On a very Halloween-y grab bag episode of Industry Focus: Energy, host Nick Sciple talks with Motley Fool contributor Dan Kline about some of the scariest goings-on in the market these days. It's a more motley assortment than the usual IF fare, with samplings from consumer goods, technology, retail, financials, and more. Tune in and find out what scares the guys most about the market/ world economy today, which companies might turn into total duds in the not-too-distant future, what left-for-dead stocks deserve a second chance at life in your portfolio, and opinions about which are the greatest Halloween candies. Companies discussed include Uber (NYSE:UBER), Charter Communications (NASDAQ:CHTR), GameStop (NYSE:GME), Macy's (NYSE:M), Funko (NASDAQ:FNKO), Grubhub (NYSE:GRUB).
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This video was recorded on Oct. 31, 2019.
Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Halloween, and we've got some fun holiday discussion planned for you. I'm your host, Nick Sciple, and today I'm joined by Motley Fool for contributor Dan Kline via Skype. How's it going, Dan?
Dan Kline: Fresh off a plane from Vegas, have not slept very much.
Sciple: That seems pretty typical from folks who just got back from Vegas. That's typical for us around the D.C. area as well. We were just talking before the show, Nats vs. Astros, these games have been going to midnight every night. But finally, the Series has come to a conclusion. The Nats have pulled it out. The team of destiny has fulfilled what they set out to do. Austin Morgan, probably the biggest Nats fan in the room right now, how are you feeling?
Austin Morgan: I feel great! They did not sweep, like I predicted on Friday's show. But, a win's a win!
Sciple: [laughs] Yeah, first World Series ever that the road team has won every single game. For a sport like baseball, which is the longest lived of any sport in the U.S., crazy to see. And we have a parade to go to next week, maybe.
Morgan: Saturday at 2 p.m. I'm a little bummed that I'm not going to miss work for the parade, but I am happy that there's a parade.
Sciple: Me too. Who doesn't like victories? And hey, D.C. is Titletown now. Caps won a couple of years ago, WNBA got a championship --
Morgan: 2018 Capitals. 2019 Mystics. 2019 Nationals.
Kline: I think we got a little something to say about that, Boston. [laughs]
Sciple: [laughs] Alright, we got some fun segments for you today. We're going to talk about what we're most scared of in the stock market. We're going to talk about the stocks that we think are going to turn back into pumpkins. We're going to talk about our zombie stocks, stocks we think can come back from the dead. And, we're going to share our Mount Rushmore of Halloween candy.
Off the top of the show, Dan, in the Halloween spirit, when you look around the stock market today, what scares you the most?
Kline: On the plus side, there's a lot of information available. There's multiple TV channels devoted to, while the stock market is open, analyzing things. But I think that's actually a major problem for stock buyers. There's a lot of in-the-moment pressure, when the talking head on TV is screaming about how great some stock is, to want to get in on the action. I think the reality is, you don't buy stocks rationally. In my opinion, you should be buying stocks that you are very familiar with the company, that you've taken some time to learn about. It's great if watching CNBC or Bloomberg gives you an idea to go research a stock, because "Wow, I just ate at that restaurant, I just used that product," and then you dig in. But you should not be buying stocks because someone is telling you how great it is. You need to figure that out on your own.
Sciple: That's true, and maybe interesting advice for a show like ours, [laughs] where we try to give folks some stock advice. But, yeah, you really need to do your own research. We talked about last week on the Friday show this WeWork filing. If you didn't pay attention to that S-1, the required regulatory filings, you might have bought a company that was drastically overvalued. Thankfully, the system worked there.
I will say, for me right now, what I'm most scared of in the market, often what is scary to us are things that we don't fully understand. And the repo market is something that's been in the news recently that I don't perfectly understand. I know a lot of folks out there probably don't. What the repo market is, is overnight banks will loan out Treasury bonds to fulfill their day-to-day liquidity needs. But we've seen in the recent weeks and months, that market has locked up a little bit. Rates have increased, and that's caused some illiquidity in the market, has required the Federal Reserve to pump some more cash into the market. We've seen some conversations from the Secretary of the Treasury that they may ease some restrictions on banking reserves to try to add some liquidity to this market. That sounds really complicated.
Why is this scary to me? Well, liquidity is really important for any market to function well. You need to be able to buy and sell, barter and trade, engage in transactions. When you don't have the cash there to make that happen, then the whole system can lock up. We've seen rates come lower and lower as the Fed has tried to stimulate the economy. But with the repo market rates moving in the opposite, to where the Fed is trying to move rates, there is some concern that there's less control than we would like to see from our central bankers.
