This week on Industry Focus, we check back on three companies that have experienced major changes in the last year -- recent IPO Hudson Ltd (HUD), Procter & Gamble's (PG 0.25%) activist investor influence, and GoPro's (GPRO -2.32%) push to recovery.
Tune in to find out more about the latest developments for each business and what investors should follow going forward.
A full transcript follows the video.
This video was recorded on Sept. 25, 2018.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen. It's Tuesday, September 25th. Feels great to be back in the studio after two weeks away, not that I wasn't enjoying the gorgeous weather and very, very good food in Spain. But if you've gotten away for vacation before, you know getting back can be a bit overwhelming with a mountain of email and long to-do list to catch up on.
With that on my mind, I thought it would make sense to do some catching up here on Industry Focus as well. We're going to carve out an episode today where we revisit some stories and companies to see how they're doing, companies that we've talked about in the past year or two. Joining me via Skype for this discussion is senior Motley Fool contributor, Asit Sharma. Hey, Asit! Thanks for hopping on today!
Asit Sharma: Thanks a lot, Vince! Good to be here! I'm so curious -- you went to a place that's at the very top of my bucket list on vacation, you went to Spain. How was it? Tell us about it!
Shen: We were able to get a good taste for at least two regions, I'd say, for the country. We spent the first week in the north, in Basque Country, and then the second week we spent on the coast of the Mediterranean, in places like Barcelona and Valencia. They say that the north of Spain has the best food. I will attest, in my short time there, I would agree with that. Up in the north of Spain being overall very famous for their small dishes, what they call tapas. In the north, they're called pintxos. The food is really great. You get to try all these different things. Of course, being in Europe in general, everywhere you go, you seem to see all these buildings, these cathedrals, very historical, tons of these small little side streets when you're in the older parts of each city.
I thought it was gorgeous. Again, we were really lucky with amazing weather. Tons of walking every day, exploring, seeing the different architecture. I loved it! I highly suggest it, if it's at the top of your places to visit, that you should make that trip as soon as you can.
Sharma: I'm going to try. By coincidence, I will be in Europe next week, in Germany for about eight or nine days. I'm going to see if I can arrange a side trip and at least get to Barcelona, if that's at all possible.
Shen: Even a day or two, you'll feel like it won't be enough, and it won't be. But if you can route out that day or two to visit, especially Barcelona, spend some time at the beach, it's nestled in between the beach and the mountains. Absolutely gorgeous.
Sharma: I have to, man! I'm not getting any younger! I have to do this! [laughs]
Shen: [laughs] Let's get into these companies that we're going to revisit. They are Hudson, GoPro, and Procter & Gamble. The first is Hudson, let's start with them. Ticker is HUD. Asit, you and I first discussed this company on Industry Focus back in March. At that point, Hudson had been trading publicly for just over a month. The stock was down from its IPO debut price of $19 per share. Now, the shares have recovered. They're in positive territory, around $23.
On the last show, we talked about the unique position that Hudson is in as a big operator of storefronts specifically in places like airports, train stations, and tourist attractions. In essence, you have this brick-and-mortar retailer that doesn't have to grapple as much with the usual industry concerns of attracting customer traffic, or even the same level of competition, because they operate in these very regulated spaces, like airports, which make up 95% of their business. So foot traffic's much more consistent barring any major events that impact air travel. There are also only so many other restaurants and newsstands within each terminal that they have to compete with.
I'll turn it over to you. The company reported second quarter results in early August. Most of the stock's gains came in the wake of that news. Can you walk us through some of the highlights from that report, and also, some other key developments listeners should be following?
Sharma: Absolutely. I was impressed that Hudson was able to grow its top line. Reported revenue increased by 7.4% against the comparable, prior-year quarter. Organic growth was up over 8%. We had talked about the long-term growth trend that Hudson had managed when we first discussed this stock. Listeners may remember that it has a European parent, which owns a chunk of stock called DuFry, which is one of the largest airport retailers globally. DuFry's total footprint in the U.S. is mostly made up by Hudson's holdings.
