Motley Fool Hidden Gems Investing - How Gen Z Spends

Episode Date: April 6, 2023

There are no style points in investing, and big brands continue to dominate teen spending habits. (00:21) Dylan Lewis and Nick Sciple discuss: - Piper Sandler’s Generation Z survey about brands and spending. - Tailwinds for Ulta Beauty, Spotify, and Nike. - Investing in resale companies. - How the competitive landscape shifted for upstart brands. (10:52) Ricky Mulvey and Sanmeet Deo look at two health trends for investors to watch.  Companies discussed: NKE, SPOT, LULU, ULTA, WINA, TSX: ATZ, LTH, XPOF  Host: Dylan Lewis  Guests: Nick Sciple, Sanmeet Deo  Producer: Ricky Mulvey  Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll.

So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. Dylan Lewis, sitting in for Chris Hill, and I'm joined by Nick Seipel. Nick, how are you doing? Great to be back with you, Dylan. Always great to be back in the podcast world. Yeah, I'd love to have you. Today, we are diving into the tastes of Gen Z, Piper Sandler's semiannual taking stock with Teens Report just published. It is a goldmine of insights about the spending habits and the dominant brands for the next generation of consumers. Just as background, the firm surveyed 5,600 teenagers in 47 states, digging into the

top brands by category, clothing, footwear, you name it on the consumer side. They also got a got a sense of the celebrities and the causes that resonate most with younger folks. Nick, when you look at this report high-level, what jumps out to you? Nick Sciple Yeah, a few things high-level. A, teens still spending money in this slowing down economy where you see maybe pressures on some retailers, still seeing teen spending, self-reported, up 2% year-over-year. Within that context, teens still spending, but spending in different channels. One channel I've been watching in particular is the second-hand channel. You see over 200 basis points increase in preferences

year-over-year. That's something, if you remember, if you were paying attention back in January, the National Retail Federation held their big show every year for all big retailers across the country. One of the big areas of growth highlighted among those folks was resale, expected to grow three times faster than core retail moving forward. A lot of that being driven by preferences among younger folks, Gen Z, things like that. Also, as far as brand preferences, it's just that the big brands that you would expect to be dominant continue to dominate. If you look at the top five most popular e-commerce websites, obviously, Amazon coming in at No. 1, but also interesting to see companies like Nike and Lululemon through their direct-to-

consumer channels really having lots of success. Apple still remains the dominant smartphone. You have 87% of teens report owning an iPhone, 88% of them expect to own an iPhone next year. The kids' generation, we're addicted. The millennials to the iPhone, it looks like Gen Z is addicted as well. Yeah, that is such an interesting story to me because you emphasize the big brands there. I know when I spend time talking to my younger cousins that are in their teen years, there are times where I have no clue what they're talking about and other times where the foundational elements of how we live our life or the way that we look at the world is very similar. And I look at some of the names on this and the leaders in some of these

categories. You mentioned Nike, Apple, Amazon, Netflix, and YouTube leading the way in terms of video habits. And I think it's a good reminder, if you're trying to be somewhat thematic in how you're looking at things like this and how you're trying to apply it to your portfolio, you don't necessarily need to be awarded style points or points for difficulty when you're to project what the future looks like. Very often, a lot of these brands that are incredibly resonant with millennials, with Gen X, are also resonating with Gen Z. That's right. I think Lululemon, really, its path to success was going from among those college folks, and now it's broken into really the adult population. Sometimes you see these big trends carry over from the

younger generation to the older generation and vice versa. You're seeing a lot of preferences too, among the younger folks around loyalty programs. That was one thing called out. Ulta, really dominant in the makeup and skincare part of the category, got 60% of teens reporting an Ulta membership. When you really capture those folks, it's really hard to get out of the ecosystem. Probably not a surprise for anyone that's been an Ulta shareholder. That's a business that has been a pretty strong one to own and a pretty successful one. I want to focus a little bit on some of these businesses like Apple, and I'd even lump Spotify and Netflix to a certain extent into these categories, where these are businesses that you make a decision once and very often you tend

to just live in that decision for a very long time. I think about my own path with a business like Spotify. I became a user probably about nine or 10 years ago, have been a paid user for probably six or seven years, and I have not once thought about my subscription since. Nick, I'm curious when you look at the names and the habits that are being formed with some of these brand associations, what you see and just what it portends for some of these businesses. Yeah. Well, I'll say my experience with Spotify is pretty similar. They grabbed me as a young free user and I got annoyed with the ads and I've been a paid user ever since. I think if you look at something like music, where really all the platforms have

