Motley Fool Hidden Gems Investing - From 40-Bagger to Flatliner

Episode Date: March 13, 2024

NYCB’s $1B cash infusion should steady the struggling bank, but don’t expect Fools to be jumping into the stock. And Family Dollar’s footprint gets a bit smaller. (00:21) Matt Frankel and Dylan Lewis discuss: - Family Dollar’s plans to close almost 1,000 locations over the next few years and what it says about the state of discount retail and real estate. - New York Community Bank’s cash infusion and reverse stock split and why it’s still not enough to get Matt interested. - The banks to watch instead. (13:50) Deidre Woollard and Motley Fool analyst Kirsten Guerra dive into Duolingo and how a little bit of its marketing spend has driven a whole lot of revenue growth. Companies discussed: DLTR, NYCB, DOUL Host: Dylan Lewis Guests: Matt Frankel, Deidre Woollard, Kirsten Guerra Engineers: Desiree Jones, Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Dylan Lewis. Turns out Dollar Tree got less than it bargained for with Family Dollar. Motley Fool Money starts now. I'm Dylan Lewis, and I'm joined over the airwaves by Motley Fool contributor Matt Frankel. Matt, appreciate you jumping on with me. Always good to be here. I haven't seen you in so long. I'm glad to be here. I know. We get to hang out on Zoom. We get to talk for the podcast. I love it. We are going to talk through one of the largest retailers in the U.S., planning to close 1,000 locations. We've got a mini-dive on a company up over 200% since the beginning of 2023. We're going to kick off, though, with Family Dollar and that retail

story. Dollar Tree down 15% today on the news that the company's Family Dollar brand will be closing almost 1,000 stores over the next several years, 600 this year, and another several hundred in the following couple of years. Matt, Family Dollar has about 8,000 stores. This is a pretty big part of their retail footprint that they're looking to close down. Yeah. The earnings don't look great. Like you mentioned, the stock still was down 14%, 15% right before we recorded this. If you look at the numbers, you see why they're closing so many family dollars. Company-wide, their same-store sales were up 3% year-over-year in the fourth quarter. The Dollar Tree brand, the same-store sales were up 6.3%. Family

dollar stores' same-store sales were down 1.2%. That's a big disconnect from what on the surface looks like two of the same business. It caught investors off guard when the family dollars going so poorly, that they're closing that many stores. You expect companies to close underperforming stores over time. Even healthy retail brands like Starbucks closes underperforming stores from time to time. The other thing I think that's catching investors off guard is how poorly they're doing compared to their big rival, Dollar General, which not only isn't closing stores, but is the fastest-growing retailer in the United States right now. Matt, let's talk a little bit about

the landscape with the dollar stores. I think it's easy to treat them as a monolith, because they offer the same thing. But those three major brands operate in very different spaces geographically in the markets they're serving. Yeah, generally speaking. Again, with 8,000 stores for Family Dollar, Dollar General just opened its 20,000th store, you can't just group all of their geographical location into one basket. But generally speaking, Family Dollar is more of an urban dollar store chain. They're based in cities and suburbs and things like that. Dollar Tree stores are based generally in the suburban areas, whereas Dollar General focuses on the rural areas like the one I live in.

It seems like that geographical diversification between the three has a lot to do with the disconnect in their performance right now. It's interesting to look at this news because Dollar Tree and Family Dollar have not been tied up together for all that long. The acquisition for $9 billion was back in 2015. When they did that, it was a pretty sizable bet. I think the market cap for the acquiring business is about $15 billion. What do you think this says about the value of that acquisition? It's catching a lot of investors off guard, and for one big reason. This was seen is a defensive play. Look back to the financial crisis. Dollar stores were some of the best

performing businesses when consumers had to pump the brakes on spending. Walmart was the best performing stock in the S&P 500 because of its discount-oriented nature. Consumers flocked there when there was economic uncertainty. We're not seeing that this time. There's been a lot of economic uncertainty. We still don't know if we're going to get the soft landing as the Fed calls it, but we're seeing a general spending pullback. When consumers reduce their spending by 10%, 20% across the board, it's affecting every business, including the ones that are discount-oriented. The management specifically pointed to the reduction in SNAP benefits that are being paid out as one of the reasons that discount-oriented stores