This long-term trend 9% organic growth, the company reported pretty much in line with that. That caught my eye. We've seen this year, for some reason, so many IPOs, after they have their big splashy debut, the very next quarter, bam, there's a disappointing earnings report. I don't know if we'll get to this, maybe in a few weeks from now, but this happened to Sonos, the manufacturer of smart speakers that we also covered after its first report. It went south. So I like the simple fact that earnings were in line. Growth was there on the top line.
Something else that caught my eye which wasn't as apparent when we discussed the prospectus of this stock, it actually got a concession from the parent company DuFry on the amount of royalty fees it has to pay. That helped, along with some rental concessions it won during the quarter, to improve its gross margin. Now, this company has a very high gross margin. As we discussed, and Vince, you just alluded to, once it gets into an airport, those are long-term leases, so it's pretty static margin structure from that perspective. The company increased gross margin by about two percent to almost 64%. Very nice, healthy profits there.
I also liked the fact that the company has increased its EBITDA. Listeners, we talk about EBITDA and its relationship to debt all the time on this show. EBITDA -- earnings before interest, taxes, depreciation, and amortization -- and its relation to how much borrowings the company has on its books. I noticed that when we first talked about Hudson, the company's debt-to-EBITDA ratio was a moderate 3.5x. That means that debt was about 3.5x annual earnings after you strip away the taxes and depreciation, interest expense, etc. Now, through this higher gross margin and also some cost cutting that the company has been able to implement, as of this most recent period, the debt-to-EBITDA ratio has dipped all the way down, my rough calculation is about 1.5x. This is evidence of higher cash flow that the company has. It still has a big debt load. It's got about $600 million worth of debt to its parent company. That's at an average rate of 5%. But given that the cash flow has rapidly increased in a couple of quarters this year, something for investors to watch.
Finally, two more quick things. I want to open up the discussion, and let's dig in a little bit more. The company won a new expansion award at Boston Logan Airport, which will increase its space at that airport from 25,000 square feet to 34,000 square feet. That's a big win. Also, it won another RFP -- request for proposal -- award at LaGuardia International, as well as a number of smaller international airports in North America. Just a reminder, all of its operations are based in the U.S. and Canada.
Vince, I wanted to open this up. The thing that really, really caught my eye was this new opportunity that Hudson seems to have in food and beverage services. The company is installing these open island coolers in general services shops in airports -- shops where you'd normally go in and get some chewing gum or a newspaper or that razor that you forgot to pack. It's installing these open island coolers with packaged food. It says that this is a driver of overall growth. Now, food and beverage is the largest category at 38% for this company. The next is cosmetic at about 15%. Food and beverage is where management is focusing. I was just surprised at the ingenuity of that. I don't know if you had a chance in looking through, if that also caught your eye.
Shen: I'll just say, traveling the past two weeks, at each airport that I went to, I saw the Hudson name. Beyond their Hudson-branded storefronts, probably a lot of the other brands that I saw. They've talked before about licensing with places like Dunkin' Donuts, basically the storefronts that Hudson has its fingers in.
We talked previously about 3% annual growth in air travel traffic and 4% growth in spending per passenger that they are forecasting and have seen in recent years. But Hudson's growth that you mentioned, with some of the more recent results, show us that the company is really taking market share. They're experimenting with their storefronts to maximize convenience for travelers now with these island coolers that you mentioned.
For anyone who has flown recently, I think you can appreciate the convenience that something like this offers, and some of the other things that they're doing with their storefronts. Ultimately, people want to get in and out of the airport quickly and smoothly. With how airlines are changing, the amenities and the services that they offer to passengers, less meals offered during the flight, for example, it's very easy when you're going in to grab a magazine or to grab a package of candy as a snack on the flight, you might grab a sandwich or something, as well. I think there's big reasoning behind that, in terms of this being the biggest category for Hudson.
