Motley Fool Hidden Gems Investing - Bull vs. Bear: Best Buy

Episode Date: April 6, 2022

(00:22) Acquisition battles are heating up as travel season kicks off. Asit Sharma joins Deidre Woollard to discuss: - JetBlue’s competition with Spirit to buy Frontier Airlines. - Amazon’s plan to launch 3,000 satellites into orbit for its broadband internet plans. - Restaurants in the metaverse. Jim Gillies and Brian Feroldi take a “Bull vs. Bear” approach to investing in Best Buy, (18:56) the company that was supposed to become Amazon’s showroom. You can decide who made the better argument @MotleyFoolMoney on Twitter.   Link: Metaverse Stocks -  https://www.fool.com/investing/stock-market/market-sectors/information-technology/metaverse-stocks/ Stocks: JBLU, SAVE, ULCC, AMZN, NKE, RBLX, CMG, BBY Host: Deidre Woollard Guests: Asit Sharma, Brian Feroldi, Jim Gillies Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. I'm Deidre Willard, sitting in for Chris Hill, and I'm joined by Motley Fool senior analyst Asit Sharma. Today, we're going to talk about the battle of low-cost airlines, Amazon's big satellite move, and restaurant brands in the metaverse. Let's begin with the big story, which is DeptBlue's move yesterday. They're announcing a proposal to acquire Spirit Airlines for $33 per share in cash works out to a total of $3.6 billion. There was already a planned merger between Spirit and Frontier that was announced in February. This is really interesting because JetBlue thinks it's offering a better deal than

the offer from Frontier, which is true from a monetary perspective. Frontier's bid would give Spirit shareholders a share of the combined airline as well as some cash per share. Really interesting because these are two very different types of airlines, whereas Frontier and Spirit are more aligned. Asit, I'm wondering what you think could happen next and what this means for consumers. Well, I'm going to be totally honest with you, Deidre. I don't know what's going to happen next, right? Because this sort of counteroffer is going to have some regulatory scrutiny around it. But let's hypothesize that the deal goes through. I think this means that For consumers, costs are going up. The reason is, JetBlue has a choice to become more like

Spirit or to make Spirit become more like itself. I think the odds are that JetBlue tries to mold Spirit in its own form. You've got an airline here which has been pretty successful in JetBlue at offering some premium perks. It's not quite the large carrier like those it wants to compete with, the United, American Airlines, and Deltas of the world. It's an up-and-coming airline. It's slightly smaller than a great regional airline, Alaska Airlines. If the merger goes through its spirit, it'll leapfrog that to become the next big carrier. I think what JetBlue is trying to do here is to really compete with these bigger carriers. It can't recreate the whole hub and spoke network that the legacy carriers

have. But what it can do is to really hone in on route density, which is what it gets in Spirit, because both are East Coast airlines. The thing that I like about this for JetBlue, not for myself when I travel, if my costs are going up, but what I like for JetBlue is that in buying Spirit, it gets a really beautiful route density into Latin America, into Central America, into the Caribbean, routes it doesn't have. Those are very lucrative routes. The travel in this area from Latin America to the U.S. back and forth has been steadily increasing, took a hit during COVID, but long-term, that's a great place to be. You buy Spirit, you get into a bunch of big cities in the East Coast and some other hub cities,

you compete with the bigger carriers, you get great route additions, and you can slowly, It'll take some time. You can make this spirit part of your business more like JetBlue, which is not, again, a premium airline, but think of it as a lower-cost carrier with some perks, not an ultra-low-cost carrier. It's just one or two steps above that. Interesting. I like what you said there about ultra-low-cost versus low-cost, because that's Frontier's argument, is that JetBlue is, in fact, prestige, and so that it's not a natural match. The other thing I think is interesting is JetBlue has tried some acquisitions before. They haven't worked out. There's certainly an antitrust concern here.

