In this MarketFoolery podcast, host Chris Hill and Motley Fool analyst David Kretzmann discuss a trio of well-known companies that delivered quarterly reports this week.

First up, retail supergiant Walmart (NYSE:WMT), which had a solid earnings beat but is also facing tighter margins and questions about how much growth it can achieve. Next is video game publisher Take-Two Interactive (NASDAQ:TTWO), which solidly beat expectations on earnings despite tepid sales. And finally, they review the missteps of second-stringer Jack in the Box (NASDAQ:JACK), the fast-food chain that hasn't been benefiting from the recovery the broader restaurant has enjoyed lately.

A full transcript follows the video.

This video was recorded on May 17, 2018.

Chris Hill: It's Thursday, May 17th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, the happiest Sacramento Kings fan east of the Mississippi River --

David Kretzmann: Oh, yes!

Hill: -- it's David Kretzmann!

Kretzmann: Man, it's been a good week, Chris!

Hill: [laughs] The NBA draft lottery working out about as well as it could for the Kings. Kudos!

Kretzmann: Yeah, we jumped from the No. 7 spot, which is what we were projected to get in the draft, and now we're going to be drafting second in what a lot of people are saying is a pretty good draft this year.

Hill: Oh yeah, you're going to get a very good player.

Kretzmann: We have to make moves this summer. This is it!

Hill: [laughs] You know, we could spend the next ten minutes talking about the NBA draft, because we're both fans. But that's not what we do on this podcast.

Kretzmann: Unfortunately, no.

Hill: We're going to talk video gaming, we're going to talk restaurants, and I have an update on The Motley Fool podcast swag shop. Let's start with a much bigger shop, and that's Walmart and their first quarter results. The headline for Walmart was great, profits and revenue coming in higher than expected, online sales in the U.S. continue to climb. You look under the hood, though, and their gross margins are going in the wrong direction.

Kretzmann: Yeah, this is a company really reinvesting back in the business. I think the headline this quarter, besides the e-commerce growth, which picked up from the previous quarter -- e-commerce up 33% this quarter compared to, I think, 23% the previous quarter. That's a strong number, but I'd say the headline this quarter is definitely the Flipkart acquisition that they announced within the past couple of weeks. Walmart making a huge $16 billion acquisition to acquire not even the entire company of Flipkart. They're getting 77%. So, I think you'll continue to see pressure on margins going forward as the company really reinvests back into their e-commerce business, the omnichannel experience. And then, internationally, Flipkart isn't going to be making money any time soon, so you'll see pressure on margins there as well.

Hill: Doug McMillon has been CEO for a little more than four years, and during that time, the stock is up somewhere in the neighborhood of 12%, something like that. That's not great, when you compare it to the market in general. But, I look at the state of Walmart's business, and it seems to me like it's more than 12% stronger as a business than it was four years ago, when you think about, not just Flipkart, but the jet.com acquisition and how that's worked out. I'm not saying, "This is a coiled spring that's going to take off in the next couple of years," but I really do feel like the underlying business of Walmart is in so much better shape than the stock performance indicates.

Kretzmann: Yeah, I would agree to an extent. I think the issue here is, even though they're plowing a lot into e-commerce, it's still not really at a level where it's going to be moving the needle to a meaningful degree. Total sales for the company were up 4.4% this quarter. You have some international sales that are growing well over 10%. But the U.S. business, for the most part, is very much established. They are seeing traffic and check growth, so same-store sales are still strong in the U.S. But, for the most part, this is still a slower growth story. 

But, ideally, if you're a Walmart investor, you're hoping that the company's investments internationally into Flipkart and new regions, and domestically here with jet.com and that e-commerce business, maybe that can pick up the growth rate. But, in the meantime, I think, expectations are still somewhat tampered. They're going up against Amazon. As you mentioned, margins are pressured as a result. But, the valuation also isn't out of this world. 

I think they're making the right moves. What gives me a little bit of pause is their capital allocation. The underlying business, like you mentioned, is still very strong, generating about $18 billion in free cash flow each year. But they're still allocating a lot of that to buying back stock and paying out a dividend. So, about $14 billion of that $18 billion in free cash flow is going to buybacks and dividends. I sort of wonder if they should maybe tamper down the buybacks and focus on these acquisitions, opening new stores, those capital expenditures, to improve the underlying business. That's what I would hope to see, is that they don't look to continue raising the dividend, they don't continue to buy back a ton of stock. Focus on reinvesting back in the business, because there clearly are growth opportunities in the retail space, online, and internationally. Focus there.

