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4 Stocks, 4 Innovation Stories

By Chris Hill – May 3, 2019 at 2:03PM

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Apple and Facebook are pivoting, Shopify is helping brick-and-mortar businesses pivot, and you’ll want to hear about the unusual way Yum China is growing KFC sales.

Though most investors like to behave as if short-term share price moves are happening because of the data, stocks often move as much on emotion as they do on raw numbers. For Apple (AAPL 0.99%), the emotions among investors following its first-quarter earnings release Wednesday were positive ones, despite a decline in iPhone revenues. Over at Facebook (META 1.21%), profits and the stock are doing well despite the visceral anger users feel about its much-publicized issues, which has led CEO Mark Zuckerberg to plan to refocus on privacy.

In this Market Foolery podcast, host Chris Hill and senior analyst Aaron Bush dig into the latest news from those two giants, as well as the first-quarter report from Shopify (SHOP -0.41%), which continues to soar by aiding other businesses in their e-commerce endeavors. They also chat about Yum! Brands (YUM 0.72%), where the story hasn't changed much lately -- unless you look to its Yum China spinoff, which is profiting from some clever rebranding of a previously unloved chicken part.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 1, 2019.

Chris Hill: It's Wednesday, May 1st. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio today, he's been busy, but he's back in studio, it's Aaron Bush. Thanks for being here!

Aaron Bush: Thanks for having me!

Hill: Boy, we've got a lot of stuff! [laughs] I love earnings season! We've got some Shopify, we're going to take a trip to Facebook's developer conference. And we've got the most delightful restaurant news I've seen in a while. But we're going to start with Apple, of course, because if you're keeping track of this sort of thing, Apple has rejoined Club Trillion. The market cap is up over $1 trillion now. iPhone revenue was down, but I guess we were expecting that? The services revenue, which is something that Apple has basically told us, "Keep an eye on the services revenue," it was up, what, 16%?

Bush: Yeah, not bad. I mean, it is what it is. It's actually not that great of a quarter. It was fine --

Hill: Wait! We'll get into the details in a second. Why do you think the stock is up? I had the same reaction as you. Like, this is good, there's some good in here. iPhone revenue is down pretty significantly. Why is this stock up?

Bush: It's important to understand exactly what Apple is right now. It's an iPhone company with a services narrative that creates the most value by giving all of its cash back to shareholders.

The iPhone sales were what they were, not great. A lot of that has to do with China not being as great as it used to be. It'll probably get better later in the year. Other things did well. iPad revenue was up 22%, wearables were up 50%, the services business was doing well. But I mean, part of the reason why the stock was up a decent amount is because they raised their dividend yet again, and they approved another $75 billion in share repurchases. They're just coming up with dozens of billions, out of nowhere, and just keep on buying back shares and giving it out. So Apple today is really an income play more than anything, which is fine. I'm personally looking forward to the next meaningful product wave, whatever that might be, so it starts getting exciting again. But this company is just printing cash, and they are creating value.

Hill: It's interesting that in Apple's history, for the size that the company is, they really haven't made many big acquisitions. Well, they haven't made many acquisitions, period -- yes, there are probably some small ones that people can trot out here and there, but when you think about the amount of cash they have on the balance sheet, they could buy just about anything they wanted to that could fit into the services ecosystem or the product ecosystem. And they've just decided, "No, we're not going to do that."

Bush: Yeah, it's crazy! I honestly don't know if that's ever going to change. It's just part of who they are culturally. It's interesting to contrast them with someone like Alphabet, whose entire growth has been based on buying things like Android, YouTube, DoubleClick. So it's really impressive that Apple hasn't needed to. But part of me wishes that they would step up big in some way. They probably will. Apple is pretty good at biding their time, waiting for the right moment when they come out the biggest and best. It could be augmented reality within a year or two, for all we know. And suddenly, the entire tech landscape has changed again, and Apple's leading the way. But for now, it's really just about, let's just sell more iPhones, let's sell more services, and let's make as many billions as we can and give it all back.

Hill: Just to drill down on the services for a second. As you said, it was up 16%. That was the part of the quarter I was the most curious about. How are they going to do, what kind of growth are we going to see? I looked at the 16%, and I just thought, OK. That's not really knocking the cover off the ball. If it had been north of 30%, I would have been particularly intrigued by that.

