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GE Shareholders, Buckle Up

By Chris Hill – Updated Sep 21, 2018 at 2:09PM

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CEO John Flannery is working to turn the sinking ship around, but hoo boy, that is going to really take some work.

In today's Market Foolery, host Chris Hill and Motley Fool contributor Jason Moser talk about a few of the market's biggest stories. Darden Restaurants (DRI 1.37%) is down a little on what seems like a pretty solid quarter. What gives? And whatever came of that Cheddar's Scratch Kitchen acquisition the company dropped some $780 million on? GE (GE -0.24%) is down yet again today, illustrating one of the unavoidable risks that comes with the company's tightened focus. How long can shareholders expect to wait before this protracted tumble turns around? Finally, there's a new player in the animal health market. What do prospective investors need to know about the recently IPO-ed Elanco before buying in? Find out more below.

A full transcript follows the video.

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This video was recorded on Sept. 20, 2018.

Chris Hill: It's Thursday, September 20th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, it's the brand-new host of Monday's Industry Focus. It's Jason Moser!

Jason Moser: Well, hello there!

Hill: Good to see you!

Moser: You know, you rattle off that ad spot at the beginning in your hosting duties. I'll tell you what, I never took your job for granted ever before. But this past Monday, it was a little bit different, sitting on that side of the table. It was a little bit different. I'm not going to lie, I was a little nervous. It was different. 

Hill: You're off to a great start, don't you worry!

Moser: Well, thanks, I appreciate it! I'm excited to be able to do it!

Hill: We're going to dip into the Fool mailbag. We're going to check in on General Electric. We have to start, though, with Darden Restaurants, which is the parent company of Olive Garden, Longhorn Steakhouse, Capital Grille, Cheddar's. I still haven't been to a Cheddar's.

Moser: Apparently, a lot of people haven't.

Hill: [laughs] Yeah. Let's start with the same-store sales. Here's the thing -- first quarter profits, higher than expected. Overall, for Darden, this was a really good quarter. Same-store sales across their restaurant group was 3.3%, which is not a huge number, but that's a good number. And it's certainly higher than was expected. We see the stock dropping a little bit, but Darren's had a heck of a last 12 months.

Moser: Yeah. They're having a good year this year, as well. You hit it, you hit the nail on the head there, these were very respectable results for what is a very competitive space. I think it's even tougher now, given the growth in quick service restaurants, the growth in fast casual. The competitive landscape for these guys is more competitive than ever. 

Every quarter, we talk about Darden. Olive Garden is what steers the ship. That's their crown jewel. Comps were up 5.3% there. I think they market that concept really well. They recognized their 16th consecutive quarter of comps growth in Olive Garden restaurants. It was interesting to hear the CEO talk about the prospects of delivery. They're not really on board yet with delivery from concepts like Olive Garden. They don't think the economics quite make sense for their customer demographic. 

On the flip side of the coin, Cheddar's one where the jury is still out there. It's proving to be a bit of a drag. I'm still actually not sold on that investment. It was not a cheap acquisition, at around $780 million. Total sales for Cheddar's grew 6.5%, but that was really due to opening new stores. It wasn't due to traffic. And that's a problem. And then, when you think about that, then you have to ask yourself the question, well, how many of these Cheddar's stores are they going to plan on opening? If you're having trouble genning up traffic, opening new stores isn't the answer. That just gets more expensive over time. And those are mostly company-operated stores there, anyway. 

I think you can see consolidation in the space making sense. You see companies like Yum! Brands, restaurant brands, Darden, you see Cava and Zoës getting together. It does seem like consolidation is a way to really compete more effectively in the space, and I think Darden continues to benefit from that quarter in and quarter out.

Hill: The Cheddar's acquisition really is questionable in this regard: you look over the last five-plus years with Darden restaurants, one of the things that they have been effective at is focusing on the flagship brand of Olive Garden. They sold off Red Lobster, I think it was $2 billion and change, maybe $2.2 billion, something like that. Part of the rationale there was, "Look, we want to focus on Olive Garden." Obviously, they bought Cheddar's for far less money than they got for Red Lobster. But as you said, it was not a cheap acquisition. You look at this quarter, you break out the comps by restaurant, and across the board, it's 3.3%. As you said, leading the way, we've got Olive Garden, 5.3%. Cheddar's comps were negative 4%. I mean, that was a really, really a drag.

