As strong as the economy is in many ways after our nine-year-long expansion, there are still plenty of hazards out there that can hammer good companies, and in this MarketFoolery podcast, host Chris Hill and Motley Fool senior analyst Jeff Fischer discuss a number of them. First off, they tackle the troubles faced by iconic U.S. motorcycle manufacturer Harley-Davidson (NYSE:HOG): trade wars and the tweeted ire of President Trump.
Next, they weigh in on the major moves General Electric (NYSE:GE) is making to get out from under its long-standing problem of having grown too unwieldy to be well-managed. And finally, they look to Starbucks (NASDAQ:SBUX), which is closing underperforming stores and adjusting its growth plan to better match demand -- choices that, while natural, have somewhat spooked the market.
A full transcript follows the video.
This video was recorded on June 26, 2018.
Chris Hill: It's Tuesday, June 26th. Welcome to Market Foolery! I'm Chris Hill, and thankfully, I'm joined in studio by Jeff Fischer.
Jeff Fischer: Hey, Chris!
Hill: Good to see you, man!
Fischer: Good to see you, too!
Hill: Thanks for being here. Jeff's here in the studio. On the other side of the glass, our man Dan Boyd has returned from Ireland. Yes, we're happy to see Dan. Austin Morgan doing phenomenal double duty the last couple of weeks. Don't worry, we'll be going to Dan at the end of this episode. We'll be getting the details, for those of you who were on Twitter and saw what Dan did in Ireland last week.
Fischer: Very exciting.
Hill: We have to start once again with Harley-Davidson, which continues to be in the spotlight. Yesterday, we talked about Harley-Davidson looking to move production outside the U.S. because of the tariffs from the E.U. adding $2,200 per motorcycle. This morning, President Trump going on Twitter and threatening Harley-Davidson, and saying, and I'm quoting here, "If they move, it will be the beginning of the end. They will be taxed like never before." I saw this, Jeff, and I just sort of shook my head and said, yeah, we called this just a couple of weeks after the election.
Fischer: He is threatening Harley, just like he threatened The Motley Fool back in the late 90s.
Hill: That's true. You were there.
Fischer: When we were short his stock. He said, "You are going to be so wrong. We're going to refinance the debt and the stock's going to soar."
Hill: By the way, that didn't work out.
Fischer: It didn't work. They did go bankrupt. But, he persuaded us to close the short. We had a nice gain, a 60% gain on it, when we closed it. Harley, though. $2,200 extra per bike these tariffs would cost if Harley made them in Minnesota and then shipped them to the E.U. because of the new E.U. tariffs on them. That amounts to, Chris, about $88 million a year in lost revenue to Harley, which already, they say, would decrease their earnings per share the next year by 5-6%, which is a large amount. If you start talking about earnings per share flattening out for just, say, the S&P 500 or many companies, let alone going down, the stock market will not be a pretty place for quite a while. So, yeah, they're looking to move some production overseas. Europe is their second largest market, I think it's about 15%.
Hill: And growing.
Fischer: And growing, nicely. So, move some production there to serve that market, makes sense. The tax threat, one of the tweets, not the threat, but after or before it --
Hill: There were several tweets about Harley-Davidson this morning.
Fischer: [laughs] It said, "If they think they can make bikes overseas and bring them back, they'll be taxed extremely when they bring them back." Well, that's not Harley's plan. They'll keep the U.S. production in the U.S., and have some in Europe, as well.
Hill: Earlier, when I said we said this was going to happen, what I'm referring to -- longtime listeners may remember this -- within the first few weeks after Donald Trump was elected president, late November, early December of 2016, before he was sworn in and he was taking to Twitter and attacking Amazon and all these different companies, one of the things we talked about on this podcast was, look at your portfolio. Everybody look at your portfolio. And know that for the next four years, for any reason, this could happen to any stock you own -- the President taking to Twitter, and for whatever whim he has, decides, "I'm just going to take a shot at this public company. For slights real and imagined, I'm going to attack this company, and the stock will drop."
Fischer: It's fairly unprecedented. That's certainly true. And it's whether you're Little Red Hen or Harley-Davidson, you can be any size.
