In this episode of Industry Focus: Wildcard, Nick Sciple is joined by Motley Fool contributor Asit Sharma to bring you an update on the blue jeans podcast they did on Nov. 26, 2019. They also discuss how the coronavirus is impacting the retail space. They share some stocks to put on your watch list and much more.

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This video was recorded on November 23, 2020.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. On today's episode, we're updating the story on blue jeans stocks, which we last discussed on our November 26th, 2019 episode. And we'll be taking a look at how the coronavirus is impacting retail. Returning to the podcast, to help me break it all down, is Motley Fool contributor Asit Sharma. Asit, welcome back on the podcast.

Asit Sharma: Thanks a lot, Nick. I'm excited to be back, and of course, this is a podcast, so you can't see, but I'm wearing my favorite pair of blue jeans to talk blue jeans today.

Sciple: We all are, right, it's 2020, I don't know anybody who has dressed up this year. Just to let folks know, we're pre-recording this episode on November 23rd, it's the week of Thanksgiving, so we're recording this a little bit early. And just one extra programming note, there will be no Industry Focus podcast on Thursday because of Thanksgiving. But today, as I said, we're talking a little bit about how coronavirus is impacting retail.

And obviously, everybody has seen the news these past couple of weeks, we've had two vaccine candidates, one from Pfizer, one from Moderna, I believe there was another one that came out today, on Monday, from Oxford. So, lots of great news about it, and folks really positive about this idea that maybe toward the end of next year we can have a vaccine with a wide distribution that's effective. So, Asit, I'm going to ask you a question, we're making assumption here, that's always dangerous, but let's assume everything goes according to plan and we're in a position next year, come Black Friday time, that we've got a widely distributed vaccine and retail is coming back to normal. How is retail impacted, how are things different in, say, 2021 than they were in 2019, even with a vaccine?

Sharma: Yeah, Nick, I'm so curious about this, as everyone is. Bottom-line, we're not going to see an overnight return to the shopping habits that consumers exhibited before the pandemic, but it's going to be a net positive for retail. There's lots of really big retailers that have managed to keep their doors open and, hey, bankrupt retailers, rest in peace. But now there's light at the end of the tunnel, and you know, it's easier to obtain bridge financing if you are a big retailer. With these vaccines that are out, it's much easier to go to your bankers, to the capital markets, and get some debt, because we see consumers viably coming back into stores, maybe by the Spring, Summer. As you say, by this time next year, I expect to see traffic, hopefully, at 75%, 80% of former levels. Now, that's enough with this new e-commerce piece that a lot of retailers have tacked on to make results look almost like they were before the pandemic by this time next year.

This may be slightly [laughs] optimistic, we should never, as you say, assume, but that's, sort of, a big picture that we can hang our hats on when we start looking at investment theses around different major retailers, that things are going to be somewhat back to normal by this time next year.

Sciple: Yeah, one of the things I keep thinking about, whether it's in retail or teachers having to learn how to teach remotely, things like that, is anyone, even if you were a late adopter on e-commerce as a company, or a late adopter on telehealth, or a late adopter on distanced learning, you had to embrace it in a really big way this year, because, you know, that's how you keep the lights on and keep your business running. And I think, going forward, we've seen this massive amount of learning in all these industries, and I think retail is a great example of one. And so, we're going to see some shift moving forward in how businesses think about retail, how consumers think about buying things. And it's hard to predict what it will look like, but I think those companies that are really successful in reaching audiences digitally are going to really have a leg-up.

Sharma: Absolutely. One thing that won't change, consumers are going to keep purchasing. So, as a physically based retailer, how do you shift to just get both parts of that demand puzzle to make sure that whatever traffic is going to come back into stores, and don't forget, we don't want to spend the rest of our [laughs] lives in our houses just in front of our computers, we want to get out and shop some too. So, I think some will be surprised at the amount of foot traffic that goes back into some of these stores, but it may never return completely back to the way it was before.

And that's the charge, if you're the management team of a really robust retailer, how do you get exactly that right mix to most beneficially impact your bottom-line? And we're going to see the best-in-breed retailers solve that puzzle pretty convincingly, I think, by October-November of next year.

Sciple: Yeah. And so, we've got a little bit of a case study on a couple of companies that have been navigating this pandemic this year. As I mentioned off the top of the show, November of last year we did a podcast talking about jeans companies. There were a lot of IPOs. Levi's (NYSE:LEVI) had come to the market, Kontoor Brands had been spun off from VF Corp. How have these jeans companies really -- well, where were they coming into the year and how have they navigated the pandemic so far this year?

Sharma: Yeah. So, interesting, Nick, because this time last year, we were talking about how attractive jeans IPOs and Jean spin offs were, because we had seen some really big flops in the IPO market. Uber had flopped, I think, there were a couple of others that just didn't go so great. And I think a lot of investors and big institutional investors were looking forward to Levi's IPO, that was in March of 2019, so at that point in time, we were discussing a few months of performance from Levi's. The same with Kontoor Brands which was spun-off from parent VF Corp.

