Motley Fool Hidden Gems Investing - Americans are Flying, Airline Stocks are Not

Episode Date: July 8, 2024

(00:21) Asit Sharma and Dylan Lewis discuss: - How the airline industry’s focus on capacity and being able to supply more flights means fares are low, even in the face of record demand. - Eli Lilly’s $3.2B acquisition of Morphic, why it’s interested in the inflammatory bowel disease markets, and a few risks to keep in mind for the high-flying provider of weight-loss drugs. (14:39) Fool analyst Kirsten Guerra talks with Mary Long about her investing journey, and a career pivot that took her from rocks to stocks. Companies discussed: DAL, UAL, AAL, JBLU, LUV, LLY, MORF Host: Dylan Lewis Guests: Asit Sharma, Kirsten Guerra, Mary Long Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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all ready to go from day one so you can hit the ground running. Bring it with SAP Grow. AI Cloud ERP for any size business. Record numbers are taking planes, trains, and automobiles. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst Asit Sharma. Asit, thanks for joining me. Dylan, happy Monday. Happy Monday. Back from the holidays, we are taking a look at some travel trends from the

holidays. Also going to take a look at one pharma company building out its portfolio. Asit, it's our first day back from what was a long weekend for some, and AAA estimated that the road and air travel for the holiday weekend hit new records this July 4th. Were you one of the $71 million that went out of town for the fourth? I thought that going to the grocery store was part of this survey, if you hadn't done your groceries in two weeks, but apparently not. So, I guess I'm not included in these statistics. I think it's a 50-mile radius. I think that's what you need to get out of to be included. So, it depends. If you're remote and the grocery store is that far away, you can work your way in.

So, you stayed put for the fourth? Yeah. How about you? I hung out in D.C. too. It's kind of nice. There's a lot of folks that come in for the fireworks on the 4th, not a lot of people stick around for the weekend, so it's nice to have the city to ourselves. That said, a lot of people did decide to travel over the holiday weekend. Record numbers, as I mentioned before, on the road and in the air. It's easy to understand why. In an environment where a lot of things have gotten much more expensive for a lot of people, gas is below 2022 peaks. Airfare is generally down for travelers as well. This is one of the few spots where consumers have actually been able

to catch a break, Asit. When you see gas prices below the average that your brain has been keeping track of for rolling 12-month periods, you want to travel because intuitively, you understand that's something that you can afford. We do the same thing with air travel. I think most of us check up a little bit less frequently on air prices. But when we start dreaming in the winter and in the spring, we get a sense, it's not that expensive vs. last year, so we're more inclined to spend. But of course, this has an effect, too, on companies that are trying to make money within the industry. Yeah. You would think, when you see these record numbers, that it would be good

for the people who help make that travel happen. That hasn't really materialized, though, especially when we look over at the airline stocks, all of the major carriers behind the S&P 500 so far, year-to-date, what exactly is going on in the industry right now? It's such a complex industry, Dylan. Just to recap a few broad things about it, it's an industry in which there's a high fixed-cost base. You have to have a lot of infrastructure supporting an airline. You have, of course, this enormous amount of capital expenditure that you've got to make in airplanes. You've got high labor costs. That's a very high labor field. And then also, you've got these variable expenses like the price of oil. You've got consumer

preferences. You have the variability of business travel, which contributes to your revenues and profits. So, there's so many factors. It just seems like an industry which is really difficult to, over the long term, succeed in. Now, having said that, to answer your question, like the near-term factors, what's going on here is that airlines have this one big lever to expand their revenues and profits, and that's capacity. So, adding planes and adding routes. But when there's more capacity in the industry, if you and I are both running airlines competing against each other, how do we get people to fill up that capacity? We cut prices. Yeah, we have to work on our pricing

against each other, which lowers our profits. Now, the answer that the airline industry has come up with over the last few decades is to have ancillary revenue. You have loyalty programs, you partner up with major cards, and you also have premium seats in airlines. You try to attract every bit of add-on revenue that you can. This model works better for some airlines than others. But what we're seeing here really is a lot of capacity that's been built over the last year. Airlines struggling to fill that with consumers that at peak periods want to travel. But outside those peak periods, we don't see them traveling quite as much. You mentioned the capacity build out there.