Do you think that that's going to be a concern? How are the regulators going to look at these two deals? I want to say it is a shot from left field. If you've read any of the news stories around this story. Many airline analysts, and I'm not an airline analyst, but I totally get this, they're scratching their heads. Just because of the regulatory aspect, this is a move that is the opposite of a frontier spirit merger, in which costs could stay level for consumers. You've got two ultra-low-cost carriers that would be merging. Here, how does this benefit the end user? It doesn't. Now, JetBlue can make the argument that in becoming a bigger airline, not quite as big as these huge competitors I mentioned before,

we make that part of the airline segment more competitive. We come in and compete with bigger carriers. I think that's a bit of a stretch, but there is some logic there. I don't know where regulators will land. I think this is indicative of a company in JetBlue that is really looking to grow, but doesn't have a great organic path to do it. So, they're not grasping at straws here, but they're going after propositions which aren't natural fits. And this is what happens in an industry like the airline industry, where you have just decades of consolidations, just a few players on the big end. To get bigger in this industry is not so easy. Very good point. Just to wrap up, what are you thinking about the energy costs

and airlines. Prices seem to be going up for airlines. Looks like we're going to have a big travel summer. What are you thinking that we're going to see on that front? I mean, it's so interesting, Deidre. The two biggest costs for an airline are labor, of course, and fuel. And we've seen over time that airlines will go for utilization. They want to fill seats. They will deal with higher fuel prices in a number of ways. The best way, I think, over time to counter the effect of rising fuel costs is to add on ancillary services. This is something that JetBlue excels at. I don't think that there's much that any airline can do in the industry just now. They're going to have to absorb some of these costs.

The rest, you and I are going to be paying more when we board. I'll tell you one thing, I'm traveling this summer. Please, world. Please, universe. Please, cosmos. No more exogenous shocks. Give me just even a couple of weeks of a window in which I can have some fun travel. I will get on a plane this summer. I think you are not alone in that. All right. Let's move on from airlines to space. Amazon has announced ramping up Project Kuiper, which is its satellite operations. It's just really ambitious. They're planning 83 launches over the next five years. They're putting more than 3,000 satellites in orbit. Why? Because they're going to try to provide broadband internet for consumers, businesses, government agencies.

It's a massive, massive project. Really interesting to see. And I'm wondering what this means for Amazon's core businesses, for Prime, AWS, things like that. This is a multi-year effort. It sounds like it won't have much impact on Amazon's business for a while, because they've got to get these satellites into space. I believe that Amazon does have a little bit of an impetus to start putting its satellites into space because of some licensing requirements. They received licenses from the Federal Communications Commission in 2020. They've got to start putting up satellites within the next couple of years to keep those initial license grants. So, there's nothing on the surface or in the immediate future that's

going to impact the other businesses. But, Deidre, I remember that Morgan Stanley had a projection, I don't know, a couple of years ago, in which they said that this total space business, putting satellites into space and having consumer services, is going to be potentially a trillion-dollar business for a lucky few companies over the next 10 years. Who on earth has the kind of capital to put thousands of satellites in space? Only a very few private companies or public companies can do this. While we look at this large opportunity that is going to cost, by Amazon's own estimates, $10 billion of its capital. Potentially, they get a fraction of this market, say 5% or 10%.

That starts to impact the other business lines. Let's fast-forward, I don't know, six or seven years in the future. That's where you start to get some incremental gravy that's flowing to Amazon's bottom line. It makes them better able to compete with that additional cash flow, to lower their infrastructure costs for stuff that we order here on Earth. in that sense, it will potentially have an impact on those other businesses. It's just not going to happen overnight. Yeah, I think there's so much potential. One of the things I've heard about is the potential for data centers in space and things like that. I mean, there's all sorts of interesting applications. You mentioned big companies. Well, the other one in this is,

of course, Elon Musk and Starlink. There's been a lot of talk, a lot of back and forth between the to a bit of one-upsmanship about Blue Origin versus SpaceX. Is Amazon too far behind Starlink to catch up at this point? Starlink's already launched about 1,900 satellites. They've got a quarter of a million subscribers. Does this mean Elon's got the jump on Bezos, or what? Yeah. Deidre, this is a G-rated show, so I don't mean any innuendo here. But I was around seven years old, I walked into a friend's garage. There was a sign that my friend's mom had put in the garage. There's a common saying, you have to think back to the early 80s here, late 70s, the only difference between men and boys is the size of their toys. The picture

was of two boats, a little boat and a big boat in the water. This is what it's boiling down to with all these billions of excess capital that Jeff Bezos and Elon Musk have created. They want bigger toys. They are in the never-ending contest to see who can win here on the planet and in space. It's a great question. Has Elon, in this part of the competition, just gotten the head start, and Bezos can't compete? I actually don't think so. I think, again, going back to the point I was discussing earlier about the capital required to put all these satellites, thousands of satellites into space, if only a few companies can do this, it means that there's not going to be a monopoly business in space. It's probably going to be like

