The Headwinds Were Too Strong for Macy's, Kohl's, and Blue Apron

On this Market Foolery podcast, host Mac Greer is joined by David Kretzmann of Supernova and Rule Breakers and Ron Gross of Motley Fool Total Income to review the day's interesting market news.

Shares of both Macy's (M -2.12%) and Kohl's (KSS -2.20%) tanked despite better-than-expected quarterly reports; and meal-delivery service Blue Apron (APRN) revealed a host of issues both operational and financial on its earning call. Facebook (META -2.28%), though, is making a new push to overcome one of its weaknesses by revamping the way it handles video, and that could be bad news for its rivals for our eyeballs.

A full transcript follows the video.

This video was recorded on Aug. 10, 2017.

Mac Greer: Guys, on today's show, YouTube getting some new competition. We'll talk about that a bit later. And Blue Apron seeing a lot of red. Woof. We're going to talk about that. Blue Apron, a fairly new IPO.

David Kretzmann: Yeah, it went public at the end of June. So this is their first quarter since going public, and not a good start.

Greer: Had had a rough debut. We'll talk about that. But let's start with retail. Ron, shares of Macy's and Kohl's both down big on Thursday. Now I hesitate to call this a good news, bad news story. It feels more like a less bad news, bad news story.

Ron Gross: That's fair. Everything's relative.

Greer: Both retailers reported better-than-expected earnings, and same-store sales were down for both, but they weren't down quite as much as expected. So that seems relatively not bad. But investors are not buying it. Shares are down. What's going on?

Gross: It's interesting that that's how you put it. Relatively not bad. If you had asked me to make a bet pre-market, I would have bet the stocks would have been fine to up, because I think the expectations are pretty lousy. And the fact that the results, specifically the same-store-sales results, for both companies were not really as bad as expected, I would have thought investors would have responded favorably. Shows you what I know. ?The stocks are getting slapped.

It's interesting, though. It's kind of a "we're not dead yet" moment, it feels to me. "We're Macy's and we're Kohl's, and we're around, and we've been around, and we're not going anywhere. In the age of Amazon, there's still a need for both of us. And we're getting our shop in order, and we're taking the necessary steps in order to make sure that we can get growth back into our business and improve profitability." Easier said than done. 

I do like some of the steps they're taking, especially Macy's. They're closing the stores they need to close. They're cutting costs pretty dramatically. They're focusing on their backstage discount line, which is kind of like a Nordstrom Rack, if you will. Their Bluemercury, a relatively recent acquisition, is pretty strong for them as well. So they're doing what they need to do. They're saying a lot of the right things. It's a wait-and-see-what-happens kind of moment for me, because it's too early.

Retail is notoriously a tough business. Even the best of these companies basically file bankruptcy at some point during their life. Bloomingdale's, which is part of Macy's, has had its ups and its downs. Macy's has had its ups and downs. Dillard's has struggled. J.C. Penney we talk about ad nauseam, which is a tough one. This is a tough, tough business, made even tougher by the internet and Amazon in particular. So I'm still on a wait-and-see mode. But at least they're taking the steps necessary to right-size the business.

Greer: I'm going to call you cautiously pessimistic. [laughs] 

Gross: [laughs] That's fair. I wouldn't be a J.C. Penney buyer, for example, even though, as a value investor, you could say maybe it's been beaten down so bad at various points that you would want to dip your toe into that water. But that business in particular, I don't think it's strong enough for me or will be strong enough in the future. Macy's I feel a little bit differently about. And Kohl's, differently, but a little less.

Kretzmann: For me, just looking at both of these companies, when you have companies like these that are going through difficult times or facing a lot of headwinds in many different areas, when they have such a high debt count, that really ties your hands with what you can do. Macy's has $5.5 billion in net debt. Kohl's has $4 billion in net debt. This, for me, reinforces why, in general, I like to find companies that have minimal debt or even no debt. It really opens up your options to be flexible when you do hit hard times. You're not trying to figure out how you're going to make that next interest payment, or whatever it might be. So to me, that's another yellow flag with both of these companies. If one of them didn't have debt, that might make it a little bit more appealing to me. But at this point, when you have a fairly weak balance sheet and a lot of headwinds, it's hard to see this as a strong turnaround candidate.

Gross: I think that's actually a fantastic point. It could be a point that you can take for any industry, and that's a great lesson to teach, that balance sheets are important. You can't just look at same-store sales and earnings and cash flow. You need to look at the balance sheet. Now, back to the retail in particular -- that's why you have some of these companies that have been forced to restructure in bankruptcy proceedings in the past, because of that debt load during times when business was really weak. So, really important lesson.

