Wednesday Was Schadenfreude Day on Wall Street

In this MarketFoolery podcast, host Chris Hill and Motley Fool Asset Management's Bill Barker check in on a number of big names and big companies, and probably none of their shareholders were all that happy with the way things were going. They open with a quick update on the situation with JD.com (JD 2.40%) CEO Richard Liu, accused this weekend of rape in Minneapolis. It now appears that, even though he was released without charge and permitted to fly back to China, the investigation is still ongoing, and indications are that criminal charges may be in the offing after all.

Then they segued to the second-most-interesting Washington hearings of the day, where Twitter (TWTR) CEO Jack Dorsey and Facebook (META -0.13%) Chief Operating Officer Sheryl Sandberg had to field a barrage of questions about election interference, fake news, fake accounts, and political bias from senators.

In the only slightly upbeat note of the podcast, Hill and Barker review the quarterly report from upscale furniture retailer RH (RH 0.44%) -- you probably still think of them as Restoration Hardware. It was actually a reasonably good showing, and the company's recovery remains surprisingly robust. But the share price took a dip anyway, for reasons the Fools explain. And finally, in rough news for those who still dig the sugary cereals that once dominated breakfast tables across America, Kellogg's (K 0.09%) just recalled a massive quantity of Honey Smacks cereal due to its connection to 130 cases (so far) of salmonella.

A full transcript follows the video.

This video was recorded on Sept. 5, 2018.

Chris Hill: It's Wednesday, September 5th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, from Motley Fool Asset Management, Bill Barker. Thanks for being here!

Bill Barker: Thanks for having me!

Hill: Thank goodness for coffee, which is keeping you awake. The U.S. Open, for those not following the tennis tournament, it's keeping some late hours, and so were you last night.

Barker: Yeah, between the U.S. Open and my new puppy, I'm not getting a lot of sleep.

Hill: So, more coffee than usual?

Barker: No. [laughs] I drink coffee from the time I wake up until I go to sleep. There's more coffee because I've been up more.

Hill: There you go. The overall volume is the same.

Barker: No. It's really a matter of how many hours awake I am that allows me to drink more coffee.

Hill: Right. I mean, not to get too in the weeds -- we've already gone off the tracks here. The overall volume of coffee you're consuming is up because the number of hours you're awake is up. But the like coffee per hour ratio is still the same.

Barker: Yeah. It's all.

Hill: We have some earnings. We have some more bad news from the world of packaged foods. And, we will touch on the drama taking place across the Potomac River from us. Want to start, though, with a quick update on yesterday's lead story, JD.com. When Matt Argersinger and I were talking about CEO Richard Liu, we were operating on not a lot of details because not a lot of details were available. More details available now, and it is what's sending shares of JD.com even lower amid these reports that now, Richard Liu is facing an allegation of rape. It could bring formal charges as early as Friday when a police investigation is expected to wrap up. Clearly, this is very much a story in flux and we'll continue to keep an eye on it as things unfold over the week, and possibly, if not probably, hit it on Motley Fool Money this weekend.

With that, as you and I are sitting here recording this, across the river on Capitol Hill, all eyes on Jack Dorsey, the CEO of Twitter, and Sheryl Sandberg, the Chief Operating Officer at Facebook, as they are spending some quality time with some members of the United States Senate. You and I were talking about this earlier. Certainly, in the in the coverage leading up to this hearing, which is ongoing right now, there certainly was a lot of speculation about where it might go, what questions might senators ask, what might the answers be, what possible ramifications could there be for these large businesses, -- including Alphabet, by the way. Alphabet decided they weren't going to send anyone to testify to this. There was some open mocking of Alphabet at the hearing because of that. But, as you and I were talking earlier today, it seems like the way to bet is on how these things have played out in the past. We're not sure exactly what Jack Dorsey and Sheryl Sandberg are going to say, but we have a pretty good guess at what they're going to say. Is that fair?

Barker: I think that what they're going to say is that they agree that more needs to be done, and they're going to direct the who needs to do it toward themselves. That is the best-case scenario -- they are not faced with regulations from Congress or anywhere else, and that they can show, as I believe they are showing, that they're spending more money on confronting fake accounts, and that they are handling it. They need to show some results, and they have been showing results, in terms of how many accounts have been shut down. They have to tread carefully. In terms of what questions the senators are asking, I imagine a lot of senators are there more to make speeches than to ask questions, not having watched it. I think that's the way these things do play out.

Hill: That is typically how they play out. This is one of those times where it's worth remembering that, once upon a time, before she was Chief Operating Officer of Facebook, Sheryl Sandberg was one of Larry Summers' top lieutenants when he was the Treasury Secretary. So Sheryl Sandberg very much knows her way around Washington D.C. and these types of ... well, I'm not sure. I'm guessing he's going to comport himself well. I watched a little bit of the opening of the hearing, and Sheryl Sandberg was every bit as impressive as I expected her to be. But, to your point, there's going to be a lot of, "Yes, Senator, that's a great point. Sure we need to do more."

Barker: "That's a great question."

