Earnings: When a Big Brand Isn't Enough

Clorox (CLX 1.19%) ends its fiscal year with a whimper, not a bang. Under Armour (UAA 1.62%) (UA 1.45%) shares rise on a strong second quarter and there are reasons for optimism. Gartner (IT 1.59%) pops more than 10% on its own strong second quarter. In this episode of MarketFoolery, Asit Sharma analyzes those stories and shares why having a good brand is helpful, but not always enough.  

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This video was recorded on August 3, 2021.

Chris Hill: It's Tuesday, August 3rd. Welcome to MarketFoolery. I'm Chris Hill. With me today, our man in North Carolina, Asit Sharma. Thanks for being here.

Asit Sharma: Hey, Chris. Thanks for having me. It's good to wipe the clean slate with a new day, referring with a little bit of foreshadowing to a certain company that we're going to talk about that specializes in disinfecting wipes, among other products. But good to be with you once again.

Hill: Absolutely. We've got athletic apparel, we've got the sexy world of research, but we're going to start with what turns out to be a rough end to the fiscal year for Clorox. Shares are falling more than 10% this morning after fourth quarter profits and revenue came in lower than expected. I was saying to you right before we started, the past, let's just call it six to nine months and maybe even a year, it really hasn't gone as well for Clorox as I would have guessed.

Sharma: Yeah. Same here, Chris. I actually thought last year that Clorox was going to have some sticky advantages coming out of COVID. We've seen a lot of companies that have taken the benefit of all the sales from the spring and summer of last year and they've parlayed those into longer term advantages; Clorox, not so much. We have to understand here that Clorox doesn't really face the retail world. It applies to retail outlets. It's a consumer packaged goods company so it doesn't have a lot of opportunity for, say, huge direct e-commerce sales. You have to grant them that. On the other hand, this was really a chance to get in front of customers and reassociate them with the brand. Because of a few thorny problems, like supply chain logistics, rising commodity costs, etc, Clorox hasn't been able to capitalize on customers remembering how much they relied on the company for household products. I want to read this quote from this morning's press release from CEO Linda Rendle, give my quick comments on that, "Fiscal year 2021 was an extraordinary year for Clorox with the pandemic putting us through the test of volatility, including rapid changes in consumer demand and inflationary pressure which is reflected in our fourth quarter results." 

Now, those fourth quarter results include a 9% decrease in sales year-over-year, 10% on an organic basis, and earnings per share slipped 68% to 78%. I have to say that everything that CEO Linda Rendle said is true for Clorox, but it's true for all of its competitors. It's true for so many other companies in the consumer goods world, and not to save the tech world, manufacturing; that's everyone's experience. Yes, the pricing results and shareholders are punishing the stock today. This is the second or third quarter where I feel they've underwhelmed with results. What do you think, looking forward, I was curious, Chris, you have such a good long-term view of companies, you're a very stable investor, does this change your opinion of Clorox or do you think, maybe, hey, I buy now, they'll work through these problems, it's great brand, great company?

Hill: You look at the stock down 30% over the past year and the long-term record of Clorox paying a dividend. I could see some investors looking at the drop today, the recent past. If you're looking for a dividend payer, and not everybody is, but if you are, you could do worse than Clorox. Again, it's 10% cheaper today than it was yesterday. That being said, a part of me wants [laughs] to do a deep dive and investigative research and just be like, what is wrong with the execution of the business? Because as you said, they're not facing any headwinds that any of their other competitors aren't already facing as well. They're the name brand leader in their category. They have built-in advantages. A part of me just wonders what is happening on an execution level that they are struggling like this? I get that there could be an argument that, hey, look, this is a stock that got ahead of itself. It had a run-up in 2020 that it probably didn't deserve, at least in historical terms. You can convince me of that. But I don't know. Again, it goes on the list for if you're looking for a dividend payer, but I think that's the only list that goes on.

Sharma: This becomes a problem as we move out of COVID because in this world of consumer packaged goods, you have to have a little bit of income growth, you have to have a little bit of revenue growth, you have to stay ahead of inflation. No one expects a multinational conglomerate that competes in this space to deliver huge double-digit revenue acceleration. That's not going to happen. But you have to show shareholders that we are solid-state, we'll be able to pay out that dividend and raise it. This brings up some short-term questions. On that execution front, they did mention in the press release today that they've delivered over $120 million in cost savings in the fiscal year. That e-commerce business, which I was talking about, that's never going to be a huge portion of the business; they did double that business over the past two years. They're doing all the right things: working with data personalization, more customer engagement. But I think that maybe they need even a higher focus on whatever management decides those growth drivers truly are. If it is the e-commerce, if that's part of it, double down on that investment, but find the levers that will bring you into a little bit better of earnings complexion and certainly a top-line outlook going forward. 