Greer: Ron, you're our resident value guy. So, what gets you interested? What makes these stocks more appealing for you?

Gross: So typically, when I look at a beaten-down company or a beaten-down industry, there's always a reason, right? And if you believe the market is somewhat efficient, the stocks are selling of for a reason. So at what point, then, do you say, "Well, I'm going to think like a contrarian and I'm going to be a buyer when everyone else is a seller?" When you find a stock that is troubled, you have to believe in some sort of turnaround, and you have to believe in the management to execute on that turnaround. 

So for Macy's, as I said earlier, I like some of the things they're doing. They're reducing their footprint. They're focusing on areas of their business that I think will do well. I think management is saying a lot of the right things. I'm not there yet. But you can't just look at valuation in a vacuum, because even though these stocks are 10, 11, 12 times earnings, which, in a vacuum, is theoretically cheap when the market is 25 times, there's a reason these stocks are, in quotes, cheap. Because they're troubled. So you need to be careful, you need to look at each company on a case-by-case basis and believe in the strategy and be willing to put your money where your mouth is and invest alongside that management team in the belief that they can turn the business.

Greer: Ron, you made the mistake of telling me before today's taping that you worked at Macy's.

Kretzmann: Juicy details.

Gross: As a high schooler.

Greer: As we wrap up this story, how about one highlight, one lowlight from your Macy's career?

Gross: At the time it was Bamberger's, which was owned by Macy's, and eventually that particular store I worked at changed its name to Macy's. I was in high school. Definitely the low point was when one day they came to me during the Christmas season and said, "Could you go to the gift-wrap department? We're swamped." I had never wrapped a gift in my entire life. I'm still not good at it. You make that triangle and you fold. Not a thing.

Greer: Hate the triangle.

Gross: Origami and me do not mix. So I was really stressed out, actually. It's funny to think about it now, but sometimes I think I still dream about it. The high point was definitely when I resigned and moved on to bigger and better things.

Greer: OK. Not a lot of high points for Blue Apron, the meal-delivery service. Shares down big on Thursday. David, they reported better-than-expected second-quarter revenue. So that sounds good. But then things really started heading south once the earnings call happened this morning. Do tell.

Kretzmann: Yeah. They had a lot of unexpected complexities and costs, in management's words. They're rolling out a new manufacturing facility, a facility where they put together these meal kits, in New Jersey. It's supposed to be very automated, but that's taking longer than expected, they're running into issues as they try to ramp it up. So that's one thing. They also raised less cash than anticipated with the IPO, because their timing really couldn't have been worse after the Amazon-Whole Foods announcement, so they had to slash the entry price for the IPO, so they raised less capital. They still raised about $275 million. But as a result of having less cash than anticipated, as well as these other headwinds for the business, they're also reducing their marketing expense. This is a company that has spent a ton on marketing trying to get new customers in. 

As a result of all these different headwinds, they're having to shift their strategy a bit. Something that they found is that once someone signs up for Blue Apron, they really only stick around for about a month. So when you're trying to build a business model on a subscription model, that's awful. That's not going to turn out very well. As a result, they're losing a lot of money. Over the past year, they've spent over $450 million per new subscriber to the service, and the average revenue per subscriber right now is about $250, so you're losing a lot of money. With all those different headwinds, shifting their strategy, that's not a strong entrance to the public markets when this is your very first quarter.

So a lot of things here. They're also guiding for revenue to stagnate and drop later this year. So as a result of pulling back on that marketing spending, they're expecting revenue to essentially flat-line. Revenue grew over 40% in the first quarter, it grew 18% this quarter, and we'll probably see it flatten and drop the next couple quarters this year. So not a good entrance as a newly public company.

Gross: Yeah, completely agree. I think that hit the nail on the head. To me, you could boil it down to they have a business-model problem, both in terms of competition and what it costs to acquire a customer and keep a customer, and then you pile on top of that an operational problem now with the New Jersey facility. Those are two things that never go well together. It'd probably be enough to have just a business-model problem, and as an investor you would say, "I'm going to stay away. Why would I want to invest in a company with a business-model problem?" Layer on top of that, now, operational difficulties, and you can see it in the stock. The market in this case seems perfectly efficient to me. Investors really don't want anything to do with the stock until, perhaps, maybe, they can get their act together. But it's going to be tough.

Kretzmann: And that business-model shift is the recognition on management's part that people are not treating Blue Apron like a subscription service. They're treating it more like any other e-commerce purchase that they make. So I'll sign up, I'll get a few meals this month, and you can choose when you want to use the service. Mac, I think you've used it. Is that in line with your experience?