And VF Corp, for those of you who don't recognize this company from those two initials, it's the parent corporation for North Face, Timberland, Dickies, and Vans, among other major brands. So, they spun-off their jeans business in May of 2019. And that business consists of two major brands, Wrangler and Lee. So, we'd had a few months of performance from that spin-off as well. And our thesis, Nick, was that, this industry looked pretty good, because it has very stable cash flows, it's not the most exciting business in the world, it's not, [laughs] like, a Software-as-a-Service type of investment, but the industry is growing at a compound annual growth rate of 4% every year, projected to pick up slightly to 5% in the next few years. Now, that's been put on hold a bit [laughs] after COVID-19.

But you know we were excited about the utility, the durability of jeans, even as other fashion trends come and go. And so, we were talking about the strong brand power of Levi's, Wrangler and Lee jeans, and also how appealing these two companies were -- so, ticker symbol KTV for Kontoor Brands. Ticker symbol Levi's for Levi's -- how appealing they were as dividend investments. That's sort of where we left it, both these companies were poised for a good year.

And remind me, Nick, what were we talking about in terms of the strategy for, both, Levi's and Kontoor Brands?

Sciple: Well, so the big thing with Levi's was trying to push into this direct-to-consumer market, trying to really emphasize and expand that Levi's brand going to more of the premium side of the market. VF Corp, the big thing is, that coming out of the spin, there would be a little bit more focus on their brand specifically, maybe push more toward internationalization, broadening their brand as well. They're a little bit less premium brand than Levi's, so going toward the wholesale market.

One last thing I did want to mention, though, to Asit, along those things of what you said, one of the trends that we were talking about is, coming into the year, we've seen this multiyear trend of to the more casual workplace, less suits in the workplace, we didn't predict that everyone would be wearing pajamas every day working from home in 2020.

Sharma: Yes. So, that unfortunately doesn't have one big major company that you can go invest in the pajama market, [laughs] but at some point today -- and I'll be honest, I mean, there've been some days where it might have been early afternoon where I switched [laughs] from pajamas into jeans. So, you know, in terms of the next best investment opportunity, I really like the whole casual trend for, if not khakis, for blue jeans and maybe shorts, I don't know, will become another cycle where we'll hit Spring and Summer in just a few months here. I guess my mind is already on warmer weather. [laughs]

Sciple: For sure. And so, you talk about these brands, there was a little bit of this trend toward casualization, but these stocks got whacked whenever the coronavirus news came down. So, just looking at Kontoor Brands -- and Levi's was down as much as 50%, Kontoor Brands almost down by two-thirds in April. But these companies have snapped back, they're back basically back to even, to where we were a year ago. What's kind of been this trajectory from the market writing them off to now Kontoor just actually reinstated their dividend?

Sharma: Yeah. So, the market took the big advantage that we were talking about last year, and saw what a [laughs] potentially big disadvantage this was going to be during a pandemic. In that, both of these companies rely a lot on jeans that are sold in retail stores. So, while both companies are building up those direct-to-consumer online channels, there're still so many department stores, specialty retail stores, and third-party stores, where you walk in and you buy a pair of Levi's or Wranglers or Lee jeans. In the second quarter of this year, I think, Levi's got hit the hardest in terms of its whole arc, it saw a 62% decline in its second quarter revenue versus the prior year, to just under $500 million. And it generated an operating loss of about $381 million off of that. So, that was, sort of, a red flag signal for Levi's. It halted its share repurchase program, suspended its dividend.

And as for Kontoor Brands, it was a little bit quicker to pull the trigger. So, after its first quarter, it sort of saw what was coming and management halted the dividend at that point. Their worst quarter was also the second quarter. They saw a 43% decline in the revenue to about $349 million, but their operating loss was a little smaller, they lost only $22 million on that versus a profit of $54 million in that prior year quarter.

Now, as the year has gone by, both companies are seeing their sales normalize. Meaning, sales are still down, but they're not down quite as much. And you can, sort of, see in the numbers how customers are slowly coming back into stores, both Levi's and Kontoor Brands are ramping up e-commerce. Levi's third quarter e-commerce sales are up 50%. And I think Kontoor Brands also had a pretty big boost in the third quarter, it was about 43% greater in e-commerce sales versus the last year.

Kontoor Brands has already reinstated its dividend, Levi's says that it's going to reinstate its dividends next year. Kontoor Brands, bear in mind for those of you who own the stock, the new dividend is just $0.40/share every quarter versus $0.56/share before the pandemic, but that's still a 4% yield at current stock price.

And Nick, what's the net result of all of this as these companies have seen sales normalize? As you point out, the stocks which had hit this big valley, they both have recovered really, really strongly just over the past few months and things are looking up again for both retailers.

