Barron's Streetwise - Cocktails and Cannabis. Plus, Peltz’s Disney Slideshow.

Episode Date: January 14, 2023

Jack talks with an alcohol and weed analyst and considers an activist’s take on the Magic Kingdom. Learn more about your ad choices. Visit megaphone.fm/adchoices

When you were buying on the illicit market, you're not paying excise taxes. If there is an illicit market dealer that's getting much better pricing on their wholesale, they're going to price that presumably in line to below, obviously, what you would pay at retail. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard that's gerald pascarelli he's an analyst at wedbush securities covering cannabis and alcohol and he's talking here about the illicit trade in cannabis not really something we're going to be talking much about here i don't really know why we use

that jackson why did we use that for a quote it's provocative it draws people in get some leaning forward you gotta you have five seconds to get someone's attention on this all right well now that we've got it uh we're gonna talk about the legal trade in cannabis and alcohol coming up uh and we're gonna say a few words about nelson peltz and his attempt to get disney to give him a board seat and to get the stock moving higher and whether it might work. Listening in is our audio producer, Jackson. Hi, Jackson. Hi, Jack. Tell me everything you know about Nelson Peltz. Go.

Sounds like a candy proprietor. Come on. Well, a candy proprietor. You on. A candy proprietor? You know what? You're not far off. You're not far off. He's an activist investor, although he says he doesn't like the term activist, but that's kind of what he does. He takes big stakes in companies, and then he pushes for changes that he thinks can get their shares running. And you said candy.

It just so happens that the guy has done a lot of food deals. I'm looking at his record here. PepsiCo, Heinz, Cadbury, Kraft Foods, Wendy's, Dr. Pepper, Snapple, Mondelez. They make Oreos, you know. Not exactly a health food. Yeah. No. Although I think he's the son of someone who had a produce delivery business in lower Manhattan.

So I think he got his start in healthy food. But yeah, he's got Domino's pizza, lots of other stuff on the list here. One of his greatest hits was a purchase of Snapple from Quaker back in 1997. He paid $300 million for it. And then three years later, he sold it for a billion and a half dollars, including debt to Cadbury Schweppes. And then several years after that, in 2005,

he founded a company called Tryon. And that's to go after bigger targets, to go after big companies to take stakes in their shares and to push for change. One of the things he says he likes to do, the man likes a good slide deck. It's kind of like a PowerPoint roast, you know, all of the things that the company is doing wrong. He shows it to management and then he says, I want a board seat and I want to make some changes. And if he doesn't get a board seat, then he makes his slide deck public.

And he has done just that this past week with Disney. Apparently, he approached former CEO Bob Chapek. Does it mention the Country Bears Jamboree? The animatronic bears at Disney World. They don't come up direct. I feel like they're implied, but they don't come up. What about the Jungle Cruise? Nope.

Neither the movie nor the ride came up. But what comes up a lot is, first of all, the Fox deal, and second of all, streaming. He says that Bob Iger paid way too much for Fox assets, the television and streaming assets that I think they net, it came out to $53 billion. They paid, I believe, 71 billion, but you have to back out some divestitures and back out some cash. They picked up $53 billion and he says the price was too high and that the investment hasn't worked out. Nelson Peltz has some math here in his spreadsheet. He basically says that Disney's adjusted show business earnings, there were a

little over $9 billion before the Fox deal, should be over $13 billion today based on the promised synergies from that deal and the money that Fox was making. But instead, they're down to just over $3 billion. If we back out the streaming losses, we're higher than that, over $7 billion. But that's still a big decline from where he thinks earnings should have been. And he asked the question, is there a write-down coming on this Fox acquisition? Because he thinks it isn't earning like Disney thought it would earn. That's one complaint. I mean, there are many others. The dividend has been cut. The company has spent a ton on content and capital investments. He makes the case that since 2018, earnings per share have been cut in half.

Even though Disney has spent $162 billion, that's across dealmaking, capital investments, and content. He says that's equal to the company's whole stock market value now. So it spent this ton of money, and it doesn't have the's equal to the company's whole stock market value now. So it spent this ton of money and it doesn't have the earnings growth to show for it. He thinks that in the past, executives, including Bob Iger, who's back at Disney, he thinks he has made too much money. He says the company is over-earning at the parks, which is a nice way of saying it's hitting park visitors with costs that are too high and it's not paying workers enough.