Hill: Yeah, if you're a small restaurant in rural Virginia or you're a public company managing an iconic American brand, it could happen to you.
Fischer: It could be kind of fun, if you were president, and you're like, "This morning, my coffee from Peet's Coffee on 7th Street Northwest was not hot enough! Those guys are Un-American!"
Hill: It could be.
Fischer: Let's talk about the trade deficit, which is the target of what's happening right now, and a lot of concern in the stock market, too, because of the tariffs that are happening. It's a tough battle, to be sure. The U.S. total trade deficit as of last year was only 2.8% of our GDP. It's small. It's only about $500 billion. And China is around 70% of that deficit. So, rightly so, the focus is on China.
But keep in mind, the U.S. has a $19 trillion economy GDP, and China has $12 trillion. Our economy is much larger. You would expect a trade deficit with basically almost every country in the world, given that we have the largest economy by a multiple compared to most countries. We're going to be able to buy a lot more than we sell to these countries. You have to keep in mind, China for years has bought U.S. treasuries and supported us in other ways other than just trade. So, if your relations turn south, they could start to let our debt interest rates rise. They could do all sorts of other things if they're unhappy with us.
But, it's a small number. To make it the battleground is tricky. So many studies show that if you put tariffs on products, you're very likely to lose more jobs than you gain, at least the way we're doing them right now. The U.S. put tariffs on steel and aluminum and whatnot, but the number of jobs in this country that produce steel, say, it's fewer than 20,000. The number of jobs affected by steel prices going up is in the hundreds of thousands. So, when your input costs are going up and you only output a little bit of the commodity, it's a net loss. So, it's a tricky game. I think it's important to try to decrease the consumer electronics and electronics in general pirating that's all over China.
Fischer: Definitely, I agree with that. It's tricky. This is one way to try to put the squeeze on China and Europe and everyone else, but the repercussions --
Hill: But, yeah, if you're the CEO of Harley-Davidson, you're like, "What did I do?!"
Fischer: [laughs] Exactly! Or if you're soybeans, or bourbon. Bourbon! Jeez! The repercussions could reverberate for some time to come. We're just starting to see them trickle out with Harley lowering its earnings guidance, for instance.
Hill: Also just a little bit surprising when you look at, in the years before he was president, the merchandise that was produced that bore Donald Trump's name, most of it was made overseas. So, there's that, too.
Let's move on to General Electric. Some good news for General Electric and its shareholders. GE's stock having its best day in three years. Up on, actually, a lot of news, but I guess first and foremost, General Electric is spinning off its Healthcare unit. The company also said it plans to, eventually, over the next couple of years, divest its stake in Baker Hughes, which is the oil services company. What did you think of this move, when you saw it this morning?
Fischer: The portfolio is changing, as GE's CEO put it. I think that's a good way to look at it. They have a portfolio companies --
Hill: [laughs] That's also, in some ways, a huge understatement. I mean, yes, it's changing today. Just, in the brief tenure of John Flannery, that's a massive understatement.
Fischer: A sprawling portfolio. They're going to focus -- and it's going to take time -- around its Power and Aviation and Renewable Energy business. Chris, as you said, they're going to slowly move away from oil and gas and focus more on power turbines; aviation, which is one division that's doing well; and renewable energy, where they think there's a lot more growth ahead.
I think it's going to be a long road to get there. They still have their struggling finance division, which they didn't talk about today that I saw. They have a net $100 billion in debt. S&P is warning that their debt could be downgraded. These moves will cut revenue by less than half. They're looking to focus on business units that now account for a bit more than half of revenue and a bigger portion of net income and profits, which is smart.
But the bigger change that I like is that the plan is going to move from being very centrally managed to a much more Buffett style. Each division gets to manage itself. For decades, they've been managed from the top, even though they're a sprawling conglomeration, spread all around the world. I think if anything points to how poorly that can work compared to how well diversified management works, it would be, compare GE's return over the past ten, 20 years to Buffett's return. As we all know, Buffett is very decentralized. He lets each business run itself. GE is moving in that direction. The head office, which is getting much smaller, is going to think more strategically in capital allocation, and not so day-to-day, hands-on. That should be taken care of at the direct company level.
