Motley Fool Hidden Gems Investing - Chipotle CEO Orders Coffee

Episode Date: August 13, 2024

(00:21) David Meier and Ricky Mulvey discuss: - Why Starbucks wants Chipotle’s CEO. - What Home Depot’s quarter says about the economy. - On Holding’s impressive growth. Plus, (15:39) Alison Southwick and Robert Brokamp discuss how investors can prepare for a lower-rate world. Factor offer: Head to www.factormeals.com/foolpod50 and use code foolpod50 to get 50% off your first box and 20% off your next month. Companies discussed: SBUX, CMG, HD, TREX, ONON, NKE, OTC: ADDYY Host: Ricky Mulvey Guests: David Meier, Alison Southwick, Robert Brokamp Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

You gotta try breakfast at A&W. You gotta try breakfast at A&W. And what better way than with a delicious Pret Organic Coffee, starting at just $1 all day, every day, now until December 31st. You gotta try breakfast at A&W. At participating A&W locations in Ontario. A burrito for a coffee, please. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by David Meyer. David, we got a lot of news to talk about,

and I appreciate you being here. Yes, we do. And thank you for having me. All right. So Starbucks has a big swap on its hands. They want a little bit of that Chipotle magic. The coffee giant is replacing its current CEO, Laksman Narasimhan, with Chipotle CEO, Brian Nicol. This morning, Chipotle is down about 13%. Starbucks is up more than 20%. There's some negatives and some positives to this, but let's start with the positive with Chipotle. Brian Nicol has been the CEO there since 2018. What's he been able to do in the last six years there? What's Starbucks hoping that he'll be able to bring over? The better question may be, what's he not been able to do? He's done quite a bit. He's been

able to raise prices consistently and actually quite significantly, which, if you think about it, unlocks a lot of Chipotle's brand value. Pricing power is one of the signs that you have an enduring brand. He took advantage of that, rightly, I should add. During the COVID era, he really supercharged Chipotle's digital presence. This is not just in terms of taking digital orders, but in addition, he really pushed hard for the loyalty program, which was something that the founders wanted the food to speak on its own. It didn't want to necessarily give benefits to customers as a result of eating it, but Nichols said, you know what? Nope. this is the direction we're going. That's also been huge. Then lastly, he experimented with the

menu. That's not an easy thing to do at Chipotle. Again, not something the founders necessarily wanted. They liked their limited but customizable menu. He found some ways to get some incremental benefit out of that. What does he bring? Well, he brings all that strategic and tactical knowledge and experience with him. And I think it should benefit Starbucks when he takes that post. Yeah, we got the chicken al pastor out of it. Hard to be mad about it. A little bit mad about the price increases. Anyway, turning to Starbucks, a few months ago, Howard Schultz wrote a letter to the board, which he posted on LinkedIn, that its leaders, kind of implying that the leaders did not understand the soul of Starbucks and its brand. I mean, even though Nara Simmons has been there

for just a short time, it seems like that might have been the writing on the wall. One of the interesting things to think about here is, Howard Schultz obviously has had a huge impact on Starbucks over the years, and he continues to be a very influential figure there. We shouldn't forget, he actually helped recruit Narasimhan to the role, so he takes a little bit of the blame as well. Unfortunately, though, the stock price has been pretty much trending down throughout Nara Simmons' tenure. It's not really surprising that Schultz and activists and plenty of others have been chiming in that, hey, we got to make some improvements, and they decided now's the time. Well, the market has been fairly unhappy with Nara Simmons' ideas basically really

expanding the menu uh bringing in energy drinks and the refreshers and you know this is something that we complimented for brian nickel for doing but maybe it was a little bit done in a little bit more of a thoughtful way he really wanted to build up the starbucks app engagement we got a we got a transformation plan where narasimhan promised to unlock efficiency david by the way do you know he spent a couple decades at mckinsey i saw that i think there were several things that the market was a little unhappy with him on that. But I have to say, David, Narasimhan, he's in the role for just a little over a year. Do you think future employers are going to worry that he's a job hopper? He's just going from one opportunity to the next. This is bad for