Sciple: Yeah. So, Jim Gillies actually recommended Kontoor Brands in Hidden Gems Canada over this Summer, and I followed his recommendation, it's performed quite well since July. And really, it just goes back to that thesis that we talked about back in November of 2019, of these being companies that can generate cash flow on a pretty reliable basis, is still intact, these brands are still strong. And if you look at the third quarter, Kontoor Brands revenue was only down 9% year-over-year despite the pandemic. Now, part of that is, they're selling in places like Walmart and Target and things like that, that aren't going to close down, but part of it is that, you know, we wear jeans every single day and these brands are super-strong and folks are super-brand loyal. And so, you know, these are habits that are difficult to break when it comes to purchasing what people wear and that sort of thing.

Sharma: They're so difficult to break, everyone that I've done any kind of business with, colleagues, anything, it's all been from the waist up, Nick, [laughs] during the pandemic, like so many people. You and I recording this episode, looking at each other via a Zoom call, but that hasn't stopped me from buying a new pair of jeans just a few weeks ago. So, yeah, it is something that is a real strength of both of these businesses, just locked-in stable cash flows. We love to upgrade our clothing just a little bit, we like to be comfortable.

Sciple: Absolutely. One of the interesting things that we had talked about before this show on Levi's front, is this idea that they're rolling out a resale program or a reuse program, Asit, can you tell us about that?

Sharma: Yes. So, this is called Levi's SecondHand, and it is basically a re-commerce site. It taps into the idea of circular buying-and-selling. Meaning that a piece of clothing doesn't have a beginning point and an end point, but it can keep being distributed among numerous hands. So, via this site, which Levi's recently launched, you can -- Nick, if you've got a torn-up pair of jeans that no one else would [laughs] want to wear, you can still send that into Levi's. They will give you credit for another pair of jeans for purchase on the site. And there are a ton of nice styles, a really broad selection of basically secondhand jeans.

Now, for certain of us, who are maybe a bit older, this sounds like maybe a so-so proposition, but I want to say that for younger consumers this is hitting just a really great concept, and it's something that Gen Z consumers, millennials are really into, which is the idea of expressing social consciousness through the clothes you wear. Those of us who are older, maybe are used and programmed to buying new clothes every so often, I just mentioned buying a new pair of jeans, but I will say, one of my teens who is 17, loves to go thrifting with his friends and loves the concept of resell, because he feels that that's helping him make something of a more sustainable impact on the environment.

So, I want to read an item from Levi's SecondHand site, they say, if everybody bought one used item this year, instead of buying new, it would save 449 million pounds of waste. There was an article in Vogue which talked about this new site, and they point out that Levi's is the most searched for brand in vintage and secondhand denim markets. So, that's just a tremendous advantage in organic web search, Nick, why wouldn't Levi's want to take advantage of this, because it's not only doing good by the customer and their preference for sustainable clothing, it's also a really great business.

Levi's CMO, or Chief Marketing Officer, Jen Sey says, 60% of Gen Z-ers already purchase secondhand clothes. She says, they love the hunt, they love finding really unique items, and it makes it even better that it's a sustainable choice. Buying a used pair of Levi's saves approximately 80% of the CO2 emissions and 1.5 pounds of waste compared to buying a new pair. As we scale this, that will really start adding up. What will start adding up as well, Nick, is that this is yet another e-commerce site for Levi's, and it's a higher margin business, and it's a business that can just keep feeding on itself with this idea of circular clothing. Maybe that pair of jeans that you sent to Levi's, maybe that's the pair of jeans that I end up buying; I don't know how close our waist size is though, you might be a little bit -- how close are ours? You might be a little skinnier than me. [laughs]

Sciple: Yeah, so this whole resell trend is something that I've been interested in for a long time, and I think it really has a lot of legs for it. You mentioned the ESG side of things, which I think certainly helps make folks feel good about purchasing, things like that. From a business point-of-view, if I can take the same item that I spent X dollars making, and I can resell it three or four times, the margin profile on a per item basis starts to become a little bit more attractive as well. Thirdly, if you create a market for used items, then the purchaser of new item somehow has more liquidity, is going to be buying more, because I can buy a pair of jeans for $150, I can turn them in for $50, take that $50 then go buy back another pair of jeans. So, from an environmental point-of-view, really you know, there's a lot of merit to it there, but also from a from a business point-of-view, you can make more profit per item, because as you resale these items, it's additional revenue to capture, as well as you're creating a scenario where your most loyal purchasers are perhaps going to be purchasing on a little bit higher rates.

