NIO Is Not a China Proxy

In this episode of MarketFoolery, host Chris Hill talks with Motley Fool analyst Emily Flippen about the market's biggest news. Abercrombie & Fitch (ANF 3.74%) is up huge on a deeply lame quarter. Was there some gold hidden between the lines, or was this yet another case of bad results beating terrible expectations? Dollar Tree (DLTR 1.95%) saw a little pop after its earnings report, but more interestingly, the company announced some big changes regarding its Family Dollar acquisition. Brown-Forman (BF.A 0.96%) (BF.B 1.15%) fell about 7% after reporting earnings. Could it be that they just have too many brands? Chinese automaker NIO (NIO 0.48%) tanked, but investors probably want to resist the "China is too scary" narrative that's cropping up as a result. Tune in to find out more.

A full transcript follows the video.

This video was recorded on March 6, 2019.

Chris Hill: It's Wednesday, March 6th. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio today, Emily Flippen in the house. Thanks for being here!

Emily Flippen: Thanks for having me!

Hill: We've got earnings. We're going to talk electric vehicles. We're going to talk alcohol. Let's start with retail.

Abercrombie and Fitch, fourth-quarter profits were higher than expected and I'm assuming their guidance for 2019 was amazing because shares of Abercrombie and Fitch are up 21% this morning.

Flippen: [laughs] Oh, is it 21% now?

Hill: Yes, just in the time since we walked in the studio a few minutes ago. Was it that good? My assumption when Abercrombie and Fitch does this -- and it's not the first time that they've shot up on an earnings report -- my assumption is that this is one of those apparel retailers where expectations are just always pretty low.

Flippen: Yeah, I think that analysis is completely accurate. The sales, while they beat expectations, were still a 3% decline as compared to sales last year. It's definitely just a reaction to the fact that people thought Abercrombie and Fitch was pretty down and out. Maybe it's down, but it's not out. 

What I thought was interesting is -- I feel like it was just yesterday that we were talking about this company, and it was the same trend that we talked about then on the previous podcast -- the Abercrombie brand itself is doing so terribly. The brand itself decreased 9% in terms of sales. Meanwhile, Hollister, their other sister brand, had revenue growth of 1%, which is not great but still better than a 9% decline. 

Hill: It's in the plus column. 

Flippen: Yeah, exactly. They're planning on closing 40 stores in 2019. I think it's just part of their cost-cutting, leaner business model. We'll see how that turns out for them. But, yeah, expectations here were very low. 

Hill: We were talking the other day about Gap announcing they're going to spin off Old Navy into a separate company. Certainly, quarter after quarter, Old Navy's been the star of that brand portfolio. I get what you're saying, Hollister 1% growth, that's not great, but it does seem like it's a similar narrative, at least over the past couple of years. Hollister has been doing better than the namesake. Do you think, on any level, management looks at what Gap is doing with Old Navy and thinks to themselves, "We should at least consider spinning off the Hollister brand?" Or are there other levers they can pull?

Flippen: I would say management must be at least thinking about it. Abercrombie and Fitch has performed so poorly for so long now, and they have so many other brands that offer greater potential. I'm not sure if it's just me, maybe it's just me when I think about this company, correct me if I'm wrong, but I just can't separate them from their former CEO, Mike Jeffries, who made all of those terrible comments and was a relatively controversial figure. So, when I think Abercrombie and Fitch, that's who I associate with that, even though he's no longer CEO of the company. I don't know, maybe it's a good move for them, almost part of a rebranding effort. 

Hill: It's interesting because, I think you've got both things going on. Yes, Mike Jeffries, [laughs] a bad CEO for a lot of reasons. They have also had other PR-related stumbles over the past five to 10 years. That being said, it is a brand that people know. It seems like there's some potential there under the right set of management or in the right hands. And maybe, by the way, those right hands are in the private market. There's some brand equity there, and I'm wondering if three years from now, Abercrombie and Fitch is gone from the public markets simply because someone in the private equity space has just decided, "Look, we're going to fix this thing, but we're going to have to do it outside of the spotlight of the public markets."