Moser: Part of it is, I wonder how much brand awareness is out there for Cheddars. I don't know about you, but I have never seen or heard an ad for Cheddar's ever that I can recall. That potentially is a problem. They do a really good job at marketing their key concepts -- Longhorn Steakhouse, Olive Garden. You see good marketing campaigns centered around those businesses. And that makes sense, those are the two biggest names in the portfolio. But if they want the Cheddar's acquisition to prove out, I think they're going to have to do a little bit of a better job of creating some brand awareness, marketing that out there a little bit. Right now, I just don't think the customer awareness is quite there. Frankly, I can't even tell you what they serve or what kind of demographic they're aiming for. I guess, Cheddar's Scratch Biscuits tells you a little bit about it. But there are a lot of biscuit places out there, Chris. I make some really good biscuits at home, so I don't even know why I have to go to Cheddar's. Why? I make my biscuits at home.

Hill: It will be interesting to see, when we had recently the acquisition of Zoës Kitchen, we talked about on Motley Fool Money at the time, Look, you look at Cava and the success the Cava has had. You look at the acquisition they make of Zoës Kitchen. There's no way they're not converting some of those locations over to Cava. I'm wondering if we're going to see, over the next couple of years, to some small degree, some of these Cheddar's locations get flipped, whether it's to an Olive Garden or to some of the smaller brands, Bahama Breeze, etc.

Moser: It's certainly a possibility. It's hard to say. I wonder, does Cheddar's maybe compete against the Cracker Barrel demographic? I don't know, it's really difficult to say. But I think that is always an out they have, if they decide that concept just isn't working out. They have some other proven concepts in the portfolio that they could certainly shift over to.

Hill: Shares of General Electric are down again today, this time on an analyst downgrade. This was not the typical, "Well, we think, we feel," kind of downgrade. This was specifically about concerns in GE's Power division, a gas turbine launch that looks like it's going to have a negative effect on earnings, at least in the next quarter, probably the next couple of quarters.

Moser: Yeah, it's distinctly possible. I think if you're an owner of GE shares today, then you need to take CEO John Flannery's language very seriously when he says that they are in a multi-year transformational journey. In English, he's saying, "You'd better pack a lunch, because it's going to be a while." I think we've come to accept that, based on how many moving parts are still involved with this business. They're trying to shed certain assets and refocus and get the business back around its core in Aviation, Power, and Renewables. I like that move. I think that's the right strategy. The downside to that is, though, when you run into trouble in any one of those core segments, it really has a material impact on the business. I think we may see something like that play out here if there are indeed troubles with the turbine blades that were discovered from Exelon, I believe is the power company. 

Flannery noted on the most recent call that the biggest challenge the company faces right now continues to be the turnaround of the Power of business. I think that tells us a lot. The core of the business is still, I don't want to say in trouble, but it sure is close. It requires a lot of working capital to operate. You look at their balance sheet today, to call it challenged is really an understatement. I think if you're going to be an investor in GE, you truly have to take a long-term outlook here. Understand that it's going to be three years before we see any real material progress. 

I actually think that Flannery can do it. I think that he's probably the Alan Mulally for GE. I think if anybody can get this taken care of, he can. He's proven he's not scared to go in there and shake things up. We've seen them already shed a lot of assets in order to try to streamline this business and just get back to focusing on what they're really good at. But it's going to be a bumpy ride.

Hill: Give him credit for being as clear as he can possibly be. He's done that throughout 2018. He's just been very clear, like, "Look, this is what's going on. This is how long it's going to take. You can get on board if you want, but pack a lunch."

Moser: Yeah. That's just such a big advantage for investors. He is very transparent. You know what you're getting into. I feel like he's a no-BS kind of guy. He speaks to analysts very frankly on the calls, he gets out in front of things. I think that's a real strength that they're going to be able to benefit from in the coming years, if they're going to get this business turned around. 

Hill: Our email address is [email protected]. Question from Evan Machete, who writes, "What do you know about Elanco Animal Health and this week's public offering? The company is seemingly a dynamite fit for Jason Moser's healthcare and wealthcare space. I don't usually invest in IPOs, but is this company worth watching over the next few months?"

They certainly had a great IPO. Elanco Animal Health was spun out of Eli Lilly. Kudos to them, because the range of the stock going into the IPO, they bumped it up $24 a share, and it took off like a rocket.