Greer: Yeah. We were talking about this before the show. We used it for a month or so. The recipes are incredible, and I should say that, but you also feel this pressure, because sometimes you get home and you're like, "You know, I don't want to cook tonight," or you want to go out or you want to do something on the fly, and you have all these Blue Apron fresh ingredients.

Gross: A piece of salmon in the fridge.

Greer: Just waiting for you, yeah, and you just feel all this pressure. But when you cook it, it's absolutely incredible. The other big issue I had with them -- we don't use it anymore -- is the packaging. Everything is wrapped, and you get tired of all this packaging. And that's why I think, like an Amazon-Whole Foods, if they can solve that, if you've got a cooler on your front door and you've got fresh produce that they can deliver and there's no packaging, that to me feels like an even bigger problem for Blue Apron. Now, I really loved the recipes. But we don't use it anymore, at the end of the day.

Ron, you're a great cook. I come to you for advice all the time. Is Blue Apron ultimately after the aspiring gourmet foodie? Or are they after someone who just wants convenience? Because if that's the market, they're not quite convenient enough.

Gross: I think it's convenience with also a person who enjoys the process of cooking. Now, I enjoy it so much that I actually enjoy the process of shopping for the produce or the fish or the protein or whatever it is. So that isn't really something that would interest me. I don't want someone to do that for me. But I certainly understand that there are plenty of folks who do want it done for them.

Kretzmann: Mac, speaking to your experience, that is something Blue Apron is focusing on. That's what they're shifting their strategy toward. They're shifting away from trying to acquire new customers, which they've been doing guns blazing over the past few years, and instead they're going to try to focus on customer retention, so, keeping the people in their ecosystem once they have them in. But that's obviously a pretty big shift. And especially, as soon as you go public, you're announcing this shift, that isn't exactly a strong show of confidence on the part of management's talent. This is something you should have mentioned before you went public, and you should have had some idea that these headwinds were arising.

So to drop this on the public markets within a couple months of going public, this is really just a case study for what not to do in an IPO. Because when you go public, you want to make sure you have a good idea of what the business is going to do. You want to go public at a strong time. You want to gain that investor confidence and build that confidence. But in this case, it's hard for me to take management at its word now, because these are all substantial issues that they should have known about a couple of months ago before going public.

Gross: And if you ever see a pre-IPO price come down -- I believe in this case, priced lower than the range or at the low end of the range -- big, big red flag. That means there's not the proper demand. The investment bankers are going out looking for the institutional demand to sell the stock into the marketplace, and if that demand isn't there, they have to bring the price down to a point where the demand is there, and there's equilibrium between the supply of the stock and the demand for the stock. Big, big red flag.

Kretzmann: Yeah, and looking at the high-profile IPOs this year, it hasn't been a great here in that sense. If I'm a private company now, I'm taking note of what happened to Snap and Blue Apron, companies that have been struggling pretty much right out of the gate. The public markets are different than the private markets. It's a different ball game. I think Redfin is a recent IPO that, I think they have their act together a little bit more. The stock has actually been doing well since going public a couple of weeks ago. But yeah, if I'm a private company, you have to make sure you have your act together before you go public, or you're going to get whacked like Blue Apron and Snap.

Greer: Guys, let's move to Facebook. Facebook, making a big push into video. Facebook is adding a Watch tab that will include original video produced exclusively for Facebook. The Watch tab will feature personalized recommendations as well, and categories like "most talked about," "what's making people laugh," and "shows your friends are watching." David, what does it all mean for investors?

Kretzmann: I think the interesting thing here is, this will really be the place that Facebook houses a lot of its original content. So there will be some live media, like its new deal with Major League Baseball -- they'll be showing one game a week. They have some original content from Mike Rowe, the former host of Dirty Jobs on Discovery. So they have a lot of different content that really runs the gamut here. It makes sense to house that content in one place.

At this point, video on Facebook -- it's not easy, I don't know if it's even possible to search for a video. I've never done that. Sometimes you'll see videos in the Facebook feed itself, but you don't go to Facebook as a destination saying, "I want to find and watch this video." Typically, for that, you'll go to YouTube or somewhere else. So I don't know if I necessarily see this as a direct competitor to YouTube. From what I've read so far about this announcement, it seems like it's mainly focused on that original content. But I'll be curious to see if they try to have this new feature house a lot of the users' content and things like that, and just make video in general more searchable and discoverable on Facebook, because up to this point, that hasn't been a focus, and they're clearly lagging YouTube on that front.