When you combine something that addresses illiquidity, which is very scary in and of itself, that's difficult to understand, that's really scary for me in the stock market today.
Kline: Yeah. It's just one of those things. It's this shadowy, sub-financial system that the average person doesn't understand. Makes it very hard to regulate, and really hard to follow. It's one of those things that you want to know as much as possible, and this isn't something that generally makes the news.
Sciple: Yeah, that's right. The other thing about it, from an individual investor's point of view, is there's not much you can do about it. This is something that the Fed and our regulators have control of. Nothing you can do actively from an individual investor point of view. I don't think you should change your investment strategy based on these fears. But, who knows what's going to happen there?
Alright, let's move onto to another one of our segments. Dan, I think this will be a fun one. I'm calling this our WeWork memorial -- stocks that are going to turn into pumpkins. We saw WeWork, when they dropped their S-1 a couple of months back, had a $47 billion valuation. That's since been pulled, and then bailed out at $8 billion. Let's see if we can call out a couple of stocks that we think might have a chance to turn into pumpkins, maybe not quite as bad as WeWork.
Dan, what do you think? What's a pumpkin stock for you?
Kline: For me, it's Charter Communications. Of all the big cable companies, Charter is the one that's most heavily invested in cable and broadband. They don't own theme parks, they don't have TV networks. What you see happening now is, broadband growth has slowed to a trickle. Cord-cutting has massively accelerated. We lost about 3 million cable customers last year. And in the first half of this year, we've lost almost the same amount. You've been able to cover your cable losses at Charter with broadband gains. But I think we're now moving to a reality where that's not going to be the case. The cable numbers may happen very, very quickly, and Charter does not have alternate means of delivery or streaming services. They're very late to the game. I'm not saying their business is going to evaporate. They have monopolies in many markets, and old people will still keep cable, and there's no alternative for broadband. But this might go from a growth story to an erosion story very quickly.
Sciple: Yeah. We've seen another cable example, [Comcast's] Xfinity has tried to diversify its revenue stream. I don't know if you've seen this Xfinity Flex box that they're pushing out there, competing with Roku. They realized that folks are not subscribing to cable at the same rate. So now, if you subscribe to their cable services, they'll give you a Xfinity Flex box that acts kind of like a Roku stick. What it does is allow them to sell ads on their service, which gives them a new revenue stream. Across the board, when it comes to the cable industry, you have those safe revenues, as you mentioned, from broadband. There's not another alternative to receive internet beyond these folks. But, when it comes to continued growth, there's certainly a lot of threats there.
Kline: Yes. Charter should have been doing all that. The reality is, they haven't been doing all that, and it's almost too late. It's a very nice business model that has recurring revenue, but eventually, they'll be an alternative to broadband, too. And then it becomes, why is there any reason to use this company that has a reputation for not treating people that well? I think that's fair to say of the whole cable industry. So, it might take 10 years, it might take 20, but their entire business could be under threat.
Sciple: Yeah. We'll have to see how this industry evolves when it comes to cable. Clearly, as distribution methods change, that's certainly a threat to these established players.
My pumpkin stock is Uber. A lot of folks might say, "Hey, this stock has already sold off 25% this year, why do you think it's going to turn into a pumpkin?" Well, their lockup expires from their IPO on Nov. 6. About 65% of its float is currently outstanding. However, VCs and sovereign wealth funds hold about 38% of its shares. 13% of those belong to SoftBank. 8% of those belong to Benchmark, its primary venture capital investor. Obviously, as that lockup expires, we're going to see some selling of those folks as they want to take some profits on their VC investment. At least Benchmark. I don't know if SoftBank is showing a profit at this time. That's really going to increase the float.
But then, looking at even longer-term, I think the economics of this business -- which has been well-documented -- are really questionable. This company has never shown operating cash flow. That means that this company is completely dependent on the public markets for its continued existence. They're burning cash in excess of $10 billion per year. We mentioned the monopoly power that these cable companies have. That was a big thesis of Uber as it was scaling up, "We're going to take over all these markets and become the dominant player so we can control the market." However, that's failed repeatedly overseas. They burned a ton of cash and were unable to capture those markets.
There's been some more promise from the company and from observers that maybe food delivery, maybe Uber Eats, will drive some profits to the business. Well, we saw this past week with Grubhub's earnings that maybe that's not quite going to materialize. Grubhub sold off 40%. Management of Grubhub has said U.S. delivery coverage has now been commoditized, and now, with non-partnered restaurant delivery becoming more prevalent, the supply side of the business is going to be commoditized as well.