The last thing I'll say on this, the company just disappointed the investors not just with these earnings, but with their outlook. They're calling for a 2-6% decrease in sales for fiscal year 2022 and earnings per share of only $5.40-$5.70, which never gets too hung up on earnings per share in one given year, but that's well below what most people were expecting for the year. We'll have to see how they can get some momentum in the next couple of quarters. Hopefully, we can revisit this later this year.

Hill: Under Armour's second quarter profits and revenue came in higher than expected. Unlike Clorox, Under Armour actually increased revenue guidance for the full fiscal year and shares are up more than 6% this morning. This, I say, is a relatively longtime shareholder. This makes me nervous. It makes me nervous for the following reason; that I believe Patrik Frisk, the CEO, when he says this year sets the foundation and this is putting us in a good place for what he calls our next chapter of profitable growth. On the surface, it really does seem he's not just blowing smoke. That's what makes me nervous because it's getting my hopes up.

Sharma: I've been a skeptic of Under Armour for several quarters and I have to admit that Patrik Frisk is growing on me. He is executing. Patrik Frisk has been with Under Armour since I believe around 2017, that's right. In a short amount of time, he was really promoted up into the CEO role. That was the beginning of 2020. Shortly thereafter, he instituted a pretty major cost-cutting reorganization plan. In today's earnings release, the company recapped what's happened since last year. They have recognized about $483 million in pre-tax charges related to this restructuring plan, out of an estimated 550-600 million bucks. In other words, they have, with all speed, reorganized the business. I think it is showing in these results, we should say, take these numbers with a grain of salt, which I'm about to read out because they reflect comparisons against the period last year when many of the stores were still closed, but revenue was up 91% year-over-year. 

Their North American business increased 101%, so that doubled. They even were able to increase gross margin to 49.5%. That's not a huge jump, it's 20 basis points or one fifth of 1% over the last year. But it shows a little bit of operating leverage, or at least a stable gross profit equation. I like all of this and restructuring charges, only $3 million in the quarter. The bulk of all of that work is getting behind them, Chris. I guess you almost have to get your hopes up here. Everything I looked at this morning, I was pleased with, operating income was $121 million. The bigger picture here is, we knew that Under Armour needed to execute. We could see that they probably would after Kevin Plank took a back seat and got out of that driver's chair. The question was, would they be able to execute and still maintain some of their brand cache in the market? I think it has held up. For all the negative articles that have come around about Under Armour's missteps with their brand, it's still out there. I think the younger generation still sees it as an aspirational brand. Maybe they have the equation down right here, Chris, and you can breathe a sigh of relief. What do you think?

Hill: But just on an operational level, and this is part of what Frisk and his team have been doing. You look at their results, and it's clear that they are relying less on discounting. They are doing more in terms of direct-to-consumer. It's taken a while, but from a strategic standpoint, they finally appear to be moving in the right direction. On the flip side, the stock is where it was four years ago. It's dipped and bounced back up, but it is right there in the low-20s like it was in the summer of 2017. Part of me just thinks about the great line from Ted Lasso, "It's the hope that kills you." I'm trying not to get my hopes up too much about this. But I've had years of practice of having my hopes dashed by this business. Maybe I'll be pleasantly surprised at this point.

Sharma: That hope muscle is toughened, Chris. Let me play skeptic for just a second here. The other side of this equation is the fact that Under Armour still has to go out and compete every day with the Nikes and the Adidas' of the world. It has to compete with a host of companies that are in the athleisure market. Almost everywhere this company looks, there is fierce, never-ending competition. But I like their balance sheet now. I like the way their cash flows have improved. They've got a little bit of ammunition now to try to maybe claw back a few nice super athlete endorsements if that's part of the equation, but store expansion for them would be great. Introduction of new brands which they've been rolling out, I think continue with that. 

Again, we will see there is a spot for Under Armour in this fight among these major brands when you look at the athletic part of the market. There's a spot for it in the athleisure, the connected fitness areas that it's exploring. It's just that they've got to always do both things at once. They have to keep that brand strong. We have to execute under current management. I think you have both. I think they can sustain the brand and I think they can execute. Keep that muscle under a good regular fitness regimen. Chris, it'll work out.