So he makes the case that Disney is making up for its streaming losses with the amount of money that it's making at the parks and that it's unsustainable. What do you think? Well, you kind of talked about some of these points when JPEG was ousted and we did the episode back then. I'm wondering if Peltz has a plan here. It's easy to just go down the list and criticize all this. There's not a ton that looks plan-like in this slide deck. He makes the case, there's this comparison with Netflix. And he says, you know, Netflix has higher stream, much higher streaming revenue

than Disney. And it does spend more on content for that than Disney does, but it has lower non-content costs than Disney in streaming. And that's why Netflix has better profit margins in streaming than Disney. So he says Disney lacks cost control. Iger has said since he returned that he's going to take a hard look at costs. And I think that that is probably a prime target for cost cutting, because I've heard that now from a number of places that those non-content costs in streaming are too high. But I would point out that Netflix has been streaming since 2007. Disney Plus is a little over three years old. So, you know, there's a certain amount of money

you have to spend to ramp the business up. But I think what it all comes back to, you know, most of the complaints that he makes about Disney are well-founded, right? I mean, it's hard to dispute what has happened with the operating performance, the stock performance, all of this, the cost of the Fox deal, certainly. But one thing to keep in mind is where we were several years ago. There was a point when Netflix passed Disney in stock market value. That was investors saying, we don't care about the cash flows. We don't care if Netflix is burning cash. All we care about is subscriber growth in streaming because we think

that consumers are going to cancel their cable subscriptions. We think television is dying and streaming is the future. And so we want to see companies piling into streaming. And so Disney responded and it went all in on streaming. A lot of companies did, and there was a big content war and costs were low so the companies could gain subscribers early on. And also this totally worked to get the stock moving. I mean, the stock ran up over 200 bucks a share briefly in the spring of 2021. And now it's fallen by about half. And what that really is, is investor tastes reversed. I mean, they totally flipped. Investors were saying, we just want growth in streaming. We don't care about cash flows. Then the Fed began raising interest rates. Then growth stocks fell out of favor. And the things that were working before abruptly stopped working. And Disney was

one of those things. It had turned into this growth stock because of its streaming outlook. And investors said, we don't want that anymore. We want to go back to the cash flows. And so Disney stock fell apart. And that's where we are today. But really, the whole industry, I mean, all of show business had to make this move into streaming. And I honestly don't think the media operating performance is going to get much better until the consumer proposition in streaming gets, I hate to say it, worse.

They have to figure out a way to charge more and give less or some combination there, which is not an easy thing to do because customers have never had so many choices and it's never been easier to switch from one service to another. So I don't know. There's this open question about whether the future of television is going to be as profitable as the past when we were all locked into cable bundles and paying a lot and watching the ads. And that was the only place to go. So that's where we are now. Now that Disney stock has been cut in half, does that make it a good deal now? I think it makes it a fair deal. You can't go by this year's free cash flow because I think free cash flow is depressed, right? So stocks may be 40 times this year's free cash flow estimate, but you can look ahead a couple of years from now, the consensus estimate has the company

getting back from $4 billion in change of free cash flow to a little over $10 billion. And I think that's a feasible case based on where the company was earning before. So that number, Disney's stock market value is about 18 times that number, which for a company of Disney's quality, that's fair. The only thing is the S&P 500 trades at 18 times free cash flow based on estimates that are a little closer than that. So in other words, Disney, you'd have to say, even based on the bounce back that you're expecting for how much money it makes, it's still a little bit above the market, which is probably about where it belongs. I think we're back to a stock price that can work well for investors long-term,

but I don't think it's a slam dunk that the company, based on this activist interest, is going to jump right back from $100 a share up to over $200 where it was a short while ago. Do you think they're going to cut prices at the parks? That's a tough one to do at a time when everyone wants them to improve their free cash flow. I've noticed that they've started to announce these little sort of concessions like parking. Parking used to be free for people who stayed at one of their hotels. Then they started charging for it and everyone was annoyed by that, right? Because you pay a good deal extra to stay at a Disney hotel. While they returned at Disney World, they returned the free parking for hotel guests.

That's a small thing, but that has happened under Iger. And it's, you know, they might have more of these things that show that, hey, we're paying attention to what people are saying. I also don't want to overstate the case that when I talk about the parks, a lot of people say, well, the parks were great at such and such a point in time, but they've gone downhill. And I always think that's like people who say that Saturday Night Live peaked in such and such a decade. The producer of that show, Lorne Michaels, has said in the past that when people say that, the point in time they usually pick is when they were young. And what they're usually saying without realizing it is

that's when my life peaked. That's when things were super fun. You know what I mean? So I think there's a lot of cranks out there that say, well, Disney peaked in such and such a time. We used to enjoy it. It's not as fun going to Disney World now. But what they're usually picking

is a moment when their kids were small and they were super duper wowed by all the characters and things like that. When their kids were small enough to get excited by seeing Winnie the Pooh walk by or something like that. And now they're saying, well, it's not as much fun. Well, you know, of course it is. But I don't want to be one of these cranks who poo-poos the experience for some young family out there that hasn't gone. I do think that they need to cool it on the price hikes for some time. How do we transition from Winnie the Pooh to alcohol and cannabis? Maybe we go via Dole Whip. That's a deep cut for park visitors.