the cover letters. Yes, it is bad for cover letters, but no, I don't think this hurts him. So let's step back and think about this for a sec. Starbucks is an enormous company and it takes time to implement changes, especially big ones, ones with lots of fanfare, because their operations are spread around the world. Their stores have different cultures that they have to deal with. Perhaps he could argue that, hey, I wasn't necessarily given enough time, the environment's been challenging. But again, I don't want to sound like I'm making excuses Narasimhan. But let's remember, Nikola is going to face many of these same challenges. Now, he's had some experience dealing with them at Chipotle, but he's going to have to hit the

ground running and gather some short-term momentum. Otherwise, the arrows are going to be pointed at him next. David Gardner The board may not have a ton of patience on this one. Let's talk about Home Depot, which reported this morning. David, I got two quotes from CEO Ted Decker. Sounds like they came from different earnings calls. They came from just one. Here's number one. Higher interest rates and greater macroeconomic uncertainty pressured consumer demand more broadly, resulting in weaker spend across home improvement projects." This is where you're getting the CNN headline, Home Depot issues warning about the economy. Second quote, the fundamentals of the home

improvement market remains strong. We have significant growth opportunities in front of us." Which one should the long-term investors focus on more? Great question. Can I say both? Is that acceptable? Yes, you can. In all seriousness, in the near-term, I say the first one. If we compare what Home Depot said about the do-it-yourself market for home improvement, let's call those lower budget projects, That's very consistent with what Trex just said in their most recent earnings report. The alternative to wood deckmaker commented that there was weakness in its lower price

segment of products. So perhaps right now, the customer wants to forego some near-term improvements, and lower prices aren't necessarily making them change their minds. So usually stocks get hammered when they cut guidance, and Home Depot did that for same-store sales, going from a negative 1% decline to negative 3% to negative 4%. Stock doesn't budge much, and while we're long-term investors, I thought this was an interesting short-term move. Is Home Depot special or something? What's going on? So this is a very interesting observation, and it really gets to how markets work. So

So, no, I don't think Home Depot is necessarily special as a result of lowering guidance and not really seeing much penalty as a result. But let's look at the price action. If we think about what the market does, the market seemed to expect this. So despite recent dips in interest rates, interest rates are still relatively high during the company's most recent quarter. Consumer behavior doesn't necessarily change on a dime just because rates have come down a bit. The market, I don't think, was caught off guard by this, which is why they're not getting the penalty.

But this is where the long-term view comes into play. With inflation continuing to soften, rates are now starting to move down on their own, and there's still an expectation of a rate cut from the Fed, at some point, consumers were likely going to come back to these projects and maybe even expand them. That's where I think the market is looking ahead. The last thing I'll say is, their most recent acquisition of SRS Distribution closed in June. In a lower-rate environment, if they see a pickup on the professional side for home improvement projects, they could get a little extra benefit there. Before we move on to on-holding, anything else from Home Depot's quarter business really

stand out to you? Yes. Regardless of what's happening at the top line or above the top line with regard to consumer behaviors, this company is just a cash flow machine. That bodes well for the things that it needs to do right now, which is pay back its debt, buy back shares, and fund current and future dividends. Home Depot isn't the growth story it once was. So those things are what are important components of the total return potential that shareholders will want going forward. Let's talk about a retail company that's growing a little bit quicker, a lot a bit quicker. That's Onholding, the sports apparel maker. A lot a bit quicker.