are being hurt at the moment. Was it a good acquisition at the time? Maybe. But just the way the economy has evolved, especially since the COVID pandemic initially started, in terms of just people's economic feelings and the amount of disposable income that the dollar store chain's clientele has, we went from stimulus checks every few months to reduction and SNAP benefits. That's a big swing in disposable income. This is a retail story, but it's also a real estate story. In the PR for this, they specifically mentioned that 370 of the stores that are closing will be closing as leases expire. They're a pretty major tenant, Matt. What does this mean in the overall retail and real estate landscape?

You know, I mean, between the three major dollar store brands, you're talking tens of thousands of stores. And you knew you weren't going to get me on the show without talking real estate one way or another. But one of my favorite REITs, the first REIT I ever bought, Real Estate Investment Trust, is called Realty Income. Ticker symbol is O. Dollar stores are their single biggest property type. The company collectively owns about 13,000 properties, and dollar stores make about 10% of the rent. Dollar stores are generally small, so that means more than 10% by store count is probably dollar stores. Family Dollar is up there on the list. They're not the only ones, that's just one that I happen to have in my personal portfolio, so I know their portfolio

composition. But this could cause a lot of these REITs that typically have a 99% or better occupancy rate like Realty Income, you maybe have to try to find some new tenants for properties that were built as dollar stores. It might be tough to get someone else in there right away. Alright, Matt, we're going to stay in your wheelhouse with our second story that we're focusing on today. We hit real estate. We're going to hit the other item for you, and that's banking. Some turmoil there as well. We have an update on the state of things with Struggling Bank, New York Community Bank. Just as a refresher, back in January, they they cut their dividend, which sent shares down dramatically. They fell further this

month after the company disclosed that there were some material weaknesses in their internal controls and that they lost 7% of their deposits. It seems like, after a flurry of bad news, we have some good news, and that's that they've locked up some cash infusion and are seemingly in a decent spot. Yeah, I don't know if you're referring to the reverse split they're talking about as good news. But it actually could end up being good news if it gets the share price in a place where institutional investors can buy it. A lot of fund managers aren't allowed to buy stocks under $5 a share, for example. It could end up being a good thing. New York Community Bank is one that I got to admit

I really didn't see coming. This was one of my favorite banks to follow when I first started at The Fool, which was at a tail end of their bull run. New York Community Bank, if you're not familiar, the stock has pretty much flatlined for the past 10 years until this recent decline from about 2000 to 2014, they were like a 40-bagger. They were one of the best-performing stocks not just in banking, but in the entire stock market. The way they did it was a really disciplined approach. Yes, the interest rate environment, things like that, the economy at the time were helpful. Their business has historically been lending money on Manhattan apartment buildings, specifically those that are rent-controlled or rent-stabilized. Those

buildings in the world. They did a great job of growing their business organically and through acquisitions while staying true to their core business at the time. They were one of my favorite banks to follow. In the past few years, they've really tried to diversify their operations, which I think was a big mistake, and now we're seeing the effect of that. Their new CEO, well, they just had a new CEO take over, but the CEO when all these declines were going on. Took over in 2021. Since then, had really been trying to reposition the portfolio. To be fair, their cost of capital was a little bit high. They had a lot fewer non-interest-bearing deposits than, say, Bank of America or Wells Fargo, things like that. The goal was to lower

funding costs, diversify the portfolio. Then they made what they thought was going to be a quote, transformational move, and acquired Signature Bank out of receivership in March 2023. Turns out, having a bunch of commercial office loans added to your portfolio is not the way you want to diversify. So, a lot has happened to the bank. And I get it. Your stock price has stagnant for 10 years. Arguably, from 2014 to 2019, the best growth environment for banking in the past 30, 40 years, with the tax cuts and things like that. It was a great environment for banks, and the stock was going nowhere, so they had to do something. But the execution was lacking, and we're seeing that now. As someone that follows banks,

