Motley Fool Hidden Gems Investing - Costco Cracks Down

Episode Date: June 28, 2023

Netflix isn’t the only company solving a sharing problem. (00:21) Bill Barker and Ricky Mulvey discuss: - Delta’s investor day and rosy profit guidance. - General Mills hitting a pricing power limit. - How Costco is solving its free rider problem. - AutoZone’s CEO, Bill Rhodes, stepping down and the retailer’s “unappreciated” success story. Plus, (14:31) Jason Moser and Matt Frankel check in on regional banks, and Apple’s consumer finance play. Companies/ETF mentioned: DAL, GIS, COST, AZO, ORLY, AAPL, GS, KRE Host: Ricky Mulvey Guests: Bill Barker, Jason Moser, Matt Frankel Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. Pricing power at the grocery store may finally be hitting a wall. You're listening to Motley Fool Money. Joining us now is Bill Barker. Bill, good to see you. Bill Barker. Good to be here. Thanks for having me. Let's start with Delta's investor day. Delta Airlines held that on Tuesday, where it bumped earnings by a smidge and free cash flow generation guidance by $1 billion, from $2 billion to $3 billion. Bill, a lot of that margin revenue comes from the Delta SkyMiles card. When you look at these numbers, is this a travel rebound story, a consumer debt story,

or maybe a little bit of both? I suppose a little bit of both, although I think investors in Delta are going to want to focus on the travel rebound part of the story, which is pretty positive. I think that the industry association is now predicting that 2023 is going to come close, not quite match 2019's levels of travelers and revenue. We're not back to pre-pandemic levels. There's good reason for that with business travel still being, I would say, highly curtailed, fighting against the pent-up vacation and individual travel stories. It's certainly much better levels than last year. Delta's Investor Day put a spotlight on that and the work isn't finished, but it's a lot closer to being back to where it was than it has been

for a long time. One of the surprising pieces to me was the rebound, especially for those premium seats on Delta flights. That's where they drive a lot of revenue and margin. The story was that that was supposed to stay down in the hybrid work model. Businesses continue to cut travel spending, but Delta says that's where it's driving a lot of growth again. What do you think is happening with that? Well, certainly the business travel is growing from a very, very, very low base in the last year. And you've got people that are willing to spend right now. They haven't taken those vacations. They haven't done the travel to see family that they had wanted to in the past couple of years. It's easier to travel now. I know last year I was flying back from

Europe, May of last year, still had to come up with a negative COVID test to fly back into the country. That's no longer the case. That hasn't been the case for a while. And so, the people who are willing to spend for business class and first class and economy plus are there. They've got money left over from all the travel they didn't take in the previous couple of years. But the airlines would love to see actual business travel return to a significant infraction of where it was in 2019. I don't know how many years it's going to take for that to occur given how much business people are willing to do on Zoom still. It seems like airlines are more cyclical than the average business. You got to worry about fuel costs, global macroeconomic

factors. Is this an area you look at for long-term investing or generally avoid? Well, in terms of long-term investing, investing through a number of cycles, I think it's a good question. I prefer to arrive when things look worst for airlines because the implication of cycles is that there will be a good spot and a bad spot within the cycle. Investing through the cycles, historically, airlines have not been good businesses. They've not done a great job of staying out of bankruptcy. You've periodically been wiped out in a lot of cases. Then they come out of bankruptcy and with a better business plan, certainly the seat capacity, seat utilization is infinitely better now than it was 20 years ago. They

do have real algorithms that are putting the right number of people onto flights. It makes it unpleasant often for travelers, but a full airplane is what they need. That's mostly what they get. I'd say it's a vastly improved business to where it was 20 years ago. But still, as we are finding out, we're still working our way back to cycle highs. We're not there yet. It's been four years of a down cycle. Let's move on to General Mills, which is telling a little bit of a different story about the economy. General Mills stock took a small hit this morning. The maker of Cheerios Pillsbury Fruit Roll-Ups announced a dividend raise, total sales increase on the year, but it looks like the

