Earnings Roundup: Chegg, CVS Health, and iRobot

CVS Health (CVS -1.07%) hits a two-year high after first-quarter profits and revenue are higher than expected. iRobot (IRBT -0.73%) takes a hit due to the rising cost of components. In this episode of MarketFoolery, Motley Fool analyst Asit Sharma, with host Chris Hill, analyzes those stories and weighs in on the latest results from online education company Chegg (CHGG -0.29%). 

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This video was recorded on May 4, 2021.

Chris Hill: It's Tuesday, May 4th. Welcome to MarketFoolery. I'm Chris Hill. With me today, Mr. Asit Sharma. Good to see you.

Asit Sharma: Good to see you, Chris. So happy to be back on MarketFoolery.

Hill: We've got tech for education. We've got tech for your home, but we're going to start today with consumer health earnings. Shares of CVS Health are hitting a two-year high this morning. First quarter profits and revenue came in higher than expected. Traffic is up at the stores. They raised guidance for the full fiscal year. I should point out that Karen Lynch became the CEO back in February. I think for investors, the Lynch era appears to be off to a good start.

Sharma: There is nothing like a good earnings report to give you some momentum when you take over the helm of such a big company like this. Good for Karen Lynch and good on Karen Lynch. I mean, these are nice results. I was impressed. Chris, as you point out, the company had really nice both revenue and earnings growth, really well divided between healthcare sales up 6.7%. Pharmacy, those revenues were up 3.8%, and retail, a little bit slower, 2.3% revenue growth. But these three big cylinders, which is a bad metaphor because have you ever heard of a three cylinder engine. I don't think so. At any rate, on these fronts, hitting their stride in each of these big buckets. It sort of is proving the value proposition from the big acquisition a few years ago of acquiring Aetna Healthcare, which now is the benefits portion of this business. I think they had probably the strongest results. The only question in my mind, you mentioned they're at an all-time high and I was curious about your thoughts on this. We can talk a little bit more about the numbers, is there's been a volatile stock, hasn't it, Chris? It's up and down. I know they are up today and that's great. I saw the markets a little bit down today, but CVS Health has had trouble just gaining traction. It seems like their peak and valley stock for the last, I don't know, three years or so.

Hill: Yeah. This is definitely one of those businesses that the longer you hold it, and I suppose there are a lot of businesses like that, the longer you've owned the stock, the better you feel. But this is a stock that is at a two-year high. It is still well below where it was, say in 2015. I talked about Karen Lynch taking over the helm back in February. I feel like there's still a lot of room to run for this business if they can pull all the correct levers. Because this is a business that really doubled down on health a decade ago when they made the decision to stop selling tobacco products. When that happened, the stock sold off about 5% that day because tobacco products counted for a couple of billion dollars worth of revenue for them.

But you look at the investments they make in a Minute Clinic, all of the service side of healthcare, I think they're going about it the right way. I think it also helps that at least in terms of drugstores, as we think about them in the United States, they're really the best-in-class. It'll be interesting to see what Roz Brewer does since she recently took over the corner office at Walgreens after all the great work she did at Starbucks. I wouldn't bet against Roz Brewer, but I think there are a lot of built-in advantages that CVS Health has relative to others in their industry.

Sharma: Yeah, I agree totally. I think that they made an absolutely gutsy decision a few years ago on tobacco products. But you look at them today, and if you're a shareholder as Chris says, you got to be happy. I'm just skimming through some of these big picture numbers. Revenue, nice increase for the quarter to about $69 billion. That's with a "b" over about $66.8 billion in the year-ago period. Operating income has a nice little bump up from about $3.5 billion to $3.6 billion. Net income, the same $2.2 billion. I think what's important for shareholders is cash flow, really great operating cash flow from this company. This is one of the things I think is part of the thesis. You wait for the company to start this momentum in all three segments and those operating cash flows are going to grow. This $2.9 billion is actually a little bit reduced from the year-ago period which was $3.3 billion but my point is a larger one. Now I think it's a dividend play. As you point out, this feels like a stock that's been down for a while, but has the thesis coming together.