Hill: "We're doing more. Obviously, we can always do more."

Barker: "And we are doing more, obviously."

Hill: "Here are the steps we're taking."

Barker: The landmine in particular that is being placed in front of them is, there are people taking their lead from the Administration on the accusation that Twitter and/ or Facebook are biased against the Republican Party. Dorsey and in particular, has to say, "No, this is what we've done. This is why it's even-handed. This is the data that we have that shows that a tweet from somebody from the right gets read as much as a tweet from somebody from the left. Here's our proof." 

I think that is the kind of mathematical proof that is not going to convince anybody up there who is out trying to make a sound bite point. I don't think that the ultimate audience for that conspiracy theory is going to be dissuaded by evidence. But that's all that I think Dorsey and Sandberg have on their side, is to produce, to manufacture evidence that there isn't a political bias.

Hill: To go back to the response, this gets made fun of, and probably rightly so, the number of times on a quarterly conference call that an analyst will lead his or her question for a company's management by saying, "Great quarter, guys! Here's my question." In fact, I think there might even be a Twitter account that's called GreatQuarterGuys. You never want to play that drinking game when you're listening to conference calls. By the same token, I don't think you want to play the drinking game today of, take a drink every time Sheryl Sandberg or Jack Dorsey begin their answer with "Well, that's a good point, Senator." "That's a good question, Senator." We're going to hear that a lot.

Barker: "But, if I could explain this in terms that your grandchild would understand," which would be more productive than trying to explain the internets to you. It's not a series of tubes, as we know, from some distant congressional hearings. 

Hill: How great would that be, by the way, if Dorsey and Sandberg could just say whatever they wanted? If it's the fifth hour of the testimony, they're like, "Oh, really, Senator? Yeah, OK. You're on Instagram? Great! How's that going?" 

Let's move on to some earnings from Restoration Hardware, which, I must have missed this, is no longer Restoration Hardware, it is formally RH. We'll get to the name change in a moment. Just bear with me as I stick with Restoration Hardware. The second quarter report was kind of mixed. Their guidance for the rest of the fiscal year looked good. But I'm wondering if the fact that shares being down about 10% today are more to do with the fact that this stock has had a phenomenal 12-month run. Even with the drop today, this thing has more than doubled over the past year. 

Barker: Yeah, I think that is correct. It is a product of the stock getting ahead of the story, as good as the story has been, in terms of the company succeeding at transitioning into this membership model and doing a good job rationalizing costs and not being in the same position as so many other retailers, of needing to catch up online and start closing down stores. They don't have that many stores to close down. They've only got about 65, I think. I think they're more, maybe, in this area than a lot of other parts of the country, because it was surprising to me how few stores there are. To backtrack on one point, we spent like half a show talking about how it was called RH instead of Restoration Hardware.

Hill: We did?

Barker: Yeah.

Hill: OK. I'm clearly old and I haven't drunk as much coffee as you. This one doesn't make as much sense to me as even Coach changing to Tapestry. That makes more sense to me than this.

Barker: Really?

Hill: Yeah.

Barker: They don't sell hardware. 

Hill: Yeah, but... I don't know.

Barker: I mean, the name made no sense. Now it continues to make no sense, but it's not misleading. RH. It could be any letters. That doesn't tell you what the store does. But at least it doesn't mislead you the way Restoration Hardware did. 

Hill: Yeah, but even when the business of Restoration Hardware was not doing as well as it appears to be doing right now, at least the name evoked a certain type of brand. You understood, "Yes, it's not Ace Hardware. I'm not going there to get a box of nails." But at least you understood what it actually did. Now, RH, it could be anything. It could be a law firm, it could be a sandwich shop.

Barker: I think you have to admit that you have picked this one wrong all the way. You initiated coverage of the business model with a strong sell.

Hill: The loyalty program. I was 100% wrong about the loyalty program when they unveiled that a few years ago. I thought, "Really? You're going to have a loyalty program on a business that sells $5,000 leather sofas? Good luck with that." And they've absolutely crushed it.

Barker: Yeah, because once you've got the loyalty program, you have to buy a new sofa every year to maximize the value of your membership.

Hill: I don't think it works like that. But it is working.

Barker: It is working. They have dramatically increased their earnings. That is one of the things they pointed to today, and part of, as you pointed out, the mixed story is, they missed on revenues and they're guiding a little bit lower on revenues going forward. OK, that's bad, right? Well, as they point out in their press release covering this, the reason that explains that is, they are not discounting. They are not being highly promotional. They are willing to miss out on some sales to keep their price points higher and their margins higher. Their margins are quite a bit higher than they had been in the past. I think their operating margin's around 13%, which is higher than the average for the S&P 500. For a retailer, that's pretty good.

That is a path that they are saying they're going to continue to do. I think they've got an investor day tomorrow. They've got a new flagship store opening in New York. On balance, I think that other than looking at the stock price retreating to where it was maybe a month ago, two months ago, something like that, it's still up nearly a triple over the last 52 weeks.

Hill: Have you ever been to a company's investor day? Not necessarily this company, but just any company?