I'm curious to get your take. I was talking about NYCB with Jim Gillies last week. His approach to financials, he was saying, was basically, if I see signs of trouble, I'm out, and I need to see a clear path forward and execution to be able to be moderately interested again. When you look at a bank that's struggling, and I think there's clearly some big-time concerns, and the bank run of 2023 is pretty fresh in people's minds, what is your approach to looking at a bank on the rebound? Very similar to Jim's, actually. This is why I sold Goldman Sachs recently, which is another conversation for another day, but their consumer banking wasn't living up to

what they said they were going to do. They're losing their credit card customers. The Apple card was supposed to be a giant catalyst. They lost that. Find some trouble without a clear path to how are you going to grow. A clear path to growth isn't, well, we're just going to go back to being a good investment bank like we were. That's not exciting to me. The thesis was busted when their consumer banking wasn't doing well, decided to sell. I was not a New York community bank shareholder, thankfully, at the start of this year, but I had been in the past at one point or another. And it was really the stagnation of the business that caused me to get out then. But you need to show me that not only that you have a viable business, which, I mean,

that's setting the bar kind of low, but that you can thrive as a bank going forward. And I think that's what the new management team is really trying to show with this cash infusion deal. But there are negatives to that. It devalued the stock, it diluted shareholders by 50% or so. And there's no guarantee that's going to be the last capital raise they need. They do have a committed team trying to save it. Former Treasury Secretary Steven Mnuchin is chairman, though. He's very closely involved in making this happen. A really good team involved. I'm not going to buy the stock even at sub-$4 valuation. Are you? No, I'm not buying the turnaround play. I think there's easier money to be made elsewhere.

I agree, especially in the banking sector. There's some great deals. You can find banks that aren't in trouble trading for single-digit multiple start earnings right now, Especially with economic uncertainty, no one knows what's going to happen with loan defaults right now, things like that. If we hit a recession, which is still a strong possibility, let's be clear, we could see a spike in defaults across the board. You don't need a bank with added problems. The banking sector has enough uncertainty, you don't need to add to the problem. Matt, so that we're not ending this episode on a downer, I'm curious, looking out at the banks, is there anyone in particular that you're interested in owning your portfolio,

happy to be a shareholder of? I have a lot of banks. We can talk about any of them. The one that I always mention as one of my favorites to watch right now is SoFi, but I'm sure everyone's tired of hearing me talk about it. My biggest bank stock position is Bank of America right now, and has been for some time. I own shares of Wells Fargo. That was the value play after the big fake account scandal, which I happen to be one of the victims of, by the way. I had a scam letter sent to me by Wells Fargo people. It was just a value play because the franchise wasn't going to go anywhere. I owned Goldman Sachs until recently. Ally Bank is one that I am particularly impressed with how they've done in recent years. I believe

those are all the banks. American Express, if you count that as a bank, I own a small position in that. Matt, appreciate the portfolio rundown and having you weigh in on these real estate and banking topics. Thanks for joining me today. Of course. Coming up, Duolingo helps you learn new languages. And up next, my colleague Deidre Woollard and Motley Fool analyst Kirsten Guerra will help you understand how a little bit of its marketing spend has driven a whole lot of revenue growth. Are you a Duolingo language learner? I am actively. I have not completed my streak for today specifically, but I will. I promise I will. Well, the thing about the streaks, it's so addictive. They recently

reported their full year earnings. The user growth was just incredible. You've got nearly 27 million people every day completing those streaks, over 88 million monthly active users. I mean, it's not TikTok or anything, but it's pretty amazing for a language app. So what's the secret sauce here. It's got to be more than that owl, right? It is more. It's a lot of things. Duolingo is mobile first and a lot of language learning apps are now, but it was the first mobile first really in this space. And so it has that first mover advantage of brand awareness. And then it operates on a freemium model. So users can pay for a subscription if they want certain features, of course, but a lot of the functionality is really still available to free