Hill: I think it'll be curious to see if they actually do that, because particularly with the Flipkart acquisition, that's one where they want to make sure it goes as smoothly as possible, and it's entirely possible -- look, any time a company makes an acquisition, more often than not, there are costs associated with it that aren't baked into whatever the final price tag was. Kind of like, I don't know, if you're doing a renovation on your home, it always ends up costing a little bit more. Or, you take your car to the shop, it costs a little bit more than you originally thought it was going to. And it seems like it would behoove them to listen to your advice. I think the Flipkart acquisition was a smart move, but they're going to need a little bit more cash than they probably think.

Kretzmann: I think they should count on that. Really, any way you look at the Flipkart acquisition, they paid a rich price. Flipkart's a young company, still losing a good chunk of money. And they're not the clear-cut No. 1 winner. Amazon's nipping at their heels already. Amazon, allegedly, was interested in Flipkart, as well. 

I think Flipkart is somewhat of a stepping stone for Walmart into India. Something I hadn't realized is, there are some pretty tough regulations for foreign retailers expanding into India. Up to this point, Walmart only has 21 physical locations in India. And really, that's due to a lot of regulations that are in place to protect local mom-and-pop retailers and producers. Essentially, on a brick-and-mortar level, Walmart can't operate at scale. They need to source the majority of their products from local mom-and-pop shops. So, you can't have that scale advantage where you can buy a ton of stuff in bulk and then sell it at a discounted price to consumers, like we know and love here in the U.S. You just can't do that in India if you're a foreign retailer. 

But perhaps this Flipkart acquisition, if it does get approved in India, maybe that gives them a little bit more leverage to negotiate with the Indian government, maybe open up some more physical locations and build out both the e-commerce side with Flipkart, but also build out the physical and omnichannel experience.

Hill: Let's move on to Take-Two Interactive. Fourth quarter profits solidly beat expectations. Shares are up about 3% this morning. I'm assuming they would be up even more if the overall sales for Take-Two Interactive were stronger. They kind of struggled this quarter, and their guidance for the current quarter was essentially, "Yeah, this current quarter, it's going to look a lot like the one we just reported," meaning --

Kretzmann: Not ideal.

Hill: -- tepid, sales will be tepid.

Kretzmann: With any video game company, whether you're looking at Electronic Arts or Activision Blizzard, which are much bigger than Take-Two Interactive, you will see similar dynamics, where quarter-to-quarter results will be very lumpy, because this is very much a hits and franchise-driven business. In this case, you might remember that last year, Take-Two Interactive was planning on launching Red Dead Redemption II in the fall of 2017. They delayed that to the spring of this year, and then they delayed it again to October this year. That was a big release that initially would have been lumped into this quarter's results, but they've continued to push that back. Really, I think they're doing it for good reasons. They're basically saying, "We really want to make sure we have this game right."

In the meantime, their digital side of the business is helping prop up the company and bringing in a lot of cash. It's a terrible phrase, but their metric "recurrent consumer spending," which is basically all the money that gamers spend on virtual currency, add-on content, in-game purchases, essentially, purchases that gamers make after they've bought the initial game, that spending was up 42% in the quarter. It now makes up almost half of their total revenue. And that's high-margin money coming in the door. It's dropping, essentially, straight to the bottom line. 

So, right now, you look at Take-Two Interactive, they're producing over $300 million in free cash flow each year. They have $1.4 billion in net cash on their balance sheet. It's a very cash-rich business. If they can continue to churn out hits with their current franchises like Grand Theft Auto, NBA 2K, WWE, and hopefully get some other hits in the meantime, and develop some new hits, the company should be on a nice trajectory longer-term. But in the meantime, these quarter-to-quarter results will be a bit lumpy.

Hill: You're right, that is a terrible phrase for what is -- as you point out -- a great metric, and something that points to, among other things, the fact that these are well-made games. If they're that sticky, that people are, after they bought the game, they're like, "I like this game so much, I'm going to spend even more money within the game itself," for whatever you're buying. 

Fortnite. is Fortnite just going to hurt every game maker right now because of its popularity?

Kretzmann: Well, Fortnite was mentioned 17 times on their conference call.

Hill: [laughs] That sounds like a yes.

Kretzmann: A lot of analysts were interested in it. Really, the response from Take-Two was similar to the response we heard from EA a couple of weeks ago. They essentially see it as, this is a new-ish development in the gaming world, especially here in the U.S., where you have these battle royale games, where you have essentially 100 people competing live at once. I think they see it as something that's, in general, an opportunity. Anecdotally, this seems to be bringing in a lot of newer gamers into the online gaming category. Ideally, for Take-Two, this might raise interest in new gamers for new games. And down the road, perhaps, they look to develop games more in the Fortnite model. 