For those of you who have this long term view, you're investing partially for a dividend and partially to see that stock chart maybe start to normalize a bit as investors recognize that the three of these big ideas together, the benefits portion, the pharmacy and that retail portion which Chris, I think you also alluded to this. They have a really nice corner placement that Walgreens always try to do all over the U.S. so I think they're well positioned for this comeback in the consumer getting out of the house and going to the corner pharmacy, not just for the pharmaceutical prescription, but just to pick up the small stuff, even food items. I think this is maybe a company that's been overlooked simply because it's so big, but I really love the cash flows, I love the steady net income and revenue growth. I think maybe more people should pay attention to this one.

Hill: The rise of the machines is taking a bit of a hit this morning. Shares of iRobot fell 13% despite the fact that first-quarter profits were much higher than expected. iRobot is the company that makes the Roomba vacuum. On the surface, this looks like a good quarter. What is going on with the stock? Is this guidance? Is this the cost of components going up?

Sharma: Yes, it is. It's both of those, Chris. It's about pricing power. But before I answer your question, let me just second you on this strong quarter. A few years ago, I was writing about iRobot and I think even early last year on our live show for Motley Fool subscribers, I was talking about penetration into Japan, which is such a gadget centric country, even more so than we are here. They had a great quarter in Japan, revenues up 53% in the U.S., revenue grew 40% year-over-year, 74% in Europe. They have certainly benefited from the pandemic. They've benefited from leaning more on a direct-to-consumer model as well. This looked like a great quarter. In fact, the company raised its revenue guidance. But in doing so, they held their profit guidance, operating income guidance, and earnings per share guidance steady. Let's just think through that again. Revenues are getting higher, but profit isn't changing. That's because of what you mentioned. It's rising material costs. We forgot during the pandemic that there had been a tariff war going on between the U.S. and China. To some extent, manufacturers had absorbed that.

We all know that inflation is rising so different inputs into these devices that iRobot builds the Roomba and their whole line, those are subject to commodity inflation. Then on top of that, you have this chip shortage that we're all starting to hear about. The worldwide supply of semiconductor chips, that whole supply chain is really creaky just now because so many companies pulled back on ordering chips and decided that because the pandemic was indefinite, they would hold back. As a result, now everyone wants chips all at once in every industry. When you're making smart robots, you need chips and that's part of it. What investors basically are saying is we're concerned that all this pricing power we saw during the pandemic is now going to be a victim to inflation, to chip shortages, to higher steel costs. All of that together has investors reevaluating the stock. Chris, it didn't look so bad last night when you were chatting, but I checked this morning and iRobot stock was down about 14%. What are your thoughts on this big picture?

Hill: A couple of thoughts. One is, I forget where I heard this, but I heard someone make a comment in the financial media about the chip shortage. It was something to the effect of, I think some companies are going to use this as an excuse. I just thought, I don't see how that's going to work. I don't see how companies are going to effectively make the case that the chip shortage is hurting them if in fact it is not. This is one of those companies that I look at and I say, yeah, it totally makes sense to me that if iRobot, given their line of work, when they're talking about the rising cost of components, where they are talking about the chip shortage, yeah, it totally makes it.

This is not one of those things where, sometimes you will see it where some businesses will blame the weather for bad results, and it's like, I don't think that actually is why your results were bad. That's one thought I have about the chip shortage. The other is, this is the go-to name in this space. I feel like that's one of those advantages that doesn't necessarily show up on the balance sheet. I know there are other companies that make these types of devices, but I'm sure that, and I know from conversations I've had with analysts like you, is that when talking about those others, when it gets explained to someone like me who is not as deep into the industry as as you guys get, it gets explained just like, they're like an iRobot. We can go back to CVS for a second here too. One way to look at investing, and looking at your own portfolio is, or what are the industries I want exposure in. There are a lot of different ways to look at your portfolio in terms of how it is constructed. You can look at a business like CVS Health, and look at your own portfolio and say, I don't really have a lot of exposure to consumer health.