go via DoleWhip. That's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. Welcome back. Jackson, you were telling me that they're pretty loosey-goosey with the liquor laws in Washington, where you can buy booze. Yeah, I mean, you could buy little shots at the gas station, which I always thought was kind of funny. Regular whiskey, what have you. Yeah, I mean, they come in those little one-shot airplane bottles. The airplane bottles. Some people, I've heard them

referred to as the smugglers. I don't know why they're called that or where they're smuggled. You put a couple in your pocket, you go to Denny's. Denny's does not endorse that message. I was looking at a Wall Street note of predictions for beverages this year, and they were saying that they thought the fastest growing product, they called it malt-based shots. And shots, the word is in quotation marks. This comes from MKM Partners. So the fastest growing thing they think is going to be, it's called Fireball Cinnamon.

Fireball is a cinnamon flavored whiskey, but this is not whiskey. This is for states like mine where they're not loosey-goosey with the liquor laws and where they don't typically sell spirits at a convenience store. But because these are malt beverages, you can sell them anywhere. So they're putting these at the counter at gas station stores. You can go in and you can get what looks like a shot of fireball whiskey, but what is actually a shot of fireball malt-based beverages. I'm just saying, if you're looking for a fireball smuggler, you know what?

Go to a liquor store and treat yourself to the real thing. I'm not sure that malt-based is the way to go, but you know what? That's good business for the company that makes it, which is called Sazerac. And apparently that particular product is expected to be the fastest grower this year. But what I want to talk about in particular, I think we did something on this around a year ago, and this is RTD, a category called ready to drink, or you might call them pre-mixed cocktails. If you've seen a cocktail in a can or in a bottle, that's what we're talking about here. And I was looking at a different piece of research. This is from Wedbush Securities. And they were saying that RTD is the fastest grower right now

in spirits. Sales are up 47%. Tequila is the second fastest grower. That's up 10%. So something we were talking about around a year ago is up 47%. I mean, that's not quite the same as predicting a stock rise, but I feel like I caught on to something cool, maybe not early, but I feel like I wasn't the last person to spot something cool. Is that fair to say? You're basically an influencer. Well, I didn't want to say that, but okay, since you're saying it. Now, I want to talk more about the trends in alcohol. So I reached out to the alcohol analyst at Wedbush. His name is Gerald Pasquarelli, and he also covers cannabis. So we talked a bit about that, too.

Let's play that conversation for folks. In terms of specific categories, you've seen outperformance from spirits. You've seen strong performance in beer, and you've seen kind of low single-digit growth in wine. When you're looking at the outperformance that you see in RTD cocktails, number one, it's a very new industry. There's more competition coming in. It's similar to the dynamic that we saw with hard seltzer at the outset. People like to chase growth, and it's an attractive category. Many companies are entering into the space.

And I think that one of the things that RTD Cocktails offers the consumer versus a hard seltzer is flavor differentiation. I think I'm a fan of these RTD Cocktails. I mean, if you get like I can get a bottle that says old fashioned and it's the same every time or I can go out by go somewhere and order an old fashioned, you know, I got a $16 drink and it's kind of, it's like a, it's like playing the lottery. Maybe it's just wildly off the mark. I like the consistency of being able to get, you know, dial it into exactly what you want and the laziness of not having to mix it yourself. So I guess that's what people are thinking with

these. I think so. And I think to your point, there's a lot of trial in these products, right? Like if you have a Moscow Mule from one brand, maybe you want to try another brand and see which tastes more authentic, right? So I think at the outset, and we are still very much at the outset here, I think you are seeing consumer trial into different cocktails based on the manufacturer. And then I think that ultimately, you know, the winners and losers will be predicated on the repeat rates, consumers going back to the cocktail that they like best. And so what are your favorite

stocks in this group? In your coverage, who do you think is the best positioned right now? Within alcohol, we're recommending constellation brands as a, as our top pick. And we are also recommending MGP ingredients. They kind of do third-party contract manufacturing for distilled spirits for, for, for smaller people that just for smaller companies that just don't have the infrastructure to lay down their own whiskey.