It is a little interesting, because we look at some of the indications we're getting from companies in the space. I think when they last reported earnings, Southwest and American had both reduced their outlook for the year. It seems like you have the carriers making some of these longer-term investments in what they're able to actually build out, even though the near-term picture, as in-demand as airfare is, the prices aren't there to support a lot of growth for these businesses. It's just a reality we have to accept in this space right now. Yes and no. Generally, yeah. But look at Delta. This is an interesting case study of a company that didn't look much different than its legacy competitors a few years ago.

United, American, you mentioned. Delta started really focusing in on on-time travel and also moved a lot of its business to attract business travelers and to sell premium seats. They have a great tie-up with American Express, which brings in a ton of ancillary revenue, to mention that. Delta actually is a rare example of a business in the airline industry which is making some money, has pretty good free cash flow. You look at their financials, the company, yeah, it's not growing its top line quite as much, but it's managing to have a little bit fatter margins versus other carriers. And I wonder, Dylan, if just focusing in on the basics, let's say you've got all the other pieces together, right? You've got the routes, you've got good planes, just being able

to provide basic good customer service, plus a smart ancillary revenue strategy, if that isn't the answer, because they seem to be outpacing competitors over the last 12 months to two years. They're going to report earnings soon, so maybe you and I can revisit them. But maybe it's not the same outcome for each airline. I think Delta is one that I'm looking at that's differentiated itself. Perhaps no surprise, Delta, the top-performing airline year-to-date, just underneath the S&P's returns by about 1%. So, holding up pretty well while the industry is struggling a little bit. We'll get that update, as you mentioned, on Delta later this week when the company reports.

I want to turn us over to Monday and Merger Monday. Living up to the name today. We had some deals cooking over the weekend. We get to break them down now. Eli Lilly buying Morphic holding for $3.2 billion. Morphic is focused on chronic disease therapies, most known for treatments focused on inflammatory bowel diseases. Asit, when we hear Eli Lilly, we tend to think about the weight loss drugs and the diabetes drugs. Why do you think they're interested in Morphic? I think this gives Lilly some good diversification versus what has been a revenue driver for the company. Looking at the growth over the last few quarters. You're spot on, Dylan. Monjaro, which is a diabetes medication.

Zepbound, which is a weight loss medication. They're both based on the same class of drugs called terzepatides. These take subcutaneous injections. It's been a runaway success for Lilly. Look, a runaway success for the industry. Lilly is expanding its capacity to manufacture these drugs. I think if I were in the driver's seat, I'd be doing the same thing. This is not going to be a forever class of medicines, either in what it's doing for patients and also in the delivery factor. Here we've got a smaller company, which is not too big a leap for Lilly to acquire. I believe the deal size is about $3 billion. You have not only this smaller company with a lateral move into another disease state. So, this drug that Morphic is working on,

we should mention here, it's in phase two trial, so it's not yet complete. But the technology is also an oral drug. So, that's also diversification. So, I think on a lot of fronts, this makes sense. If you're Lilly, you want to keep compounding these advantages from this class of drugs, the GLP drugs, as we more commonly know them. But you want to prepare for the day where that's not going to be the new growth driver. As you mentioned, it is a very easy acquisition for Eli Lilly to make. They are an $870 billion company. Not much of a reaction on Lilly shares, though we did see shares of Morphic up 75% on the news. The deal is priced at $57 a share. The share is currently trading around $56 a share. I think the market likes

