Motley Fool Hidden Gems Investing - A Denim Moat

Episode Date: March 21, 2024

Getting into the jeans business is harder than it may seem. (00:13) David Meier and Deidre Woollard discuss: - Chewy’s customer growth problem. - If Chewy is the future of veterinary care. - The picks and shovels play behind sports betting. (14:42) Mary Long interviews Lauren Sherman, fashion reporter for Puck on two retailers looking for a turnaround. Companies discussed: CHWY, SRAD, GES, GAP Claim your Epic discount: www.fool.com/epic Host: Deidre Woollard Guests: David Meier, Mary Long, Lauren Sherman Producer: Ricky Mulvey Engineers: Rick Engdahl, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

Let the March madness begin. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Willard here with Motley Fool analyst, David Meyer. David, how's your Thursday going? It's going great. How's yours? Pretty good. Well, I wanted to dive in first and talk about Chewy. You know, this company is interesting. We were talking about it before we got started recording because we've seen this stall out in customer growth and they're telling us we're going to be there through at least the end of this year and next year. I mean, you've got this growth in sales per customer. People

love their pets, right? They're spending on them. Total sales per person, they're at $555 a year. So that's up nearly 13%. So that's awesome. But this customer growth thing, how worried should we be about it? So clearly you should be worried. You'd never want to see, you know, above the top line metrics sort of stall out. But I think a little context is going to be important here. During the pandemic, there was a pet boom. And I think there's been a little bit of a quote unquote bust, if you will. We still have the pets though. We still have pets, but I, you know, anecdotally, you know, shelters are unfortunately seeing a rise in the number of animals that are coming in, whereas shelters had no animals at one point,

at least around in my area. So, there's a little bit of that mix going on and a little bit of economic uncertainty. Okay, I get that from management. But I think we have to work through that boom, if you will, get past that and get on a more normal trajectory. But as you said, people who have pets still spend money on their pets for a variety of reasons. And when we look at some of the profitability metrics, management is still focused on, yes, making sure that they take care of the current pet owners, but also making sure that their business is more efficient, generating a little bit higher profit margins, generating a little more cash flow, which is a good thing. Well, and the ownership numbers, I always look

at that with Chewy because it's so impressive, up 8% in the quarter, up nearly 15% for the year. I mean, it's amazing. And 85% of the business is non-discretionary. So, we're not going to stop feeding our pets. But is there competition with Amazon, Walmart, others that might offer something cheaper? And if we get toward a place where people are really watching their wallets, Is that a concern? Yes, to all of that. Yeah. I mean, first of all, the technologies available and the infrastructure in place for a wide variety of businesses to get product to people quickly, efficiently, that's going to benefit the consumer.

We get it in the form of lower prices and faster delivery times. And everybody, especially the Amazons and Walmarts of the world, they have the ability to do that. But to your other point, there is some brand loyalty with Chewy. Look, I have a nice big porch in front of my house, and I'm doing my part. There are Chewy boxes on my porch, at my neighbor's porch, at my other neighbor's porch all the time. So, I don't think it's necessarily just price. I think there's something more to it. And so far, you know, Chewy's been able to use that to their advantage, but obviously

they got to keep working because the competition is not going to slow down. Well, that loyalty aspect is interesting. I mean, one of the things we always talk about is like, you know, they send you flowers. If your pet dies, they do all these, these little things, which, which is awesome. And they've been able to keep that even as they scaled. But I wonder how that translates to the, to their big news. So, you know, a few quarters ago, the news was we're going international, we're going to Canada and they're there.

