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Buying Profits, Buying Trouble, Buying Pizza

By Chris Hill - Nov 11, 2019 at 2:00AM

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The quarterly reports of CVS, Capri, and Papa John’s all had some interesting subtexts for savvy investors.

There are right ways to do acquisitions, and there are wrong ways. For an example of the first, look to CVS Health ( CVS -3.22% ), which reported this week that third-quarter profits were up 10%, thanks largely to last November's deal for health insurer Aetna. And what's coming next may be more interesting. For an example of the latter, it's possible one could look to Capri Holdings ( CPRI -1.68% ), the luxury-brands giant behind Michael Kors, Jimmy Choo, and Versace. It delivered an uninspiring quarterly report this week, and those famous names it purchased aren't making its bottom line look fabulous.

But let's pivot to paying the piper, which pizza purveyor Papa John's ( PZZA -3.40% ) has tried hard to do. Based on its latest same-store-sales results, customers may be starting to accept that it's not the same company it was under founder John Schnatter -- and it's about to become even less that company, with big C-suite changes coming.

In this MarketFoolery podcast, host Chris Hill and Motley Fool senior analyst Abi Malin discuss the positives and negatives of each of these companies, the growth paths available to them, whether investors ought to have the stocks on their short lists, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Nov. 6, 2019.

Chris Hill: It's Wednesday, Nov. 6. Welcome to MarketFoolery! I'm Chris Hill. With me in studio today, Abi Malin in the house. Thanks for being here!

Abi Malin: Thanks for having me!

Hill: We've got health earnings. We've got luxury fashion earnings. But we're going to start with something that I think is good 99% of the time, and that's pizza. Papa John's, specifically, today. Shares of Papa John's up more than 5% because same-store sales in the third quarter were up 1%. That's a tiny amount, but that's the first time in two years they've had positive comps. So, yes, it's a low bar, but Papa John's cleared it.

Malin: Expectations were that they were supposed to be down about 0.6%. So, exceeding expectations, and actually reversing a trend, which is always going to be very positive news for them.

Hill: So, you've got Rob Lynch, who's been the CEO since August. He basically just got there. I'm assuming this is part of why the stock is moving up today -- Rob Lynch basically announced a shake-up of the management team. You've got a longtime CFO who's going to be leaving in the next couple of months. Chief marketing officer, chief operating officer, they're all leaving. And Lynch is basically bringing in his own team, and is saying, "Papa John's needs to focus on quality." I don't know. This seems interesting to me in the way that 10 years ago, Patrick Doyle, when he became CEO of Domino's Pizza came out and said, "Yeah, we have to make our pizza better." It seems like it's potentially that type of moment for Papa John's.

Malin: It is. I mean, it's interesting. It's really been a turbulent story ever since their former founder and former CEO, John Schnatter drove the brand's image really into the ground with those super controversial comments. Then they appointed Steve Ritchie, who'd held the position for about a year and a half. The interesting thing about Ritchie was that he had actually worked his way up through all of the ranks of Papa John's, and really had been there since the beginning, was an insider. He actually owned 27 franchise stores within that Midwest region. Now they've brought in this outsider, Rob Lynch, who was previously the president of Arby's, as well as various leadership positions at Procter & Gamble and Taco Bell. I think they're recognizing that a change needs to be made here. And I think it's positive. Something's not going well in this business, for sure. I still don't know that this is an attractive investment. Even within delivery, fast food pizza, I don't necessarily think this is the company I would buy.

Hill: See, that's what I was going to ask you about. Year to date, shares of Papa John's are up about 50%. Maybe it's trading at a rich valuation. I don't know, though. It's still less than a $2 billion company. I'd be remiss if I didn't mention, Shaquille O'Neal, on the board of directors. I don't know! I'll just put it this way -- it wouldn't surprise me if three years from now, we looked back and said, "Oh, yeah, when Lynch came in the door, cleaned out the management team, replaced them and said, 'We have to focus on quality,' that was the time to buy the stock."

Malin: Yeah, I think that's a fair assessment. My thing is, I would never want to pay a premium for what's essentially a turnaround story. I think that's what we're seeing with the stock right now.

Hill: CVS Health, third quarter profits rose 10%. The part of CVS Health that's getting the credit for that is Aetna Insurance. A November 2018 is when CVS Health closed the deal on Aetna. Shares of CVS up a little bit today. This seems like one more brick in the wall of CVS transforming itself from mom and pop drug store to a full-fledged health behemoth.

Malin: If we go back, it was November 2018 that they acquired Aetna. I think that was an interesting acquisition for them. CEO Larry Merlo, he's really begun testing medical services inside the chains, more than 9,900 locations. They have an explicit goal of reducing a patient need for hospital outpatient services. Funneling those Aetna-insured patients to CVS pharmacies and retail clinics. I think healthcare obviously needs an overhaul. So I think it's an interesting strategy. I think it's a powerful cycle that they have going. I just continue to be amazed by this business, actually.

Hill: So, you look at, in the wake of the Aetna acquisition, go back 10 years or so, CVS is starting to introduce these MinuteClinics in some of their locations. Now, they've got this HealthHUB format. They only have it in a few locations. They said they're going to remodel somewhere in the neighborhood of 1,500 locations with this HealthHUB format to offer more health services. It basically sounds like a MinuteClinic on steroids. They're not really disclosing the financials of how these have gone, but I'm assuming they're pretty attractive if they're going from, "We've tested a few" to "We want to roll out 1,500."