They're also seeing the success of this new addition to these newsstand stores, and the tailwind from that, where they're maximizing convenience for travelers and taking advantage of what they've dubbed that "dwell time", that waiting time that people build into their itineraries in case there's long lines at the check-in counter or security gates. If you have an hour and you're sitting at the terminal, it's not unsurprising, with impulse purchases, that you end up buying something from these stores. They want to really give the passengers, their customers at these airports, essentially, as many opportunities and retail experiences that will get them to pull out their wallet and make a purchase.
I'll just add to that, more broadly, with their organic growth, how that has trended really consistently at around 9% annually. Their comps are still really strong, their profitability improves. You have to keep in mind, this isn't an upstart business. Hudson has over 1,000 stores in about 90 locations across North America. That scale and strength really puts the company in a formidable negotiating position whenever new square footage opens up, like with those opportunities that you mentioned earlier, Asit.
There are some other growing tailwinds on that front. More broadly, there's an estimated $70 billion of spending expected at 50 U.S. airports in the next few years, to bring essentially what are these aging facilities up to date, this aging infrastructure. Some of the biggest airports, like Chicago O'Hare, Los Angeles International, and New York's JFK, they're each spending $10 billion or more on their current expansions. A lot of those investments will accommodate growing air traffic. They'll also add facilities focused on retail and dining. That's right in Hudson's wheelhouse. That's just another opportunity for them to expand their footprint, their market share, within each of these major airports, these big businesses for them.
I'll turn it back to you, Asit. Any final thoughts from you, in terms of what you'll be watching as the company closes out 2018? Any other takeaways or updates you'd like to share before we move on?
Sharma: I've got one. I want to read a quote from the company's CEO, Joe DiDomizio. This is from their most recent call. It will give more insight and perspective on how the company runs its business. This is in the context of what you just described, Vince. There's this in-built opportunity as aging airports in the U.S. are renovated and expanded. If you are from the perspective of the person who's awarding contracts at a certain airport, you want to give your business to a proven leader with a track record, the company which is going to bring in the traffic and enhance your terminal. That's where Hudson has an edge. It's been around for 31 years.
Let me just read this, then we'll move on. I found this very insightful into the company's approach and how it looks at a terminal. The CEO said, "Unlike traditional mainstream retailers, which have more control over the timing of individual store openings and closings, our business is centered on being as responsive as possible to the ever-changing dynamics of each individual terminal and airport. In fact, we view each of our terminals as one large individual store where we populate concepts, brands, and merchandising categories to maximize growth. Our top line opportunity and our entire expense structure work across the entire terminal, similar to the way a big box retailer would manage an individual store. In this context, we are constantly managing our portfolio of stores in a particular terminal to maximize our exposure to passenger traffic and optimized penetration."
Just to give you a sense of the holistic way that Hudson, with its various concepts, looks at growing that business over time. It's really shuffling pieces, whether that be a Dunkin' Donuts license or a perfume store or one of these more convenience footprints, which is offering the open island coolers and grab-and-go food. I really liked that. It gave me more insight. I'm looking for the next quarter for continued growth and more wins in terms of RFPs with other airports.
Shen: Thanks, Asit! Our next company is Procter & Gamble. Specifically, we want to look at the company and the impact that activist investor Nelson Peltz has had since joining the board in March of this year. That whole process was its own epic saga that we talked about last August. When we last covered this news, Peltz and his firm, Trian Partners, were angling for a greater say in the company's future by this big proxy battle. Supporting their push was the fact that even though Procter & Gamble has been in this multi-year reorganization, they've reduced their brand portfolio by essentially two-thirds from over 200 brands to less than 70, the company's still putting up weak growth for the remaining business lines. A lot of people look at Procter & Gamble, the fact that it's a dividend king. They've been growing their annual payout over 50 years. But its total return performance in the past decade has really lagged the broad market and the competitors.
Again, Peltz took a place on the board earlier this year. To address that underperformance, his fund, Trian, suggested several changes. Asit, can you walk us through some of their major suggestions?
Sharma: This goes back to the original white paper, the argument for Peltz joining the board, which was in the fall of 2017. This summer, as Vince alluded to, the company regained some ground. The stock was down almost 24%, it's down about 8%. This is after Nelson Peltz told a conference in the industry that the company was considering his proposals.