Hill: Shares of Gartner are up more than 10% today, this is the global research and advisory firm. Second quarter revenue up 20%,profits were higher than expected. This was one that you brought to my attention. What is it about Gartner that interests you as an investor?

Sharma: The biggest thing that interests me about Gartner is the fact that it's a $25 billion company in terms of market capitalization. Revenues for the quarter that they just reported on were $1.2 billion. This is not a small company, and yet they're growing like a much smaller scrap your upstart in a space in the technology world, which is very difficult to even wade in this water. Gartner basically gets its money from providing research to companies and executives, to providing consulting on technology and holding conferences. These are its three major business lines. It's not a type of company that immediately comes to mind as a great Software-as-a-Service play. But in some ways, that's exactly what it is because it sells its biggest revenue stream as a subscription. That's the research it provides. I also like that Gartner has an incredibly well-known brand name. If you've done any research at all in the tech space and you're trying to figure out as an investor, which is the dominant company in this particular technology sphere that I'm looking at? Who is the No. 2? Who is the No. 3? Then you're familiar with this visual called the Gartner Magic Quadrant, where they show where the industry leaders are in a certain sector, where the challenges are. 

They have a number of other branded reports that investors look at it and pay for. The brand name is very strong in the tech world. But as an investor, you look at Gartner and it's almost like an afterthought, they're the people who rate these other technology companies. Yet here we see in this latest quarter, just very strong revenue growth, very strong profit growth. Revenues grew 20% to that $1.2 billion. Net income was up almost 85% to $271 million. They had free cash flow of $563 million. That's up 75% year-over-year on that $1.2 billion in revenue. It's got a lot of characteristics that are very appealing. If I gave you a lot of these stats and told you it was a subscription business, but maybe introduced it as a specialized SaaS software company. I think most investors would be really excited when I say the name Gartner, interest subsides, but here they are, I think up over 8% this morning with the second-quarter report. Last thing that I want to mention just as we begin to talk about it, is their total contract value, which is like their version of annualized recurring revenue, was up almost 11% year-over-year to $3.8 billion. They have a very nice base of recurring revenue. It's another thing that you want to see in a company like this.

Hill: You touched on something that I think is really important. You said a bunch of things that I think are important, but one that I think gets overlooked is, for lack of a better term, the casual reputation of Gartner as this legacy, boring business. It's easy for me to imagine older investors who work with a financial advisor. If this stock comes up, the client is almost waving their hand away, as you said like, "Oh, yeah, the people who do the reports, I know them." Look, there's a bias against businesses like this. There's a bias against businesses like Clorox. It's like, "Wait, they do what? Oh, yeah, they make the bleach. That's it." There is almost an inherent bias against boring businesses. But as you said, you look at the growth and it is one of those situations where you're like, "How big is the market cap of this company?"

Sharma: Absolutely. One of the things that all three companies that we've talked about today have in their back pocket, is a really strong brand. We were talking about this a few minutes ago. Gartner, that brand is so important because the people that buy the services are executive level, and they will pay good money for great research. That's where that billion dollars of revenue in one quarter just from providing subscription-based research comes in. As investors, we often get distracted, and rightfully so, in the latest technology. Show me the software-as-a-service company that is specializing in artificial intelligence and machine learning and it's doing all of these wonderful things in the world. It's an innovator. I want to put my money in that company. It's going to grow at this amazing rate. We often will ignore companies that are capitalizing on an everlasting brand and are turning out great results quarter-after-quarter-after-quarter. Now that's to our detriment. Chris, we were talking about this last week and I was beating myself up further. I think yesterday I happened to pull up a chart of Home Depot over the last 10 years. You wouldn't think that's an 1,100% total return in a 10-year period, but there you have it. Yeah, I think that this is important for investors who want to stabilize a part of their portfolios and maybe balance out more riskier elements in newer companies that are infused with growth potential. You've got some quality names like Gartner that won't hurt you to buy and hold. You don't have to bet the form on these, but just to provide some balance and not bad balance, this is good balance. This is a company that itself is growing at a double-digit rate. Why not? Ii is the last thought. Why not Gartner?

Hill: Asit Sharma, loved talking to you. Thanks for being here.

Sharma: Thanks so much, Chris. Fine, as always.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery, the show's mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.