Hill: I think it's a great move. Presumably, beyond the fact that you're going to have this decentralized decision-making at General Electric, you're also presumably going to get greater transparency into how those --
Fischer: That would be good.
Hill: -- units are doing on the private side. And, as you said, you look at their Aviation division, that's one of, if not the best-performing division at GE. The Power business has really struggled. I would expect that, over the next couple of years, what we'll see is, potentially, some changes there, whether it's further divesting from that unit or potentially taking some of the cash that they have and looking to acquire other divisions.
We were talking this morning -- and I've said this on the podcast for months now -- I think General Electric, as a company to watch, is the most interesting it's been in 25 years, easily. And I think that's because of John Flannery and the fact that he went in there as CEO and basically said, "There are no sacred cows here. I'm going to look at everything. Everything is on the table, in terms of whether or not we're going to increase investment or just cut it all together."
Fischer: And it's because, Chris, you have a dark side that likes to see things be dismantled, dismembered. [laughs]
Hill: [laughs] It's not so much that! I mean, I have a dark side, but it has little to do with corporate structure. But, I'm always interested to see with these larger conglomerates -- and we've seen it for years play out with Procter & Gamble -- is, what's working? Procter & Gamble at one point had over 100 separate brands that they were managing. They're not all performing at the same level, so how did they decide what to cut and what to double down on? That sort of thing. I think in the case of GE, I don't expect Flannery, over the next three years, to methodically make this a smaller and smaller company, as some people have theorized. I think at some point, with this greater transparency, he's going to look at these divisions and say, "This is where we need to be making further investments."
Fischer: I agree, Chris. That's very interesting to me, and probably to most of us listening, because we're portfolio managers ourselves. That's really what he's doing. But, the company will end up being much smaller for quite a while, maybe roughly half its size. When they spin off the health business, it's very likely they'll need to lower the dividend again because their income just won't support the current dividend. Investors should be aware that the dividend, which is around 3.6%, I believe, is likely going lower.
You still have surprising losses in the long-term insurance business that pop up here and again. That business is not well-run, in my opinion. GE Capital lending is still kind of a black box. There's a lot that still needs to come to light. It's going to get messy, it's going to get much smaller. You can't count on the dividend staying where it is. And, again, there's that $100 billion in net debt. That does limit how much more they can acquire and how aggressive they can be in trying to go after market share and be innovative, etc.
They almost have to focus on the few things that are going well for them. Aviation is one of them. Imagine if they started to lose their edge in that business. They're doing everything to avoid losing that edge. They need to focus on their strengths and go from there.
Would I own the stock? I don't, I don't plan to. I think it's a really interesting case study, though. It entered the Dow in 1907, and now, as of today, it left. This is a bit of history here, Chris.
Hill: Right! And, again, to go back to the people who make the decision -- I don't know who these people are, but the people who decided, "GE has to go, and Walgreens is the one we want." Today is Walgreens' first day in the Dow, it's GE's first day out of the Dow. Last time I looked, Walgreens was in the red and GE was up 7%, it was having its best day in three years. Well-timed, everybody at the Dow committee! Well done!
Fischer: I think GE had to have timed this announcement last night, too. Like, "We'll show the Dow!" And to take the pressure off.
Hill: Yes. Good for them! I like, by the way, how you referred to the fact that we are all portfolio managers. I think that's one of those things that, the average listener doesn't necessarily think as himself or herself as a portfolio manager, but if you're investing in stocks, or you have your 401(k) plan, yeah, you actually are.
Fischer: Yeah. Once you own three, four, five, six stocks or a 401(k) plan with however many holdings, you're managing that portfolio. In Motley Fool Pro, which I manage, we have 25 long investments, and we're struggling with a couple of them almost always. You're always thinking, "What do we do with that one, or that one?" That's GE in a nutshell, just slightly larger.
Hill: [laughs] Just slightly.
Fischer: With a lot of jobs at stake.
Hill: Last week on Motley Fool Money, we talked about Starbucks because Starbucks had a bad week last week, in terms of lowering guidance, announcing that they were going to be closing 150 company-owned stores next year, which is roughly 3X as many as they typically close. Today, Starbucks is hitting a three-year low, leading to a bunch of people on Twitter, on Facebook -- Motley Fool Podcasts has a Facebook group that anyone can join if they want -- leading people to ask, where are we now? When you look at Starbucks -- do you own shares?