Now, having said that, if this is something they can sustain; if for the next three to five quarters, they can continue to put up with this type of growth, then it starts to become meaningful. A year ago, when they really started to talk about, "We're really going to invest in services," it was significantly smaller. You would be forgiven for laughing out loud, like, "Come on, it's such a tiny part of your business." Now, in terms of straight revenue, it's the second-largest part of the business after the iPhone. It's a distant second, but it's well ahead of what they're doing in terms of iPad sales or Mac sales or wearables.

Bush: Yeah. I think it's important to put it in context. It's second to iPhones, but if it was a stand-alone business, it also would be one of the largest businesses in the world. I actually do think that that 16% growth, they can keep that up, not just for the next couple of quarters, but for the next few years, probably, if they do a good job. I know in the past, I've talked about how their services business, particularly their App Store practices, they'll potentially be the subject of antitrust regulation. That still could happen. I do think that something probably needs to change. But their strategy is sound. All of the categories that matter most -- news, games, payments -- they're finding ways to not only provide that basic-level platform but get in on bundling all of those different things into something where they can make even more money and put even more pressure on other companies. Their strategy is right, they're doing a good job. But when you're a trillion-dollar company, it's tough to move the needle.

Hill: That's true. Let's move on to Shopify. Shares are up more than 10% this week. Their first quarter revenue grew 50%. I get that they're not profitable, but that is a really impressive number.

Bush: It is. That definitely is what pops out. Let's break that apart a little bit. The majority of that growth, the revenue growth, came from their merchants solution segment, which is driven by a ton of different things, like Shopify Capital, which provides loans; Shopify Shipping. A lot of that segment is driven by gross merchandise volume, or the total dollar amount of orders placed. It shows that not only are consumers buying through Shopify sites more than ever, but the business owners running them are investing more heavily into their solutions to support these businesses more than ever before. If you look at the company's press release, literally half of it is just saying, "Shopify launched this, Shopify launched that, Shopify launched this list of a dozen things." So their pace of innovation isn't slowing. And I think what they're building is really cool.

I will say, though, those numbers sound great. Unsurprisingly, it is decelerating. But what I think investors should keep in the back of their head is that the growth is great, but it's decelerating at an accelerating rate. That doesn't really matter if the company is making money and is scaling that, but since Shopify doesn't make money, if that growth continues to decelerate at an accelerated rate, then it puts more pressure on the bottom line, which they don't have a lot to show for right now. So there is some risk there. But it's such an enormous market, literally hundreds of billions of dollars in online commerce. They're the biggest and best at what they do. I think if you're looking 10 years out, they're well positioned. But there could be some bumps along the road.

Hill: As you were saying about Apple, when your company is $1 trillion, it's hard to move the needle. Shopify is a $27 billion company. They've got a lot of room to run.

Bush: Yeah, they definitely do have a ton of room to run. But they also are priced as if they're going to be running super fast.

Hill: You strike me as someone who would be unconcerned by something like that.

Bush: I think it depends on your time horizon. If I were to close my eyes and wake up in 10 years, I'd be totally fine owning Shopify. And I own shares right now, and that's essentially what I plan to keep on doing. But I do think it's important to look at the growth rates, especially when I see things accelerate in a direction that you don't like. Acceleration is great when it works for you. It's terrible when it works against you. It's worth paying attention, that's all I'm really saying.

Hill: F8 kicked off yesterday. This is Facebook's annual developer conference. I don't know about you, the image I could not get out of my head in all the coverage that I looked at was Mark Zuckerberg standing on stage in front of the huge backdrop, which read "The future is private."

Bush: Uh-huh, sure it is! [laughs]

Hill: [laughs] I just thought, boy! I guess we've completely turned around from, was it 2010, where he was at TechCrunch and saying, basically, "Yeah, there's no such thing as privacy." He gave an interview at TechCrunch on stage where he basically said, "I think the age of privacy is over. It's not really all that important." Anyway. There were a bunch of announcements there. I'm curious if there was anything in particular that stuck out to you.

Bush: I might rant a little bit on this. What I like about this conference is that it always shows where Zuckerberg's head is at. In 2015, it was all about video. Then it was about bots. Then it was about augmented reality. And now, privacy. Obviously, some of those topics have been hit and miss. I actually do think that this year's big topic is extra important. And I do think that Facebook is serious about changing. A lot of these bolder changes only come from founders. I respect them for that. But it's probably not 100% as it seems. There's some spin going on there. There is a lot we can learn from what they said, but there's also a lot to learn from reading in between the lines.