everything you could possibly want, once you get into a platform like Spotify, they start servicing, serving up playlists to you and making recommendations to you over time, it gets harder and harder to get out of these ecosystems. Another thing that I think is interesting, I alluded to the direct-to-consumer side of these businesses before. As the e-commerce side of these businesses gets stronger and stronger, I think you're going to see companies like Nike and Ulta have even more dominance in their industries as folks form loyalties earlier in their life. The other thing that I think is interesting is, over the past seven, eight, 10 years, you've seen this big trend of new entrants in apparel, retail, you think about your Allbirds

types of companies. A lot of those companies were able to flourish in a low-interest rate environment, an environment where it was a lot easier to target advertising. I think just the competitive landscape today is even more in favor of these big brands than maybe it would have been been five years ago. Yeah. If you're in a tight budgetary environment, a business that already exists in your brain is going to have a little bit of an easier time being there when you're trying to make a purchase decision as a consumer where some of those upstart brands, they need to do a lot of education. They need to do a lot of awareness for you to even think about them when it comes time to buy new yoga equipment or a new set of footwear or whatever it might be.

That's right. And you've seen the Lululemon get involved in footwear. You've seen some of these brands will be able to extend their offering to take that mind share and be able to gobble more of the addressable market. Nick, you mentioned trends in resale and secondhand before. I want to touch back on that because I think that is something that we've seen bloom over the last five to 10 years. We didn't really get too much into the investable side of that earlier in the discussion. For people that are interested in following that trend and are looking for ideas to get exposure to it, anything comes to mind? Yeah. Well, I think that the resale industry certainly has seen lots of growth in recent

years. We've seen some companies come public. Poshmark has come public and then since been taken private, ThredUp came public, has really had a really tough time in the market. When I look at the investable companies in the resale space, they're really the only one in the pure play world that comes to mind. For me, it's a company called Winmark, ticker is W-I-N-A. It's been a recommendation in the Canadian side of Motley Fool for quite a while. They're a franchisor of a number of resale concepts, Plato's Closet, Style Encore, Music Go Round, Play It Again Sports, among others. As a franchise business, they get a percentage of sales from their franchisees, a low single-digit percentage of sales. As a result, the margins on this business are really

remarkable. The company has been public since the mid-90s, has been really an amazing performer. They take all that cash that comes in and for the most part, they just return it to shareholders. They buy back a heck of a lot of stock, send out special dividends. Just so far this year, the stock is up almost 40%. Valuation maybe is getting a little bit aggressive here, but they're one of the few companies that has been able to figure out the resale business in a really profitable way. We may see some new entrants, some of these bigger retailers try to get involved in the business. But Windmark is really a company that's proven out this business model over 20 plus years, and I think they'll still be able to do it going forward the next 10.

Yeah, I think it's a compelling trend and one that, regardless of where my investing dollars are, the human in me, the consumer in me wants me to see businesses succeed that are trying to do that because there's a lot of value left in clothes that people have decided they're no longer going to be wearing. It's nice to see reuse, resale be a trend that is on people's minds. Before we wrap up here, Nick, anything else from this report jump out to you or any other names that you want to surface for listeners? Yeah. A second company that I would put on listeners' radar is a company called Aritzia. If you drive into some of the trends within the Piper Sandler report, among the top brands starting to be worn among teens, Aritzia is

starting to move up that chart. Aritzia is another company that's recommended on the Canadian side of the Motley Fool services. The ticker is ATZ on the Toronto Stock Exchange. It has some parallels Actually, with Lululemon, we talked about earlier, both founded in Vancouver, both companies that really expanded across Canada and have increasingly become not just Canadian businesses but North American businesses. As of the most recent quarter, Aritzia just ticked over to over 50% of its business in the United States as opposed to Canada. Looking forward to the next five years, they expect to open eight to 10 stores per year, expect that to trickle down to about 15% to 17% sales growth per year and a faster rate than that of earnings per share

growth. The stock trades at about 25 times earnings, which I think is very reasonable relative to that opportunity I just laid out for you for growth. I think if this company traded in the U.S., the multiple would be over 30 times earnings, but that kind of smaller investment environment gives us, the folks that are willing to invest in Canada, an opportunity to get a growing company at a reasonable price. So we have a couple names that maybe people aren't as familiar with. And a reminder, you don't have to think too hard about it. A lot of the businesses that you think are quality businesses and good services are probably going to be around for quite some time based on the survey results we're seeing, Nick.