pricing power might be hitting a wall for this consumer goods giant. Yeah, there's not much cyclical about eating. You do it every day, and you're going to tomorrow and for many years to come. It doesn't have the highs and lows by any means. General Mills brands, you look at them, They're the ones that you've grown up with, you know, whether it's Lucky Charms or Bisquick or so many, Pillsbury, there are things you know from however old you are, you probably learned about them through commercials from your earliest days. What they're looking at now is, the population is not growing that fast, and they're going to be looking at more or less inflation plus population growth as the benchmark. Unless

eating habits change dramatically, that's the kind of growth you can look for here, absent really discovering a better selection of things that people want to eat. Of course, a lot of their historical legacy brands are on the wrong side of the nutritional and health trends. I don't know that they've got a better-looking future than their past. It seems like a lot of disrespect for the Lucky Charms there, Bill Barker. I love Lucky Charms. There aren't enough people like me. That's the problem for General Mills, I think, is that there are too many people that have decided to pay attention to all the nutritional information. What a shame for their shareholders.

General Mills, I think, also ran out of some room to cut around the edges. Maybe people are finally getting fed up with the shrinkflation. General Mills is not the only culprit in this phenomenon, but they did cut family size cereals by an ounce. Members of the Reddit community have pointed out the Pillsbury toaster strudels are getting smaller, and the amount of frosting in packets is also diminishing. Even for your current customers, they might not be delighting them like they used to? No. A couple of places in the earnings report, they refer to lower organic pound volume. They're maybe selling the same number of packages, but with less weight. They're ending up with slightly improved revenue, but really not quite keeping up with inflation.

Inflation is going a little hotter than what they added to year-over-year. Net sales increased 6%. 6%. Inflation was a little bit higher than that over the previous 12 months. I think that this story is going to look very similar from quarter to quarter, from year to year, but there are limits on what people will put up with in terms of being charged the same or more for less and less. The media is putting a spotlight on that, and that's not helping General Mills. Let's move on to Costco. Now, Costco is cracking down on membership sharing. Maybe they're taking a page out of Netflix. Bill, the retailer says that it is now asking shoppers to show photo ID at self-checkout registers.

Does this signal anything to you or is this just a fun news story? I think it signals an interest in supporting their membership. Members are asked pay an annual fee. And by definition, they're sort of subsidizing the non-members, the free riders that are borrowing somebody else's membership. So, I think that the honest members, not that there's really, you know, I wouldn't go so far as to call sharing a membership dishonest, but the people who are playing by the rules are subsidizing the free riders. And it's in Costco's interest to, with very crowded stores much of the time, to make sure that the ones who are getting in the door are the ones who are supposed to be getting in the door and paying

for the privilege to do so. Also, I think it's worth noting just how important those membership fees are to Costco and the investors in the stock. Yeah, the membership fees are the lion's share of the profits here. They are dedicated to keeping costs low and running a very, very tight margin operation outside of the membership fees. And people are glad to pay them, find value in the membership fees, renew at extremely high rates, way, way, way above 90%. They don't get raised every year. I think we're about due, but I think that Costco has done a great job of keeping the loyalty through service and through not frequently raising prices on the membership.

Big news for AutoZone, its CEO Bill Rhodes announced that he is stepping down in January of 2024 after leading the company for 18 years. Bill, this is someone that we don't talk about a lot, but this guy has been a tremendous friend to shareholders during his tenure. This is an underreported story, I think, or underappreciated by many who haven't followed it. AutoZone has just done a tremendous job for long-term shareholders, largely following a model of aggressively buying back its own shares, not overexpanding, not wasting money on acquisitions, not necessarily empire-building as much as just taking as much money as it can, borrowing a little bit as well to fund

share buybacks. The result has been, for long-term shareholders, a compounding, increasing ownership stake in the company. That's reflected in the share price, which is $2,400 some dollars today. There are many, many, many happy shareholders who are going to be sorry to see roads go. I think one reason this isn't getting a lot of attention is because there's not a lot of drama associated with it, and that makes the story a little bit juicier. This transition is probably a relatively boring one with about six months to go to hand the reins to Philip Danielle. He is a Vice President of Merchandising, Marketing, and Supply Chain teams, and he's the guy who's going to succeed Rhodes. Yeah, stable leadership team. Rhodes