and that's going. But now their big news is chewy vet care. So planning to open four to eight clinics this year. First one, I think, is going to be near their HQ in Florida. And they say this adds a total addressable market of $25 billion, which is very substantial. I don't know, though. I'm a little skeptical here. I'm pretty loyal to the vet that I use. If they became a chewy vet, I'd probably still go there. I don't think that's happening anytime soon. But I'm thinking about this move because it kind of reminds me of what we're seeing in person care, right? Like, CVS has the Minute Clinic that you can get, you know, Walmart is doing this, Walgreens is doing this, everybody's, you know, Kroger's doing this, everybody's putting

a clinic in the stores. This is similar and yet different because Chewy doesn't do physical retail. Yes. So, I agree. It's similar, but not quite the same. And the way I might look at this is, I compare it to something that I'm seeing in the dentist market, which my daughter and her husband are both dentists. One of the things that she worries about as a dentist and he worries about as a dentist is, how can I practice without necessarily owning a practice? There's huge challenges to be able to do that. If Chewy can provide, let's say, the space and some of the infrastructure to a vet who doesn't have to take on the additional risk of actually owning and operating a practice in terms of the financial risk of these things can be expensive. It could

provide some incremental benefit to Chewy, as well as perhaps make more vets available, Which also, if they're at a good price point, as well as taking advantage of the Chewy brand, maybe you get incrementally additional pet visits to a vet where you can use Chewy's infrastructure in order to get the things that you need from them. So I think, you know, I can make the case that it's good, but I can see where exactly where you're coming from, where this is, this is out of your, you know, this is out of your experience level, right? This is not what necessarily what you're good at. The good thing is the, I see, you know, single digit openings. This isn't, this doesn't seem like a big thing that we're, you know, we're going to roll out a multi hundred of these, you know, in a year. No. We're going to try, we're going to see how it goes, and we'll adjust accordingly. That should control some of the risk from a financial standpoint and help them get maybe a cheap way to get some data to figure out, is this viable? Yeah. Well, you've convinced me there. I'm like, wait a second, that could be almost like a franchise model. But yeah, I'm glad it's a small test, but I'm also wondering

if this is just they had to do something. There's only so much time that you can talk about like, hey, we're cutting costs, we've got efficiencies, and we have no customer growth. You have to have something else that shows that there's a plan. I would say there's probably a little more emphasis on that in terms of, hey, they're certainly feeling the pinch above the top-line metrics not going well. But I would also hope that from a corporate evaluation standpoint, that they've run some numbers and this is an adjacent for them. This is not a coming out of left field type event. So I agree. This seems different, but again, I, as, as a, within their, you know, within their sphere of influence, not a big test, uh, you know, not going to cost them too much. And the other thing that I thought was interesting that they mentioned was they've already staffed it. Like there's people who want to do this. And so that hopefully, you know, that could be a, that could be a good sign.

Yeah, yeah, absolutely. Well, I want to move on. David, I know you're a sports guy and you happen to be wearing a shirt today that is cluing me into the baby that you're a March Madness guy. But we're getting ready for the playoffs. You know, we've got NBA, NHL wrapping up March Madness. It starts today. This feels like the perfect time to talk about Sports Radar, which you've covered and it also reported yesterday. I'm not really familiar with this one, but I looked at the, at, at the presentation and the third year of, of, uh, over 20% top line growth that that stood out to me. I'm like, huh? So it sounds to me like it's a picks and shovels play for sports betting. Is that what it is? Spot on as usual. So sport radar is a, is a Swiss based company.

And what it does is it licenses data packages from sports leagues around the world. When I say around the world, I literally mean around the world. Cricket leagues in India, soccer leagues in South America, sports leagues in the United States. Wherever there's a sport, they want to be licensing data from the leagues. What they do with that is transform that into betting opportunities. They have a lot of experience. Carlston Curl has been doing this for a long time. He's the founder and CEO. They sell those betting opportunities to sports betting outfits around the world, like bookies in the U.K.,

DraftKings, Flutter, FanDuel, things like that, as well as to media sites, content sites, So, CBS Sports, Facebook, wherever they think someone is going to want to interact and see a bet, they want to be there. But one of the other things that's happening is many leagues are trying to change the way that a non-in-person fan, what their experience is with a game. And so, they have lots of technology development in terms of enhancing the viewing experience along with your opportunity to make a bet before the game, a bet during the game, all these different things. And lastly, it's kind of a little bit maybe backwards to say this, but it's actually the United States that's the emerging market here.