the chances of this one going through. I do want to note, as we were taking this an opportunity to check in on Eli Lilly's business. They have made several other acquisitions over the last year or so. They bought Dice Therapeutics for about $2.4 billion. They bought Point Biopharma for, I think, about $1.5 billion. They have been trying to set up the foundation of these other businesses, as you mentioned, Asit. It feels like, while business is booming for them, it's a great opportunity for them to do that. I think so, Dylan. I was surprised just refreshing myself on their financials this morning to look at their balance sheet. The goodwill on the books is about $5 billion. That's a lot of goodwill. It accounts

for so many transactions over the year where you have to book the difference in the hard assets you're getting with the intellectual property. But their total asset base of Eli Lilly, because this company's been around for so long, is $64 billion. In relation to its total asset base, even in relation to its current assets, which are $25 billion. The Goodwill is not that big. This is a company that's grown largely organically over the decades. So I think there's some room here to pick up diversification, to invest in some R&D, which this industry is great at. You have licensing agreements with smaller companies, but just buying them outright can be a good strategy. And there's so much on the books here.

if we just look at the difference between current assets and current liabilities. Working capital, $6 billion. It'll be $3 billion after this deal, because as you mentioned, it's an all-cash deal for Morphic. But a clean balance sheet, and they can easily finance other deals by smaller companies for $100 million here, $200 million there. I think this isn't a bad strategy. There is a downside, though, that the innovation doesn't pan out. That's always a risk in the pharmaceutical industry, you're always looking to the next class of drugs, the next blockbuster medicine, especially with a company this size, which has always made it hard for me to invest in because you've got to keep up that past performance.

I'm always thinking, you mentioned this, Dylan, nearing $1 trillion in market cap, $800 billion in market capitalization, correct? Yeah, it's $870, I think. That's a lot of performance to keep up over the long-term. Yeah, I'm actually glad you brought up the balance sheet, because I wanted to get your take on this. They have been acquisitive recently. You mentioned they have a decent amount of working capital. But one thing that has gotten bigger, faster than their working capital, is their long-term debt. They had about $13 billion in 2019, up to $25 billion in the most recent quarter.

I think that is probably a mix of some of the acquisitions we've seen, but also the focus on building out capacity for these drugs that they see as being blockbusters, hugely successful. Is that something you are willing to stomach, given the appetite for those drugs, Zepbound and Mojaro? I think so, Dylan. One of the things to look at here is that Lilly, as a very strong company with a big balance sheet, gets pretty decent interest rates on its long-term notes. This last series, though, was a little bit on the high side of the interest rate they're paying. The maturities of their debt are pretty spread out. When they issue notes, they issue them out 20 years, 30 years into the future.

For the large part, when they take on debt, it's not debt that's due tomorrow. And the free cash flow has really increased over the past few years. Again, this is due to those weight loss drugs and the diabetes drugs, so that's not going to last forever either. But looking at how they're leveraged versus the maturities of the debt, the interest they get on the debt, plus that strong cash flow. I don't worry about it too much, but I think you're right to call this out. Let's take these numbers we've both put together. I mentioned $64 billion of total assets on the balance sheet, and you're mentioning about $25 billion of long-term debt. I think here, if it got 60% of the total asset base, I'd be a little more concerned. I do think they've had,

had, as you mentioned, a little spike up over the last period as they've started to acquire. In fact, just $7 billion added to that total since the end of last year. I suspect this is not the last we'll see of adding to long-term debt, but at some point soon, they'll probably slow down on that. Yeah, that lever is going to go away soon, right? Yeah. All right, Asit, thanks for joining me today. I'll have you back on in about 2044 we can check in on their debt maturity and see how things are going. Sounds great, Dylan. I look forward to that. Awesome, Sharma. Thanks for joining me. Thanks for having me, Dylan. Always

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to them. This started off as something we thought, oh, well, we'll get to talk to people about their first investing jobs and kind of learn how they wound up here. And that's still the case, but each chat has kind of taken a life of its own. And I am especially excited to chat with you, not only because I love to chat with you about all things investing, but also because I like had a front row seat to some of your career journey before you were an analyst while you were at The Fool. For listeners that don't know, Kirsten and I worked on the editorial team of Fool.com together before we were in our current roles. So anyway, because of that experience, I am especially interested to hear and to have listeners hear how you wound up not just in an analyst role, but maybe before that, just to the fool in general.