Flippen: Yeah, I definitely think that's the case. Any publicity is good publicity, and while Abercrombie and Fitch has had its share of controversies, ultimately, you're right, it's still a household name. 

Hill: Let's stick with retail. Fourth quarter profits for Dollar Tree were slightly higher than expected. Shares up a little bit. I'm wondering if that's because of the results or because of their plans for 2019 which they announced, which include closing up to just shy of 400 stores.

Flippen: They made an acquisition a while back of Family Dollar, not the same as Dollar Tree. Dollar Tree stores are, you come in, spend $1. It's trinkets, it's a fun place to shop. Family Dollar is very different. I used to live in a location where the main grocery and retail shopping location was a local Family Dollar. It's targeted at lower-income communities for which they don't have other options nearby that they need to walk to. Family Dollar, Dollar Tree thought, was a great acquisition. I actually think that the little bit of a rise that we're seeing today is in spite of what is turning out to be a bad acquisition. The losses they had this quarter were pretty substantial thanks to an impairment charge associated with that Family Dollar acquisition. In layman terms, basically what they're saying is that, "Yeah, we spent $9.5 billion on Family Dollar. It's actually worth over $2.5 billion less now than we thought it was when we bought it. We overpaid for that acquisition." They're going to rebrand about 200 of those stores and put them into Dollar Tree stores, and then close the rest. 

Dollar Tree itself as a brand is doing really well. Same-store sales just for the Dollar Tree brand was up 3.2%, which is pretty significant. I think they're realizing the future for Family Dollar might not be there, but Dollar Tree itself is still going strong. 

Hill: I'm wondering if this is a buying opportunity in this regard -- tell me where you think this stock is on a valuation basis. Yes, they're going to be closing some locations this year. They've got, all told, north of 8,000 locations. They're obviously looking to close some underperforming stores. They're talking about an optimization strategy to remodel some of them. If the stock is cheap enough, and you've got a five- or 10-year horizon, I'm wondering if this is a stock to at least consider. If they can pull this off, we've seen retailers have success aiming at lower-income families out there and doing it in a way that makes sense for the consumers and doing it in a way that rewards shareholders. 

Flippen: It's funny you bring that up because we actually had an intern last summer, Troy -- who listens to the podcasts, so shout out to Troy -- he really loved Dollar Tree for exactly that reason. He thought it was a great value. I think he saw the trends that we saw with discount clothiers -- Ross, Burlington, TJ Maxx. He saw what he perceived to be a similar trend with Dollar Tree and other discount stores. 

Personally, I think it's a little bit risky. The Dollar Tree store and Family Dollar stores themselves are a little bit predatory because they know that the low-income communities around them often have no other options, and they charge more for your basic household goods than you would get if you went to a Walmart, for example. So, I'm not completely sold, but I definitely think that if they're able to pull off that strategy, yeah, Troy would be completely right that it's an amazing value opportunity.

Hill: Shares of Brown-Forman down around 7% this morning. Brown-Forman is in the business of alcohol. Similar to Diageo, they have a portfolio with a number of different brands and a number of different types of alcohol. Yes, they have tequila and vodka and wine, but Brown-Forman is mainly known as the parent company of Jack Daniel's, a number of other whiskey brands, bourbon brands including Woodford Reserve. So, Brown-Forman shareholders, don't blame me. I certainly tried to do my part this last quarter. 

What do you see when you look at their results and where this stock is? One of my takeaways just looking at their portfolio -- and this is not to pick on Brown-Forman, I have this reaction when I look at others, Constellation Brands, in the same space. I just sort of look at them, and in the same way that retailers have a number of locations, and some of them are underperforming -- and, as we just talked about with Dollar Tree, maybe a good strategy is to shut some of those down. I look at Brown-Forman and I just sort of think to myself, "Is it really helping your business to have as many types of alcohol and as many brands in your portfolio as you do?" I wonder if maybe smaller is going to be a more effective strategy.