Maybe this is one of those stocks I should consider if I'm going to construct my portfolio that way. I think iRobot is one of those businesses in terms of robotics, particularly as they relate to consumers. I'm sure there's a drown company out there that is just going to crush it over the next 20 years. I don't know which one it is. But to me, iRobot is one of those businesses that I think is a lot easier for a lot of people, myself included, to wrap their head around, where it's like OK, I get why someone would want some of these devices in their home.

Sharma: Yeah, for sure. I will say it like this, really a standpoint there. My wife and I were chatting just the other day. We don't have any kind of robotic device. We do have a robotic device, because when I sweep the floor, and we've got a vacuum cleaner for our kitchen, and I also sweep our floor, I feel very robotic because I'm [laughs] doing, it seems like all the time I'm in robotic mode. But in terms of a real robot, when we were discussing it, we didn't say, hey, we need one of those automated floor sweeper slash vacuum devices. We said, we need a Roomba. We're thinking of going in for one. This is the difference. They have the brand power. As I was referring to before, if you can make it in Japan with your brand, that shows that as an electronics device, you've got a lot of potential all over the globe. This is something we should remember about iRobot.

The argument has been made for a long time that this is a commodity business and its numerous competitors will undercut it. But they've displayed a lot of pricing power. Of course up until today, there are more external factors. I'm not going out and recommending that people pile on to iRobot, but I am saying that if you like the company, if you liked it before, and you see the haircut it's got today, and you understand that large brand, and how financially sound it's been, as it's built its business. This might be a time to nibble on some shares.

Hill: Last thing I'll add is that, to go back to the chip shortage. This is a real challenge for a lot of companies across a lot of industries. We're talking about iRobot. If you don't own shares of iRobot, as I'm guessing the majority of people listening right now don't, hey, use this as an opportunity to look at your portfolio and ask the question, how exposed are the companies that I own shares of with respect to this chip shortage. If you find a couple that you think are exposed, that's a little homework assignment. Dig into, what is management saying? That's part of what separates great management from good management, is how they weather the unexpected storms.

We can move onto Chegg. First quarter revenue for Chegg, 51% higher than a year ago. This is an online education company. They raised guidance. Normally, that's a recipe for the stock bumping up a little bit, but shares are basically flat today, although shares of Chegg have almost doubled over the past year.

Sharma: Yes. It's a company I've been interested in, a while. I think even before the pandemic, they really had a good lock on one part of the market, which is helping students to try to succeed in the classroom with textbook quizzes and more and more tools that are artificial intelligence powered, I should say. If you think about using a program to help you with your grammar, or a program that watches you as you solve math problems, and then suggests different ways to solve the problem. These are the types of tools that Chegg has been investing in. They were in great shape for the pandemic, and probably not to anyone's surprise, that a company which specializes in remote learning tools, really flourished over the last year, still growing very quickly. But Chegg has a history of beating not only its own projections, but beating analysts' projections. Sometimes it hits that inevitable wall where the growth is really spectacular, but it's not what analysts expect. They're flattish in the market today, I think they were up pre-market, and now the total market is down, and they followed suit. Wanted to say a couple of things about them.

One number that I look at is the number of Chegg subscribers, that is Chegg Services subscribers, I like to see that at a healthy rate. That increased 64% year-over-year, even more than total net revenues. I love that number. The total Chegg Services revenues, which is the bulk of the business that increased 62% year-over-year to $162 million. Still actually a very small company, if you think about it. The company I think is poised even beyond the pandemic to keep growing, as more and more students are going to want this progression of using Chegg in high school, where a lot of them get hooked on their services in college. I will say, I don't like their tag line. I've mentioned this before. [laughs] A small diversion here. Chegg incorporated a smarter way for students. [...] sometimes you try to change a noun into a verb and it works, I don't know. Chris, you're an expert on brands, just curious before we talk any further about the numbers and the performance. What about that tag line, they've just mirrored. Is that a Michael Angelo level to you?

