Motley Fool Hidden Gems Investing - Calm Before The Storm

Episode Date: October 10, 2022

It's quiet before earnings season. Too quiet. (0:21) Jason Moser discusses: - Expectations for earnings season (which really starts on Friday) - Jamie Dimon's comments about a U.S. recession being 6-9 months away - Key data around consumer savings and spending (11:58) In 2017 Intel bought Mobileye, a self-driving car company, for $15 billion. As Intel prepares to spin it out, Dylan Lewis and Ricky Mulvey discuss the relative attractiveness of the soon-to-be public Mobileye. Got questions about stocks? Call the Motley Fool Money Hotline at 703-254-1445. Stocks discussed: ADBE, INTC, MBLY Host: Chris Hill Guests: Jason Moser, Dylan Lewis Producer: Ricky Mulvey Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hartigans. Don't know them yet? Then Google us. From the underworld of Guy Ritchie. Do you want to step up the ladder?

I want Comet dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren. Do I have to do everything myself? You want more? I'll give you more! Mobland, new season hits September 18th on Paramount+. Don't look now, but we have another tech IPO. Motley Fool Money starts now. I'm Chris Hill. Joining me today, Motley Fool Senior Analyst, Jason Moser. Thanks for being

Hey, thanks for having me. Welcome to the calm before the storm. I say that because there's really not a lot of news. Jamie Dimon made some comments that we'll get to shortly, but four times a year, it's very quiet right before earnings season. There are increasingly indications that this upcoming earnings season is going to be stormy for investors. For anyone who missed it on last Friday's show, our guest was Malcolm Etheridge, financial planner here in the D.C. area, and I asked him what he was expecting heading into earnings season, and his one-word answer was bad, which he expounded on. But I tend to be optimistic by nature, but Jason, I think he's right. In terms of the results, I think we should

all sort of prepare ourselves for the three-month results that most companies are going to be reporting, particularly when you look at how strong the dollar is for companies that have international businesses. Yeah, it's not going to be great. Yeah. I'd love to meet the person or the people who are like, you know what? I think this is going to be a pretty good earnings season. I think I'm feeling good about things. There's going to be some surprises to the upside. I think that's probably correct. I don't know very many folks that are out there expecting a whole heck of a lot from this particular earnings season. This is going to be talking about the third quarter of the year. If you look into fact-set data, for example, as of today,

the S&P 500 is expected to report revenue growth of 8.5% from a year ago. If that is the actual revenue growth rate for the quarter, that'll mark the first time the index has reported revenue growth below 10% since the fourth quarter of 2020, where it was 3.2%. Then if you look at the actually earnings side, earnings growth is estimated around 2.4%. If that's the case, it would mark the lowest earnings growth rate reported by the index since the third quarter of 2020 when it chalked up negative 5.7%. It just all goes to speak to, generally speaking, expectations aren't that high. It's very understandable why that's the case. I think if you look at what's going on around us today, we have to acknowledge the level of pessimism

is pretty darn high right now. A year ago, for example, you could buy anything in the stock market. Just throw a dart, hit a company, buy it, and it goes up. That's what it felt like. Clearly, the pendulum has shifted. It feels like anything you buy, you can bet money, it's going to go down. That makes a lot of sense. When you look at everything that's going on right right now. We've got recession talk, we've got inflation. I saw a report here. Adobe does not have very high expectations for holiday spending. Clearly, there are foreign exchange challenges. We have 40% of international revenue exposure to the S&P 500 overall. That does matter. While we tend to take a longer view on that currency issue, it is something that

exists and you have to at least expect it to impact the numbers here over the coming quarters. Credit card balances saw their largest year-over-year percentage increase in more than 20 years here. Aggregate limits on cards, largest increase in over 10 years. A personal saving rate of 3.5%, historically very, very low. When you hear someone saying, well, we think the consumer is still in a good position, I would push back on that. To me, it doesn't feel like the consumer is in a very good position right now. They're employed and wages are keeping up, but it feels like the consumer is increasingly in a tougher position. You put that all together, it's very easy to understand why expectations are so low, because there is just so much pessimism out there.