They make OnClouds, which I really like the shoes. I did a segment about them a while back and ended up getting converted into an Onholding customer. Still on my watch list as an investor. It's net sales are up almost 30% from just one year ago. Operating profit up about 20% a year ago. It's adding some retail stores. David, if you look at this business, it seems like we've got a growth company moving like a growth company here. 100%. It's interesting. The stock was off to a rocky start in pre-trading. It was down, but as we're talking about this, it's up somewhere around 6% to 8%. It looks like at least since the market is open, the stronger hands have prevailed in digesting more of the information. Look, sales growth came in slightly ahead of

expectations, but as you noted above, operating profits were off a little bit relative to expectations. It looks like as a result of higher costs. Looking a little deeper into their income statement. They only give a single line item for operating costs in the press release. I don't know exactly where the culprit is, but this company has been spending to innovate and to invest in its brand. I wouldn't be surprised if those were the two areas responsible for higher costs. Frankly, I have no problem with investing more there. Yeah, there was some currency stuff between the Swiss franc and the American dollar that also, I think, uh, hit it for a little bit before the, before the, uh, bounce came back. Let's talk about the brand stuff. Um, some big

developments with this company on launching a multi-year deal with Zendaya, the actress challengers stars, challengers, and dune challengers was good anyway. And they've also got spray on shoes, shoes that quote fit like a glove for performance athletes. I want to talk about the spray-on shoes because that seems like a pretty significant innovation. And I, at least, I was surprised to see it from a company like On and not from a company like Nike or Adidas. How about you? First of all, I agree. The spray-on technology that they have is pretty cool. But I just want to be clear, both Nike and Adidas have what are essentially 3D printed footwear options. But so far, all three of these companies have been focusing on a little bit different parts

of the shoe in order to bring that innovation to the market. So, I have to confess, I'm a former shoe junkie. I love shoe technology, especially when I was working out more and playing soccer and playing basketball, etc. And I have to say that this spray-on innovation is really pretty cool. So what it does is it changes the way the upper part of the shoe is formed and how it attaches to the midsole. So it removes the laces while still providing a comfortable, durable glove-like fit.

And I have to say, if this had come out five years from now, I guarantee you I'd have a pair on my feet right now. Yeah, it helps that one of the winners of the Boston Marathon was wearing them as well. One of the things I liked from the call as well was co-founder David Alleman reflecting on you know hey we're going to report these numbers quarterly but let's not think of this as a quarterly business looking at sort of the four-year cycle of the olympics which you know saying that quote big dreams require a longer period to train evaluate and prepare end quote thought we'd wrap up by looking back on this business looking ahead you know in 2019 on did

about $250 million in sales. Over the past 12 months, it's done almost $2 billion. Good or bad, this is a growth company that's going to act like a growth company. What should long-term investors or people like me who have this company on their watch list expect by maybe 2028 when the Olympics arrive in Los Angeles? I think this was a great frame for the CEO to use, and it fits exactly with what we try to do here at The Motley Fool, which is take a longer-term view. I think the conclusion to be drawn here is that ON has arrived. You don't just take market share away from big players like Nike and Adidas very easily. You have to have good products, you have to have strong distribution,

you have to have the ability to build a brand, and ON has done all of those things extremely which should help propel them to be even more successful going forward. I think this is where we're going to see some of that come from. Right now, analysts are seeing somewhere between 23% and 30% growth per year over the next three years. Yes, still a growth company. But the company is now generating significant operating and free cash flow, which puts them in control of their future growth. They don't need to go back to the capital markets to ask for capital in order to try to fund some of the projects that they want to do. They can actually take even more incremental risk as they innovate.

Let's see what they do with the spray-on technology. Let's see what they do to incrementally improve that technology and roll it out across their product line. Frankly, with the growth still ahead and the huge cash flow that they're generating, if you think about what Nike and Adidas did from this point forward in their careers, there's a good chance On has a good probability of doing something similar. Ron has answered the conversation. David Meyer, appreciate you being here and thank you for your time and your insight. Thank you very much. This was a lot of fun. And what better way than with a delicious Pret Organic Coffee,