Just to break that apart a little bit, what they said. They've indicated that most growth in social over the next couple of years will come from stories, private messaging, and groups -- aka, not their bread and butter, which is news feeds. They've also obviously preached recently about how they're chasing privacy, which is a big word. But really, that's driven more by public sentiment and a lot of criticisms that they've gotten more than anything. What they were able to do in this conference was, they were able to meld those two narratives together and show that, by changing how Facebook looks and what it prioritizes, it can better change its privacy image and remain a good business at the same time. That's really the message they're trying to convey.

But if you read between the lines a little bit and step back at first, when Instagram and Snapchat took off a few years ago, Facebook almost definitely noticed a hit in user engagement, especially from Snapchat. The truth of the matter is, Evan Spiegel with Snap, despite their issues and IPO-ing too soon, he actually has the correct vision for what the next phase of social is. News feeds have a place, but the future is about private messaging, groups, and stories -- those three areas where Facebook is now prioritizing and where Snap has always prioritized. Now, Facebook did a good job adjusting Instagram to compete. But it also decided a year or so ago to reorient the purpose of Facebook, bring it back to its roots of prioritizing real-life relationships over third-party content, which almost definitely caused yet another hit in user engagement. So now they're taking even larger steps to more dramatically change what they're doing, but also -- I think what they're not telling us -- stopping a leak in the core Facebook app a little bit.

Facebook's going to be putting stories and groups front and center again. They actually said that they expect stories content to surpass news feed content this year, which is a pretty huge deal in terms of monetizing with ads, and what it means for the business model. They're also going to turn Messenger itself into more of a social network, building out more features there, allowing people that you're more closely connected to to engage in more types of ways. They're adding encryption.

The truth of the matter is that Facebook isn't embracing privacy by tearing down the old. They're just adding a bunch of new stuff that they're framing up in a more privacy-centric lens without even really touching the old stuff too much. We'll see how that goes. They're certainly moving quickly. But it'll probably change how they make money.

Hill: It will be interesting to see what the reaction from the advertising community is. I'm sure that's not going to happen immediately. I think that's going to play out over the rest of 2019 and obviously beyond that. But it will be interesting to see maybe two quarters from now, what effect, if any, it has on their ability to sell ads, because that's the business they're in.

Bush: Yeah. And I actually do think they're pretty well positioned. A lot of these changes on the advertising front they've gone through with Instagram already. You see, with stories in particular, how ad prices changed. But it also increases the ad load. I think they'll be on a good trajectory there.

But, yeah, it was really interesting to see how they frame things up, but particularly what they didn't say. I think there's a lot of value in just trying to figure out, what are you trying to skirt around? [laughs] That says a lot.

But, they did announce other things which are interesting. They continue to invest in their Portal device -- which, again, no one ever asked for that.

They're launching it to more countries. Again, those people didn't ask for it. But, whatever. They're adding new features around relationships, new capabilities to their marketplace. WhatsApp is testing payments in India, which maybe is a big deal. Instagram is testing letting people buy actual goods through influencers' posts, which probably is a way of strong-arming Pinterest the same way that, with Instagram, they used stories to strong-arm Snap.

I don't know. When you have 2 billion people on your site and you have a giant money-printing machine, there's a lot you can do to change. And honestly, I think what they're doing will keep them going strong for a while.

Hill: There are definitely a lot of things you can test when you have that kind of platform and that amount of money.

One thing you didn't mention that I'm curious about is -- I guess you touched on this in terms of the big themes in years past -- the Oculus headset is going to start shipping later this month. I almost forgot about the Oculus headset, [laughs] because there was a point in time where it's like, "Oh, they've got Oculus! This is going to be amazing!" We've tested out those devices. We've got a VR room here at The Fool. It's definitely something with a lot of promise. I don't think there's any real expectations, from the perspective of the stock, in terms of sales of this device really moving the needle. But it's definitely something worth watching, to see what extent, if any, if they have success with that, do they begin to start doing testing around that, whether it's around gaming or movies, television, whatever?