As states are beginning to open up their sports betting opportunities, there's actually a considerable runway of growth in the United States. Yeah. The amount of partnerships is pretty amazing. They've got 800 betting operators, 400 sports leagues and federations, 900 media partners. I was surprised to find out that tennis is the number one or number two betting sport worldwide, which I found was really fascinating. NBA is number one here in the States. But this just seems the scope here is massive. Yes, it is. Almost 80% of their revenue comes from outside of the United States in probably a sport that not many people have seen, cricket as an example. Well, so I want to go back to what you said about the changing the watching experience,

because I've started to notice this a little bit in things that I've been paying attention to. you start to see more, more probability and, you know, AI is being layered in here. So it seems like this is, this is really changing how we see the game. Is there a place where this maybe gets to be too much? Like how, how much, you know, how many stats do we really need to see it? Is this going to, is this going to change the, I mean, I know why they're doing it so that we want to bet on every little thing, but is there a saturation point here? If there is, we haven't found it yet. Again, all these creative ways of taking the data, analyzing it, and turning it into a betting opportunity, there's still incredible demand for it.

Where I think you probably have the most risk is actually the regulatory frameworks that each individual state is creating. What that might mean is, if a state legislature can't figure out how they want to regulate it, that could delay the opening of a state to accept sports betting. They could also write in where the taxation of the revenue might be too onerous and could prevent that as an opportunity for Sport Radar to get another revenue source. So, I don't think we've hit the betting experience saturation point yet, but we'll find out because there's still plenty of demand out there. So, did you fill out a bracket this year?

I did. We have a little in-family bracket. Did you? I haven't. It's probably too late already. Yeah, I think the first game started at one. Yeah. Well, thank you for your time today, David. Thank you, Deidre. We talk about a lot of stocks on the show,

but it's just a peek at the Motley Fool's investing universe. This year, we're rolling out a new offering. It's called Epic Bundle. the service includes seven stock recommendations every month model portfolios and stock rankings all based on your investor type we're offering epic bundle to motley fool money listeners at a reduced rate as a thanks for listening to the show so for more information head to fool.com slash epic we'll also include a link in the show notes for you yesterday we played the first part of my colleague mary long's conversation with lauren sherman a fashion reporter for puck they

discussed the incredible turnaround at Abercrombie and Fitch. Today, they look at two other retailers seeking a turnaround and one that might be too big to succeed. Quick note, this conversation was recorded before guests reported its quarterly earnings. So let's pivot to talk about some other fashion brands quickly that are maybe hoping for similar successes as Abercrombie's had recently. Yeah. Guess, which I was trying to think of a way to describe it. Like, is it entry level luxury type brand? But they acquired in February, they acquired Rag and Bone or announced their intention to acquire Rag and Bone. Can you kind of give us a peek behind the curtain of this deal? Walk through maybe why it makes sense for Guess? Yeah. So what I had heard previous, and I reported this, what I had heard a few months earlier was that Guess was in the Middle East trying to raise funds to do a take private. Because Abercrombie is an exception. The stock market is not kind to retail stocks, especially the last few years.

And so they were trying to go private. And the pitch in the fundraising was that they were going to buy Rag & Bone, which has been owned by some private investors and a private equity fund for like the last 10 years. It's still pretty popular, but really reliant on and is heavy on denim. And it's interesting, obviously the through line with all these brands is that their success and their failures both come from being mostly denim brands. And so Rag & Bone is still a go-to for a lot of men, but it's not as relevant as it once was. And also they're really relying on the off price market. So they needed to be sold the private equity firm that owned them wanted to get out of the deal and was being patient, but was ready. And, and so they've entered this potential

deal. I don't think it's closed yet. I assume that they'll do an announcement when it is, but to be bought partially by guests, partially in this sort of split between guests and this licensing firm. And so I, I think the idea with guests, guests is the, it's still family run by the Marciano's and Nico, the son is, is sort of up and coming. He wants to do really interesting things. They're based in Los Angeles. They're deep in the art world. They've had some issues with, you know, the, the senior, the elder Marciano's with some me too stuff, some legal stuff. So going private makes a lot of sense for them. And this new young Marciano seems to be really excited and wants to do interesting new things. So the idea of buying Rag and Bone,

