
Gross: Interesting comment. I'm a Nike shareholder, and I keep looking for a reason to get into Under Armour, and I just haven't pulled the trigger. I'm rooting against the company in the short-term because I want that stock to stumble a bit and give me a better entry point. I'm not there yet, but I'm laser-focused on it. I keep checking.
Greer: Guys, let's move on to pizza. Domino's up big on Thursday and stronger than expected earnings. Ron, you recommended this stock back around $5 a share. In 2010, they ran those ad campaigns saying, "Yes, the pizza tastes like cardboard," the stock was around $10 a share. Today, it's around $187 a share.
Gross: Holy cannoli. I wish I held on this whole time. Truth be told, I sold a while ago. I did wonderfully on it, and got a nice rebound. At $5, it was much too cheap a stock. To their credit, they really recognized what was wrong with business. Not every management team does. And not every management team is transparent about it. So, kudos to them for revamping the menu, revamping the pizza, adding things to the menu, focusing on the franchise story, getting the stores back into the hands of good franchisees, and really turning the business around. You continue to see it. Domestic same-store sales this quarter were up 10%. That's the 24th consecutive quarter of positive comps. International had 93 consecutive quarters of positive comps. Profits up 42% for the quarter. They just continue to really execute. Now, the story is about technology, and how they're using technology, whether it's the Amazon Echo or app or mobile to really help people purchase their pizza.
Moser: Wasn't there a pair of shoes that just came out where you can order Pizza Hut from the actual shoe?
Greer: Is that right?
Moser: You can push button on the shoe and order pizza. I'm 99.9% certain that was not fake news.
Greer: That's amazing. Ron, you were telling me, you're still old school, you still call for your pizza? We were talking before the show.
Gross: No, I don't call. We go on the website and do it exclusively that way. But I have yet to download an app. I have an Amazon Echo, we have yet to teach Alexa how to order through --
Greer: Oh, so you're just not doing the mobile. But you're not, like, faxing in your order.
Gross: [laughs] No. Carrier pigeon over to the local Domino's.
Moser: Don't you think, though, based on a couple companies here, between Domino's, Under Armour, potentially, I think Netflix was a good example, there's a pattern there in that if you find management teams that are willing to step forward and say, "You know what? We screwed up, we did something wrong, we missed this, and we're going to own that mistake and get back down to work here and figure out a way to move forward," it seems to me like when you find a management team that's embracing their mistakes -- I mean, we always talk about that as investors. When you're an investor and you're going to embrace your mistakes, you learn from them, it makes you better. Management, it's very much the same thing. I think when you find a management team like that, it's worth giving it another look there. There's a lot to be said for that as a long-term investor.
Gross: And it's very brave to be so transparent about it. You have management teams tweaking businesses behind the scenes all the time, but to go out and make it the centerpiece of your marketing campaign, it's very clever, but it's also very honest and transparent.
Moser: And you get raked over the coals these days between Twitter and Facebook and wherever else. People are so quick to jump on success stories that have fallen from grace. It's not very nice, I don't teach my kids to do that. But I guess we all have to recognize what's going on. It just strikes me that whenever you find management teams like that that are willing to embrace their mistakes and really get better from them, those are investments that I tend to give a little bit more consideration.
Greer: I like that. We talked about maybe starting the Humility Index.
Moser: I think we have to patent that.
Greer: I think of Ron Shaich at Panera, when a few years ago, he basically said, "The restaurants are mosh pits."
Gross: Perfect example.
Greer: "They're a mess. We're going to fix it." And they did. And we have a Panera 2.0 right across from The Motley Fool here, and I freaking love it. You don't have to interact with anyone. You just go and grab your food.
Moser: "I'm Mac Greer, and I don't like people."
Greer: Yeah, that's frightening, I can't believe I just said that. OK, let's stick with restaurants. Shares of Buffalo Wild Wings down on Thursday after the company reported disappointing earnings. Jason, what's the story here?
Moser: Oh, Mac. The news with Buffalo Wild Wings has been really more about activist investing than anything else, recently. I think the good news for the business, they finally got back to positive comps, albeit very close to flat. The bad news is, it was really close. I think this is going to open them up, perhaps, for some more targeting from Marcato Capital, that's the venture capital, the activist investor that's really trying to get in there and force management's hand here, I think actually force some change in management. I mean, it's at least understandable. This is a company that, right now, is in full-on cost control mode. They spent a lot of 2016 trying to figure out ways to gen up new traffic. Offers, daily deals, whatnot. That did OK. But it's not been enough to offset what has been a tough restaurants sector in general. There's a lot of competition out there. They're going to sell 13% of their company-owned stores, about 80 stores, that have been underperforming pretty significantly, generating operating margins, restaurant level margins of around 8% to 9% versus the 16% that they're turning in as a full base there. I think this is going to be a very tough year for Buffalo Wild Wings. I don't think this does anything to quell the activist investor talk.
Greer: Ron, let's talk Marcato, because they own a 6% stake in Buffalo Wild Wings. They've been pushing for the company to franchise more of its restaurants. Last week, they called on CEO Sally Smith to resign. What do you make of all that?
Gross: Activism is interesting to watch. It depends what the goal is. I like activists that are coming in intending to stick around for a while, they're shareholders for the long-term, and they see improvements that can be made to increase shareholder value for all shareholders. Sometimes, you'll get these activists that come in for a quick hit, they come in with the typical, "I think you guys should pay a dividend, I think you guys should buy back stocks," they're in and out, they make a quick buck. That's not the activists that I prefer to see. If I'm a shareholder of a company and I see one of these longer-term folks come in with a real plan, that makes me happy because it's likely that they've identified that the stock is undervalued, and they have a plan, if management will listen to them. And that's where it can sometimes get contentious. If management will listen, there's a way to improve shareholder value here. That typically makes me feel good rather than bad. If I get one of these junkie guys that come in for a quick hit, that's not so great.