Starting at just $1 all day, every day, now until December 31st. You gotta try breakfast at A&W. At participating A&W locations in Ontario. All right, up next, the Fed is implying that a rate cut is coming. Market thinks so too. Alison Southwick and Robert Brokamp discuss how investors can prepare for a lower-rate world. Most investors recognize that the stock market has been the place to be for the highest long-term returns. But that doesn't mean every one of your dollars should be in equities. Depending on your

risk tolerance and time horizon, you should likely have some of your money in cash or bonds. The returns you'll get from those assets depend an awful lot on interest rates, which have been dropping over the last several weeks. Plus, the Federal Reserve has hinted that they may begin cutting the Fed funds rate as soon as September. All this means that there could be big changes in what we get from our cash and bonds over the coming months. Yep. Most interest rates have actually been coming down. The 10-year Treasury hit a high of 4.7% in April and has since dropped below 4%. And that rate, as well as the rates on other intermediate to long-term bonds are mostly determined by the bond market, as investors

anticipate a rate cut from the Fed and maybe a slower economy. Short-term rates, such as those paid by treasuries that mature in a year or less, as well as just plain old cash, they're more driven by the Fed, which has two primary mandates, low inflation and maximum sustainable employment. And sometimes they're kind of at odds. The focus has been much more on inflation since the beginning of 2022, with the response being this aggressive rate hiking cycle intended to put the brakes on the economy. However, the rate of inflation has come down significantly with the most recent 12 month change in the consumer price index coming in at 3%. Meanwhile, the unemployment rate has increased to 4.3% up from 3.5% a year ago. So as Chair Jerome Powell said in the press conference

after the Federal Reserve's July meeting a couple of weeks ago, the Fed is going to start focusing on both of its primary goals. And here's a quote from the press conference afterwards. He said, as inflation has come down, and I think the upside risks to inflation have decreased as the labor market has cooled off and now the labor market has softened, I think the downside risks to the employment mandate are real now. The time is coming at which it will begin to be appropriate to dial back that level of restriction so that we may address both mandates, end quote. In other words, it'll soon be time to cut rates, and the Fed would be sort of late to the game. Central banks in Sweden, Switzerland, England, Canada, and the European

Union have already cut rates. The market has been lowering rates in anticipation of the Fed's first cut. What has happened to cash and bonds so far? Well, as rates fall, bond prices go up. Since the end of April, the bond market has returned around 5%, which is pretty good for bonds for just a few months' worth of work. The returns do vary on the type of bonds you own. Longer-term bonds are more sensitive to moves in interest rates. Long-term bonds have returned almost 10%, whereas short-term bonds have returned close to 3%. As for cash, we've already started seeing rates on CD, savings accounts, and money markets start to drop ever so slightly, but they will react very quickly to a rate cut from the Fed. We've probably likely seen the highest rates we're going to see this

cycle. And I'll just also add that loan rates have also started to come down. So for example, the rate on the 30-year mortgage is now 6.6%, down from 7.5% at the end of April. So what should people do now to prepare for a possible lower rate world? So I would say the first step is to consider locking in today's rates with CDs or individual bonds for the money you don't need to be completely liquid and that you can leave loan for a year or maybe a few years. For money that you do need to be liquid, like your emergency fund or maybe any cash you need to pay the bills, then look for higher-yielding savings accounts or higher-yielding checking accounts. You can find just such accounts as well as higher-yielding

CDs at The Ascent, a Motley Fool website. For your bond funds, I think it makes sense to consider moving some of the money that you have in short-term bonds to intermediate-term bonds. If interest rates continue to come down, you'll get a little bit more price appreciation. The same could be said for long-term bonds, but they're so volatile that I generally stay away from them. The risk-reward trade-off, I think, is not there, especially if this is money that you want to be a little more stable. But longer-term bonds definitely have been the better performers over the past few months. So, if you don't mind that extra volatility, maybe even having a little bit in longer-term bonds makes sense. So, you've been lumping cash and bonds