I find it interesting from the guest perspective because guests has a very strong aesthetic and a very strong DNA. They're sort of the opposite of what Abercrombie is doing. So they are, you look at the billboards on sunset or on La Cienega in LA and they look like they could have been shot 30 years ago. And in a way that it's interesting, it doesn't feel super dated. It feels dated, but it's also sort of charming and like a cool black and white sexy way. And, and you would, you'll also see that guests has been distributed on, uh, in bigger retailers like essence and these luxury brands to give it, like you're saying this sort of fashion luxury adjacent feeling. And so rag and bone is similar that it sells at all the luxury

stores. It's not crazy expensive. It's not cheap, but it is what they call contemporary price. And so they, they are almost sort of the more standard preppy go-to that, that Abercrombie no longer is. And so it doesn't make sense for guests to buy rag and bone. I would say that, you know, if, if what they're trying to do is build a little portfolio of great denim brands that have a loyal customer, then sure. And also they got a good deal on it. You know, at one point it was valued at $250 million. And I think they paid like their part of the payment was only 39 million or something like that. So it was, it was pretty low. So, um, they got a good deal on it. And if they are going to go private and kind of build up this, this denim portfolio,

it's interesting. And you have to also remember the denim business is really based on supply chain and having those relationships. So if you have relationships with the manufacturers or you own the factories, a lot of this stuff happens in, in LA actually, but also in Turkey and Mexico, there are some, some in North Carolina, some really big hubs for denim making. If you have really great relationships on the supply chain and you're able to get good deals, you can have a great business. Cause denim is one of the few things that people are willing to buy not on sale. And so the margins are pretty good, especially compared to other types of clothing. Gap is another retailer that hasn't, it hasn't had a pretty past few years, I guess.

20 years. When we were talking about Abercrombie, you know, the, the focus of the story seems to be Fran Horowitz and like what she's done to focus on product and turn around the brand gaps kind of had a lot of people coming in and out the door of the, as CEO. Um, now they've got Richard Dixon. He stepped into the spot this past summer. I believe you had art pack helming the retailer from 2015 to 2019. Sonia single was ousted after two and a half years Or Sonia. Yeah, that feels like a lot of turnover to me. Can you give us a peek behind the curtain of the corporate machinations that are going on there?

Why are people leaving the job? What are the key issues that this retailer is facing? Oh, man. It goes back to Mickey Drexler, the merchant prince, the king of them all. Mickey was the CEO of Gap in the 80s and 90s and made Gap what it is today as we know it. you know, pre prior to the eighties gap sold Levi's, they didn't sell their own products. So he brought in, made, made it, you know, if Abercrombie was sort of the heritage preppy gap was the new American and, and it changed, totally changed the way people dress and the

rise of casual Fridays, all of that stuff. And when Mickey was fired in the early two thousands after a couple of bad quarters, they, he obviously went on to J crew where he revitalized that brand and it sort of killed gap for about 10 years and then had its own problems. But you know, one, when Mickey left the family that owns gap or now owns part of it, it's, it's a public company is the Fisher family. They really just never figured it out. They never were able to regain the magic. And I'd say, and, and it was such an important, iconic brand more than any of these other brands, because it, it spanned generations. It was so important to my parents, me, and also my little sister or whatever. It really did. It really did span

the whole, it was, it was a monobrand for a monoculture. And so people feel really emotional about gap in a way they don't with other brands. And, you know, in the mid two thousands, they brought in this guy who was a big cost cutter. Then they brought in art who came from management consulting and I think tried really, really hard to fix it, but was getting pummeled buy fast fashion and didn't know how to price things and didn't know what the consumer really wanted. Then Sonia, she was a sort of lifer there, but came from more of the tech and supply chain side and probably didn't get brand. And the other thing is they just have all these, it's in San Francisco. They have their executive lineup or people who have worked there, many of them since