sticking around, though not in the CEO position. I think that the market is going to continue to look for the past business practices to continue. It might be a little harder with interest rates at 6% running a buyback, which is partially debt-fueled rather than the near 0% interest rates that were available for a large chunk of the last decade. Nevertheless, I don't think that you're going to see a big change in the business model here, and AutoZone and O'Reilly are likely to continue feasting on the carcass of advanced auto. Yeah, I think it's worth discussing the balance sheet flag and funding share buybacks through that debt. Right now, AutoZone has about $750 million in cash and receivables,

but it's got $8 billion in payables, current debt, and retirement benefits. Is this a real problem in a rising interest rate world? Well, it's a growing payment that they need to make to fuel all this. The thing is that the car repair business is extremely predictable. We know how many older cars there are. We know how many new cars there are. You know the age of the entire fleet. You know that when there's a particularly tough winter in terms of weather, the number of potholes that that creates and how much additional damage happens to cars. So, there really aren't new variables that appear. So, it makes the predictability of the cash flows something sustainable and allows a little taking on more debt than you

otherwise would like to see. I'm sure shareholders would love to see less debt on the balance sheet, but they can't complain with what the debt that has been put onto the balance sheet so far has translated to in terms of equity. I wouldn't look for the same returns to shareholders over the coming decade that they've had over the last decade, but I continue to have faith in this company. Bill Barker, appreciate your time and your insight. Thanks for having me. Apple has entered the battle for your deposits. Jason Moser and Matt Frankel take a look at the tech giant's offering and check in on regional banks.

Hey, Matt, it's great to catch up with you again. It's been a while. Yeah, I haven't seen you in a few months now. We want to get back to what we've done so long in talking financials and in talking banks, particularly today. We want to dive into banks and talk about the regional banks in this fight for deposits. Interest rates, of course, have moved up considerably, making these deposit accounts a little bit more attractive for consumers these days. As such, these banks need to compete a little bit more for those deposits. Looking at the state of regional banks today, specifically in regard to deposits, how are these regional banks holding up?

It's been a strange dynamic this year, to say the least. When interest rates started to rise last year, a lot of consumers started to take their money out of the big banks, which pay like nothing. My Wells Fargo account pays like 0.01% still. They started moving out of the accounts like that into regional banks, which can afford to pay more. They generally have lower regulatory costs, for example, and can offer a little bit more with still having the convenience of an in-person bank. Then when this banking panic happened, if you will, earlier this year, people started to move their money out of regional banks at a rapid pace, especially in March and April. Since then, it seems to have calmed down.

There's a few reasons for it, but we're starting to finally see some positive numbers. Recent Federal Reserve data shows that overall U.S. bank deposits are starting to increase for the first time in a while. A lot of people are just taking their money out of banks and putting them into treasury bonds and non-bank assets like that. Now that seemed to have A few of the most affected banks are starting to report good numbers. Western Alliance Bank was one of the big hard-hit ones in the panic. They recently said that their deposit base grew by $2 billion in the recent three-month period. We're seeing some positive numbers come out of the regional banks. They're doing a lot to bolster consumers' confidence in

the regional banking system. Yeah, it does feel like a lot of this just stemmed from a lack of awareness on the consumer's part, regardless of where their money was parked. FDIC insurance is a real thing. There was a crisis of confidence, I guess, is really what it all boiled down to. But at the end of the day, the funds are still insured, whether it's a regional bank or a big bank. You mentioned something there that I want dig into a little bit more. You mentioned a phrase, non-bank instruments. That makes me think of Apple. Apple now, they're rolling out a banking relationship or a banking product, a savings account, I think it is. It's interesting. Apple's not a bank, it's not beholden to those

same types of regulatory constraints that banks typically are, but they partner with banks. I think maybe in this case, it's Goldman Sachs. Is the Apple bank account, is this a threat, do you think, to regional banks? I mean, are they feeling pressure from this? Like you said, Apple's not a bank. They have no desire to be a bank. There's a lot of regulatory headaches that come with that. They don't want to be a bank. So, what they're doing is, they're essentially offering a Goldman Sachs savings account product that they're just slapping their name on. Now, I mean, big companies do this kind of stuff all the time. Big brands, they slap their name on products to get them to sell. That's what they do. That's the whole