Barker: Yeah.

Hill: I'm curious what, as an analyst, are you getting out of an investor day that you wouldn't out of, say, a quarterly conference call or something like that?

Barker: They'll give you maybe three or four hours instead of one. It's more about the state of the company in the future rather than the quarter. It's a lot of PowerPoint presentations, and you have presentations from different people, it's not all the CEO or all the CFO, as an earnings call is. And, you get more food out of it, too. You could get a decent lunch, maybe some tchotchkes, maybe some swag. I got Kobe beef at one of these things. 

Hill: Really?!

Barker: Last year, yeah. 

Hill: Do you remember what the company was? 

Barker: Yeah, NMC Health.

Hill: A health company was giving out Kobe beef?

Barker: Nothing healthier than beef, right? 

Hill: Only coffee. We've talked before about the packaged food industry being, perhaps, the most troubled industry in 2018. Certainly, if you look at the turnover in the executive suite at packaged food companies, it's getting pretty grim out there. It gets even grimmer with the news today that Kellogg's has issued a massive recall of its Honey Smacks cereal. They had already had salmonella concerns earlier this year. The Center for Disease Control and Prevention says now, the number of cases of salmonella linked to the cereal is up to 130, spread out over 36 states. If I'm Chipotle, as discreetly as possible, I am pushing this story to as many people in the media as possible. If you're Chipotle, you're like, "Hey, we had one location in Ohio. Just one. The monsters at Kellogg's are blanketing this country with this death cereal of theirs." I shouldn't say death cereal, there's not actually --

Barker: It wouldn't be as funny, would it, if it were a death cereal.

Hill: If people were actually dying.

Barker: Joking would be inappropriate.

Hill: Yes. Instead, people are just getting sick from Honey Smacks.

Barker: Salmonella can kill you, but it has not. Therefore, we feel that there is license to make jokes about this. Yeah, it is tough times for cereal, although Kellogg's stock has rebounded a little bit lately. But it's mostly a flat place to invest over the last half decade. 

Going back to what we were talking about with Restoration Hardware and the margins being a big part of their story, that's a big part of the problem for packaged foods. They just don't really have the pricing power that they used to. The private label options are better. They're coming much closer to the quality of your classic branded cereals. Inflation is showing up in the input costs for Kellogg and others. They're also wedded to a lot of things which are not exactly healthy, which is part of the reason that I've always loved eating their cereals.

Hill: Right! I mean, you and I are old enough to remember when the name of this cereal in particular was not Honey Smacks, it was Sugar Smacks.

Barker: Yeah, that sounds better. 

Hill: It certainly was.

Barker: Better than Salmonella Smacks, which I recommend they do not pursue.

Hill: To go back to the stock, you talk about how it's rebounded a little bit. But this is already a troubled industry. This is just one more headline that makes me as an investor...it just reminds me, "Oh, right, I don't want anything to do with investing into this industry right now."

Barker: Well, it can be part of a completely nutritious portfolio, as they would tell you. That's how they would phrase it. It's not going to be the sugary part. It's more like the wheat bread part of your completely nutritious breakfast.

Hill: Which is ironic, given the amount of sugar in these cereals. In terms of your investment portfolio, it's like, "No, you don't have to worry about us, we're not going anywhere. We're going to be the blue chip. We're going to give you a little dividend," that kind of thing. 

Barker: I feel like I was blessed with more sugary cereals in my youth than you were.

Hill: Oh, I don't think that's a feeling. I think that's a fact, based on conversations we've had.

Barker: Part of my proof of this is, when we discussed the Mount Rushmore of cereals, and I decided you could have two sugary and two non-sugary cereals, and that was the right way to divide up Mount Rushmore, you were trying to place Rice Krispies as one of the sugary cereals. Which is ridiculous. 

Hill: And yet. I'm a product of my own upbringing. 

Barker: What sugary cereals were you allowed?

Hill: Rice Krispies was kind of pushing the envelope there. On Christmas Day, one of the things I would get was, they have the individual boxes. They sell them in eight packs. I would get an eight pack of sugary cereal. And that was glorious. First of all, it's Christmas. Second of all, no school. Third of all, for the next eight days, I've got all the sugary cereal I want.

Barker: This explains your addiction to Pop-Tarts now. You weren't allowed --

Hill: I think that's an overstatement on your part. They're an indulgence. Every now and then.

Barker: But you'll make a trip specifically to get some Pop-Tarts. Or, you used to, before the place closed that had them.

Hill: Yeah, but here's the thing. I don't go crazy with Pop-Tarts. I'm not one of these people who's like, "I'm going to have the chocolate s'mores, cookie dough Pop-Tarts." No. I'm old school. I'm going fruit. 

Barker: Yeah, there's no sugar in those. 

Hill: There's sugar. But you know what else there is? A little something we like to call eight essential vitamins. 

Barker: [laughs] And iron.

Hill: Exactly, all the good things. You can also find all those good investing things at foolfunds.com. You can read more from Bill Barker and his friends and colleagues at Motley Fool Asset Management. Thanks for being here!

Barker: 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!