Follow the Cash: Celsius, Chegg, Nelnet

In this podcast, Motley Fool analyst Jim Gillies and host Dylan Lewis discuss:

• Celsius' incredible top- and bottom-line results and why investors should pay attention to the energy drink maker's relationship with Pepsi and accounts receivable.
• Whether Chegg can harness AI for its education offerings.
• Why Nelnet's slow and steady approach continues to pay off. 

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 August 09, 2023.

Dylan Lewis: We've got some interesting earnings updates, just not from companies you'd expect. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool Candidate Analyst Jim Gillies. Jim, thanks for joining me.

Jim Gillies: Thanks for the invite, Dylan.

Dylan Lewis: Of course, today we're going off the beaten path, Jim, and we are taking a look at earnings from a few lesser-known names. But we're going to start with one of the biggest movers. Celsius may be accompanied on people's radars. If you're looking at big movers today, shares up 20% after reporting earnings. Jim, if you haven't heard of this one, pay attention when you're in the beverage section of the supermarket, they are growing their presence there and some big numbers in the earnings report pushing that big stock pop today.

Jim Gillies: Yeah. This is what I have heard of. I was briefly an owner back a while ago and it was just a small position that we were playing games with. But their earnings report, the headline news looks pretty darn good. Revenue was up 112% year over year. That's OK. Gross margin was up 10% points, not basis points, percentage points up to 48.8%. Net income was up 345%. That sounds good. Earnings per share is up 333%, adjusted EBITDA is up 350%. To be blunt, with those types of numbers, Dylan, I'm shocked. The stock price is only up 20% today.

Dylan Lewis: You don't see the triple-digit top and bottom-line growth all that often, Jim, doesn't happen.

Jim Gillies: Triple-digits in the earnings thing where the first digit is not a one or two. 

Dylan Lewis: It's remarkable.

Jim Gillies: That's really good and I think that should be celebrated. I think that there is something under the hood that I think investors should be aware of. But a lot of this is tied to an investment that came from PepsiCo. Noted large beverage player, half of it a duopoly, PepsiCo versus Coke. There's a lot of moving parts that are actually associated with that partnership. For those who are unfamiliar with my style of investing, I'm very cash-flow focused and so I really liked the numbers that are in the page to start with this. But once I started looking at the cash flows here, I started having some questions.

Dylan Lewis: Yeah, let's move past the headlines on this one, because in prep, you built up the intrigue for me. You said as you start digging in, there was some stuff that had you scratching your head as you were looking at cash flow, what was it?

Jim Gillies: I'm just going to operate on the first because cash flow statements are cumulative throughout a year when they reported. We're halfway through the fiscal year. I'm looking at the first six months here. In the first six months of the year, Celsius does just shy of $93 million in net income. But the cash flow, cash flow from operations, which starts with net income and then you start adding back all the non-cash charges like depreciation, amortization, maybe stock-based compensation, and you do working capital adjustments. But generally, a quick rule of earnings quality thumb, is you want to seek cash flow from operations higher than net income because its calculations starts with net income and then you're adding back things. In the first half of the year, they do about $93 million in net income to shy that. But they only did about 45 million in cash flow. That's interesting. The second thing is year over year, the first half of this year net income has sextupled six-fold versus the net income in the first half of last year. Yet, cash flow from operations is flat. Free cash flow, so the simple definition, operating cash flow minus CapEx, it's actually down from last year, not much. It's just shy of 40 million last year. It's just over 38 million this year. My next thing as well, with the Pepsi deal is the culprit. Why is there cash-flow down? Why is there cash-flow far below their earnings? I'm like, well, I wonder if that's because of the Pepsi deal, and it is, but it's not the way I was expecting it to be. Inventories actually been a source of cash this year and usually when you push out inventory and Pepsi is obviously taking a lot of inventory from them. Where I found the the issue is that accounts receivable in the first half of this year has been a massive $136 million use of cash. Someone ain't paying them for product. Would you like to guess who that someone is?

Dylan Lewis: Based on everything you've built up so far, I have to imagine it's Pepsi, Jim.