So, I think that this whole resale market, whether it's thredUP, or Poshmark, or The RealReal (NASDAQ:REAL), or I think Farfetch is getting into it as well; I think that this trend is really massive. And maybe it gets pulled forward by the pandemic, who knows, because people are more likely to buy resell items during economic downturns. So, you've got this trend that was already in place coming into the year, and then you've got economic conditions that are maybe pushing it forward. I think resell has got a whole lot of legs whether it's for Levi's or for folks all over the place in retail.

Sharma: I think so too, and I think there's going to be so many new investment opportunities created by this trend, it's something that I really want to learn more about, as you and I were chatting before we went on air for this episode, it's intriguing. As I was going through that Levi's site, I was thinking, man! I've got a bunch of older jeans I really don't wear anymore [laughs] in my closet, I could trade those in for credit. So, I might become a customer after we get off air.

I wanted to mention one more thing on sustainability, Nick, and this is -- let's not leave Kontoor Brands out of the picture, although, they're not big into reselling yet. We did talk about their bent to be a lot more sustainable last year. They actually released a set of long-term sustainability goals after we aired our episode last year. And these go beyond normal boilerplate environmental, social governance goals that I've seen put up by a lot of corporations that just seem like goals put out to satisfy [laughs] investors, but don't really put the onus on the company to do anything. They've put these aggressive goals, for example, they want to source 100% sustainable cotton by 2025 in their jeans. They want to save 10 billion liters of water, cumulatively, by 2025, and they've got a number of other ones.

I think Kontoor Brands really will be able to win over some more advocates to its brand as it makes public everything that it's doing to be a sustainable company. And to take this really intense process on the environment, just as Levi's has thought through this, and make it just a lot more friendly. It's not cheap or easy to produce a pair of jeans, there's a lot of water, there's die, there's cotton, there's so much going into that process, but both of these companies are really trying to pull forward the idea of making a sustainable pair of jeans, cutting down the waste, cutting down the emissions. And so, I give plaudits to both of them for the action they're taking.

Sciple: Yeah. The last thing I would say, you know, on the ESG stuff and the resale; I think that that's a really interesting thing to follow. Last thing I would say on these companies too is, you know, what they're doing on the merchandising side, I think, is interesting. So, Kontoor has been pushing the Lee brand into places like Walmart. They have their partnership with Walmart. One thing I found interesting is they've got a collaboration with Rick and Morty, like I'd seen the Wrangler stuff with Rick and Morty. But I went and looked, there's like this Rick and Morty Jean Jacket, and literally all the comments on the post are when is this thing going to get back in stock again, which just says to me that people are very excited about this partnership. I think they also have a partnership with Nordstrom. So, it's interesting to see the different ways they're extending their brand.

And obviously, Levi's is doing that as well. You've seen over the past several years them move into product categories that aren't necessarily jeans, but are in that kind of workwear category. And you hear the Kontoor Brands folks talking about trying to do that with Wrangler and that as well. So, I think there's opportunities to extend the brand. Again, anytime you see a spin-off, you see maybe a little bit more focus on the opportunities within the business. And when you hear management talk, they definitely emphasize that.

I own Kontoor Brands, I thought it was cheap over the Summer. Like I said, Jim Gillies just really, really brought that forward to me. I think there's still opportunity for this business going forward to just produce value for shareholders.

Sharma: Yeah, absolutely. You know, it's a dividend play, first and foremost, that was part of their original investment thesis they put forward to investors in their roadshow before they had their spin-off, but there is definitely some room for earnings expansion in there. And I think it's still -- while it's not as cheap as it was because it's gone back to par, I mean, I think it's trading around $40/share, and this is a stock that had been nearly cut-in-half, it's not expensive either.

And I wanted to point out, you know, both of these companies, Nick, you're absolutely right, they're starting to become really forward-looking at how they interact with customers. Levi's has this new partnership with Kohl's (NYSE:KSS). So, they've got a virtual closet experience on Snapchat, which I hardly know what that means. I mean, I have a sense, to be honest; you know, my kids use Snapchat. But it just shows how forward both companies are in understanding where the market is going, where the buyers are and where you have to go to get in front of the buyers.

Sciple: Yeah, I think one thing that I do think on any of these retail companies today that I think is interesting is just to watch their marketing, because you know, the way different generations respond -- like, the Brett Favre Wrangler ad of throwing the football, is probably not going to work with the demographic that's going to be the primary buyer of Wranglers in 15 years down the line. And so, to see these brands, kind of, evolve their messaging and see how they target some of these audiences, I do think it's really interesting.

Before we move on from Levi's and Kontoor Brands, Asit, any last thoughts, things that investors should be watching with these companies?

Sharma: So, Nick, both of these companies are pretty strong cash flow generators, really the only thing investors need to worry about is just to see the sales levels resume. As I said earlier, it won't happen overnight, but as long as we see some sales progress, getting back to positive year-over-year sales over the next few quarters, the rest you don't have to worry about. The only thing that might throw a little monkey wrench in this is the COVID spikes in cases that we're seeing now. So, potentially there could be another short setback, but with the vaccines on the horizon, definitely by midyear, late next year, as we were saying before, those sales trends will be healthier and the water should be good if you want to dip a toe on either of these tickers.