What was your path to to fuldom? Right. Well, it was a it was a relatively straightforward path, you know, to geology school and then to the oil and gas industry. and then from rocks to stocks, sort of a natural progression into editorial work at an investing media company. And then again, the next most natural step into investing itself. I mean, I think it, I think the story sort of writes itself, right? Self-explanatory actually. Yes. Yeah. We can scrap this question. No, no further explanation needed. Yeah, that's exactly it. No. And I mean, obviously, of course I keep saying obvious, none of it's obvious, but I think that if you are interested in business and investing in general, like I was, it, it can make sense,

you know, for me, very short story. It just, I was, it happened to be that I got burnt out in the field that I was in and investing was something that I did on the side and found very fun. I think maybe that's the case for a lot of people, especially for the audience listening here, you were likely doing this for fun. And I was as well. In fact, I was listening to this specific podcasts while I was in that other role. And I heard someone say one day, check out careers.fool.com and I did. And that's how I wound up in editorial. And then as you said, ultimately making my way to the investing team here. So you were investing on the side before you started doing it professionally. How did you get started investing as a hobby? I was always very good at saving, but that's

only half the equation, right? So before The Fool, like I said, I worked in oil where I made good money. I spent substantially less than my own personal cash flows. Then one day, I just realized, hey, I think I'm supposed to be doing more with this money than just letting it sit here. I had actually done a stock market simulator at one point. Despite having real actual money to invest, I had only played around with some fake money. When I remembered it a few years later, I checked back and the couple of stocks that I had picked had done really well. So it was like, okay, yeah, I definitely should be doing more than just building a cash pile. I need to actually deploy some of this. And, uh, that, that was, that was

really kind of the impetus to kind of look more into what should be done there. So when you're picking stocks for this simulator, was that like a throw darts at the wall and see what sticks kind of approach or, or were you applying something a bit more, shall we say high-minded to that picking process? Oh, it was absolutely high-minded. It was following the famous philosophy of investing in what you know. No, it truly was, because I picked only two stocks. One was Chipotle, and the other was for a company called Schlotzky's, which traded under the ticker BUNZ, B-U-N-Z. Are you familiar with it? I'm not. It's also a sandwich company. It still is,

though it's not public anymore. But yeah, those were the two companies I picked. Clearly, just, they were places I got lunch all the time. And so I was like, you know, that's what I reached for. There was nothing more obscure. I didn't know any of these other companies. So I just reached for what I knew. And yeah, like I said, I checked back a few years later. It was before the Chipotle norovirus issues that I looked back. So fortunately, that could have scared me away, right? If I had looked back at the wrong time. Fortunately, it was a positive story when I looked. And so I just, you know, decided I needed more of that. It's interesting to me that your like first intro to stock picking was through Chipotle and like these restaurant companies,

because I feel like, or at least speaking for myself, when I, before I really got started investing, if you asked me about stocks, the thing that came to my mind was like purely tech stocks and to think outside of that bubble felt novel. And so I kind of love that you have the opposite approach. You're like, what am I eating? Okay. That's what I'm going to invest in. Yeah. Which is funny because I, you know, my mom had opened her own business, a pet store. And so through that whole journey though, I knew that in general restaurants are one of the hardest businesses to open just on your own as an individual franchising on a massive scale is of course, a different story. But knowing that, it is extra interesting that I went for

food service stocks. But that is where I went, and it worked out in my favor. So you go from food service stocks, you check back in on the simulator, see that they've done pretty well, and then decide to give this thing more of a go. How did that process of stock picking evolve over time for you? It was definitely very slow. Naturally, one of the first things I got into was index funds. Once I decided that something needed to be done with this cash pile, I was very interested in business at that point. I wanted to try my hand at picking individual stocks, and I did. But I would say the bulk of what I did was first to just put everything in index funds, and then just take