users like myself. And that's really key to attracting this wide user base. Because another part of the secret sauce is that Duolingo is only part education app. It's also really part social network. Your friends and connections on Duolingo are completing quests together, or you can compete against each other to progress faster through language courses, or you're in each other's feeds all the time high-fiving each other over different accomplishments. and maybe all of that kind of clues you into what i'll call the last part of the secret sauce and that is that duolingo intentionally borrows whatever addictive practices it can from major social networks and game designers duo is absolutely designed top to bottom to keep you

addicted and give you those intermittent rewards and collect that dopamine rush and if that sounds a little sinister uh it is a little but every major company is doing it right so duo is just trying to harness it toward something a little bit more productive. Yeah. It's basically the same way that, you know, like a meta or something is doing that. I mean, one of the things that's kind of fascinating here is the effectiveness of their ad spend, their quirky use of social media, word of mouth. They're able to get more and more users without maybe putting out the effort that some other companies have to go through. Yeah. Duolingo is fantastic at social media. I've said it before, but whoever is running their TikTok account specifically deserves a raise. I have

no idea how much they make already, but they certainly deserve a raise. They've created such a really strong, quotable, memeable brand presence there. And as you alluded to, it really centers on that owl mascot that they call Duo. And on the app itself, it's that owl character who will pop up and push you to complete your lesson for the day or remind you that you haven't completed lessons in two whole days. How embarrassing for you. Or when I've missed several days in a row, the app icon on my iPhone will actually turn into a sad, melting version of Duo to guilt me into coming back. And their TikTok account has just taken that brand awareness centered around the owl to the next level. It appears all over TikTok. It's even commenting on other popular videos as

well. And TikTok users lovingly call the bird unhinged. It's like a huge joke that everyone is in on, but one that ultimately builds incredible brand awareness all back for Duolingo. Yeah. It's so off compared to the way you see traditional brands speak to their customers that it makes it riveting. It's a story unto itself, really. It is not what you would expect. Yes. Well, so you mentioned you've got the free account. So let's talk about the paying users. They're a smaller piece of the pie, about 6.6 million, but up 57% year-over-year, which is really strong. They're growing their family plan. They've got those different tiers that you

mentioned. Family plan bookings, they grew 100% year-over-year last year. Still only 18% of all paid subscribers, though. What's happening with the subscription business? Most of the family plan users I know are just groups of friends who've agreed to share a plan. There are a couple of families, but mostly it's that, right? So in terms of maximum revenue generation, that could be an issue for Duolingo long-term. At some point, they may feel that need to go the Netflix route and kind of force users off into their own plans, maybe. But there's a benefit to having these different options in different tiers. Again, the social element is really important for Duolingo to keep users there. So there are network effects at play here in a way

that just don't exist for Netflix. So for Duolingo, maybe they're actually better off letting the quote unquote family plan groups do their thing and at least contribute the price of one premium subscription. It's a delicate balance between encouraging friends to use Duolingo together because it's a better experience for everyone that way. And you're more likely to keep using the app versus the goal of just collecting all the revenue that Duolingo can by forcing individual subscriptions. Interesting that you brought up Netflix because the other part of the business I'm thinking about too is ad growth, much smaller part of the business at this point. But is there a comparison there? Could Duo be going more toward ads to boost that as time

goes on? I think largely not. In 2023, advertising contributed only 9% of revenue, right? You said It's very small. Subscriptions, by contrast, contribute 78% of revenue. And that separation has really only been growing more pronounced. So now that 9% for 2023, that's still $50 million, right? So it's not not important. It's a pillar of the business that you want to keep. But when you've got something like 8% of your users contributing nearly 80% of revenue, well, one of those monetization paths is clearly more important than the other, right? Yeah. And you can see how clearly Duolingo management understands this from the free user experience in the app. I'm a free user, as I said. So technically, every time after I complete