Hill: No, that's clunky, and there's room for improvement there. In the same way that we talked about stocks that have room to run, that tag line has room to run. There's a way to make that better without turning it into the tag line version of truest, or trunk, or something like that. But yeah, I agree with that.

Sharma: Anyway, a few more words about the quarter. I did want to point out that their gross margin projection for the year, they pulled that back slightly to the 68%-69% range. The outlook for next quarter is slightly higher, 69-70%. Right now they are in a sweet spot. Why am I focusing on this gross margin number? Somewhere between 68% and 70% is really a stable rate gross margin for this company. They continue to grow their revenues at this double-digit rate that's usually 40% to 50% to 60% with the same gross margin. They have a really clear path to long term profitability. That's their equation. For those of you who are wondering what number I should maybe horn in for the next few quarters along with that Chegg subscribers number, each quarter you want to see the gross margin fall between 60% and 70%, and they have a history of keeping it within there, so I like that. I want to say globally, I really like the CEO, Dan Rosensweig. He is a very thoughtful CEO. He understands that this company actually needs to supplement its organic growth with bolt-on acquisitions.

They did another capital raise in the quarter. This has been a cadence for them. They are bulking up their balance sheet to keep acquiring companies as they go along and maybe fend off future competition. A lot to like in the quarter and a lot of like overall in this company. I will say, let's just talk about one risk. In the past, some unscrupulous students have used Chegg services to cheat on college exams, which is really the worst thing you can do. They have pretty much worked with universities to close that door. It's an ever present risk in investing in Chegg. But I think watching them over the last couple of years, they're slowly getting a handle on that and trying to exclude the bad actors. There's always going to be some in a class, Chris, that are looking over their shoulders at the student beside them at the next desk. In an online environment, there's always going to be a few bad eggs in every class who're trying to find other ways to cheat. Chegg doesn't want to have that as part of their global reputation as they grow.

Hill: Real quick before we go. For all the growth and success of Chegg, this is an $11 billion company. This is not prohibitively enormous. If some regime were to come in and make them a godfather offer, who do you think would be a likely candidate because off the top of my head, and I say this in part on the relative spending spree there been on lately, it wouldn't be the most shocking thing in the world to me if Microsoft walked in with a check for $15 billion, $20 billion, something like that, and decided that Chegg was going to be a bolt-on acquisition for Microsoft.

Sharma: I love that idea. I think that would be a really great example of the potential suitor. One other little less obvious one is an erstwhile competitor. Amazon.com used to be a head on head competitor with Chegg because Chegg was only in the rentals business. They started out renting textbooks to students and they were renting e-textbooks and they still do some of that, but it's more like a side business now. But there was a time when it was an open question, Amazon just coming and scoop up Chegg. It's not quite Amazon's industry anymore. Chegg has moved on more into that education aspect, but that could be interesting bolt-on acquisition for Amazon. They've looked at it before, they don't do a lot of that. Microsoft makes a lot more sense, Chris. My bet would be Microsoft. There are some not really true competitors, but peers in the same industry like Coursera that probably aren't big enough, but it could be like a merger of equals. Coursera just went public a few weeks ago really. There's some other ideas but I love Microsoft. They could just pull a dime out of not even a pocket, they could pull a dime out of that little place in your jeans, the sub-pocket, that little pocket that holds some change or maybe a key or two, they could pull out a dime and buy this company tomorrow.

Hill: Our Producer Dan Boyd just sent me a message on Slack to go back to something from early in the episode. He said three cylinder engines are common in racing in F1 and F2, and also there are tons of three cylinder motorcycles. There you go, people. That's just a little extra world knowledge from producer Dan Boyd.

Sharma: Dan, I owe you one for saving my [...] on that metaphor. I knew that one of my sons is a big F1 fan.

Hill: Asit, great talking to you. Thanks for being there.

Sharma: Thanks, Chris. Appreciate it.

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 stocks mentioned, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.