So, I don't think they see it as a threat. I'd say, at this point, all these video game companies, whether it's EA, Take-Two Interactive, or Activision, are probably looking at what's happening with Fortnite as an opportunity, just that there is a growing interest in interactive gaming. And that's where these companies have largely been spending a lot of their time as they develop and expand their existing titles. I mean, you look at Grand Theft Auto V -- which, by almost any measure, might be the most successful media franchise in a long time, if not ever -- that's sold over 95 million units. So, you think, if there's an average selling price of, say, $60 -- and that might not necessarily even include the money people are spending after the fact, once they buy the game -- that would mean that Grand Theft Auto V alone has brought in over $6 billion.

And it's probably even more than that. And that title was released in 2013, and still continues to be the primary revenue generator and earnings generator for Take-Two. So, the power of having a hit title, developing that online experience. I think Take-Two already has a lot of know-how, and they recognize that that's really what you're shooting for. If you can hit one of those, they can just keep milking that for a long time.

Hill: If you're going to be in the D.C. area at the end of the month, we're having a podcast listener meetup in Washington D.C. It's going to be on May 30th. If you're interested in joining us, email marketfoolery@fool.com, and we will send you all the details.

Jack in the Box's second quarter earnings came in light. Their same-store sales were down ever so slightly, 0.1%. The stock is down about 6% this morning, and I totally understand why, because management said nothing that would give anyone any optimism for the rest of this fiscal year. Management was basically like, "Yeah, this is pretty much how it's going to be for the next six months."

Kretzmann: Yeah. And, I guess, to be fair, a lot of restaurants are still struggling. But, in general, the restaurant picture in the U.S. is looking brighter than it's been in a long time over the past couple of years. But, in this case, their company-owned same-store sales for the quarter were up just under 1%, but traffic was down almost 2%. So, it's really just, people are spending more when they go in to Jack in the Box. That's what's carrying their comps. 

But, there's also the downside that those company-owned same-store sales now represent an increasingly tiny part of their overall system. Right now, they're focusing on refranchising. So, more and more of those company-owned stores are becoming franchised at this point. I think 92% of the company's total restaurants are franchised. 

So, really, if you're investing in Jack in the Box today, they sold off Qdoba -- which we can talk about. The more I look at that, the more I wonder. It seems like they sold at a bad price, and maybe a bad time. But, you really just have to buy in to this concept becoming more relevant in the coming years, but also management's strategy of really bringing on a lot of debt to buy back stock and pay a dividend, that kind of thing. They're trying to be Domino's, but without a concept that's doing as well as Domino's.

That's really the direction they're going with this franchising strategy. You lever up the balance sheet, you return a lot of cash to shareholders, but when your core concept is Jack in the Box and it just isn't doing that well, it's hard to replicate Domino's.

Hill: [laughs] They're trying to be Domino's, but without Patrick Doyle running the company.

Kretzmann: Exactly!

Hill: Let's go back to Qdoba for a second. We talked about this right before we started taping. A little bit of background here -- Jack in the Box bought Qdoba, which is basically their version of Chipotle (NYSE:CMG). They bought it in 2003 for $45 million dollars. They sold it at the end of last year for just over $300 million. Just, on the surface, you can look at that and say, "Well, they made a heck of a nice profit off of that." But, there were a bunch of years where, when Jack in the Box reported their quarterly earnings, it was Qdoba that was really doing the heavy lifting. It was Qdoba that was putting up the really impressive double-digit same-store sales growth. 

So, like you, when they said, "We're going to sell Qdoba," I was sort of scratching my head over that, even though Qdoba had cooled off in terms of the performance. Like, the comps came down to single-digit growth instead of double-digit growth. But, this, to me, was not like -- when Darden Restaurants, which is the parent company of Steve Broido's beloved Olive Garden, and The Capital Grille, and others. When they announced they were going to sell Red Lobster, that made sense to me, because they have a bunch of restaurants in their portfolio, they were able to get some cash upfront for that, and they were able to focus on their other brands in the portfolio. Well, it's not like Jack in the Box is trying to manage eight to ten different restaurant brands. So, I don't know. History may not be kind to this decision to sell.