Flippen: I actually might disagree with you there. Granted, I am not a huge connoisseur of any Brown-Forman's products. This is coming from a relatively uninformed opinion in regard to actually using their products. But what I found interesting was that their super-premium -- [laughs] and I have no clue what this would include -- super-premium American whiskey brands, their sales rose 21%, which is huge. Greater than the 3% overall sales growth they saw in general. It's interesting because yeah, you could think to yourself, "OK, just focus on the super-premium American whiskey brands and get rid of the underperforming brands." But in my mind, tastes change, and having a diversified portfolio of brands gives them some insulation from changing tastes. We talked a bit a while back about Sam Adams. I actually think Sam Adams is a great example of a company that has done well in having a wide portfolio of drinking options, which has allowed them to sustain themselves in a consumer culture that went against craft beer. 

I don't know, I kind of like their diversified approach. But I will say, they topped earnings, but they missed sales, so maybe there's something to be said for what you mentioned. 

Hill: It is always interesting to me when we look at this industry and we see acquisitions being made. Some of them appear to be tuck-in acquisitions that make a lot of sense. Certainly, if Brown-Forman were to go out in the next year or two and add to that whiskey portfolio -- which is the biggest part of their portfolio -- that would make sense. Constellation Brands, they came out a few months back with their investment in Canopy Growth. Brown-Forman can make acquisitions that I think people will applaud. I wouldn't necessarily recommend that they look to get outside of their portfolio and invest in a marijuana company. 

Flippen: Well, you're talking to the marijuana analyst, just so you know.

Hill: I know!

Flippen: I'm not sure if I can completely agree with you there. But there's a point to be made. 

Hill: Fair enough. Let's close out the earnings with NIO, which is the so-called Tesla of China. Down about 20% this morning. The loss in the fourth quarter was bigger than expected. Any number of industries doing business in China, any number of companies we've talked about over the last six months, and the narrative is the same, and it's certainly the case with NIO: the slowdown in China. It's definitely affecting them. 

Flippen: Yeah. We're fresh off the plane from last week's Austin member event. This was a company, NIO, that many, many members came up to me asking me questions about. I was a little surprised because it's a little underfollowed here at The Fool. Unfortunately, they missed expectations. And regardless of the fact that their losses narrowed, the stock was down over 15% last time I checked. 

It really comes down to two things, which is a slowdown in the number of monthly deliveries. They're seeing a lagging demand for electric vehicles, which makes people internationally very worried about the future of electric vehicles. Then, they're also seeing a general economic slowdown in China. Those two things might be related. I told the members this in Austin and I'll reiterate it here, I think NIO is extremely interesting when you look at it in the perspective of a company like Tesla that gets a large portion of its sales from China. Their business models are so different. I think it might have reverberating effects for the entire electric vehicle market if the slowdown in China continues to persist. 

Hill: For those curious about this stock, it's an ADR that people can buy shares of if they're interested. Yeah, I...I just look at this, and I know you and I think you and Ben Ra did a breakout session at the event in Austin about investing in China. I heard a lot of good things from people who attended it, so kudos to you guys for that. I think that this does not help the narrative for people who are looking to invest in China -- four to six months ago, the narrative was about the biggest players in China. Tencent, Alibaba, iQiyi, etc. Having a smaller company, in the case of NIO -- market cap is around $8 billion, something like that, so it's not a small company, but small relative to those -- this doesn't help. For people who are thinking about investing in China, this is one more narrative that makes them go, "I think I'm going to sit on the sidelines a little more."

Flippen: That's so unfortunate because economic growth in China, with their most recent numbers, was still up almost 7%. It's unfortunate that people see a slowdown with one company like NIO and may associate it with all Chinese companies are therefore doomed. I think that's completely inaccurate. We're looking at a very expensive luxury electric vehicle maker. Sure, there's a market for that, but that's a much smaller market in China than the Chinese market as a whole. In my mind -- and I told this to a lot of the members that I met in Austin -- there are a ton of wonderful China plays still out there that are poised to succeed off of the changing demographic shifts that we see in China, from lower-tier cities moving into higher-tier cities. NIO, while it's an interesting company and a very interesting play, it's just not one of those companies for me.

Hill: Emily Flippen, thanks for being here!

Flippen: Thanks for having me!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

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