Every earnings season, we talk about companies that the company executives issue guidance that is different from the actual results. It's the company had great quarterly results, but the stock is down because of their overly cautious guidance. Because we all have, or most of us have, this expectation that the actual results companies are going to be reporting are not going to be that great, does the guidance that we get from management this upcoming earnings season, does it matter more? Not to say like, oh, look, we're looking to cling to anything positive. But when, for example, I look at the data around the cost of a shipping container and how that has dramatically come down over the past year, I do wonder if some

of these large, important companies are going to give us guidance not just about their business, but about what they are seeing on a more macro level when it comes to input costs like that. Yeah. I think that's what I'm personally paying more attention to here this coming earnings season, is really the guidance going forward, not just for quarter four, but really for going into 2023. If you look at the last several quarters, at least the last couple of quarters, labor costs and supply chain disruptions have been cited as the top two challenges to revenue and margins. Really, coming in third place is currency impacts. You've got this trifecta of challenges that companies have been dealing with here. It's

going to be helpful to get an idea from these management teams when they see these challenges start to abate, or are they seeing signs of abating now? Because as we know, the market is forward-looking. It's a forward-looking mechanism. It's looking into the future and essentially telling us what the future holds, more or less. I think that's something very important to remember because right now, we're sitting here talking about all of this pessimism and these weak expectations, these low expectations. It's not like you and I are in on some big secret. That's common knowledge. Everybody knows this. The market is pricing a lot of that in today. But if we get a lot of these management teams on these calls here in the

coming weeks, and they start talking about how they're starting to see some light at the end of the tunnel, then I think that's going to make a big difference. I mean, you look at right now, the forward 12-month PE for the S&P 500, it's just under 16. It's 15.8. And that's below the five-year average of 18.5 and below the 10-year average of 17.1. So again, the market is pricing in some pretty weak expectations. If we start to see signs that things might start improving a little bit, then I think that bodes well for the market. We've talked about this before on this show. Generally speaking, historically, we see the stock market performs worse in the time leading up to the recession. The year leading up to the recession is when we see the worst

performance. We very well could be living through that right now because we've seen Jamie Dimon's comments, Europe already in a recession. We are not far behind. The expectation is six to nine months. We're probably witnessing that official declaration here as well. Some would argue that we're already in a recession. I certainly understand that perspective. We did witness two consecutive quarters of contraction. It's a unique time for sure. But again, going back to your point there, I think paying attention to guidance here And really, those challenges, labor costs and supply chain disruptions, I think will be two key things to search for these calls and get an idea of how leadership's feeling about those.

Yeah. Speaking of management teams, Diamond gave an interview to CNBC this morning talking about what he called the, quote, very, very serious mix of factors that he believes are going to push the U.S. into recession in the next six to nine months. I did appreciate the fact that when speaking about the Federal Reserve, you get the sense that because there are some people who are willing to go on financial television, talk about the Federal Reserve, and just bash away at Jay Powell. I appreciate the fact that Diamond basically said like, look, I'm rooting for this guy. To paraphrase what he said, he's like, yeah, I'm hoping this works out. There's no real incentive for me or anyone to root against Powell and to have this all go

worse than we want it to. Yeah. It's very much in vogue these days to go on Twitter and just bash the Fed and Powell and just give them a piece of your mind and tell them how wrong they are. Anybody can do that, right? Anybody can do that. Obviously, they missed that transitory call. They're not going to get everything right. None of us will get everything right. I like that about Diamond. He's certainly rooting for the best outcome. He's more often the guy who's trying to be a part of the solution as opposed to a part of the problem. Clearly, one of the smartest guys out there. When he speaks, it's worth listening. I like his equanimity. he takes that smart middle-of-the-road approach. He's like, hey, listen, we hit a recession.

It could be very mild to quite hard. There are a lot of things we just don't know. If the Fed continues to keep its foot on the gas in regard to interest rates, you've got this war going on over in Ukraine with no clear outcome and no real sign that it's going to be concluding anytime soon. There are a lot of different ways things could be impacted. recognizing that. Consequently, he's saying, hey, look, from our perspective as JPMorgan, we're going to be very conservative with our balance sheet. I don't know if he was a Boy Scout, I think he may have been because I love his advice here. He said, hey, be prepared. From the investor's perspective, from the consumer's perspective, you just have to look at this and

say, well, I'm hoping for the best, but I'm expecting or preparing for the worst. As such, she said they will be very conservative with their balance sheet, make slow, methodical, smart decisions. We'll see how this earnings season plays out, see what companies, see what these leadership teams are thinking, and that'll help dictate how we approach the beginning of 2023 as investors. Jason Moser, great talking to you. Thanks for being here. Thank you. In 2017, Intel bought Mobileye, a self-driving car company, for $15 billion. Just four years later, Intel announced it would be spinning it back out into the public markets, and that time has come.