a duopoly or an oligopoly. Is that right? We have more than a couple. There's always time to catch up, especially if you're relying on a consumer model. At the end of the day, these are consumers that are going to propel this. It could get into corporate business later, as you mentioned, with data centers in space. But with a consumer-centered monopoly, regulators, just the idea of competing lent itself to another company, even if it takes a couple or three years more entering that. Now, do Amazon and Starlink, between them, have a business model that's probably airtight? They don't have to worry about much more competition? Yeah, I don't see many more companies coming into this game. One last thing on this subject. I'm a little bit concerned about

the potential for things being crowded. There's already been talk of not necessarily space junk, but when these things, you know, when they exceed their usefulness, they have to be disposed of some way they can come to Earth and, you know, burn up in the atmosphere. We haven't seen a lot of crashes or things like that yet. But do you think going forward when we have thousands of satellites in orbit, is that a potential risk? I'm worried. I'm no expert on objects in orbit, but we know just from reading the news that the number of satellites which have been put up ever since the first one launched into space in the 50s, just that tiny number of satellites creates its own ecosystem of space debris. So you think about multiplying that, even if these are much

smaller satellites. But if you think about multiplying the number of objects by so many magnitudes, it just begs the question that this potentially isn't that great an idea in terms of efficiency. So yeah, I think me and so many other people who are watching this story evolve are worried, and you as well. Hopefully, the technology that's being invested will be able to anticipate this, but I have my doubts. I'm a little skeptical on that front. Well, I think it may create a new business in the future. Well, let's move on from space. I feel like we're getting gradually further and further out, so let's go into the metaverse. I wanted to talk a little bit about a Wall Street Journal article we saw about restaurant brands setting

up shop in the metaverse, Wendy's and Chipotle. We've already seen McDonald's talk about ordering your food in the metaverse. There's so much excitement from brands, but the interesting thing in the article was that there was a study from Forrester that showed 43% of adults would avoid a brand-sponsored experience in the metaverse. So, that's not great news. Is this a smart move for brands to get started in the metaverse? Is this where we're headed? It depends on the brand and what your objective is and who your customers are. I think in some cases, it makes a lot of sense. My typical example is Nike creating an experience on Roblox, which is good for its culture, for its fans. They can go and experience Nike land.

So, this is an example. And I know, Deidre, you have some thoughts here. I'm really interested to hear your thoughts on these. So, I want to just finish this short opinion by saying, in some cases short, it makes a lot of sense. And in others, it's like that song, we're not going to take it. We're not going to take it anymore. Brands try to sell to us in every conceivable location. And we're sort of used to this, but they're selling to us on social media. They're selling to us in the subways. So do I really want to be sold to in the metaverse? And maybe more pertinently, if you're a quick service brand, do I want to be dragged into the metaverse, just to place an order for delivery. Not me, personally. I don't think it makes as

much sense for brands that have a quick service model in the restaurant industry, these two examples of McDonald's, especially with Wendy's, and Chipotle's in there as well. But yeah, it can be valuable to some companies. Now, I've tried to stay a little neutral there, but you've got thoughts and opinions, I know, on this. What's your take on this, Deidre? Well, I've been studying the way that luxury brands are getting in. Specifically, they had the first Metaverse Fashion Week recently in Decentraland. Part of it was that Dolce & Gabbana had this $300,000 Metaverse tiara. Neiman Marcus recently announced that they're working on NFTs. So I find it fascinating from the luxury perspective. And I think that may be

more of a natural fit for the metaverse at this point than some of the more mid-market brands, just because really the people that are interested in the metaverse, it's a small group, but it may be a more sophisticated group of consumers. So I've been fascinated by seeing just how many luxury brands are getting in. Makes me think a little bit of Second Life for those who remember that happened, what was that, about a decade ago and all brands rushed in. Second Life is still out there. Their CEO recently came back, but Second Life never became what we thought it was going to be. So there's a little bit of concern there. Yes. There's another argument that younger consumers, sort of the digitally native consumers, are going to embrace the

metaverse. And so you need to put your expression of the metaverse in now because it's only a matter of time before, let's say, I don't know, someone in their teens grows up for a few years and they have their own spending money and they're going to spend it. They'll be the people going into the metaverse to order from McDonald's. But I'm not so sure. I mean, there's part of the metaverse that still seems very much like a transient thing. We're always trying to pin the next technological innovation and say, this is how the world is going to work. We were talking about 3D just before the show, Deidre. We were talking about visual 3D, but I was also thinking about 3D printing. I remember just a few years ago, we were going to print everything