The major point of the proposal is to organize Procter & Gamble in a way that promotes accountability. He wants the company to be organized basically into three stand-alone units. The first would be beauty, grooming, and healthcare. That would have about $26 billion in sales. The second would be fabric and homecare, which would be $21 billion in sales annually. The third would be baby, feminine, and family care, which would have about $18 billion in sales.
The company as its structured now has separate marketing units, sales units, from its many divisions. Even though it's whittled down its total number of brands, as Vince just mentioned, down to about 70, it still has a very complex organizational structure. Peltz wants to really whittle that down. If you read between the tea leaves, this opens it up to maybe separating those divisions, maybe spinning off the weakest division in a few years. That's a hallmark of the activist investor. Simplify the company structure, then spin off divisions, make them their own publicly traded company, usually with a tax advantage in doing so, which rewards shareholders.
The rest of the points didn't get quite as much publicity, but I want to read through them. They're important for current investors to note. The second point is to ensure management's $12 to $13 billion productivity plan delivers results. If you're a longtime shareholder of Procter & Gamble, you have probably wondered, "Why do I keep hearing every two or three years about this multi-billion dollar productivity plan? The stock never really seems to get a benefit from this. When I read the financials, the margins look the same." Peltz says it's all well and good that the company has engaged in the cost-cutting endeavors that it has, and it's worked on its supply chain. But you have to see bottom line results. You have to see top line results from the greater efficiency, which drives more sales volume. He wants to hold management accountable to this moving target of multi-billion dollar productivity plans that take place over several years.
The third is to fix the innovation machine. Peltz has long argued that Procter & Gamble is broken and that it hasn't come up with a major new brand, by his count, in over a decade. The one quibble that investors should have with that is that Procter & Gamble has had a tremendous amount of innovation, but it's focused that innovation on packaging. Tide Pods is probably the easiest example to recognize. This was a market that Procter & Gamble created by itself, simply taking its detergent and repackaging it in a new formula. It sold billions of dollars worth of that product. But what Peltz argues is, you've got to come up with new brands. Your innovation machine can't be focused just on packaging alone.
The fourth point is develop small, mid-sized, and local brands. Anyone who shops is familiar with the disruption that's going on in retail. With fewer visits to the grocery store and more opportunities to order stuff online or have it delivered to your house, you don't have that visual read-through on the grocery shelves where many of Procter & Gamble's products sit, whether those be grooming or beauty, what you would normally see in your weekly cycle of buying groceries. That's getting disrupted. Peltz argues that without buying up small innovative brands that you might buy through an alternate channel, Procter & Gamble's missing out on a huge opportunity.
I wanted to point out that the giant rival of Procter & Gamble, Unilever, has actually been pretty savvy at snapping up these small and mid-cap companies over the past couple of years. By my count, they spent about $9 billion. Management says that this new portfolio of smaller companies, most of them have a sustainability bent. They have a local focus. They return about 16% annually per investment dollar spent on these. It's working out for Unilever. Peltz argues, "Procter & Gamble, you need to start ramping up the M&A and jump in this game as well."
To that next point, he says, make M&A a growth strategy and a core competency. We will grant that Procter & Gamble has made at least one natural products acquisition in the past year. It bought manufacturer Native Deodorant for $100 million cash. This was last November. But it has not really jumped into the mergers and acquisition game as it probably should.
Sixth point is win in digital. We all know what that means. Procter & Gamble does have a good outreach in digital commerce. But Peltz will point out that companies that he's been involved with in the past have spent more and really researched more innovative ways than Procter & Gamble has engaged. He wants them to ramp up digital spending to get to the consumer who isn't going to those retail outlets.
The last point is, address the insular culture. Personally, I have written a lot about Procter & Gamble's tendency to simply repurchase shares and issue dividends with the massive amounts of cash that it generates. If you take a look at the company's balance sheet, it's always slightly heading toward that moderate to high leverage, and current liabilities are always outweighing current assets. With such a big fortress-type balance sheet, the company has really done little to invest, in my opinion, in radical strategies to innovate and grow at sales. But it returns a heck of a lot of money to shareholders.