Bush: I think it's still early for VR to go mainstream. I also think that Facebook probably isn't the best place for VR to succeed. They just have very conflicting models. Facebook is all about horizontal integration, I guess you can say. They want to be on every different type of device, every different type of platform, to get the maximum number of people. Something like Oculus and VR, it's much more vertical in the sense that they're trying to create their own platform, where people come to them for this instead of being all of these different places. It's very different, and I'm skeptical that they'll be able to pull that off. But, again, it's early days. We'll see how things frame up.

Hill: Final story. Yum! Brands' first quarter was pretty much like every other quarter.

Bush: This is the most important story!

Hill: This is the most important story. It's worth remembering that Yum! Brands spun off their China business into a separately traded stock, Yum China. Yum! Brands, the U.S. story continues to be what it seems like it is every quarter: "Hey, same-store sales at Taco Bell look good. KFC was pretty good. Pizza Hut was flat or negative." In this case, it was just flat. Pizza Hut continues to not... [groans] It's pizza! How are they not -- someone is going to write an article a year from now about the completely blown opportunity at Pizza Hut. Papa John's lit itself on fire from a business perspective, and it was the perfect opportunity for Pizza Hut to take market share. Yes, they got the NFL sponsorship, but it's not showing up in the sales! Anyway, that's a blown opportunity.

So, that story is the same as it always is. The most interesting part is Yum China, where the results for KFC were boosted because -- [laughs] I can't believe I'm saying this out loud -- their sales were boosted because they sold parts of the chicken that were never used before. Let me say that again. You want to talk about innovation in restaurants? KFC China is selling a part of the chicken that they've never sold before. CEO Joey Wat was asked about this on the call. She said, "This is a piece of chicken that's between the chicken wing and the chicken breast." I'm not so intimately familiar with chicken anatomy that I can picture what she's talking about, and it was said on the call in Mandarin, and it was not translated, so I don't know what we're talking about here. But I am now insanely curious about this.

Bush: I mean, genius comes in all forms. Whoever came up with that idea deserves a promotion. I was talking to Emily Flippen this morning about this, who fell down this rabbit hole really deep.

Hill: We both know Emily. She didn't fall down, she willingly went down.

Bush: [laughs] Oh, yeah, she willingly skydived down that rabbit hole. But, what she was saying was also disruptive about this is that because this part of the chicken has been traditionally deemed undesirable, KFC was able to purchase it at really low prices, and then also able to sell it at really low prices. It's a way to bring people in for something new and something cheap. But she also told me a stat that blew my mind. How many loyalty members do you think KFC in China has?

Hill: Oh, this is just going to upset me, I know. I'm going to go high and say 40 million.

Bush: 175 million.

Hill: Oh, my -- !

Bush: Isn't that insane? Most streaming sites would love to have the amount of loyalty that KFC China has. 175 million people! I totally understand, they're working with a lot of people. They're working with Facebook numbers, [laughs] to bring people in.

Hill: That's insane!

Bush: Yeah, that's wild! Also, I'll say, I know you were talking bad about Pizza Hut earlier. Apparently, one of Yum! Brands' partner companies is Telepizza. Emily also showed me this today. She was saying that they just launched the Telepizza Burger, where instead of the meat and vegetables being on top of the cheese, it's now in between the bread and the cheese. More innovation going on at Yum! Brands.

Hill: We have to bring in our man behind the glass, Dan Boyd. Dan, what's your reaction to all this?

Dan Boyd: Well, Chris, I don't know if you've had lunch yet, but how about you and I go down to KFC and get some chicken armpits?

Hill: [laughs] See, sadly, I don't think they're selling them here. At least not yet.

Boyd: Not yet, Chris! But we'll get our chicken armpits before too long, I'm sure.

Hill: I guarantee you someone at KFC here in the United States has got a team working on whatever the branding is going to be. If it really is a situation where we can buy this part for not a lot of money, we can sell it for just slightly more money, we can do this in a profitable way, they are going to rebrand it. It's not going to be chicken armpits, but it's going to be something.

Boyd: Chick pits! [laughs] Sorry! We're so bad!

Hill: [laughs] We're going to work on this. Well, we're not going to work on this. We don't have to, we're not getting paid to work on this. The people at Yum! Brands down in Louisville, they're working on this. Alright, Aaron Bush, thanks for being here! Good talking to you!

Bush: Thank you!

Hill: As always, people on the program may have interest 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 the immortal Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Aaron Bush owns shares of Alphabet (C shares), Apple, Facebook, and Shopify. Chris Hill has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Apple, Facebook, and Shopify. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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