Malin: Yeah. I think at the J.P. Morgan Healthcare Conference this year, their CEO made a comment that they have the potential to allocate up to 20% of existing space to healthcare services, offerings, by scaling back on underperforming categories and products while scaling up in new categories, primarily those health services that you were mentioning.

Hill: This is a business that's performing well. When you look at this stock, do you think it looks expensive?

Malin: Good question! I think companies like this demand a premium for a justified reason. This is a very steady business, a pretty predictable business. It continues to gain strength as they go on. That was a very strategic and notably very large acquisition for them that's going well. It's certainly not cheap, but I do think it's a justified premium.

Hill: This also comes on a day when there are reports that Walgreens is considering going private. They're not commenting on it, but there are multiple reports out there that they've been meeting with private equity firms. It's pretty amazing when you think about, even just five years ago, you could look at the basic footprint of the average CVS, the average Walgreens, the average Rite Aid, and you could just say, "They're basically the same." But the divergent paths that the businesses have taken are pretty remarkable. 

Malin: Right, definitely. 

Hill: Let's wrap up with Capri Holdings. Not a household name, even though the brands underneath the Capri Holdings umbrella are household names -- Michael Kors, Jimmy Choo, Versace. Second quarter profits came in low. Overall sales seemed to be in line with expectations. We were talking right before we started recording here, holy cow, the name change -- it used to just be Michael Kors -- the name change to Capri Holdings has done nothing to help this business.

Malin: Yeah, I'm actually not sure if it was better or worse it then Coach's name change to Tapestry. Equivalently poor decisions on the management side there.

Hill: [laughs] Whatever you think of the names, I understand at least the rationale of, we've got multiple brands, and sometimes we report earnings, and one of our brands doesn't do well, and that's dragging things down, particularly if it's the namesake brand. So, I understand the rationale. But, unless you actually are performing well in the underlying businesses, then it really just looks like you're rearranging deck chairs on the Titanic.

Malin: Definitely. I would agree with that.

Hill: I guess the best thing I could say about Capri Holdings right now is, the stock hit an all-time low in August, and it's up from that. What do they do here? Two questions, take them in whatever order you want. What do they do here, and why is this so hard? Why is this particular brand of retail so hard to get right? It's not like Tapestry's stock is lighting the world on fire, either.

Malin: Right. You mentioned they own Versace. They bought that in December of 2018. This year, they're expecting flat to comparables same-store sales year over year. I feel like, obviously, they weren't buying that as a growth engine. You're buying that on the back end so you get a little bit of efficiency by owning multiple brands. Probably looking at an LVMH or a Caring Group model. I think the difference is, obviously, fashion is hard to invest in, particularly luxury fashion, because it tends to change with tides. If two out of three of your brands are out of favor -- that would be Versace and Michael Kors is struggling, as well, down 4.2% year over year on revenue, which is in line with expectations. Probably gets to why they changed that namesake. Jimmy Choo is actually a pretty strong brand. Also an acquisition for them. But, not profitable business segment for them. 

I think they're probably looking to become sort of that LVMH or Caring Group that has a flywheel of multitudes of brands that come in and out of favor at different times. I think it is worth noting, LVMH partnered with Rihanna in May, I believe, to launch her fashion line called Fenty. And then they also have recently, within the past month or so, made a bid, or are rumored to be in talks to acquire Tiffany's. So there is something to this rolling up luxury fashion houses. This one is just struggling really hard, and it's hard to see the pathway out here.

Hill: Do you imagine there are any discussions at Capri Holdings -- or Tapestry, for that matter -- of spinning off one of the brands? Selling it outright? Just as a way to raise some money and focus on, maybe, brands that you feel like you can do well with? I don't know, just, knowing very little about fashion, even I know that Jimmy Choo is a respected brand when it comes to luxury footwear. So, it seems like someone would pay some amount of money for that brand. And if that's the one that's a respected brand and it's actually not profitable for them, then maybe the move there is sell off Jimmy Choo so you can focus on brands that maybe you have a chance with.

Malin: Interesting thought. If I was their strategic management sitting around the table, I feel like that's the one that's lifting the group up in terms of clout, which matters a lot in luxury fashion. So, I don't know that, unless you're trying to make a portfolio of lesser desirable fashion names... I don't know that I would get rid of the one that's like your life raft. But, I think this is an interesting time to be Capri Holdings. I don't really know what management's path out here is. How do you turn this around?

Hill: In terms of the stock -- and we can wrap up here -- you look at both Tapestry and Capri Holdings. In the case of Capri Holdings, it's close to an all-time low. Tapestry's close to a five-year low. Do either of them look like value opportunities to you? Or are there just so many questions and so many challenges that they're both facing, in part because these are global brands and you're dealing with international politics, among others? Does either stock interest you?

Malin: Fair question, given that they are -- again, we're talking about turnarounds here. You're hoping that things get better. I personally don't invest that way unless I see a pretty clear path, and I don't see the impetus on the horizon of the catalyst. Even at a very low likelihood, I don't really know what it is for either of these brands. So, I would not invest in either of these, personally.

Hill: Here's hoping for their shareholders that they have a really great holiday season and there are a lot of Jimmy Choos under a lot of different Christmas trees. Abi Malin, thanks for being here!

Malin: Thanks for having me!

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'll do it for this edition of MarketFoolery! This show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Capri Holdings Limited Stock Quote
Capri Holdings Limited
$59.22 (-1.68%) $-1.01
CVS Health Corporation Stock Quote
CVS Health Corporation
$89.06 (-3.22%) $-2.96
Papa John's International, Inc. Stock Quote
Papa John's International, Inc.
$121.92 (-3.40%) $-4.29

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