we needed from our homes. If something broke in your house, you just go to your 3D printer, print it up, and put it, let's say, replace a couch leg. That really never came to fruition, although 3D printing is in various parts of the economy in its more serious expression of additive manufacturing, is there. It exists, but it hasn't overtaken our lives. And I have my suspicions that even for young people, the metaverse will be the dominant place that we exist, interact, and transact in the future. coming up next jim gillies and brian feroldi are going to take a bull versus bear approach to a company that amazon was supposed to knock out years ago best buy ricky mulvey moderates and

you get to decide who made the better argument by voting in our poll on motley fool money on twitter We got bull versus bear on Best Buy today. You know the electronics retailer. It is within 10 miles of 70% of the U.S. population. They sell computers, games, whatever you want. Best Buy's got it. Taking the bear case, we got Brian Feroldi. Brian, you got a book out. It just came out yesterday. It's called Why Does the Stock Market Go Up? But looking at the risks to a company, that's not unfamiliar to you. You like putting stocks through the gauntlet all the time. Yeah, I've made plenty of mistakes with investing, and I've learned the hard way that you need to know the bull case for a business just as well as you know the bear case for a

business if you want to make an informed decision. And we've got the returning champion, the Canuck, Jim Gillies. Jim, you also have a book that came out a few years ago that you'd like to plug. It's my master's thesis on bringing environmental aspects to a chromium plating shop. There are four copies in existence. No one should read it. Books are available on Amazon, but let's get right to it on Best Buy, starting with the bull case. Jim, you've got three minutes. Cool. Well, I know that Brian, my esteemed opponent, likes company mission statements, and so I thought I would start with one of his favorite tricks. And I'm going to call out what Best Buy's purpose is. They state their purpose is to enrich lives through technology. Now,

the important thing here is this is an adaptable company. This is a service company that sells hardware and technology. Yes, you can go to Amazon or eBay or wherever you buy your electronic and online stuff, but their customer service model that Best Buy offers is essentially impossible for Amazon to copy. Amazon is for people who know exactly what they want, want it at a better price, for example, and will implement their own technology solutions for themselves and God bless them. People think of hardware and technology as something of a commodity, the reality is it's more nuanced. Sometimes people don't know what they want, sometimes they would choose differently or might want something completely different if they had

a better understanding, there's different fulfillment or installation options. Sometimes my parents want someone to hold their hand when they're getting their technology set up or what have you, and that is the service that Best Buy provides in the guise of a big-box store. You can get in-person consultations online, on the phone, pickup and delivery, curbside pickup, home visits delivery. The point is its flexibility and adaptability to customer needs, and it has worked. Best Buy is one of my favorite types of retail company stories because people, including my esteemed opponent, have been writing this one off for well over a decade. Would you like to take a guess as to what the best year in company history was in terms of free cash flow generation

for Best Buy. If you guessed fiscal 21, the year ending in January 2021, aka the year stricken by shutdowns for the pandemic, you are right. Of course, no one's going to guess that the pandemic year was the best year free cash flow production in Best Buy's history, they made $4.2 billion. If you wanted to guess the second best year in the company's history, it's in the year that's just ended where they produced $2.5 billion in free cash flow. Now, true, I think fiscal 2012 was about $25 million more, $12 million more, but that was a 53-week fiscal year, there's some calendar chicanery. So, still, last year, second-best year. Over the past decade, Best Buy has averaged a return on capital of 19.5% as per CapIQ, well above their cost of capital.

And I will argue that the return on capital numbers for CapIQ and Best Buy is actually too low because they put operating leases into the capital, that's an argument for another time. we'll let it stand. Return on capital has also been increasing over the past decade. Also over the past decade, margins are resilient and rising. Gross margin has averaged 23% over the last decade. Operating margin averaged 4.9% over the last decade and 5.8% in the last fiscal year. They have produced $17 billion in free cash flow over this decade, returning $14.3 billion to shareholders in the form of dividends and buybacks. Their dividend is up 5.5-fold over that decade, going from $0.64 a year to $3.52 a year,

and it's a 3.7% yield today. Their buybacks have reduced their shares outstanding by a third. The rest of the cash they generated went to shore up their balance sheet. They went from $0.5 billion in net debt a decade ago to they have $1.75 billion in net cash today. This is a capital allocation success story, and pokey Best Buy that everyone knows is Amazon showroom, that's going to go away just like GameStop. How'd that work out? Best Buy, 10-year annual return with dividends reinvested 18.6% annually, a market smasher. By the way, if you happen to pick it up at its low in December of 2012, a time that I'm sure Brian remembers, you are sitting on a 26.8% annual return. That's not bad for Amazon's showroom. And the final point is, no one today

is surprised by, you know, oh, Amazon's going to eat their lunch. That argument has been around for over a decade. It's priced into the stock. And here's this thing trading at 10 times earnings with, I think, blue skies and clear sailing ahead of them going forward. Ooh, we are a minute and 26 seconds over, but a strong bull case for Best Buy. That's pretty good for me. Shocker, shocker, Jim Gillies goes a little bit over the time limit. Brian, feel free. Who could have predicted it?