a little bit of it out and put it into an individual stock if I felt confident in that specific company. At that time, it was much more rudimentary, of course. I wasn't looking in any particular depth at a company's financials or anything. It really was more of an investor or a consumer sentiment feeling around the company. That was how I made the transition. Slowly over time, as I grew more confident and learned more skills about how to actually deeply assess a company, then I took more and more out of index funds. I think today, I'm at half and half index funds and individual stocks. Once you maybe started to invest more in your investing journey and your learning journey here, are there any early mistakes that you made

that made you realize, oh, wait, this is a little bit more complicated and involved than looking at what I eat for lunch and putting money into that company behind that? No, that's still the strategy. No. Here's the thing about being an analyst for less than two years. As we've talked about, I've invested a little longer, about six years, but two years officially in this role. I don't even fully know what my mistakes are always because I'm a long-term investor. And I do my research and make predictions about where companies will be at minimum three to five years from now. So even my first high conviction idea in this role hasn't had time to play out or even meet

that milestone, right? So I'll give you an example here from in the role. Enphase Energy is a company I stood behind and helped recommend when it was around, I think, $180 per share. Today, it's somewhere around $130. And the thing is, solar energy recovery will come, but the timeline is unclear. It's still unclear. And I believed it was undervalued at that time. But I also knew it was, at minimum, a three-year story to turn around. And that was one year ago. So, it could be easy to look at that down something like 30%, I think, and call it a failure or an early mistake. I still don't think so. I expect that the same

thesis will play out. It just needs that more time. And so I think anyone who's investing will probably know that it's a continuous journey. It's a continuous learning journey. So I will continue to learn and make mistakes over my career, I'm sure. But it's also a weird role in that it usually takes some time to even really fully encapsulate what those mistakes are. Before The Fool, just in investing in general, one of my biggest mistakes, I think I've talked on a podcast before, was diverting a lot of my own salary into my company's stock purchase plan. It was nothing against the company in particular, it was just that I bet a lot on, well, not bet, it was investing, but I allocated a little too much of relying on

both my income stream and also a lot of my savings into that company, if that makes sense. So it was less about the specific company and more about the portfolio decision to put a little bit too much risk all in one company. I mentioned that I've been talking to a number of different fools and kind of having similar conversations with them a theme throughout all of this that i feel like we've implicitly hit on just here now talking with you is intellectual curiosity and and being curious and interested in a number of different topics you mentioned you got your start i guess the question is like how do you feel your your other intellectual interests and your past experiences in, on the surface, really different fields. How has all that made you a more successful

investor today? I'm a big believer in analogs as a way to refine your thinking around approaching a new company or a new field. It's always helpful to have things that you do have experience in that you can relate back to. Some people call them mental models, whatever semantics you want to use. It's really helpful to be able to relate anything back to, like I've read whole books about relating science concepts to investing and understanding business and how that can help. I think we may have read one of these books together, Mary, if I'm not mistaken, but maybe not. And so there are little things like working specifically in micro seismic geophysics in the oil industry. For example, there's a lot of work around just the concepts of signal to noise ratio

and refining that, for example. That's certainly something that applies to the market, in that you always want to look for the noise. Not the noise, that's incorrect. You always want to look for the signal. But the more noise there is, the harder that can be. It's definitely a skill to learn to ignore the noise and really hone in on what matters for a business. Ignoring things like these day-to-day movements, it's really easy to get caught up on as an investor. Why did this company move? Why did the stock move 2% today? It probably doesn't matter. The real story is, why will this stock grow 500% in the next three years? Well, that's a pretty big leap, but you get the idea. It's the big story that matters and it's very easy to get

caught up in the noise. But anyway, back to your original question, it's just understanding, Being able to relate concepts like that, I think, helps ground yourself as an investor, no matter really what your background is that you're coming from. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow. you