I think that one of the things Peltz is getting out in this idea of addressing an insular culture is that there is no skin in the game for management. There have not been hard consequences for underperformance. The stock has been flat for several years, and it's coasted on this formula of selling its brands in the marketplace, buying back a lot of shares, issuing dividends, being that safe widows and orphan dividend-issuing stock. He wants to break that up and bring out more people from the outside to fill the ranks of P&G's middle management, with folks who have been in rotations at other companies.
Last thing I'll say is, Procter & Gamble is famous for moving people up in its own organization. That is definitely a positive, in terms of performance among individual middle management and executives, as they move into higher management. The problem with that is that you do tend to have a dearth of ideas from the outside. Trends can upend you, and you don't see them coming. This is one of his primary arguments on why the company has underperformed. It's really had its head in the sand, in his opinion.
Shen: Asit, thank you for that awesome rundown, in terms of some of the strategic changes and the organizational changes that Peltz is pursuing. Things have been relatively quiet, in terms of headlines and updates from the company. There has been some stock price movement since Peltz mentioned that management is seriously considering some of the suggestions that he and his firm have made.
I'm curious about your personal view on some of these changes, in terms of maybe the top one or two priorities that could have the greatest near to mid-term impact for the company, its results, shareholders. What do you think?
Sharma: Well, if we went with that very first idea, which is to break the company up into three major divisions, I think that would have a really strong impact, near-term and medium-term, on the stock. It would be that radical change which P&G has avoided. That's the single most important thing the company could do if it wants to inject some life into the stock.
If the company wants to compromise, it could signal to Wall Street that it is interested in maybe spinning off a smaller division or a group of companies and pursuing this mergers and acquisitions strategy. I think that would have a medium to long-term impact on the stock and would probably be the best way to go. As I've said, the company has put so much of its free cash flow back into shareholders' pockets. But when the stock doesn't move after years and years of following this formula, maybe it's time to allocate capital in a different place and acquire some other younger companies.
These couple of things, I think, would have, out of all the options, the most impact. I, too, find it interesting that since Peltz joined, it's been sort of quiet. One of the things that you get when you bring on the activist shareholder and add him or her to the board is that that outside criticism, that loud voice, suddenly quiets down. Now they're on the inside and they have to produce. [laughs] So, it'll be very interesting to see, over the next few quarters, what they choose to enact.
He has the Street's attention after that conference in June. There is some expectation now, with the stock clawing its way back to par, that something is going to shake out in the next one to two quarters. I'm sure we'll be returning to this if we see that happen.
Shen: Awesome. We have a couple of more minutes, running short on time here. I want to make sure that we can talk a little bit about GoPro, ticker GPRO. Shareholders of this company have had to stomach quite a bit of volatility since the company went public back in 2014. Keep in mind that the stock fell from almost $90 per share, and over $10 billion dollars in market cap shortly after the IPO, to just $6 per share and less than $1 billion currently.
The last two years in particular, CEO Nicholas Woodman has himself acknowledged a lot of missteps in areas like their inventory management, their pricing for their HERO camera lineup, the failure of the Karma drone, which was a pretty big PR disaster for the company, and then, execution during their holiday shopping season, which is really, really critical for GoPro's business.
Revenue last year, down 25% from the company's peak in 2015. More recently, the second quarter earnings report had a much more bullish tone to it than we've seen in some time from management. They had a much clearer product and pricing strategy for the holiday quarter. They're talking about increased units sold this year over 2017. Guidance for really rapidly expanding gross margins, which, combined with a tight lid on expenses, could lead to a positive bottom line in the second half of this year, and then full-year profitability in 2019, which is an important goal for management.
What do you think, Asit? The company's new HERO7 lineup of three cameras launches in the next few days -- internationally, September 27th, and domestically September 30th. Are you feeling as good about the company's prospects now as management seems to be?
