A Good Day to Be Selling Luxury -- but Not Furniture Online

On this Market Foolery podcast, host Chris Hill is joined by Million Dollar Portfolio's Jason Moser to discuss a handful of companies that recently turned in their quarterly earnings reports. Wayfair (W 1.96%) shares took a hit, but Chris and Jason aren't sure the reaction was justified. Michael Kors (CPRI -1.48%) and Ralph Lauren (RL 2.21%) bounced after showing how they're navigating this challenging retail environment. What both Jason and Chris agree is unjustifiable, though, is the odd way that Shake Shack (SHAK 1.06%) tweaks its reporting metrics -- they want the 100% pure beef, please.

A full transcript follows the podcast.

This podcast was recorded on Aug. 8, 2017.

Chris Hill: It's Tuesday, Aug. 8. Welcome to Market Foolery. I'm Chris Hill. Joining me in studio today, from Million Dollar Portfolio, Jason Moser. Thanks for being here!

Retail earnings. Earnings-palooza just chugs along, and thank goodness, because it gives us more to talk about. We're going to get into the apparel, fashion apparel retail, in a moment. But let's start with online furniture, and that of course means Wayfair. Wayfair taking a little bit of a hit today. Stock down around 8%. But, help me understand this, they had a loss for the second quarter, but it was smaller than people were expecting. Their revenue grew nearly 50% from a year ago. This is a stock that's had a great 2017, even with the drop today. I'm not sure why people are selling this stock, because Wayfair is doing what Wayfair has done for a while now.

Jason Moser: Yeah, and they continue to do what they tell us they're going to do. As you know, I'm always a big fan of that. The story with Wayfair is pretty simple. It's a matter of how much slack the market is going to give this company as they continue to grow. It's a good business, it's not a profitable business yet, so that's the near-term concern there. But there are signs, certainly, that at least in the near term, all of these investments that they're making in the business are working. So, to your question as to why the market might be selling the stock today, I think it's a combination of two things. No. 1 is, they had a very good year thus far. Whenever you have these businesses that aren't profitable yet, you have to judge their valuation a bit more subjectively. Valuation is an art in and of itself anyway. Probably, the bigger concern is that they are forecasting some modest profitability headwinds in the back half of the year as they continue to build out this business, particularly on the international front. But, all in all, the metrics are still pointing in the right direction for these guys. They're doing a good job.

Hill: The stock is up -- even with the drop today -- more than 100%, I think it's around a 110% gain for 2017. How are they doing in terms of their spending? Because that has been, at various points of the last couple years with Wayfair, you could look at their marketing spend and you could either be pretty happy with how it was going, or you could look at it and almost wince a little bit like, boy, they're spending a lot.

Moser: They are spending a lot. If you watch your linear TV at all, or you have Hulu or a skinny bundle, you'll see Wayfair is still out there a good bit. It needs to be that way for right now. When you look at the company's margins, encouraging for the quarter was, gross margin held steady from the quarter a year ago at 24%. That's important because their gross margin includes all of that spending on fulfillment and shipping, which is obviously the major expense for this company, is getting that stuff from point A to point B. Sort of the thesis behind this investment, behind the idea, at least, is that at some point, they're going to pull back on that customer acquisition and marketing spend and unlock some more profitability in the business as they grow their footprint, as they grow that distribution network. It seems like it's working. We talked about all of these metrics pointing in the right direction. 

The big metric that I always look at first and foremost is the percentage of orders from repeat customers. All that tells us is, the more customers they're able to acquire and keep in and retain, that means those customers become more profitable over time, because they don't have to pay those high acquisition costs of getting new customers. So, a year ago, that number was 57.6%. This quarter, it was 61.3%. So, that number is higher. That's good. That means they have more repeat customers coming back to order more things. 

Again, it's a matter of how long the market is going to let this thing play out. If we ran into a hiccup here with a correction or any kind of recession, this is the kind of business that would probably feel a pretty good pinch from that because of the fact that it's still in growth mode, investing so much, not really demonstrating material sustainable profitability yet. That's only a matter of time. Again, the management team keeps on doing what they say they're going to do. And having just moved here a few months ago, I've seen a lot of Wayfair boxes on my front porch, Chris, so we're doing our part to keep these guys moving in the right direction.

Hill: You're welcome, Wayfair shareholders. Let's move on to retail. A couple of retailers are having really good days. Ralph Lauren first-quarter profit came in higher than expected. Michael Kors, same story, Q1 profit better than expected and they raised guidance. Michael Kors up 20% today.