Jim Gillies: It is absolutely Pepsi. Pepsi in fact, accounted for 68% of their receivables at the end of the quarter, about 135 million, which of course, is roughly equal to the increase in the accounts receivable. Pepsi has been getting paid by Celsius here. First off, the investment that Pepsi made in them is in the form of convertible preferred shares. Those preferred shares have a dividend, so of the free cash flow that Celsius has generated for the first half of this year, about a third of it went to Pepsi in the form of dividends on those preferred shares. The other thing is there's a boat. They gave some, Pepsi that is, gave Celsius some cash that they had to use as they're doing their distribution network conversion over to Pepsi that they were carrying on their balance sheet. There's just over 30 million, 34 million, I think if I don't have the balance sheet up on my screen, that all got returned to Pepsi during the quarter as well. Pepsi's a drain. The other thing too is, the only reason that Celsius has positive operating cash flow in the first half of this year is because if you look through the line items, there's a 57, $58 million source of cash, which is basically an unpaid taxes. If they actually pay their taxes, say on June 29th versus say July 2nd after quarter was closed, these guys have negative cash flow, because you're going to have to pay your taxes.

Dylan Lewis: Yes, that's a matter of timing more than anything else.

Jim Gillies: It's a timing issue. All of this makes me go. My take and I have no stake in this company or Pepsi for that matter. Again, I really liked the headline numbers here. But there's something weird going on under the hood with cash flows. Look, any of my concerns go away. If Pepsi pays these receivables by the time Q3 is reported. Like if this has been a timing issue. But it strikes me. Again, because I'm a cash flow guy, when I see stuff like this, it gives me some qualms. I'll put it that way. Now, I ultimately think the ultimate play here is probably Celsius goes away at some point is gobbled up entirely into the great mall that is Pepsi. We saw this a few years ago was SodaStream. They made an initial investment in SodaStream, ran a partnership for a couple of years, and ultimately acquired the whole thing. I think that's probable with habits here and I think Celsius, I mean, they have a very recognizable brand, they have relationship with Costco, they've relationship with Sam's Club, but right now, just be aware of the cash story is not as optimistic and bullish as the press release earnings income statement story.

Dylan Lewis: Jim, to back that out a little bit and put a bow on the way that we're looking at Celsius and Celsius's quarter, sounds like looking forward, you need to be watching the Pepsi partnership. I think the story for the business, whether it's quarters or years, is, does this partnership become something that becomes less of a partnership and more of Pepsi just owning this business outright.

Jim Gillies: Yes, I think that's a fair comment.

Dylan Lewis: Certainly a lot to follow with Celsius in the upcoming earnings report, and really for the next couple of years. Jim, we also got an update on Chegg. This is the online education company and some interesting after hours movements with this company and its earnings report. Share shot up 30 percent after the company reported and is now basically back down prior to reporting. What happened there?

Jim Gillies: People, I think a little enthusiastic that it wasn't a sucky quarter, and I'll explain why I'm going in that direction in a minute, and then I think the last couple of days is just in general markets have been BLA. I think people are giving it back. The story with Chegg starts about three months ago, or at least my interest in the story with Chegg, starts about three months ago when they reported Q1, and basically I'm going to paraphrase, but essentially they said, hey, remember how we weren't terribly concerned about AI impact on our business? Well, by the way, it's going to have an impact on our business, but hey, don't worry, we're going to co-opt it for our benefit. The market didn't believe them, stock fell almost 50 percent in a day. Management here, and the story they were telling their and the story there telling in the most recent conference call as well, is that they're treating AI and the move to AI as more of a tailwind versus a headwind. They were talking last quarter about their virtual tutoring tool, which they're developing in cooperation with OpenAI, they were calling it CheckMate.

Thankfully, a name that seems to have been dropped because that is a terrible name, it's bit hokey. Well, I look, the name Chegg itself is hokey. It's a portmanteau of chicken and egg, which came first. You need a degree to get a job, but you can't get a job without a degree. Anyway. No. I think they have made some good progress in this quarter, they made some progress in terms of they're saying that what their research is telling them and what their experience is telling them in an end, especially with ADVATE as they've released this first iteration of their virtual tutor, is that students are looking to ChatGPT and looking to Chegg for separate things. They are saying that we can leverage our large, giant, giant database of solution sets, answers and just teaching tools. Marry that with a conversational AI interface that actually improves educational outcomes for students. Now, if you're a student who's looking for a ChatGPT to write your essay for you, well that's another thing to talk about. But everything in the conference call and in this quarter says that they are making progress on leveraging AI for the value of their shares. As for the market reaction, Dylan, I think it's fair to say the market reaction says the market doesn't believe them.