Sharma: Maybe I'm not as enthusiastic as management, but I do think that they have an opportunity here if they can execute it in this fourth quarter. One thing you mentioned caught my eye. Gross margin in the last quarter was 29%. If you just came in on an alien spaceship, you'd say, "Wow, that's a really low gross margin for a manufacturer!" But hey, it was 22% in the prior sequential quarter. There's a jump sequentially. One of the things we saw in that report is the comparison of sequential numbers. In other words, saying that, "Hey, our year over year comparisons aren't great. But if you just look at the leap we've made in these last three months ... " They did have some impressive numbers in there.
To your question about the new lineup, I think that they may benefit from something which has been missing before. In the past, the company really wanted to dazzle consumers every time they had a new lineup. They did spend good money on enhancing their product, but the pricing was always an issue. Sometimes they overshot, sometimes they hurt their own margin. What we've seen in this new lineup -- I am no device expert, but what I've been able to grasp is that the new HERO lineup focuses on image stabilization. If you think about steadicam in the film industry, it uses a technology which the company calls gimbal-like -- gimbal being the type of device which steadies the image. They call it, I think, hyperstabilization. This is actually a lower-cost move for the company vs. having higher-end sensors and better image quality, smoother HD quality, that it could offer. What that does, it'll help them raise the average selling price of their devices. But it's not out-pricing them in the market or giving consumers a product which they may or may not want.
I think that is a savvy move. It's a more realistic move. I think if I had one word to characterize management's approach for this quarter, and maybe moving forward, it's realistic. What are your thoughts?
Shen: I think that's a good one-word summary of their approach to things now. At a conference earlier this month, let me pull up the quote. Woodman talked about, quote, "A maturing of our approach to the business with a better understanding of who our customer is, understanding customer segmentation of our market, understanding pricing sensitivity, and understanding customer desire to see annual product refreshes from us."
They see to have a better grasp now of some of the mistakes they've made previously. They really hammered on this clear strategy that they have for this upcoming holiday season. They realized their strength, their area of expertise, lies not in drones, not in this content or multimedia platform that never materialized. Where they still have the strongest position, they dominate most of the action camera market. Originally, it was with high-end devices. Now, they're making sure that they can serve the needs of customers at lower price points, as well. They have this $199, $299, $399 pricing model for the three new cameras in this 2018 lineup. That introductory-level camera was something they said that was missing last year. Management said that was a major driver of their shortfall, in terms of results, in the last holiday season.
This is really a beaten-down stock. They're trading at less than 1x sales. It definitely seems at face value like an attractive opportunity, if you believe in the ongoing recovery. I'll be watching the fourth quarter results pretty closely to see if some of the bullish demand materializes, and also the solid execution that they're promising materializes.
Any final thoughts from you, Asit?
Sharma: Sure. One last thought is a note of caution if you're thinking of jumping in now. There is this outlier. The company has strong demand for its products in the fourth quarter, but it's having, as other manufacturers are, some component supply issues. With its resistors and capacitors, it has a major contract manufacturer, Jabil Circuit. Its ability to meet total demand may be crimped for the next few quarters. Quarter four is right before. It's that important holiday season. That's a little caveat.
One more I'll add is that historically, the company has botched its fourth quarter, that all-important holiday season. I don't think that'll be the case, honestly, this quarter. I think, from everything Vince just said, I totally agree with that, I think they have some clarity. But this external factor also may hit them.
But definitely a stock now that, for the first time in a long time I've felt, "OK, this could be a value investment." Up until now, I really haven't had that sense. But I do like management's idea that "Hey, we could be this great manufacturer of devices. We own the market. We have huge market share. Why don't we just make our products better, more affordable, and with features people want?" That is a recipe for success. So, me too, I'm going to watch this fourth quarter very carefully.
Shen: Thanks, Asit! That's all the time we have for today. Great to have you with us, as always!
Sharma: Absolutely! A pleasure!
Shen: Fools, thanks for tuning in! Remember that if you have any questions or topics you'd like to hear about, you can reach the Industry Focus crew via our email, email@example.com, or on Twitter. Look for @MFIndustryFocus.
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