Moser: Yeah. Hey, listen. I have four words for you. Global fashion luxury group. Is that something you might be interested in?

Hill: Go on. [laughs] 

Moser: It sounds like Wall Street is interested in it, and that's really what's going to be key to Kors' success here in the coming years. We watched this Kors story play out sort of the way we watched the Coach story play out. It was a handbag maker that really saturated the market. The brand lost its cachet, they started discounting and had to start liquidating more and more inventory, margins got killed, the stock went down the toilet. What they're doing going forward, Coach is doing this, we're seeing Kors doing this, they're acquiring other businesses to bring in additional dynamics beyond handbags. The Jimmy Choo acquisition here is a good example of that recently. They acquired Jimmy Choo for about $1.2 billion, and that's a big shoemaker. So really, what they're trying to do is build out this fashion luxury group. The addition of Jimmy Choo is part of that. They also acquired the exclusive China licensee for the business for $500 million not too long ago. So, that really gives them tremendous exposure to an up-and-coming Asian market. We talk all the time about the growing middle class in China and how much they're going to be spending in the coming years, and how much they really like big brands like these. 

There are reasons for investors to be optimistic there. They raised their guidance a decent bit for the quarter and for the year. Their year was essentially still the same. But the thing is, that that doesn't reflect the Jimmy Choo acquisition. So, that actually means that things were getting a little bit better even before that. So, they continue to streamline the business. While comps were down, top-line revenue is up. Now, that was due to opening stores. So, we have to keep an eye on that, because they can't just keep opening stores forever. But all in all, it wasn't a bad quarter for Kors. It's certainly less bad than probably the market was expecting.

Hill: In the case of Ralph Lauren, we saw something that we have seen previously with Michael Kors, which is less discounting. I get that it is a tough needle to thread for all of these companies, in terms of, at what point and how do you get the inventory off your shelves? In a perfect world, people are buying it, and that's what's getting it off your shelf. But at some point, if stuff isn't moving, you need to make that decision, and you have to choose very wisely what you're going to do. In the case of Ralph Lauren this latest quarter, it paid off for them to just say, "Yeah, we could discount the hell out of this stuff just to get it moving, but we're not going to do that." And it showed up in the margins.

Moser: Yeah. I think you keyed in on exactly what was really was part of the success for this quarter for Ralph Lauren. Top line sales fell 13% from a year ago. It's not like they just blew out the numbers here. But they got their inventory levels down significantly -- 31% from a year ago. And they were able to do that with a minimum of discounting and liquidations and whatnot. Because, yeah, you're right, any given day, you can go into a TJ Maxx, and you're going to see a slew of Coach, Kors, Ralph Lauren stuff. That's not good for those businesses. It's great for TJ Maxx, but it's not good for Ralph Lauren, because those are basically just liquidations and discounting. 

So, when they were able to get that inventory level down 31% from a year ago, while keeping discounts and liquidations at a minimum, that tells us at least that there's some demand out there for the brand. Ralph Lauren is a unique brand. It's important that they have Ralph Lauren in there still as the chief creative officer. He's able to offer his input on the fashion side, while giving this business over, perhaps, to folks who are a little bit better schooled on how to take this business forward in such a challenging environment. With Ralph Lauren, they have a very strong balance sheet. Balance sheet has more than $1.1 billion in net cash. They kept guidance intact, and they're really identifying digital as this big opportunity, and they continue to invest in that while pulling back the reins a little bit on their department store presence. And really, for any retailer in this decade and beyond, that's going to be the key -- establishing that digital presence and really taking advantage of it. It seems like they're taking the steps to do that.

Hill: You can follow our show on Twitter. Our handle is @MarketFoolery. We're actually Periscoping today's episode. It's through Jason's feed, but retweeted through the Market Foolery feed. One of the people that I follow on Twitter, and if you're at all interested in investing you should strongly consider it as well, is Jeff Fischer, our colleague here at The Motley Fool. He's @FoolJeffFischer. Jeff was tweeting this morning about Shake Shack. They reported last week, and Jeff was tweaking the management there, and rightly so, for talking about same-store sales, not in terms of the most recent quarter -- and the same-store sales were not good.

Moser: Same-shack sales?