Gross: Yeah. I like this. Anything to make Facebook more sticky, like the world needs more excuses to suck productivity out of their day. I'm on there as much as the next guy, and I think I like this. I do have a demographic question. Whereas I think YouTube is watched and searched by people of all ages, I think of Facebook as having lost the youngest of our generation, the younger kids, let's say. And I don't know if this gets some back. I don't think it does.

Greer: I don't think they ever had the youngest.

Gross: Right. But even teenagers and college-aged kids, I think for the most part, they'll do a little bit of posting, but they've left Facebook up to us older folks. Therefore, I question whether the videos that are produced or put on YouTube, will they have the same viewership? On YouTube, if you get something hot, you can have multimillions of viewers watching that video. I'm just concerned that Facebook's narrower -- is that a word?

Kretzmann: Why not?

Greer: I'll go with it.

Gross: Their narrower demographic could restrain that a bit.

Greer: But if this gets people to engage with Facebook for longer -- it's not so much that more people are coming to Facebook to watch videos, because to Ron's point, I don't think they are. But if you're spending more time on Facebook because of videos, this is a win, right?

Kretzmann: Yeah. Facebook is all about engagement and keeping people on that platform longer. I think video has been a focus on Zuckerberg's part for a while now. And this, I think, should be a more concrete, dedicated hub for that video content. It'll be interesting to see how this deal with Major League Baseball turns out. If you're going on Facebook to watch live sports, original shows, then it becomes even more of a destination as a platform, not only a place that you go just to blow off some steam and not be productive.

Greer: To that point, do you think this sets off even more of an arms race between Facebook, YouTube, Netflix, HBO? Does this up the ante for all of them? Or do you think, if you're YouTube, you're looking at this and saying, "Eh, I'm not really worried."

Kretzmann: I think you certainly need to pay attention to it. This really is a battle among platforms and ecosystems at this point. There's only 24 hours in a day and you're trying to capture as much of that from your respective users. YouTube's been doing some similar initiatives with their YouTube Red offering, where they have original content. They're paying some of their top creators and stuff. So you're seeing more of these companies, even Apple, push into original content. Still very early days. So I'm not really convinced on what strategy makes the most sense yet. But I think it makes sense for these companies to be testing that.

Gross: In the end, let's not forget, this is still all about advertising dollars. There's only a certain amount of advertising to go around, and there's only a certain amount of dollars that advertisers will pay for more eyeballs and stickier eyeballs. Obviously, you should be able to charge more for that, which is, I think, the game plan right here. But still, you can't have all the companies charging all the money for all the advertising. The math just doesn't work.

Greer: OK, guys. As we wrap up, I mentioned that one of the sections on Facebook's Watch tab is going to be "what's making people laugh." So how about one video or one type of video that you have to put in that section?

Kretzmann: I'm going to go with some inside baseball here. I'm going to go with the earthquake 2011 video, courtesy of Fool Lawrence Morrison. This is on YouTube, and I think it needs to be on Facebook, too. Maybe we can tweet it out or something.

Gross: Shout-out to Randy.

Kretzmann: Yeah, this is a legendary video that always makes me laugh.

Greer: OK, that's a bold call. Ron?

Gross: I like watching comedians, specifically anything Louis C.K. puts out, but there is a bit of schadenfreude, I'm going to say, on my part, because I also like watching the videos where people are falling and hurting themselves. [laughs] Nothing too bad. I don't want anyone going to the hospital, but I do like a good fall every now and again.

Kretzmann: The fail videos.

Greer: I love watching old concert videos, like the Eagles from 1971. I love watching that. And then my guilty pleasure -- it's not even guilty -- the video I love, my go-to make-me-laugh video is the video of the monkey riding the dog. And it's usually at a rodeo or somewhere. I think the monkey may even be wearing a bandanna. If that video stops being funny, then I'm dead.

Kretzmann: It's sort of like the video of the kitten riding the turtle. That's another one that always does it for me.

Greer: Oh, how solid. My favorite joke, once a month, I'll send my wife an email and say, "You have to check this link out," or "Here's a very important document," or "I don't know if you saw this bill," and it'll be the link to the monkey riding the dog, and she's got speakers in an office, and it's got the "Yakety Sax" music. Everything about the video is perfect.

Kretzmann: The secret to a happy marriage, following up on yesterday's episode.

Greer: It's impressive, and the monkey stays on the dog.

Gross: Of course. It wouldn't be funny -- well, it would be funny for me.

Greer: It would be funny for you. OK, guys, thanks for joining us today!

Gross: Thanks, Mac!

Kretzmann: Thanks, Mac!

Greer: 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. Thanks listening, and we'll see you next week!