Moser: Yeah. You can be forgiven if you thought Elanco was perhaps yet another venture of the Elon Musk's that was just taking him into another direction altogether.

Hill: [laughs] If you like SpaceX and you like flamethrowers, wait until you check out our animal health line!

Moser: Yeah. First and foremost, I'm pretty consistent with my general feelings when it comes to IPOs. I think you need to wait and watch. I think you need to give it a couple of quarters so you can assess what you're dealing with, in regard to the business, in regard to management. Given everything I've learned about Elanco, I'm going to stick with my guns on that one there. 

That said, I do think it is a very interesting company, given what it does. What do they do? They are in the business of animal animal vaccinations, animal health, whether its companion animals or farm food animals. They are producing a lot of the vaccinations and nutritional supplements and whatnot for that space. And it is a very big market opportunity. You look at it altogether, it's somewhere in the neighborhood of $35 billion. It's not insignificant. It's an attractive market in that it's very resilient, high barriers to entry. I think they stand a chance to do very well, given their background as a part of Eli Lilly for so long. 

Now, with that said, there is tremendous competition out there. If we look at Elanco today, 2017 revenues came in around $2.9 billion. Zoetis, which is another company out there in the same market, they're bringing in basically about double the top line that Elanco is, and it's a much, much bigger company. They have, of course, more resources. Now, that's not to say that Elanco can't be successful. I think they can. It reminds me a lot of a company I covered a while back called MWI Veterinary Supply. That was a business that was in very much sort of a similar line of work. They were acquired by AmerisourceBergen not all that long ago at a premium. I think a lot of that was because of the market dynamics. It's just a very attractive market. 

One thing to keep an eye on with this company is going to be how much they continue to devote to research and development. That's really how these businesses remain relevant. I look at a company like Idexx Laboratories, for example, which is a stock I own, I recently purchased it. They are in the business of the testing equipment and diagnostics supplies for veterinarians and the companion animal group. Not a competitor, really, with Elanco, but you could see with Idexx, they consistently devote a significant percentage of the revenue every year to research and development, to continue to advance and bring new products to the field. I think as long as Elanco does that, if we can look at that R&D line and see that they are investing in the business, they stand to do well, well. 

But, it is a brand new IPO. You have to recognize Eli Lilly is still going to hold a lot of control of this business, at least in the initial stages of its existence as a publicly traded company. But, yeah, there's definitely something there. I could see why this company would do well. It's a very attractive market. 

Hill: Before we wrap up, reminder that we are hiring here at The Motley Fool, all kinds of jobs. We're good on podcast hosts for the moment, unless... I actually have a meeting with my manager later. 

Moser: I think you're OK.

Hill: A lot of jobs posted at Check that out. You mentioned Elon Musk earlier. This week on Motley Fool Money, our guest is Ashlee Vance from Bloomberg. Talked to Ashlee, taped an interview yesterday with with Ashlee, talking a lot about Elon Musk, because Ashlee Vance literally wrote the book on Elon Musk. A great read!

Last but not least, on Industry Focus tomorrow, Friday, the Technology episode, Dylan Lewis is going to be talking about wearables, among other things. You got a sneak preview for Monday's episode of Industry Focus?

Moser: Yeah. I'm having a lot of fun trying to put together some new things to try and whatnot. We'll always be doing a stock on our radar thing. We stole it from Motley Fool Money. We call that One to Watch. I think that we are going to discuss Facebook's relationship with banks, the relationship they've been trying to forge and haven't seemed to really do such a good job of at this point. We're going to talk a little bit about Amazon and their attempted entry into the banking market, as well, through their Prime membership, which we know pretty much dictates everything they do. And, as always, taking some questions from Twitter, email, and whatnot. Joined every week with Matt Frankel, he's a Certified Financial Planner. He's down in South Carolina, so he calls in and we have a good conversation. That's what we're thinking about hitting on Monday.

Hill: How's he doing down there in South Carolina?

Moser: Thankfully, he's OK. He's in Colombia. They avoided the worst of the flooding in whatnot. But it was a scary time for a lot of people down there, for sure. 

Hill: Big cleanup, and it's going to take a long time. Hang in there, Carolina! 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 next week!

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. Jason Moser owns shares of Idexx Laboratories and Twitter. The Motley Fool owns shares of and recommends Amazon, Facebook, Idexx Laboratories, Twitter, and Zoe's Kitchen. The Motley Fool has a disclosure policy.

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