Hill: We're going to get the same-shack sales in just a second. He's tweaking the management for talking about how they were doing a year ago. Jeff's point, and he's absolutely right, is, "Look, that's irrelevant. Don't tell me about your greatest hits album. I want to hear the new stuff. I don't want to hear about how great your sales were a year ago. I want to hear about the most recent quarter. A year ago? That's not relevant." So, I was reading some stuff this morning, did you know that same-shack sales are a different metric than same-store sales? In this sense -- when we talked about same-store sales, whether it's restaurants or retailers, same-store sales are generally agreed to be, these are sales on locations that have been open for at least a year. Typically it's 13 months, but at least a year. Same-shack sales, as I just learned this morning, two years.

Moser: Yeah, it's a different timeline.

Hill: It's a different timeline. So, they are ... I don't like this. [laughs] 

Moser: In their defense, at least, I will say, a lot of times you'll see, whether it's grocery stores or restaurants, some of them, at least, will give you same-store sales, and they'll do it over one and two-year stacks, to give you an idea of how traffic is looking there. To your point, I think that is important to know. It's not as clear as it could be. So, you look at same-shack sales and you think, that's just some clever branding like the Zestimate, or something.

Hill: Yeah, that's what I thought.

Moser: Yeah, exactly. You have to understand exactly what they're measuring. If you don't understand what they're measuring, then you might be interpreting that data wrong. With Shake Shack, they think the same-shack sales metric is cleverly branded, but by the same token, it's very good to understand how these businesses are performing on two-year versus one-year timelines, because they could be, obviously, very different.

Hill: And in the case of Shake Shack, this is not a mature company. They have 134 locations. Only 37 of them have been open for two years. So, when they're throwing out same-shack sales, that's a fraction of their company.

Moser: It is. It's not the biggest presence to begin with, I think they have somewhere in the neighborhood of 120 stores, or something like that. But it's basically split down the middle as far as franchise versus company-owned. The big question, at least, with Shake Shack, remains how much can they grow this concept? We were lucky enough to take that train up to New York City last year and do a little market research. I loved the food, it was great. But you know what? I ate at Five Guys last night, Chris, and it was really just as good. I don't know that they really have anything that truly differentiates themselves beyond the same-shack sales metric. I mean, that's clever, but that's the thing we talk about with these restaurants. There's so many burger places out there. 

We saw a decade ago with Chipotle, for example, making such progress and having so much success because they were an innovator in that space and introduced a new concept, a new way of doing food that was, you saw the fast casual dynamic come out. Now we see all the imitators. And Shake Shack is one of those imitators, along with Five Guys and a million other ones. You just have so many in there now that it becomes very difficult to really gain any serious, sustainable traction there, because you have so many options. So, when we look at Shake Shack, it's really difficult to justify it as an investment. Again, it's not like the performance is all that great. The success on the top line there was due to opening new stores. And at some point, you can't do that. So, once they stop opening stores, how are they going to gin up traffic? They only have a modicum of pricing power. Really not much at all.

Hill: That's the thing. To the extent that anyone at that company's management cares, my two cents is, if you're performing, you can be as cute as you want with your metrics, branding, and all that sort of thing. Look at John Legere at T-Mobile. When you are putting numbers through the roof, then you can be as cute as you want to be. Until then, to Jeff's point this morning on Twitter, you can't hide the numbers.

Moser: No, you can't. The numbers tell the story. Maybe what we need to do next quarter, Chris, is we need to jump on that earnings call, and we need to actually call them out on this and say, "Listen, guys, just come back to earth. Just be like everybody else. Same-store sales is just fine, it makes it easier. Don't try to obfuscate the data. Let's just be clear and understand what you're trying to do."

Hill: Speaking of our trip up to New York, we're going to be tomorrow, Wednesday, at Chatter in Washington, D.C., at the corner of Wisconsin and Jennifer. The doors open at 11:30 if you want to come out. But, you just reminded me with your comment about our trip, later this year, we're expecting an IPO from Bobby Flay, from Bobby's Burgers. I think we've got tentative plans to hit a Bobby Flay Burger location for a Market Foolery taping. I would think either the day of or maybe the week after that IPO.

Moser: I really hope our listeners recognize the selfless acts of market research. Because, this is for them, right?! We're taking the bullet here and getting in the car and putting on the miles and trying that food. Hey, look, Bobby Flay, that might not be the biggest concept in the world, but he apparently feels pretty good about that Crunchburger. We have to give it at least a test drive.

Hill: Do you think our man behind the glass, Dan Boyd, the hardest-working man in podcast business, do you think he wants to go to a burger place and just try their food? No. Again, selfless. He's selfless. Jason Moser, thanks for being here!

Moser: Thank you!

Hill: 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 at Chatter in Washington, D.C.