Mickey was the CEO, which is well over 20 years ago now. So, so it is, it's sort of one of these stories and the family, the Fisher family, they're good people. They care about it, but none of them really ever wanted to be running it. And so they dip in and dip out and they're involved, but they, they didn't want it the way that Don and Doris, the founders did. So it has just been one of these sad, sad situations. It's been one of these sad, sad situations of the past 20 years of just back and forth, back and forth. When is it going to come back? When are we going to get our gap back? When are we going to get our mellow yellow commercial back from the, from 1998 or whatever? And, and I would say with Richard Dixon, they hired this guy from Mattel who,

got a lot of credit for the Barbie phenomenon, I would say that it should not all be given to him. He's a great executor and he has great relationships. But Inan Kreetz, who became the CEO of Mattel a few years ago, he is really the driver of that in partnership with Warner Brothers. And so Richard got a lot of credit for what happened with Barbie. And I would say he deserved probably a quarter of it, but he was already on the board of Gap And he had been observing Gap for the last year before he was appointed CEO. And I think it was a brilliant choice. He is driven.

He wants to change things and he is not stuck on the past. That being said, Gap Inc. is a large business that includes Old Navy, which is the first or second largest apparel only retailer in the US. There is Banana Republic, which has been a struggle since they bought it in the early 80s. They've never really managed to figure it out. For a while, Mickey was able to do some stuff within the 1990s, but it's been a sort of albatross. They also own Athleto, which is a very good activewear brand with good product that has faltered in the last few years. And then they've owned other weird things.

They've sold Intermix, a multi-brand retailer. So it's not just the Gap brand they're dealing with. It's all this other stuff. And so, so far I've been really interested in what Richard has done. He, you know, I thought the, the idea was when you talk to executives who work there, they really thought he would have fired more people at this point. But instead, you know, the athletic team is still pretty new. The old Navy team is still pretty new. Instead he's, he's trying to get, get them on track and, and let them revitalize these brands. And he made this crazy move a couple of months ago where he hired the runway and red carpet designer,

Zach Posen to be the chief creative officer of old Navy of all the brands, old Navy. And then also to essentially be a creative advisor to him on the gapping portfolio. And so a lot of the headlines have essentially said that Gap that Zach is designing Gap, but which is not exactly true. So I think you will see them bring in someone else, maybe not a big name, but someone to kind of overhaul the Gap brand itself. But, you know, one of these things with Gap is it just feels too big to succeed. you say too big to fail. I it's just so big. And they tried to spin off old Navy at one point. Maybe they'll try that again. It doesn't really make sense to, you're never going to be able to really fix gap and banana Republic and Athleta. If you have this giant $7 billion business that you have to reckon with that, that matters so much. But I would say early on, I've heard some stuff about Zach's feedback to the old Navy team. He did indeed. This is a really New York guy who

really made like almost haute couture level stuff. He really has like, he's there, he's living in San Francisco. He's involved. He did come to LA and made the rounds Oscars weekend. I saw him at a Giorgio Armani party. And then also he went to the vanity fair party. So he still wants to be in the spotlight, but he is really, he's really there every single day and, and is going to make some changes. All that being said, again, like I just think if, if gap owns old Navy, if gap ink owns old Navy, it's just really hard to fix gap and banana Republic, because you have to put the focus on fixing old Navy because there that's where the most sales and profits come from. So it's, it's not an easy, it's not an easy task, but I do, I do give the board credit for hiring

Richard and not one of their, their lifers, because that's sort of what they have been doing for many years or, or a management consultant or something. They, they hired an executive with real experience and has seen success in his career. And so let's see what happens. I think unfortunately, or fortunately, I don't think he is going to play the Abercrombie playbook with gap, which maybe he should just seeing it. I know that he has been advised to do so, and I don't think he will. So we'll see. Can he give gap magic? I don't know. 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

on what you hear. I'm Deidre Woolard. Thanks for listening. We'll see you tomorrow. Thanks for watching!