Sciple: Awesome. And last thing on jeans, the last episode that we did, Asit, November 2019, we talked about Kontoor Brands, we talked about Levi's, we also talked about a third company that's made well, was planning to come public via an IPO, a part of J. Crew, and it's one of these companies that was a victim of the coronavirus.

Sharma: [laughs] Certainly. So, J. Crew was having its own issues before the pandemic, sort of a dying brand in the malls, but it had this really nice property Madewell, it's popular jeans, a high price point, they've got a good e-commerce site, they had their own retail footprint, their own stores. Madewell was, sort of, firing on all cylinders. And after Levi's and Kontoor Brands both coming to market in 2019, so many people were looking to Madewell, and we were too, as the next IPO. But COVID got in the way of that.

J.Crew filed for bankruptcy [laughs] earlier this year, and they dragged down Madewell with them. Now, J. Crew has recently emerged from bankruptcy, they did that in September, but they've got new owners, it's a private equity firm called Anchorage Capital. This private equity firm is now the majority owner of J. Crew. So, they are going to make the ultimate decision on Madewell. For now, they formally pulled that IPO filing in September, so there's no IPO on the horizon. But, Nick, a question you asked me, which I'm curious about. Could Kontoor Brands or Levi's buy Madewell in the future now that it is under the control of a private equity group? Still within the J. Crew umbrella, but the J. Crew management team of old isn't calling the final shots here. What are your thoughts?

Sciple: Yeah. So, I've thought about this some. I think Madewell's approach is interesting, because as we talked about in the last episode, they lean more into the direct-to-consumer part of the channel. They were maybe a little bit earlier into some of this, kind of, resale market that Levi's were talking about. I don't know if they were actually reselling or if it was, you kind of got a credit on your next purchase of Madewell?

I think, for me, if I was Levi's, I would copy Madewell, I wouldn't buy them. I think it'd be cheaper to copy them and try to scale that into your business model than purchase them. But I don't know, what do you think?

Sharma: I think it's definitely a viable purchase for either company, if they want Madewell. And the reason is, because private equity groups are, sort of, ruthless [laughs] they deploy capital ruthlessly, they are no strangers to trimming operations to the bone, but also, they are opportunistic. So, if they see that they can, sort of, increase the internal returns of Madewell and have that be a very attractive brand proposition for a company like Kontoor Brands or Levi's, I don't think they would hesitate to maybe float that.

The other thing we might see is just for this company to have its own IPO again. Maybe in a couple of years it reintroduces itself and finally has that IPO. So, I could see either of those happening, but it's much more likely now that it's in more-or-less private hands than it was before.

Sciple: Yeah. So, all that to say, it is might be a little awhile before we get a chance to invest in Madewell, and just the story of how, if you were shaky coming into this year, coronavirus was really going to nudge you over, just like how -- [laughs] with a lot of different trends we talked about earlier, that this casualization trend or the work-from-home trend or the telemedicine trend, it was a trend that was already there that got pulled forward. The retail company that's teetering on the edge trend was already happening, and it got pulled forward here in 2020, if you will.

Sharma: For sure.

Sciple: So, as we look out into 2021, as we look into, you know, the changing face of retail, do you have a company that's on your radar that you think is interesting that folks should be paying attention to, Asit?

Sharma: I do. And this shouldn't be an unfamiliar company to most listeners, that company is Kohl's Corp, symbol KSS. So, for me, this is a value play. Be careful with this, listeners, don't jump all in, [laughs] but I'm going to pitch it to you. Nick, Kohl's has been one of the retailers that's really gotten beat up in the market this year, and unlike Levi's and Kontoor Brands it really hasn't rebounded completely yet. I think it's still down about 44% year-to-date as of this taping. People associate Kohl's with the store closures that it had and also there's risk in this company going forward, I just mentioned spiking COVID cases, we don't know if there will be another wave of lockdowns over the next month or two, which would hurt Kohl's business. But the thing to remember about this company is that they have really improved their liquidity position since the beginning of the year.

They did that in several ways, one is that they've had fairly decent cash flow this year. They've generated about $910 million of operating cash flow versus just over $1 billion this time last year; that's in the first three quarters of 2020. They've used some of that cash flow to pay down their revolving credit line. They've got total working capital on their book, so this is the excess of current assets versus obligations due in one year of $2.3 billion, and that's almost as much as all the long-term debt on their books of $2.5 billion. So, they're really much better positioned than some other big retailers you've heard about -- [laughs] you know, let's mention J. Crew or JCPenney or Macy's. Kohl's is in a much healthier position.