Noted short-seller Jim Chanos, who is short Grubhub, said this a couple of months ago: "Grubhub competing against Uber is like being locked in a cage with a psychopath with an axe." That's pretty appropriate for Halloween, and it's pretty appropriate to the amount of cash that Uber needs to burn to claim these markets.
Dan, what do you think about Uber's chances to not turn into a pumpkin?
Kline: Uber set up a business model where they undercut pricing -- and I've talked about this many times -- they undercut taxi pricing by dramatically too much. They've built up this expectation with consumers that it's going to cost you much less to use an Uber. That makes absolutely no sense. They could have been 15% cheaper than taxis and 100% more convenient, and the model would work. What I don't see this company doing is raising prices. If your business model doesn't work, but there's heavy demand for what you're selling, you need to rightsize with pricing. They've tried surge prices, they've tried other things. But in general, they are selling $20 bills for, I don't know, $12. It doesn't make any sense. I am very negative on this company. I'm very negative on the industry. And I'm very negative on food delivery for the same reason you talked about. There's like 10 people I can get food delivered from, and half of them send me free coupons during the day. And yes, that will motivate my behavior in that moment, but I can get some restaurants from six different places. I'm always going to look for the best and cheapest option. And they've created that habit, and it's very hard to pull back from that.
Sciple: Yeah, I agree with you, Dan. From my point of view, I almost think the food delivery market is less attractive than ridesharing. Ridesharing, you have an ability to raise prices for the consumer. But when it comes to food delivery, these restaurants are already at razor-thin margins. There's a limit to how much you can lean on these folks and how much profit you can squeeze out of them. So, yeah, the fundamental economics of the business require a person to be in a car, driving people around or delivering food. That doesn't scale in the way that software does, which a lot of these folks wants you to believe with a "tech" company like Uber.
Another thing to point out here. When it comes to the cash burn this company has had, it's been well-documented the way drivers are paid and treated on this platform. When you account for the wear and tear on your vehicle, driving it around, these folks are making less than minimum wage. When you arguably are exploiting your workers, and you still cannot turn a positive cash flow, it just boggles my mind how this company scales and becomes profitable and justifies their near $50 billion valuation today. I think it has a lot further to fall.
Kline: Yeah, and the question is, where's all this money going? Uber is still spending a lot on marketing. Do you know anyone who doesn't know what Uber is? What they aren't doing a great job with is education. My mother takes an Uber if I order one for her, but she's not comfortable using it. They don't have to market to her. They actually have to teach her how simple it is to use the platform. They're making things easier for drivers, that's great, giving them better access to their money, but they're not expanding their customer base. And even if they do, they'll just lose more money, because it doesn't cost enough.
Sciple: Alright, Dan, enough beating up on Uber. Let's talk about our zombie stocks now. What are zombie stocks? Zombie stocks are stocks that we think can come back from the dead. Dan, what do you have?
Kline: I'm cheating a little bit because this isn't a dead stock, but it's in a space where a lot of companies are dead. Macy's has basically had its price cut in half in the past year, from about $30 to $15. It's one of those on-the-precipice companies. Is it going to be a "victim of the retail apocalypse"? Or, is it going to survive? But when you look at the companies that have turned the corner -- Best Buy, Walmart, Target -- the commonality is that they all invested in omnichannel. While you may not feel that way about Macy's, Macy's is shipping individual orders from stores, they have some interesting checkout technology, buy online pick up in store. They've made all those investments. And generally, people do want to see clothes. They want to try them on.
I'm not 1,000% sure that Macy's is going to make it, but I do think they're in a pretty good position that will be enhanced by other department stores, other retailers, going out of business. Again, I'm not buying a suit online. I'm going to go to Macy's and try it on.
Sciple: Dan, we've talked about Macy's pushing into omnichannel. I think another one of the areas that they've tried to experiment a little bit is with this Macy's Backstage concept, similar to a TJ Maxx. They've also pushed into resale. They have a partnership with thredUP. When you look at what Macy's is doing in this off-price segment of the market, how optimistic are you that that can show some real promise for the business?
Kline: I'm fairly optimistic. They're moving in the direction that customers are actually in. Again, there's no guarantee that any of these things connect. We've seen partnerships between digital and physical brands fail. But Macy's is taking one of those, let's look at everything that works and throw it at the wall. Walmart did that. I recognize Macy's and Walmart are very different price points, but that strategy lets you figure out what's going to work, and then you can double down on your investments and go from there.