So how interested should investors be in shares of Mobileye? Ricky Mulvey and Dylan Lewis break down the offering. We've got a second big-name IPO in 2022. Intel is spinning off Mobileye, which makes chips and cameras and driver assistance features. Joining us now to talk about it is Dylan Lewis. Good to see you. Dylan Lewis Great to be here. Another IPO, Ricky. We went such a long time without them, and now we get two in relatively short succession. It's pretty awesome. Porsche and Mobileye. My question, though, is because it is a little strange,

is Mobileye brave or does Intel need some money? I'm going to say that people feel like Mobileye is a business that can weather current conditions and will not be dampened too, too much by what we've seen in terms of growth stocks being hit and some of the growth expectations being hit. I do think it's a little bit of column A, column B, where Intel sees an opportunity here to spend something out that has a very different profile than its core chip business, and maybe feels like there's an opportunity for the market to realize a little bit more value for Mobileye than we're currently seeing. But it's certainly an interesting development. I'm excited to talk about it. The headline is that it's getting into autonomous driving, which would make you

think this company makes no money. However, 800 vehicle models already have Mobileye's advanced driver assist systems. You probably know this if you've seen a lane departure warning, lane-keeping assist, emergency braking. That's where the company is making the majority of its money right now. They recognize that. They say, we believe that the future of mobility is fully autonomous. These technologies build into each other. For example, with the advanced driver assist systems, when your car uses that, it sends tiny packets of data back to Mobilize so it can make these highly detailed maps. The company has said, while today ADAS, advanced driver-assist systems, is central to the advancement of automotive safety,

we believe that the future of mobility is autonomous. Yeah, Ricky, earlier you said fully autonomous. I think that we have to recognize that autonomy in driving is both the future and, to some extent, the present. It's easy to think about it as something that you sit back, you're in the car, and you're doing nothing. But we already have the creep of driver-assistance features coming in and helping realize a quasi-autonomous existence. It's not necessarily what people have in their mind. It's not as sci-fi friendly. But that's where Mobileye is really plugging in right now, and that's where a lot of the money is coming in for this business. It's sensors and cameras.

Speaking of money, let's dig into some of the numbers. Mobileye already has some revenue. Mobileye made $1.4 billion in 2021. However, it recorded net losses of $75 million, slowing down net losses. But do the numbers, when you look through the income statement the balance sheet, do you have confidence that this company can become profitable? I think so. You look at their growth profile, 45% year-over-year growth in 2021. It's looking like we'll see 21% year-over-year growth in the first half of 2022. When you see a business that's losing money, what you want to really look at is, is there expanding margin potential? And where is the spend going that's preventing that company

from being profitable right now? They tout an adjusted positive net income figure. we have to remember, that's non-GAAP, so you can't hang your hat on that one. It's not net income. But generally, yeah, the losses have narrowed. And when you start zooming in on where the spend is actually going, I think that's the key. Because this is a business that has roughly 50% gross margins. When you look at where the remaining money goes, for the most part, it's in the company's R&D spend. The vast majority of the money is going there. A comparatively small amount is going into their selling general administrative and marketing spend. The reason I think that is important is because this is a tech business. It truly lives on

the cutting edge of technology and where the world is going. The R&D work for this company is really its moat. If that's where they're spending, they're allocating capital correctly. It also signals to me that they don't need to spend a ton of money to acquire customers and grow their business. The technology is able to do that for them. It's got another important company under its arm called Moveit. It's a bit like Uber and Lyft, and this is going to be the robo-taxi arm of Mobileye, or at least that's the plan for it. Are you excited about this partnership, or do you think Mobileye is trying to do too much at once? It's hard to tell. This isn't uncommon for companies in this space. You look at other

companies that play in autonomy, and you see a lot of them leaning into various ideas of what mobility could look like in the future. I think Uber and Lyft are good examples of this. Uber, in particular, they are originally a ride-hailing company. They have autonomous driving ambitions, or have had them in the past. They've expanded into food delivery, but they've also expanded into a lot of last-mile urban commuting. I think the reason a lot of these companies try to do this is to have fingers in the pot for a bunch of different places for where mobility could go and where we could see autonomy early, because it's going to be a big part of whoever wins that market, and really whoever takes a sizable share to begin with. It's also,

let's be real, a way for these companies to expand their total addressable market and look for other opportunities to make money while some of these more futuristic business lines take a little while to materialize. There's also a huge amount of room for disruption, because you think about how many cars are just sitting in the driveway. In the S-1, they mentioned the Department of Transportation's figure that cars are only used for an hour a day on average. You can imagine how a company would want to make that more efficient. One other piece of the Mobileye dynamic is not just the companies that it owns, but the company that owns them. That is Intel. Mobileye was already a public company between