together, but which is better? Well, I would say it depends on what you're going to do with the money. Cash is all about liquidity and not losing value. So it's for the money you want to keep super safe and that you may need to spend in a moment's notice. Plus on top of that, you get the FDIC insurance up to $250,000 per account type. Now, usually you pay a price for that safety in the form of lower yields, but that hasn't been the case for the past couple of years due to something called the inverted yield curve, which I'm sure we all heard about it. It's just an economist way of saying that cash and short-term bonds have yielded more than intermediate and long-term bonds. That's not usually how things go, but the yield curve has been inverted for a while

now, really since the summer of 2022. It's the longest period of inversion in modern times by passing the previous record set way back in 1978. But that's going to change. In fact, it's sort of changing now, the yield curve is starting to flatten out. Eventually, we'll go back to a more normal environment in which bonds return more than cash. And just to give you an idea of what that looks like, according to a report published earlier this year by LPL, over the 40 years ending in April, bonds have returned an average 6.1% a year versus 3.5% for cash. And bonds had better five-year returns in 95% of the rolling five-year periods. When cash did do better, it only outperformed bonds by 0.4%. And I'll throw in some tidbits from a recent report from

Schroeder's, which found that over the 22 rate-cutting cycles we've seen since 1928, bonds have outperformed cash on average by 3% to 4% over the subsequent 12 months. Doesn't happen every time, but definitely most of the time. So for money you want to keep out the stock market that you don't need in the next year or two or three, you'll likely earn a higher return from bonds over cash. Plus, you can make more strategic tax decisions with bonds. Cash is always taxed as ordinary income at the state and federal level. I'm assuming it's not in some sort of a retirement account. The taxation of bond interest depends on the bond. Corporates are also taxed by states and Uncle Sam. Treasuries are free of state taxes, and municipal bonds can be

completely tax-free depending on your state and the municipal bonds you choose. So your tax status also plays a role in the cash versus bonds decision and which bonds you might choose. We've been hearing the word recession more frequently, which is why many people think the Fed should cut rates. Jeremy Siegel, the Wharton professor and author of Stocks for the Long Run, he told CNBC last week that the Fed should do an emergency rate cut of 75 basis points now saying it should be somewhere between 3.5% and 4%. Otherwise, Siegel says, if we don't do this, we're not in for a good time with this economy. I like a good time economy, don't you, bro? I like a good time economy. So should people be worrying about a recession?

So I would say that people should always be prepared for the consequences of a recession, which generally involves a decline in the stock market and an uptick in unemployment. So regardless of what's going on in the economy, you should always have a plan B for what will happen if your portfolio loses value or you lose your job. Now, is the risk of recession growing now? And I guess I would say yes. I mentioned that the yield curve is inverted, which is a pretty reliable predictor of a recession, though it takes several months to more than a year for the recession to begin. Hasn't happened this time so far, but we did have a few quarters when GDP growth was pretty low or even slightly negative. Now, what happens often right before a recession

is that the yield curve begins to uninvert, and that's starting to happen. But the other reason we're hearing more about a recession is due to something called the SOM rule, spelled S-A-H-M, created by economist Claudia Somm, who used to work at the Fed. And the SOM rule says that the initial phase of a recession has started when the three-month moving average of the U.S. unemployment rate is at least half a percentage point higher than the 12-month low. And the July jobs report officially met this criteria. Now that said, Claudia Somm herself is not so sure. She told CNBC, quote, we are not in a recession now, contrary to the historical signal from the Somm rule, but the momentum is in that direction. A recession is not inevitable and there is

substantial scope to reduce interest rates. So she's joining the chorus of experts calling for the Fed to cut rates, but she is pointing out that things are slowing down. But even if a recession may not be inevitable, I think it makes sense to do all the things necessary to sort of build up the defenses of your personal finances. And you know what these things are, right? That would include having a big enough emergency fund, re-evaluating how much you want in the stock markets, especially since we've had a pretty good couple of years, and then what to do with that money you keep out of stocks. And finally, do all you can to ensure your job is safe if unemployment keeps up. As always, people on the program may have interests in the stocks

they talk about, 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 Ricky Mulvey. Thanks for listening. We'll be back tomorrow. Thanks for watching!