Fischer: I do.
Hill: OK. When you look at this company right now, what do you see? As a longtime shareholder, in terms of the company-owned stores and the closing, that's one of those decisions that I look at and I say, "Alright, Kevin Johnson. I trust you on this." I certainly don't want under-performing stores out there. It's not that stores should be, once they're open, they stay open forever. I'd be lying if I said it didn't give me pause that they're not just closing the usual number of stores, they're going 3X.
Fischer: One thing to keep in mind is, new CEO. A new CEO is going to want to step in and start to take charge and show how things are going to be different. Part of the reason they're closing more stores -- in my opinion; they didn't say this -- is because same-store sales are suffering. One way to give those a little bit of stability is to close some that are close to densely populated stores, or ones that are obviously not doing as well as possible.
But when you have as many stores as Starbucks does have, the number of closures every year is a given, and the number of them will fluctuate. But yeah, Chris, you're right. 150 is not a massive amount, given the store count. It's surprising that in the past, it's been so low as 50. The 3X number is scary, but the absolute number isn't. I think it's just Starbucks realizing, "We have a same-store problem in the U.S., and we have a new CEO who's going to be a little more aggressive at managing the weaker store locations."
Hill: What do you think investors should be watching with Starbucks over, say, the next six months, beyond being on the lookout for further announcements like this? Is there a metric we should be watching in particular, beyond same-store sales?
Fischer: You know, that's a great question, Chris, so I hate to completely just ignore it, [laughs] but I think I will. Like you, I'm a longtime Starbucks shareholder. I haven't added to the stock for years, maybe ten years or longer, because that's how I feel about it. It's a middle-aged company, I would say. Nothing against middle-aged --
Hill: I was going to say, we're both middle-aged! Let's not come down on middle age!
Fischer: [laughs] We can be pretty energetic and keep improving all the time. But in the U.S., anyway, that's where investors are focused. The same-store sales story there is, I think, going to suffer for a while. It was so strong for so long. Remember, just a few years ago, 8%, 9%. Now it's flat, low single-digits. The challenge of getting that to grow again is significant. It would take at least a few years. The next six months, I'm just hoping same-store sales in the U.S. are stable, even if that's near flat, and that the China story keeps playing out.
China, of course, is talked about all the time now. As large as it is for Starbucks already, and as large as it will be, so far, it isn't yet enough to move the income needle. The U.S. is still really the bottom line. That's why investors react to the U.S. But, over time, China will become much more meaningful. The great thing about China is, the store economics there are such that they don't have to do as well volume-wise as U.S. stores, absolute dollar-wise, to do as well or better on the margins, the way the store economics are. It just takes time to get there.
Hill: That is good. I was reminded of something recently, and this ties into -- we're talking about Starbucks, but we could be talking about any company if you have a long enough time horizon. I was chatting with Alison Southwick, one of the hosts of our Motley Fool Answers podcast, which people should absolutely check out if they haven't already. Alison is putting together -- because this weekend marks the 25th anniversary of when David and Tom Gardner and their friend Erik Rydholm put together the finishing touches on the very first monthly newsletter of The Motley Fool and stuck it in the mail and sent it out to people.
Fischer: I have one of those issues.
Hill: Do you really?!
Fischer: Yeah. Should I put it on eBay? Is now a good time?
Hill: I was going to say, put it under glass!
Fischer: Oh, yeah, it's protected. I'll keep it.
Hill: Alison was putting together some highlights of the last 25 years. One of them had to do with Starbucks and a television appearance that David and Tom did where they were talking about Starbucks. This was in 1999 when it took a dip. You may recall, it dropped for very good reasons, because Howard Schultz got on the conference call when they had reported whatever earnings it reported. I don't even remember what the results were. I just remember that the results were rendered immaterial, because once Howard Schultz started the conference call, he started talking about how Starbucks didn't really think of itself as a coffee company, Starbucks was more of a lifestyle portal, and he was talking about starbucks.com, where instead of going and buying coffee and coffee makers, you could buy high-end furniture, all this stuff. Basically, they were going to be a .com. And, rightfully so, analysts freaked out, and the stock dropped about 30% the next day. But, Alison has the chart there. I remember that day. That was terrible.