2014 to 2017 before it was bought out by Intel. Now, it's being spun off, but Intel is still owning a majority stake in the company. One of the big questions is, why is Intel spinning it off now? Then also, why are they cutting its valuation? Originally, they were looking for about $50 billion. Now, they're settling on around $30 billion. Yeah, it's an interesting dynamic. I think you always want to understand why a company wants to spend something out, particularly in the case of Intel and Mobileye, where they bought it for $15 billion about four or five years ago. They are now bringing it to the public markets at $30 billion. I think we're seeing that revised number just because the

appetite for growth has slowed pretty dramatically, and they just want to be able to right-size the offering a little bit. That's why we're seeing it come down from about $50 billion, which was speculated when this was originally announced in late 2021. But you think about that, that company has doubled basically in value for them if they hit that issuance price in a relatively short period of time. It has performed dramatically better than Intel stock, even when you consider the dividends that it's paid out to investors. So, why do they want to spin something out that is growing faster than its core business? And let's be real, $30 billion is not insignificant to a company like Intel that has a $100 billion market cap. It's increasingly becoming a

large part of the pie for this company. It seems to me, and we saw some indications of this and how the company has talked about it, they want to spin this out so that the financials for Mobileye are not being weighed down by the financials for Intel. The growth story that is happening with autonomous driving and some of these driver assist features now can really play out and be realized by the market rather than being weighed down by the overall Intel business. Now, they have a reason for that. It's because the plan is for them to continue to be the majority shareholder of Mobileye. You could see this being something where they're maybe able to realize a little bit more value on the equity that they hold in this business, even as they reduce some of that holding

to make it a public company. And Mobileye owes Intel a little bit of money. It looks like there's a promissory note of $3.5 billion, and Intel's looking to recoup some of that from the IPO. Yeah. Always want to zoom in on the intent of proceeds or use of proceeds section in an S-1. In this case, $3.5 billion seems like a loan, basically, that Intel provided to Mobileye. We're going to see them repay most of that with this deal, and then we'll see any additional money from the deal wind up going over to working capital and general corporate expenses. Basically, working capital just gives them more money to be able to finance the things that they want to do.

Not surprising, but it is a little complicated. One of the things that I had a little bit of a harder time working through the ins and outs of when I was looking at this prospectus. Yes. Speaking of the perspectives and the risks that they list there, is there a particular risk that caught your attention? I think the biggest thing is just how the market materializes for autonomous driving. We've talked about it before. There are a lot of companies that are approaching this in a lot of different ways. And I think the thing that hovers over this entire market is, what does the regulatory

environment look like as we start to move closer and closer to people not actually commanding the car. I think that's just a catch-all risk that we have to pay attention to for all these companies. That's the main one that I zoom in on. I do think that we just want to pay attention to some of the dynamics between Intel and Mobileye, make sure we understand them. It seems like they're going to continue to be strategic partners. Obviously, great to have a strategic partner like Intel, one of the biggest chip makers in the world. Certainly helpful for them. But just making sure we understand the corporate dynamic there, too. Yeah, Intel gets a perpetual license to the patents and patent applications and how the

intellectual property is split up while Mobileye was an Intel company, and how that intellectual property is split between the companies going forward is something that I don't know how they're going to figure it out, but I'll be interested to see how it happens. I also have a question of stickiness. Mobileye's technology has been incorporated into cars that have gone on and built their own software. They mentioned, quote, Tesla had previously incorporated our ADAS solutions in their vehicles, but then transitioned to their own in-house solutions. It'll be interesting to see how many carmakers stick with Mobileye technology in the years to come. Dylan, when you looked through the S-1, how does this fall for you between investable,

runaway, or a company worth studying? I'm not immediately buying shares of this business. A couple of reasons for that. One is, we've already seen growth deceleration and pretty dramatic growth deceleration. I'd like to get a firmer sense of where that number is going to sit long-term. We're heading into an environment that could be a little tricky for this business for a variety of reasons. To some extent, this company is going to make money based on how many cars people are shipping and selling. A tougher economic environment means that we're probably just not going to see as many cars being shipped out. Also, the financing environment for cars is going to become a little bit tougher and a little bit less consumer-friendly.

I think that's something to pay attention to. Also, there's just the catch-all here of, like I said before, understanding what the autonomous future looks like. This is something where I think there will probably be many winners, and I think it's interesting to invest in a company like Mobileye, where they're a little bit less tied to a specific brand and much more focused on the technology side of it. It kind of reminds me a little of the Roku-type approach to streaming, but just for autonomous driving. So, certainly an interesting company. I want to get a little bit more clarity, though, on where this business is going over the next couple of years and where growth rates settle for them first.

I found myself becoming more interested in Intel than Mobileye as I studied Mobileye's S1. Perhaps not a great sign. Dylan Lewis, thank you for your time. Always a pleasure. 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 Chris Hill. Thanks for listening. We'll see you tomorrow. We'll be right back.