Sciple: Alright, Dan, my zombie stock -- and this might be a little controversial, you might have some thoughts here -- is GameStop, ticker GME. This is a stock that's probably been left for dead a little bit. Shares are down 57% year to date. Most recent quarter comp store sales down 10.3%. That was driven in large part by hardware sales, down 41.1%. Pre-owned hardware and software also down 17.5%. Had to take a massive goodwill writedown. When I list all those things out, it doesn't sound like this company has much chance to come back from the dead. However, I do think there are some positive signs that show this company has more life to it than maybe the market is giving.
First off, this downturn in sales is pretty typical for GameStop when it comes to the console cycle. The Xbox One and the PlayStation 4 are both well toward the end of their useful lives. Next year, Christmas 2020, we will see the introduction of next-generation consoles. That explains part of the downturn in console sales. A lot of GameStop's business in the past has been driven by its used games business. There had been some concern that, with the push toward digitalization, we may see hardware, discs, completely go away. However, we've seen both Xbox and PlayStation announce they're going to have physical media for their next cycle.
They brought in a new CEO who has a plan to turn the company around and has pushed really hard for cost improvements. When he first came on, they had expected to have $100 million in cost savings. However, they've projected that out to be in excess of $200 million.
Another concern around this company has been, this is the next Radio Shack, this is the next Best Buy, this is one of these companies that there's not a reason for anymore. Maybe Best Buy is not that great of an example because the stock has done so well. But, maybe the next Radio Shack. However, there's not a bankruptcy coming anytime soon for GameStop, at least in my estimation. The company is projecting for $225 million to $250 million in adjusted free cash flow this quarter. They're paying down their debt. They actually have an enterprise-value-to-free-cash-flow [ratio] of under 3. Really cheap relative to their market cap. And they have $230 million left on a repurchase authorization. Michael Burry of The Big Short fame has been pushing really hard for them to repurchase shares.
So, when you see this new console cycle ramping up next year, you see the company cutting costs in a meaningful way, you see this new management team driving a turnaround plan that, whether it works or not, the finances of this company are strong enough to support a valuation above where they're at today.
Dan, I know you might have some thoughts that are contrary to that. What do you think about GameStop?
Kline: Yeah, this is sort of masking a slow decline. Yes, I think they have one more heyday. They're going to get a bump in sales when the new consoles come out. Probably not as high a bump as in the past, because more will sell direct or through other channels. But I see software sales -- and yes, there'll still be physical disks, but the reality is, I almost never buy a physical disc. I download games. My son downloads games. It's still slow. It's not quite there yet. But fundamentally, you also have to realize, GameStops are mall-driven or strip-mall-driven. You're going to see a shaking out in the United States of malls, where upscale malls succeed, and bigger lifestyle centers that have entertainment succeed, but the smaller, the B and C malls, are going to close. Some of the strip centers that GameStop is in are going to suffer from vacancies, and that's not going to drive traffic.
So, do I believe this company can survive, in the way that there's always a sad toy store at the mall? Yeah, I guess it can survive. But I don't see it thriving unless it really figures out a different niche of what to sell and how to engage people with its stores.
Sciple: Yeah, to your point, Dan, some folks in the past have talked about maybe pushing into e-sports sorts of things, and driving folks there. But there is some limited square footage when it comes to GameStop stores. Another thing to your point as well, they are well over-stored. I want to say they're in the 5,000s of stores across the country. A lot of those are going to need to be closed down. There's a lot of redundancies there that can help them out on costs. Thankfully, a large proportion of their leases are rolling off in the next couple of years. They should hopefully be able to downsize without facing these problems.
However, this is a stock that's left for dead. I think it has a little bit more squeeze left in it. What's the Warren Buffett line? A cigar butt. I think there's probably, as you mentioned, Dan, maybe one more smoke left in this cigar as the next console cycle rolls through. We'll have to see.
Kline: I'll close with, they do have a lot of time to make a change. They're managing their cash very well. This could be a company that's good. Maybe it goes private. It's not going to be a growth story, but it doesn't necessarily have to die. It could be a company that provides a niche, there will still be accessories, there'll be things you sell around gaming. If it can figure out what those products are -- we've talked about Funko products, and I think somewhat, they're over-retailed too, because you can buy them so many places -- but, whether it's T-shirts or collectibles or whatever it is, if GameStop can figure out a mix, they don't have to die. But, I don't think they're going to be super-healthy and growing.
Sciple: We shall see. This next console cycle, I think, will definitely prove it out whether there is continued demand from consumers to buy physical hardware, or whether that full shift to buying software online carries through.