Fischer: I do, too.
Hill: It was horrible. It was like, "Oh, my God, has Howard Schultz lost his mind?" But when you have the benefit of 20 years of time and you look, when you look at that chart now, you're like, "Oh, there's a little dip." Now, in the month of July 1999, it's a massive dip. But when you spread it out over a long period of time, you're like, "Oh, there was that dip."
Fischer: Chris, I love that perspective. You can do that with Amazon, too. We lived through the ups and downs of Amazon in its early years. 30%, 40% swings month to month. Now you look at the chart, and that was nothing. That was nothing. But Starbucks, speaking of the price, it's as inexpensive as it has been, on my chart, since 2008-09, since the Great Recession. It trades now at 20X estimated earnings for the next 12 months, which isn't cheap, but for a company of this --
Hill: This size and maturity?
Fischer: Yeah, and still growing earnings by a healthy 10% annualized, more or less. Higher than that, really. It's not inexpensive, especially for a retailer, but it's also not outrageous. It's well down from the multiples it was at a few years ago, unfortunately, and the stock has basically gone nowhere. I don't know if that says that you should buy shares if you don't have any or keep the shares you have, because they're at a 10-year low. But if you believe in the business, that's always what it comes down to.
Hill: It's good perspective to have. Certainly, it's been the case where we've been in this room talking about stocks that have dropped, and despite whatever the drop is on a given day or in a given month or even over a two or three-year period, you look at it on a valuation basis and you say, "This thing got cut in half and it's still really expensive."
Fischer: True. Yeah, I don't know what I was going to wrap up with there.
Hill: You know what we're going to wrap up with? Our man behind the glass, Dan Boyd.
Fischer: Oh, perfect!
Hill: That's what the people want to hear! Dan went on vacation, a well-deserved vacation to Ireland, with his girlfriend, Danielle. If you were on Twitter last week or were listening last week, you know that Dan popped the question! Well done, sir!
Dan Boyd: Thank you!
Fischer: [laughs] Dan, do you want to talk about this? Do you want to share it with the world?
Boyd: I mean, I'll share some details. Not all of them.
Hill: So, you were in Ireland, you were out in the beautiful countryside.
Boyd: Yeah, in County Clare, on the west coast of Ireland.
Hill: She had no idea this was coming.
Boyd: No, she did not. She told me after the fact that she had thought there was maybe a 20% chance that it would happen on this trip.
Hill: That's not a big percentage.
Boyd: No. I was feeling pretty good at the reaction I got.
Hill: Nice. Normally, when people go on a trip and they come back, one of the things I ask them is if they had any business observations from their trip. I don't know if that's appropriate. Any business observation you have, while valid, pales in comparison to the fact that you popped the question to your bride-to-be.
Boyd: It's interesting actually, there's a lot of talk in Ireland right now about how young people in Ireland are actually staying in Ireland and working there instead of leaving to find jobs in the U.S. or the rest of Europe. One of the things that contributes to that is their very low corporate tax in Ireland. A lot of companies come to Ireland to have their headquarters and stay there, and have large workforces in Ireland. There is a lot of talk about economics and business in Ireland right now.
Fischer: That's cool. Did you and Danielle talk about that a lot?
Boyd: No. Although, we went on a bus tour, Ring of Kerry, and the driver spent about 15 minutes talking about the impact of the 2008 recession on Ireland, and all of the things that Ireland had to do as a country to get the European Union to bail them out.
Hill: Well, congrats, my friend!
Boyd: Thank you very much!
Fischer: That's great news!
Hill: Jeff Fischer, thanks for being here!
Fischer: Thank you! Thanks for allowing me to.
Hill: [laughs] 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!
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 AMZN, EBAY, and Starbucks. Jeff Fischer owns shares of AMZN, FB, Starbucks, and TWTR. The Motley Fool owns shares of and recommends AMZN, FB, Starbucks, and TWTR. The Motley Fool recommends EBAY. The Motley Fool has a disclosure policy.