Brian Feroldi, you've got the risks, the bear case for the company whenever you're ready. Yeah, well, as Jim pointed out, this is a stock that I have been precisely wrong about giving it the red thumbs, the thumbs down in caps, pretty much at the low, which was a 10-bagger ago. Now, why was I bearish on them about a decade ago? Jim hit the nail on the head. Then word Amazon. Best Buy was becoming a showroom for Amazon's shoppers. People would go in the Best Buy, look at the items, check the price online, buy it online. And Best Buy all but admitted that this was a major problem when about 10 years ago,

they offered a price match guarantee. So if you showed them the price you could buy it online, they would be forced to match it there. Now, how could Best Buy compete? Amazon doesn't have any of the overhead of the showrooms that Best Buy does. So Amazon has counter-positioning against Best Buy, and they could offer the same products, the exact same products, at a lower price. Moreover, at the same time, we've seen a lot of other companies, the device manufacturers themselves, increase their direct-to-consumer preferences. Me, the consumer, can go to apple.com, samsung.com, sony.com, whatever, and buy the items directly from the companies. Why go through a retailer. Now, is that still a problem today? Well, how's this stat? Last year,

five suppliers, Apple, Samsung, HP, LG, and Sony were more than 56% of this company's total sales and just 20 suppliers accounted for almost 80% of total sales. When you combine those things together, I figured it was a matter of time before Best Buy joined the likes of Circuit City, tweeter crazy eddie freder the whiz hh greg etc in the retail graveyard now as jim pointed out my thesis for this company was precisely wrong this has been a fantastic investment over the last 10 years but i think a lot of the things that i was worried about actually have come true best buy has been modifying its store layouts it's been forced to cut prices to match those of internet retailers. And this is a company that had almost 1,800 stores in 2013. Currently,

they have 980 stores. So the number of stores that this company has has been sinking like stone. That's a big problem if you're going to be investing in a retailer, because that's one of the major ways that a company grows is by opening new stores. That's no longer on the table. Moreover, over the last 10 years, while returns on capital have been good, this company's same store sales, a key metric, haven't exactly been barn burning. They were negative from 2012 to 2014, barely positive to 2015 to 2017, and they've been hugely positive over the last couple of years. Why is that? In a word, COVID. People have been scrambling to build out their home offices and to make themselves electronically savvy at home. I ask this, is that something

that's going to repeat. I mean, once my home office was set up, why don't I have to buy any of the same items again? And make no mistake, this company, even today, despite having a strong service business, 75% of sales come from computing, mobile phones, and consumer electronics. The services business at this company that bulls are pounding the table on, that was just, wait for it, 5% of revenue last year. 5% of revenue. Now, the company does have a couple of growth initiatives in place. They have a subscription plan growing out. They're getting into the telehealth business. Because when I think Best Buy, what I think is healthcare, of course. And I think of myself as a consumer, when I go in there and shop at Best Buy,

the only thing that they want to do is talk to you about signing me up for a credit card and selling me a protection plan. No thanks. I'll just shop on Amazon myself. Now, if we look at the most recent quarterly results, we see a top line declining, same store sales declining, gross margin down, sales and advertised expense up, and adjusted earnings per share down 21%. Management all but admitted that they should expect exactly that over the next two years. So yes, this stock is cheap today. But when I think of the long term, no store openings, challenging same store sales, COVID is now ahead when supplier concentration, the retail landscape is changing, margins are going to be under pressure, and services are just 5% of sales. It's a hard pass

for me. Gentlemen, thank you so much. That's Bull versus Bear. You can decide who made the better argument at Motley Fool Money on Twitter. Brian Feroldi, you got a book out real quick. Where can people find it? Everywhere that books are sold, including Amazon, Best Buy's enemy. Why does the stock market go up? Jim Gillies, Brian Feroldi, thank you so much. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Deidre Willard, thanks for listening, we'll see you tomorrow.