Greer: Back in your Wall Street days, when you were an activist investor hedge fund manager, which type were you?
Gross: [laughs] We were always long-term, we always wanted board seats, we always wanted to stick around and help the company operate better. Our suggestions were typically operations-based, not only solely financial-based, such as buy back stock or pay a dividend. We were interested in seeing the company really improve operations, for the most part.
Greer: So, when you look at Marcato, do you have a feeling one way or another?
Gross: I don't think Sally Smith necessarily needs to go. I think the franchise suggestions are not bad. I see some merit to those as well. But it's a tough business out there. Right now, as Jason said, the restaurant industry is struggling. They have some work to do. I don't know if Marcato is the answer. I think they really need to roll up their sleeves and get to work.
Moser: I want to jump in here and confirm, Mac, by the way, that Pizza Hut did create a new way to order pizza with shoes. It was a 64 special edition what they called Pie Tops. They were not sold to consumers but given to individuals as part of future promotion, but you could actually order the pizza via Bluetooth technology by pressing on the shoe's tongue.
Greer: Pie Tops. I think, if there was a Humility Index that was a positive indicator, I think the Pun Index should be a negative indicator. I'm going to penalize them, oh my God. There was store when I used to live out in Colorado called Socks Appeal, and it always upset me, every time I walked by. I don't know why, but I'm like, come on. Come on. We're better than that. As a people, we have to be better than that.
Gross: [laughs] As consumers, we are better than that.
Greer: OK guys, time to talk my favorite airline. Southwest Airlines. Down on earnings here, Ron. There's an interesting story here now with Buffett, because Berkshire has a $2 billion stake in Southwest, that stake getting a little smaller today.
Gross: Little smaller. My favorite airline as well. I'm a big fan of the company. But it was a disappointing quarter. For those finance people out there, if your revenues grow 1% but your costs grow almost 9%, that's bad. It really is an expense story here. Labor costs were up, they have new contracts in place with pilots and flight attendants, so cost for salaries and wages were up about 13%, cost of fuel was up 8%, and revenues, as I said, were only up 1%. So, we have a little bit of a mismatch in terms of revenue and expenses here. But it is, as we said, a very well-run company. It is a Foolish company, in terms of the way they treat their customers and their employees and their shareholders. Love to see that, love to really participate with companies like that. And they will be fine. Profits took a smack, they were down about 30%, that's not great to see, but I don't view this as a long-term degradation of their business model, or even the industry in general.
Greer: Jason, today, Southwest CEO Gary Kelly said the airline will no longer overbook its planes. That's pretty groundbreaking, isn't it?
Moser: I doff my cap to that decision. I think that's one of the most customer-centric moves they could have made at this point in time. I think the biggest question a lot of people have had over the past few weeks is, why in the world are these airlines overbooking to begin with? And we know it's all about maximizing, fill up that plane, if people cancel or whatever. So, they take a chance there. It is inherently a chance that they're taking every time they overbook. And we've seen how bad that can actually get. To me, like Ron was saying, these are the types of businesses that we really like to be a part of, and they are businesses that, generally speaking, will make decisions that in the short run don't seem necessarily in line with near-term success. You have to let time play out, to let those decisions play out. I think this is one of those decisions where, in the near-term, certainly, it could affect capacity there, it certainly could affect profitability. But this is a business that's obviously thinking far beyond that. It cares about its customers, it cares about its employees, it cares about its status in the world. I applaud the decision.
Gross: From a Buffett perspective, he's taken a bet across the industry, he's not just betting on Southwest. He purchased the big four -- American, Delta, United, and Southwest -- thinking that the terrible 20th century airline debacle is behind us, the industry has consolidated and they can get back to better profitability, and he can do well on the industry as a whole. It's a tough business, these margins are thin, and it remains to be seen if the bet will work. But don't bet against Buffett too much.
Greer: Yeah, because at one point, Buffett called airlines a deathtrap for investors. I think deathtrap, for a lot of us, has a negative connotation.
Moser: [laughs] On the whole.
Greer: I'll tell you what I love about Southwest Airlines, getting back to how customer-centric they are. I fly them a lot when I fly to Houston to see my family. Little things, they do all the little things. When I fly with my two sons, Southwest Airlines puts lids on the drink and puts straws in the drink. And it means you're not worried about spilling. Little stuff like that. And they don't drag you off the plane.
Gross: [laughs] The details. Yeah, just this week my daughter flew and got diverted to Pittsburgh because of weather. The next day, a $100 voucher showed up for $100 worth of tickets next time she flies, and a heartfelt -- literally a heartfelt -- apology. Great company to own and put your money to as a consumer.
Moser: We say it all the time. Those businesses where leaders are so focused on the customer, they are businesses that tend to really do well over long periods of time. It seems really simple. Figure out what your customers want and then give it to them. It's just not always executed very well.
Greer: And you don't need Pie Tops.
Moser: No, you don't need Pie Tops.
Gross: No one needs Pie Tops.
Greer: No one needs Pie Tops. OK, guys, Jason, Ron, thanks for joining me today. As, always, people on the show 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 it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer, we'll see you next time.
Jason Moser owns shares of Berkshire Hathaway (B shares), Nike, Twitter, Under Armour (A Shares), and Under Armour (C Shares). Mac Greer has no position in any stocks mentioned. Ron Gross owns shares of Amazon, Berkshire Hathaway (B shares), Facebook, and Nike. The Motley Fool owns shares of and recommends Amazon, Berkshire Hathaway (B shares), Buffalo Wild Wings, Facebook, Netflix, Nike, Twitter, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of Panera Bread. The Motley Fool has a disclosure policy.