Dylan Lewis: I was going to say, I mean, so much of what we're looking at with the impact of AI is near-term roadmaps and initiatives that at least show companies are thinking about it, but the reality that a lot of this is probably being pushed out to 2024 and beyond in terms of material business impact, is that how we have to be looking at anything for Chegg here?

Jim Gillies: Well, I mean, it's the summer, so in the present quarter. The impacts on their reported financials will really start to roll in probably with Q4 because Q3 is going to be a light, because all the universities and colleges are empty right now or at least much lower student basis. But I think for me where I'm going with this is, we've seen investors over the past, I'm going to save nine months-ish get really excited 3D printing style, SaaS style, Cloud style about potential AI investments. I hope you heard that cynicism dripping from my voice there.

Dylan Lewis: Just a bit.

Jim Gillies: Just a tad. Here's a company that I will argue has to embrace. I mean, let's be honest, they have to. They are actually reporting some pretty decent results, and they're also taking some pretty good capital allocation moves. Paradoxically, they're not getting rewarded at all. What we've got here is a company that is embracing AI, the market isn't believing it, and so they're doing some interesting things to set themselves up. What are they doing? They are actually making a not small amount of cash. Again, we just finished talking about Celsius and my concerns there. I'm sitting opposite here for Chegg because over the past four quarters, including the Q1 of this year where again 50 percent down and then this quarter, which was perfectly fine, they have generated, I'm going to say about 181 or so million dollars in free cash flow. That's interesting. What have they done with it? Well, they have been deploying all of their cash wealth and a lot of free cash generation. They've been buying back stock, OK, so they're buying themselves on the cheap. They have been buying back their debt, and that is interesting to me, because this is convertible debt. They're essentially paying nothing on.

Dylan Lewis: Why are they buying it back?

Jim Gillies: Because they're buying it back at a discount. I love this. This is my favorite capital allocation move when I see companies doing this thing. Dylan, if you owe 1,000 bucks in your credit card and your credit card company says, hey, we'll take 750, who among us would not immediately pay that 750? It's a great return. Well, writ large, that's what Chegg has been doing for a few quarters, but really dialed up in this most recent quarter. I think they bought over $400 million worth for about 360 million ballpark. I love that move because when that debt eventually comes due and I hate convertible debt for a number of reasons, but we won't bore people with that right now. But the fact that they're buying it back at a discount, love that move. Fantastic. Guidance this summer doesn't look bad. For the summer term. It's the lowest seasonally adjusted term, but doesn't look bad. Their margins look OK. Even though they are spending heavily to make their AI solutions ready for prime time, if you will. Here is the thing, at this point in time today's price afterwards you say after they've given back everything, this is a company that is trading at about six times, trailing free cash flow and that's really cheap and you know what? Even if they're only half as successful as they plan to be, if this thing moves from six times to 10 times, which would still be cheap in my opinion, you get a two-thirds, you get a 67% return on your investment before actually, if they actually start growing themselves and then the question I ask is, well, what if this actually works?

Dylan Lewis: Yeah, what if it all comes together?

Jim Gillies: We're going to call this a potential double play. Although double play is negative in baseball terms, but if you get actual growth, this thing works. As a result of getting that thing working, you get a higher valuation multiple. This one could turn interesting.

Dylan Lewis: It's always nice when not a lot has to go right for exactly materialize for you.

Jim Gillies: I much prefer step AAO like, what's your hurdle? I like when the hurdles on the ground, I can just step over it.

Dylan Lewis: It's a beautiful thing. Jim, our final company that we're going to check in on today is Nelnet and a company that you call it a slow and steady one in show prep and a slow and steady quarter, a muted response to the results. Further than this company. They're generally known as the financial services business, specializing in student loans, but they do a little bit of everything. What jumped out to you in the results?

Jim Gillies: Namely that again, it was very slow and steady. Nelnet is company I've known for a while, recommended for awhile. It is a student loan servicing company. It's a professional services company. It's a consumer loan originator that got a bank stuck in there somewhere. They're a payment processor. They're a telecommunications company. They're K-to-12 and higher education, helping payment processing. I LN their private equity groups, so I mean, yeah, they're everywhere. This is a very dense company to have to pull apart and look at. But fortunately, we've got shorthand for these types of companies and it, because its financial services and financial numbers are very prominent, book value is generally a pretty good metric to be using and so there's a lot of cash flow that's flowing through here as well and you can get a really good history. They do an annual letter every year which I hardly recommend reading. I just called Nelnet the second most famous holding company out of Nebraska because that one up in Omaha is pretty big deal.