They actually generated $646 million of free cash flow off of that $900 million-odd of operating cash flow that I mentioned. They've also slimmed down their inventory. This time last year, they were going into the holiday season with $4.9 billion of merchandise inventory, at the end of the third quarter of 2020, they're going into this next holiday season with only $3.6 billion of inventory. Now, in normal times, that would be a horrible signal, [laughs] because you want to have more inventory on-hand each year as you go into the holiday season. But during this pandemic it's actually the opposite is the better case. You want to be slimmer. You don't know exactly what will sell through, so you want to be lean-and-mean with your inventory as you head into the weirdest holiday season ever. I really like this.

And part of the reason that Kohl's working capital is so strong is, because they've allowed themselves to slim down that inventory; that's a big positive. Their gross margin this year has really plunged, it's down about 7% to 30.5%. Investors will see that gross margin creep up quarter after quarter after quarter in 2021. And that is going to generate even higher cash flow, it's going to return the company to profitability as customers come back into stores.

This is a company that's got a lot of negatives hovering over it because of the pandemic, but I think they're going to surprise people. I think this is positioned for 20% to 30% upside in 2021. For those of you who want a, sort of, quantitative explanation of that, I'll keep it simple, the stock is trading for 9X forward one-year earnings, and historically it's traded at 11X forward one-year earnings. So, as things get back to normal, just going to its normalized multiple that's going to be a 20% to 30% gain right there. Forget any earnings increases which could make that picture even more positive.

Finally, on Kohl's, look, they had this really great brand strategy that got shelved during COVID. They had a new partnership with Lands' End that really hasn't gotten off the ground, because consumers haven't been [laughs] going to stores. They have this really exciting new relationship with Levi's that we've talked about, and they also are getting ready to step into the beauty business in a big way. Now, bear in mind that one of the biggest players in the beauty space in retail, which is Macy's, is itself teetering on the edge of bankruptcy. If they go out of business, there are a lot of beauty brands [laughs] who are going to look for a new home in terms of retail space. Kohl's will be a beneficiary of that.

Lastly, they're introducing their own athleisure brand FLX in March. And, Nick, you've talked about athleisure on so many Industry Focus episodes, so you know what a hot trend that is. And that's also going to be beneficial for Kohl's.

Bottom-line, this company was a little late to e-commerce during the pandemic, it hurt their results, but when you just peel the onion a bit, they're still very sound. Great cash flow, great brand. I think they're going to do pretty well next year. Again, this is a little bit of a risky play, so I'm not urging listeners to bet the farm on this, but if you have a slightly aggressive bent, you might want to pick up a few shares.

Now, Nick, [laughs] I'll answer any questions you have, but you've got two really interesting companies as well.

Sciple: Yeah. So, I was going to follow-up on Kohl's. You mentioned the beauty brands; and one thing I thought about, the first thing that jumps to mind for me is, Sephora has a store-in-store deal with JCPenney all over the country, and that's one of their biggest areas where they have an installed base. And you could see Sephora perhaps looking for a different partner at some point the future in the beauty space. And I was just going to ask you, when I think about Kohl's, I think about it being in that category, kind of, along with Macy's and JCPenney. Why are they different?

Sharma: So, Kohl's has been a little more diversified in its offerings in some ways, in that, the brands within brands, when you walk into a Kohl's store, they are more diversified for price point. And I think the other great thing about Kohl's is, they've had strong brand partnerships already. In my local Kohl's, I walk in, I take a left, and there's a whole wall of Levi's jeans. [laughs] I'm talking about Levi's as a stable revenue source this whole time. So, I think it's just had more of that broad strategy.

And the other thing is that it's got a really strong loyalty program. JCPenney actually had a great way of drawing in customers that all got upended over the years in their regular discounts. Kohl's version of that is, of course, Kohl's cash. So, it's held on to its customers during the pandemic. And those customers will be ready to spend again.

Just what they missed, and why the stock went down so much versus, say, a company that's been really good at e-commerce and also sells some clothes, take Target, they just weren't as prepared on the e-commerce front. The downside to Kohl's has been their big retail footprint. So, they do have a lot of big stores in an era where smaller is better. But they've done a pretty good job of moving inventory a little bit closer together, and not having as much inventory in stores, and experimenting with opening up stores, you know, they've got the experiment with Aldi, where you can walk straight into an Aldi [laughs] from a Kohl's. They're innovative and they're creative, so they'll solve that problem about having such a big footprint per store, and some optimistic about them on so many fronts.

Sciple: Awesome. Well, yeah, so as you mentioned, I kind of have two stocks. And for the first one, I think it's interesting and I'll be watching it this year. I own some of it, it is GameStop. I'd point folks back to Jim Gillies' episode that he did with Emily Flippen on GameStop a while back. I'll just, kind of, hit some main points of why it's interesting to me.