Kretzmann: Yeah, I really do think it will be looked back on as a questionable and probably a poor decision. If anything, you want to sell a concept when it's performing well. A few years back, when Qdoba was really the driving force behind Jack in the Box's positive results, that's the time you want to sell. You want to sell high rather than sell low, which is really what they did. I think for a while, they were optimistic about Qdoba, when the results and performance were looking great, right alongside Chipotle, back in the glory years five-plus years ago. But management changed their tune pretty quickly over the past couple of years, as soon as Qdoba's sales started to falter and maybe weren't performing as well as the core Jack in the Box concept. That's, all of the sudden, when they were saying, "Yeah, we might look to sell this."

But, I would think that a lot of Qdoba's struggles could be blamed on the wider restaurant slowdown that we saw in the U.S. over the past couple of years. Although, you also might argue that Qdoba should have taken advantage of Chipotle's woes and performed better. In any case, Qdoba had over 700 restaurants in the U.S. at the time of this sale. But they really only sold it for just over $300 million. That leaves me scratching my head, because today, Chipotle has over 2,000 restaurants, so about 4-5X the restaurants of Qdoba, but Chipotle is trading at a valuation of over $11 billion. There just really seems to be a mismatch there. 

I think they could have gotten a higher price for Qdoba if they had just waited, maybe, for a better market, or waited for the results to turn around with the wider industry. Something here just doesn't add up to me. There might be something that I'm missing here, but Qdoba was primarily, if not entirely, company-owned locations, and still performing decently, although not as well as they had been a few years ago.

Hill: Apollo was the company that bought them?

Kretzmann: Yeah.

Hill: It really wouldn't surprise me -- and of course, if this happens, we'll find out exactly if Jack in the Box made a mistake selling them -- it wouldn't surprise me if Apollo spun out Qdoba in a couple of years into an IPO.

Kretzmann: Yeah. I think that's the route that Jack in the Box probably should have gone. I think it's still a relatively strong restaurant concept. It's probably the closest to a No. 2 to the Chipotle fast-casual Tex-Mex concept. I just think that they easily could have gotten a higher valuation.

Hill: And by the way, the same-store sales, I mean, if you're just looking at burger concepts, Jack in the Box is kind of in the middle of the group in terms of most recent same-store sales. 0.1% in the negative is not great, but it's better than Sonic, Steak 'n Shake, a couple of others out there. By the way, thank you. I meant to thank you. I believe you were the one who recommended a Twitter follow for me, Jonathan Maze. Was that you?

Kretzmann: Yep!

Hill: That was you, OK. Thank you!

Kretzmann: I'll take credit, sure. [laughs] 

Hill: [laughs] For anyone interested in the restaurant business, David had mentioned this guy to me, Jonathan Maze. His Twitter handle is @jonathanmaze. He's the executive editor of Restaurant Business magazine, and a great follow for anyone interested in restaurant stocks. That little stat I just shared about same-store sales in the burger space, I didn't do that research. [laughs] That came from following Jonathan Maze on Twitter.

Real quick, before we go, if you're unfamiliar, we have a little podcast swag shop here at The Motley Fool, which you can find online at shop.fool.com. Just launched it earlier this year, got great feedback from people, people tweeting us photos of T-shirts and podcast mugs and all that sort of thing. Happy to report a couple of updates. 

One, we have worked with our partners at Social Imprints. They're the people who actually produce the swag. We've worked with them to alleviate some of the shipping costs, because one of the things I've learned is, when you're shipping stuff, not everything costs the same to ship. How much something weighs, that matters. So, for people who were like, "A coffee mug! I'd like a coffee mug!" And then the shipping cost, because the weight of a coffee mug is, you know, more than, say, a T-shirt -- anyway, we've worked to cut down on the shipping costs there. So, thank you for that feedback. Also, a new item in the store, brand new this week, women's cut T-shirts.

Kretzmann: There you go!

Hill: They were very much in demand. Those are now at shop.fool.com. Check it out. It's graduation season. It's wedding season, coming up. I don't know. I mean, we don't have a registry on the site, but you could surprise a bride and groom this wedding season with -- no. No, that would be a terrible gift.

Kretzmann: A nice Foolish gift, what more do you need?

Hill: [laughs] Alright. David Kretzmann, thanks for being here!

Kretzmann: Thanks, Chris!

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 MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon. David Kretzmann owns shares of Activision Blizzard, Amazon, Chipotle Mexican Grill, Domino's Pizza, Electronic Arts, Take-Two Interactive, and Twitter. The Motley Fool owns shares of and recommends Activision Blizzard, Amazon, Chipotle Mexican Grill, Take-Two Interactive, and Twitter. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.