They've been the beneficiary of what, what has been a very strong bourbon performance within distilled spirits for years now. And then when we look at the wine side, we're recommending Duckhorn. Duckhorn's a relatively newcomer in terms of being public. It's been around for 40 years, but it just went public in 2021. And so Duckhorn is interesting because they are like the only pure play luxury wine company that you can get access to right now. Beer. How is beer doing generally? I'm overwhelmed by the number of brands that I see in the supermarket. And I know a lot of those are smaller craft beers. I mean, how's beer doing? Beer's doing pretty well.

When you look at just core beer and then you take a category like combined beer, which is going to include core beer, flavored malt beverages, and cider, core beer is outperforming. I am, you know, less familiar with the cannabis industry, both as a consumer and an investor. I know that there was a critical piece of legislation that was in the balance and that didn't go their way. What's the outlook for this year for cannabis? The legislation you're talking about is the Safe Banking Act. As it stands, when you go into a dispensary, you need to pay cash for your products or you need to use a debit card. These dispensaries have a hard time figuring out where to put the cash. There's a lot of larger banks that will not hold cash that comes from a federally illegal category such as cannabis. So more than likely, a dispens bill is because now these companies could essentially take the cash. They could deposit it in banks risk free without fear of repercussions from the federal government, which benefits the cannabis companies.

And then again, it also provides safe harbor to the banks. This will have implications for organized crime, money laundering. It gets it gets billions of dollars off the street. for organized crime, money laundering, it gets billions of dollars off the street. And so it really wouldn't have been that meaningful of a piece of legislation when you look at fundamentals for the largest players in the space, but it would have been more symbolic in nature to say, hey, Congress is looking at cannabis. They just passed what was, in our minds, a non-controversial bill. what was in our minds, a non-controversial bill that didn't happen since, since the end of December, the shares for, for every cannabis company have, have, have been under considerable

pressure. How are the valuations right now? Yeah. So they're between one to two times revenue, you know, at, at the height, they would have been over five times revenue. So it seems like the bottom is going to be between one to two times, which is good. We were just at ICR this week where we met with multiple cannabis operators within the space. I can tell you that sentiment is at an all-time low on Congress's ability to get any regulatory reform passed this year. That means that we're left with looking at fundamentals. And when you look at fundamental performance, there's been price deflation in many of these markets because a lot of companies came in and they built out capacity, capacity came online. They're just oversupplied in key markets like Massachusetts, Illinois,

Pennsylvania, and many of the West Coast markets. So I think fundamentally, you're going to look for a normalization in the supply demand dynamic and a normalization in the price deflation. That probably happens towards the end of this year and the beginning of next year, as these companies all cut their capital spending. Is there any evidence of what impact this has had on the illicit cannabis trade? Has the legal trade just taken over for the local cannabis dealer of old? Not exactly. Now, keep in mind that cannabis, like alcohol or like tobacco or anything else, will come with an excise tax. When you were buying on the illicit market, you're not paying excise taxes. So the illicit market is real. It remains robust in key markets.

It's very prevalent in California, which is the most advanced cannabis market in the world. It's also the largest cannabis market in the world. And one of the other places it remains quite prevalent is in New York City and in New York in general. There's a lot of optimism on New York legalizing for adult use sales. They are going to have a problem with the illicit market on their hands. I mean, there are stores that will advertise for it in New York City and it's not legal and there hasn't really been a crackdown. And so the avoidance of an excise tax and the consistency of the product that these illicit market consumers are presumably happy with, it's a risk for sure. What are your favorite stocks in the space right now and what do you like about them? We cover four companies. We cover Green Thumb Industries,

we cover Curaleaf, we cover Trulieve, and we cover Cresco Labs. These would all be deemed what you would call tier one cannabis operators. They're the largest by revenue. They are the most well-capitalized and they would be the biggest market share holders among the largest market shareholders in the US. Our top pick is Green Thumb Industries. They've had strong top line growth. It's very well run. They're actually free cash flow positive. Their earnings, their EPS and net income positive, which is incredibly difficult to do, given what is a burdensome tax environment on all these companies. So we like them. They're our top pick, but we're actually recommending all four of those names.

So we think that if there is consolidation around the larger players, these companies should benefit. Now, in terms of stock price performance, it's like with anything else, these stocks tend to trade in tandem with one another. If there is negative sentiment on the industry, there's negative sentiment on these specific companies. But encouragingly, they do look to have found a bottom, again, at between one to two times revenues. And so we're maintaining our recommendations on these companies. Thank you, Gerald. And thank all of you for listening. Jackson Cantrell is our producer.

Jackson, anything you'd like to say to the folks before we say goodbye? I don't know. I don't really have anything. We've got time. We'll wait. Something will come to you. I don't know. I don't really have anything. We've got time. We'll wait. Something will come to you. Call your family once in a while.

Call your mom. You know what? It's perfect. Call your mom. Call your mom. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. See you next week.