The kind of quick-and-dirty thesis is, it just doesn't make sense to me when you've got this new console cycle coming up, which is going to lead the company to produce significant amounts of cash flow. They produced positive operating cash flow in the third quarter in significant amounts, and they've really gotten their inventory under control, which has helped them produce more cash. But you've got this console cycle pulling forward, you've got a company that is -- you know, it seems to be, a lot of folks think it's the new Blockbuster, that it's going to go bankrupt, but they just paid down $125 million of debt early.

If you look at their balance sheet, they've got more cash than debt. And then, again, you've got the console cycle, which we already knew about coming into this year, and then you've also had this significant pull forward in video game playing this year that's also a tailwind for them. I know, myself, I'm playing the new Call of Duty game. I hadn't played Call of Duty in, like, four or five years before this year, but there's just been this huge uptick in videogame playing this year, which will definitely help GameStop as more folks are playing online.

And so, you've got a scenario where the company has got more cash than debt, they're generating significant amounts of cash, and they've got this tailwind from the console cycle and from video game continued adoption this year because of the pandemic. And then you look at the stock, and over 100% of the stock is sold short, over 100% of all the shares outstanding is sold short, OK.

And then if you want to start backing out into the float of the company, you've got earlier this year, Ryan Cohen, Co-Founder of Chewy invested in about 10% of the stock, heap of GameStop stock he now owns through that venture. Wrote a letter a week or two ago talking about, kind of, what he wants GameStop to do, move to more of a digital focused strategy. This is someone who has had success going up against Amazon and e-commerce, taking an active position in the company. Michael Burry from The Big Short, Scion Capital, owns about 2.5% of the stock. We got Permit Capital and Hestia Capital, both long-term owners of the stock, have been activists, this year together own about 5% of the stock. And Donald Foss, CEO of Credit Acceptance Corporation, a billionaire, owns about 5.5% of the stock.

You put all that together, that's another, say, 22% of float that you can say is unlikely to be traded on the market. And so, you know, as a percentage of float, you've got, gosh! Like +100% of the shares available to transact, sold short in an environment where the company has got a lot of tailwinds for it to, you know, print a significant amount of cash.

Obviously, there's worries about these new consoles, Xbox and PlayStation, both have digital-only consoles. Although, it has come out that GameStop is getting a revenue share agreement there from Microsoft; we don't know the exact terms of that, but Microsoft is giving them a little bit of a kickback, which makes sense given GameStop's position in the market, they're pretty much the only specialty retailer in video gaming. And with Microsoft's strategy to move to this Game Pass model, kind of, the Netflix of gaming, installed base is the name of the game. You have to sell the Xbox to be able to sell the Game Pass, and GameStop is a really effective sales channel to do that.

So, it just doesn't make sense to me why this much of the stock is sold short given the catalysts for the company, and so I don't know what the company should be worth, but I think it should be worth more than it is today, and it's up, like, 170% over the past few months, so. And we still have the circumstance with the company, so that's why I find GameStop interesting right now. Even if you don't want to invest in it, because you know, you don't understand why GameStop needs to exist in five years or what have you or the role they're going to play in the market, this is going to be a fun one to watch, because there's activist, there's catalysts, there's lots of short sellers. It should be an interesting story.

Sharma: Yeah, this is going to be so fun. As you said, even if you don't take a position. I hope all those activist-shareholders can agree, if they want to start influencing [laughs] the Board. But, you know, I wanted to say one thing -- and I know you want to move to your next one, so we can move on out of here, but, Nick, the CEO of GameStop, when they announced that strategic partnership with Microsoft with the, you know, they'll get some amount of the Xboxes sold, he was talking a lot about digital and digitization of their revenue streams. There's a lot of hinting there. I'll just read this and then let you move on.

But he said in the press release on that deal, this is an exciting day at GameStop, as we announce the advancement of an important partnership that capitalizes on the power of our operating platform and significant market share in gaming to accelerate our digital transformation, drive incremental revenue streams, and over time further monetize the digital world of gaming. So, he just seems to be, to me, to be throwing out a lot of hints that, yes, they need to move more toward digital revenue streams. And I think that is a positive. There could be some more evolution with that Microsoft relationship that we just don't see at this point.

Sciple: Yeah, it'll be interesting to see what happens with the company. It's worth noting, you know, they are definitely over-stored, I think there's over 5,000 GameStops around the world. But I think two-thirds of their leases, you know, end over the next three years. So, if they want to rationalize their store base, they can do that in a way that makes sense. And obviously, you know, they want to keep those stores around while they've got this console cycle with lots of demand. We'll see where things go.

I think there is a chance for the company to evolve and become something different than it is today. And if it wants to be as big, you know, 10 years from now as it is today, it's going to need to evolve in some way. But in any event, the way the stock is positioned relative to the cash it's about to print, just doesn't make sense to me, but we'll see.