Alright, Dan, I want to move onto our fun part of the show. We're going to do our Mount Rushmore of Halloween candy. Snake draft style. Dan, I'll let you go with the first pick. You're the guest on the show. Let the guests go first.
Kline: I'm going to go with the classic and I'm going to say Skittles. I don't mean sour Skittles. I don't mean any of the new packages of Skittles. I mean classic, red package, the colors don't mean anything, they all taste the same, Skittles. It's one of the better-for-you Halloween snacks. It doesn't melt all that easy. Kind of a classic.
Sciple: Alright, Austin Morgan, what you got?
Morgan: My favorite candy of all time, Reese's Peanut Butter Cup. Not the shaped ones; the classic ones. The shaped ones have too much peanut butter. I know I'm going to get some flak for saying that.
Kline: My wife prefers the shaped ones, I believe the Christmas tree being her favorite of all.
Sciple: Yeah, I was going to say, the Christmas tree and the egg are really the go-to for me, but you sniped me on my first pick, Austin. That's too bad.
I'm going to go with Kit Kat. I think Kit Kat is chronically [underrated]. Easy to share. It's got the crunch. It's got the chocolate. What else could you want? So I'm going to go Kit Kat for my first pick.
Since we're on the snake draft, I get to go coming back again. I'm going to go with the one true M&M, the only M&M you should ever get -- the peanut M&M. It's the best. If you disagree with me, I'm sorry, you're wrong. That's my pick. Austin, what you got for your second pick?
Morgan: 100% agree with that pick. That was my No. 2. I guess we're even. I'm going to go with Twizzlers.
Sciple: You did not snipe me on that one.
Kline: That's a good one! Sadly, as someone who's largely gluten-free, Twizzlers are a no-go.
Sciple: Alright, Dan, you got two in a row. What you got?
Kline: I'm going to go with a candy you either love or hate and say Junior Mints. Maybe not the most popular candy, but a personal favorite. And then I'm going to follow up with one that I can't believe we haven't mentioned yet, because it is the, perhaps, greatest mainstream candy bar. I'm going to say the Milky Way. You've got your nougat, your caramel, your chocolate, all in perfect balance. An excellent candy!
Sciple: Poor man's Snickers in my book. Austin, what you got for No. 3?
Morgan: No. 3, I'm going with Take 5.
Sciple: Good choice!
Kline: [laughs] A vaguely unpopular choice, I would say. Can you even buy a fun-size Take 5?
Morgan: I have no idea. I think so. But, they're delicious. Right up there with Reese's for me.
Kline: Yeah, I would say, chronically underrated candy, Take 5. Another great pick.
Alright, I get two, my two coming back at the end. I'm going to go with, first one, Twix. If you're sensing a trend here with the Kit Kat, I like the crunch, I like the chocolate. You throw a little caramel in there, it really carries it through. Honestly, I'm not as big of a fan of the peanut butter one. Maybe that's a little controversial. But, original Twix. I would say I'm a left Twix guy. I don't know. So, yeah, I'll go with Twix.
And then, for my final pick, this is another one that's chronically underrated -- Hershey's with almonds. The plain Hershey's, I would say, I'm not into it. But when you throw the almonds in there, it is a game-changer, and it becomes one of the top four candies of your Halloween options.
Morgan: You're taking all of my picks!
Sciple: [laughs] Alright, Austin, what you got? Last pick.
Morgan: Let's see... I'm going to go with Whoppers. I like a good bite-sized pack of Whoppers.
Sciple: Alright. [laughs] No thoughts to add there. Dan, bring us home!
Kline: Whoppers was on my just discarded list, and I'm going to give a quick shout out to my favorite candy of all time, the Skor bar. But I'm going to say that no one hands out Skor bars for Halloween, so it can't really make this list. I want to throw out the Nestle's Crunch. Nick, this is in your camp. It's got the chocolate, it's got the crunch. It's maybe a little bit underrated. It melts easily. You get the little fun-sized ones, they're thicker than the regular Crunch, and you've got a top-quality candy there.
Sciple: Very nice! Listeners, if you have a Mount Rushmore of your favorite Halloween candy, let us know. Tweet us @MFIndustryFocus. If you don't like any of these candies, and you get a bunch of them in your kids' Halloween bag and you don't know what to do with them, mail them over here to The Fool. We'll take care of them for you.
Dan, thanks as always for coming on the show! Always love having you on!
Kline: Thanks for having me! That seems like a good way to get poisoned by someone who doesn't like us that much.
Sciple: Oh, that's a bummer! [laughs] As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass! For Dan Kline, I'm Nick Sciple. Thanks for listening and Fool on!