a lesson, I see an ad. But most of the time, that ad is for a premium subscription to Duolingo itself. If Duolingo can get you to subscribe to premium off its own ads, that's a light years better return on investment than any other random ad it could place. So, yeah, advertising is only 9% of revenue. It could be substantially more should they decide to pull that lever, but that would be at the expense of promoting its far more valuable subscriptions. That being said, this is a company that's an early adopter of machine learning and AI, things like that. So, I'm sure they're also using that to determine your likelihood of upgrading to premium. And maybe at some point when it's ultra clear that a certain user is not going to

upgrade to a subscription, maybe then they increase the amount of external advertising that you're seeing, and at least they start to collect more revenue from you in that way. And you've got this really driven CEO and co-founder, Louis Van Aan. He's made it clear that the company already has a lot of the language learners out there. So as Duolingo evolves, you know, is it just, does it just become a learning app in general? They've experimented with math and music. It looks like there's plenty of places they can go, but do they have run a risk of getting a little far afield of their core strength? I would maybe push back a little bit on saying that Duolingo has the lion's share of language learners, even if maybe that was the CEO

who said that. In terms of market share, yes, absolutely. It's the most popular mobile language learning app, it has the lion's share. But defining its total addressable market is a little more difficult. And I'd argue they still have plenty of potential runway there. At any given time, more than a billion people are learning a language. And you can narrow that, of course. Narrow it somewhat because only 85% of people globally have smartphones. Duolingo doesn't offer every language that people are learning. And some learners, as I said, are just more advanced in a particular language than what Duo offers. So it starts maybe above 1 billion narrows down. Either way, 88 million monthly active users is still a far cry from that.

So I think it's best to think, at least in the near medium term, this is still a very language-centric platform, and that's kind of what we should be looking for. But here's what I'll say about the expansion into math and music. I think that there's something very natural about a language education app leveraging all of its software development and marketing know-how into just another tangential learning topic. This isn't an original idea. Rosetta Stone tried to do the same thing unsuccessfully. However, what I like about Duolingo's implementation is that it's all in the same app. So rather than isolating the app and trying to build a whole separate social graph, which is really hard, now I can learn music

while you learn Spanish and everything functions more or less the same. We can still complete quest together and we can see and celebrate each other's progress because ultimately it all just comes back to how many XP or experience points each of us have in these different areas that we're learning in. So yes, I'd say let's certainly be realistic and not over-inflate our expectations about some of these new areas of education, but this is a fundamentally better approach than I've seen from the learning space before. Yeah, I love the way you connected the dots there because I think that's part of what's important. And the company does expect the user growth to moderate a little bit, definitely focus on profitability, which you talked about a little bit. What do you

want to see in terms of that cost discipline? You mentioned, you know, the risks of AI being too expensive. We've certainly seen that with other companies. Feels like they're pretty focused on profitability. What are you seeing? Definitely very focused on profitability. This business has especially incredibly efficient. It's been incredibly efficient in its cost to acquire. So from 2022 to 2023, Duolingo's sales and marketing increased $8.8 million, while its revenue increased $162 million. That's almost unheard of, an incremental spend of $9 million in marketing for more than $160 million in revenue. Duolingo is very smart about using its social platforms to generate that kind of compounding word of mouth that we've talked about,

And they're very cost efficient, even with that content creation. So they did a Super Bowl commercial, for example, this last month, and they spent about one 10th of the average spend on a Super Bowl commercial development in that process. Yet they generated the most engagement on X or Twitter, formerly Twitter, of all the advertising brands during the game. So I want them to keep that focus on efficiency front and center. Yes, naturally, over time, growth rates will slow. The growth rate in premium penetration will slow, or what percentage of all users pay for subscriptions. The focus on retention versus acquisition will become greater. There will be more shift towards retention as they've acquired a lot of the users and gotten closer to saturation.

But Duo already takes retention very seriously, and they're inherently great at it with all the social pressure to maintain the streets that we talked about. Yeah. And that pushy owl, of course. So while all those shifts are natural over time, I'd really just like them to maintain that focus on efficiency and not shift to throwing money after the slowing growth, quote unquote, problem. And maybe give that social media person a raise. Yes, absolutely. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening! We'll be back tomorrow.