So, you kind of teased the other one that I wanted to bring up. This one is definitely more of a -- well, both of these are risky, but probably for more adventurous investors, less near-term catalysts, but I think The RealReal is really interesting, ticker REAL. I have bought some shares recently.

The RealReal is a digital luxury consignor. So, it's a resale company predominantly focusing on the high-end of the market. Their thesis is that they verify all the items that are resold on their platform. We got a white glove service to really appeal to those, you know, more sophisticated luxury buyers, those sorts of things. So, that positions them a little bit differently relative to companies like Poshmark, that are more do-it-yourself consignment, things like that.

Their take rate in this most recent quarter was 35.4%, which is down a little bit. The company has had some issues this year when it comes to supply. Traditionally, you know, folks would come into the store in New York and in Los Angeles, where they're predominant bases of operation, would come in, do their consignment, those sorts of things; and those were down. But what's interesting with the business is that they've really pushed hard into, kind of, digital consignment and those sorts of things this year, which should position them well going forward, especially when you think about the real barrier to this business is how do you scale verification and all those sorts of things? So, really standing up those digital channels, I think, is important.

The other thing I think is interesting is they just started their opening stores. So, they just opened a store in Chicago, they're opening more smaller retail channels, I believe, in San Francisco and New York City. And so, I really like to see that aggression during the pandemic, going to try to gain market share and go after customers. Their Co-Founder is still the CEO of the company, Julie Wainwright, she owns about 5% of the company. And she has interesting stories, talking about someone who's tenacious and kind of keep fighting, she was the CEO of back in the day, and she's, kind of, made it all the back to be the Founder and CEO of The RealReal, so just to have -- I mean, there's a lot of people that'll be like, oh, man!, and they would just, kind of, go off into obscurity. She started this whole new business and is one of the leaders at the forefront of this kind of resale market.

They just announced a partnership with Gucci, where they're going to help Gucci facilitate this, kind of, resale cycle, do more, kind of, environmentally focused things, help them manage their brand. That's interesting, because they've been involved in some litigation with Chanel going back to last year. Chanel saying, you know, only we can verify Chanel products, things like that. There are some rumblings that, maybe that's because Chanel is invested in Farfetch, which also has a resale side to its business.

But you see these partnerships with Gucci, you see them standing up these digital channels to help with their supply problem, we're going into this next year where things should open back up, and I am just really confident in this resale trend moving forward. It's just generationally it's something that a lot of folks, you know, in the Gen Z and millennial demographic are much more embracing.

You see this idea where we're like we want to get access to brands, like, in an affordable way through resale. And then if we're not going to buy brands, we're just going to buy private labels. And that seems to be, kind of, the pattern that folks follow. So, I'm really excited about this trend, and I think The RealReal, the way they've positioned themselves through the pandemic, continuing to open stores, scaling up their digital, is really going to pay dividends over the next few years. So, I think it's a good one to watch and maybe take a small position in. Because it's a $1 billion company today, you look at how big this resell market could be going forward, and there's a whole lot of runway.

Sharma: Well, it's certainly on my radar screen now, Nick. I had been a little familiar with this company. I like everything that you've said about it, especially the fact that it's selectively opening stores; that's always a good sign, if you're able to do that. You know, retail isn't really dead, [laughs] and this might be the best time to start opening up some stores in advance of next year. So, I'm definitely going to follow this story in 2021.

Sciple: Yeah, it's going to be exciting. And, you know, the whole resell market I think is one that folks should certainly watch moving into the next year. Asit, so we're pre-recording this on Monday. This episode is going to go out on Wednesday. It's Thanksgiving on Thursday. Any big plans for the holiday?

Sharma: We are taking it easy, Nick, my folks are local, so they're going to come over just for a piece of socially distanced pie [laughs] on our deck and then they're going to head back, and then we're going to cook at home, my family. Nothing too spectacular this year, but hopefully next year will be a little bit more of a traditional Thanksgiving. What about you?

Sciple: Yeah, same thing for us, we're just going to get a honey baked ham, and like, make some slice, my fiance and me and the dog, and all that sort of thing. I'm taking a few days off from work just to, kind of, get a little rest and relaxation. But, you know, I'm always thankful to get a little bit of, you know, good food and a little bit of time-off. And so, I'm not complaining too much.

Sharma: Yeah, same here. I hope everyone has a really wonderful Thanksgiving.

Sciple: Asit, always love having you on the podcast, once again.

Sharma: Thanks so much for asking me, Nick, this was a blast.


Sciple: Hey, everybody, just a quick programming note for the podcast. With U.S. Thanksgiving falling on this Thursday, there will be no podcast on Thursday or Friday this week, as Dylan and I take a little bit of time off to spend with our families. The podcast will return, however, as regularly scheduled on Monday with Jason Moser and the financials team.

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 Anne Franks for mixing the show. For Asit Sharma, I'm Nick Sciple. Happy Thanksgiving! Thanks for listening, and Fool on!

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.