premise of a brand like Coca-Cola acquiring a new up-and-coming beverage, it could sell better under their brand. We saw a lot of early traction from the Apple Savings account. It pays a 4.15% APY, which is pretty good. In the first four days of its debut, which happened in April, which was right after the big banking panic, take that for what you will. It attracted about a billion dollars worth of deposits in four days. So, that had people thinking, is this going to destroy the banking system as we know it? Doesn't every other person in the world use Apple? I mean, between me and you and the two people behind the glass, I'm sure at least two of us have an iPhone. So, it's understandable

why people would think that that could be a big disruptor. But there's a few things to keep in mind. Number one, that APY makes them competitive with other online-based banks, not dominant. I'm a SoFi customer, for example, and mine pays 4.3% right now, so better than the Apple Savings account. So, it's not the highest rate you're going to get out there. The rollout has not been without its speed bumps. If you Google Apple Savings account, all the news stories that come up are how people can't get their money in a timely manner. I was going to bring that up. That's the one thing that stood out. I've not used this product, and I'm not going to use it. It's not something I'm interested in. But

I've already read enough of those stories where people couldn't get their money. That, to me, would be the most frustrating thing of all. You can't get your money on out. I don't expect it to necessarily be overnight. If I withdraw from my online savings account at 4 p.m. today, I don't necessarily expect it to be there tomorrow. But maybe the next day, it should be there. Not two weeks later, I'm still wondering where my money is and going back and forth with customer support. There have been some hiccups, and hiccups like that will kill a bank. Can you imagine if some of these regional banks came out in the weeks following the crisis and people couldn't get their money?

No. That's the reason for being right there. You're supposed to do one thing and do it really well. They were in the depths of a crisis people could easily get their money with all these regional banks. The third reason that I'm not too worried about Apple is, other fintechs have a lot more to offer in the financial context. Apple's a big ecosystem, but the savings is like an adjacent product. It makes sense because that's where people's Apple Card Rewards points are being deposited into. That's where the cashback goes. But as far as the primary place somebody puts their savings, people don't want to deal with two or three or four banks. They want everything in one place. I mentioned SoFi. The reason I use

SoFi, it's not just because they have a good APY. I can get that in other places. It's because I can also have my investment account in that same place. I can also get a mortgage from them if I want to. I can also finance my car. I can also do a student loan refinance. I can also have a credit card through them. I can have a big banking relationship with a lot of these other fintechs that you can't with Apple. So, yes, it's a niche product. It serves a purpose well. The Apple credit card, it's a nice user base. It's desirable. But I don't think it's going to be a serious bank disruptor. There's something like $14 trillion of deposit volume last month in the U.S. banking system. So, that $1 billion might sound like a big amount of money. But

in the scheme of things, it's really not that big in banking. So, I don't worry about Apple as really being a big competitor to the rest of the banking system. In regard to the regional banks, it does sound like at least Apple isn't necessarily the threat that maybe some thought it could have been. But when you're putting those regional banks up against the big banks and looking at the evolution of this industry, it seems like we're seeing more consolidation, and that likely will continue. Do you view regional bank stocks is a good investment today? I would say, if you're going to invest in regional banks, we've talked on podcasts a lot about doing a basket approach. I would

say even an ETF approach with regional banks makes a lot of sense right now, especially with some being really volatile, some being really stable. The regional bank SPDR ETF, the ticker symbol is KRE, is still down about 30% for the year. It was down 43% in early May at the lows, so it's come back a little bit. But that's a great way if you want regional banking exposure, if you believe in the system itself, but don't want to bet on any individual regional banks, that's a really good way to go. I like the regional banks that specialize in certain things, as an example, Ally Financials in my portfolio. They're an auto lender, they're really good at auto lending, they used to be part of GM before they spun off. They have

a great business model, great leadership, and most of their deposit clients are under that $250,000 FDIC limit, so they don't really have to worry about uninsured deposits. It's really just a straight savings and loan play, not a lot of business banking there. I like those if you're going to play an individual name, but my biggest bank stocks are still the big banks. Bank of America and Wells Fargo are still my two largest bank investments. Very interesting, indeed. Well, we will leave it there. Matt, thank you so much. Yeah, thanks for having me. I hope to do more of these with you. 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 Ricky Mulvey, thanks for listening, we'll be back tomorrow. you