Dylan Lewis: Yeah sticking with our off-the-beaten path theme, if you're in Nebraska and you go a little off the beaten path, you find your way to Nelnet instead of Berkshire.

Jim Gillies: Yeah, you go to Lincoln instead of to Omaha because these guys are in Lincoln, which is an hour down the road from Omaha, but it's their book value. These guys IPO do mid-2004, I think last third, mid-2004. They've compounded their book value. So again, this is the Berkshire argument, right? They watch book value. They've compounded book value at 16.6% annually since IPO and they're trading right now at about 1.1 times book value, which very nice valuation. Periodically, the market will give you just a tad below one times book value. So I do tend to add to my holdings on those dates, but I think there's nothing wrong with the 1.1 here. It's a cash-flow story in that they have their operating businesses that are generating cash flow for them. So that would be the loan servicing business, that would be the payment processing and helping managers, educational institutions, businesses as well. They also have a bunch of private equity-style investments. Notably, they're the largest independent shareholder of a business called Huddle, which is a sports performance analysis platform so for analysis of high school and college sports and occasionally professionals, but also athletes who are looking to maybe become professionals. I always like mentioning huddle to fellow Fools who have kids who are on that athletic track. Because they all immediately, there's a couple we work with.

They immediately go, I love huddle. At some point that's going to IPO and that's going to be real interesting. They're the largest investor in huddle. But they also own this big giant pool of student loans from a prior program that no longer exists that's slowly flowing through the cash flow statement and it's probably going to deliver them just shy of $1.4 billion over the next 13 years. But about two-thirds of that is going to come in the next five years and so all that cash-flows running through their finances and then they apportion it out. They pay a dividend, they buy back stock, they make these private equity investments, they grow their other business. They got their loan servicing business. They've just had their contract renew. There was a couple of years there where it looked like their ability to service a lot of the federal loan programs was taken away from them. They didn't get the contract and then I think the government figured out there's no one else who could do it. But we already pulled your contract so what do you do? Everyone wants to save face so they changed the name and they put a different spit shine on it and the type of contract and then Nelnet won that contract, which is basically the old contract that they lost and so they've got that for the next five years. Plus they've got, I think two five-year options after that so there's a lot of moving pieces here, but, probably to distill it down, lots of cash-flow. Those cash flows get invested in various places. It distills down to a book value number. That book value number has been growing neatly and it's trading at a reasonable price to that growing book value.

Dylan Lewis: I don't know a ton about this business, Jim, but because of where it operates and because of what I know is looming in the student loan servicing space, I do want to ask, interests on student loans is set to resume this fall. Is that something that impacts this business at all?

Jim Gillies: A little bit. Well, first-off, the servicing contracts and stuff, I mean, you just the servicer. You're earning fees on how many transactions go through or what have you. I'm not terribly worried over there. I'm not terribly worried in general, but yeah, that giant melting iceberg of loans from that discounted or discontinued, I should say, program from a number of years ago. Borrowings are at generally fixed rates, although there is some floating and yes, there's some swaps out there somewhere to adjust it but whatever. But then they're mainly financed through floating-rate securitizations. So what has happened with rates going the way they've gone? That has crimped some of the profitability there. There are some outlay versus for them to actually recoup some of their profits. This is a spread business or that part of the business is a spread business. That spread has narrowed in the most recent quarter. But I don't think that should have been a surprise. I mean, the headlines have been rates are going up, rates are going up, rates are going up. I don't think it's that much of a surprise and I what's the cliche? Things that are known tend to be built into the share price. I think that's built into the share price here. But it is something to be aware of also too, I think we're probably closer to the end of the rate hiking cycle than to the beginning. I think in Canada where I am, I think we're done. I think you guys might have one or two more hikes to go.

Dylan Lewis: Wouldn't be surprised.

Jim Gillies: Wouldn't be surprised. But also, I don't think you have eight or 10 hikes to go. Put it that way.

Dylan Lewis: Let's hope so. Well, Jim, thanks for taking us off the beaten path today and being our guide ongoing. Appreciate talking with you.

Jim Gillies: Likewise.

Dylan Lewis: As always, people on the program may own stocks mentioned in the Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what's here. I'm Bill Lewis. Thanks for listening. We'll be back tomorrow.