That's what it looks like. The kids are all right, Dylan. Nick, thanks for joining me. Anytime. We've got more trends, more discussion of Lululemon on the second half of the show. At-home fitness is evolving and pickleball is on the rise. Ricky Mulvey caught up with Motley Fool Senior Analyst, Sanmeet Deo, to look at two health trends for investors to watch. At-home fitness is changing, but joining us now to talk about two health trends for investors to watch, Motley Fool Senior Analyst, Sanmeet Deo. Sanmeet, good to see you as always. Hey, good to chat with you.

So, let's talk about connected fitness first. During the pandemic, the pendulum swung very far to at-home fitness with equipment. Where's that pendulum swinging now? It looks like the fitness pendulum is swinging more to the omni-channel fitness model, where fitness companies are meeting their customers where and when they want to work out. As the pandemic shifted a lot of our lifestyles in different ways, the fitness needed to adapt. For example, many of us have a hybrid work schedule. Sometimes people want to work out at home, maybe before they go to work, or when they're working from home, work out at home, or sometimes they want to work out at or near the workplace.

Where we work out has definitely changed from the past. While at-home fitness was always a thing before the pandemic, I think the importance of it and the value of it was more appreciated during the pandemic. It's going to continue, maybe at less levels, though. than prior. You're starting to see companies adapt Lululemon's latest quarter. Investors cheered as it beat earnings and revenue expectations. However, it did write down its mirror acquisition to about one-tenth of the original purchase price. That was the mirror where you could see yourself and workout classes in your home. What

are the lessons that CEO Calvin McDonald learned from that experience? Do you think Lululemon's learning the right lessons from this write-down? In addition to all those, Lululemon's showing us an example of how sometimes acquisitions are a tough thing. They purchased Mirror for $500 million in June of 2020. The goal of their acquisition is to make Lulu more of an experiential brand, expand its digital and interactive capabilities, take advantage of the exploding in-home fitness market. The acquisition was quite a substantial one for them, given that they had about $800 million

in cash on hand at the time. So, in retrospect, it looked like they bought a fitness company at its peak, sales weakened quickly after, ultimately resulting in them writing off about $443 million of the acquisition in its most recent quarter and shifting to primarily digital offerings. I think a big lesson that the CEO, Calvin McDonald, and Lulu must have learned is that connected fitness, especially hardware and software, is a much bigger undertaking for a company that has primarily delved into the athletic apparel market. And while they do great at that, and while there may be some synergies to having a hardware

and software brand that could help them sell some athletic apparel, maybe a better approach might have been testing the waters without a big, splashy acquisition. Now that they're shifting to a more digital offering like Peloton and many others, and while there is, in my opinion, an oversaturation of digital fitness apps, they're doing something a little bit different by partnering with some other more well-established digital fitness companies to offer their classes on their own Lululemon Studio offering. I think they've learned a little bit of the lesson of the connected fitness market, but it might have been a better approach to do what they're doing now back then, to dabble

in slowly offering digital without having that big purchase. Yeah. The strategy now, it's called Lululemon Studio. The mirror still exists, but they're investing in getting this lower-cost offering to folks where they can watch workout classes on their phone. You can do it at the gym. You can do it wherever. I think two of the lessons from this for me are, number one, be careful thinking in absolutes. I think there was a lot of interest in this idea that no one's going to work out at the gym again. And then also, B, a lot of investors are not health experts. Working out in your home or apartment by yourself is not fun. It's not what I'm trying to do the whole time. Going beyond that, what are some of

the applications of this connected fitness, this saturated market that you're talking about that you think have potential? Are you excited about it? Or is this a wait-and-see approach to see who breaks through? I think the thing I'm most excited about is smaller hardware offerings that offer comprehensive digital analytics softwares that help customers really put numbers behind their fitness and health. I don't think people want to buy big, bulky equipment in their homes anymore, especially when they're not in their homes as much as they were in the pandemic. but smaller hardware products, something like something I came across, uh, Kabata, which is smart dumbbells that kind of offer real-time metrics, AI powered workouts, and specific

tracking to kind of enhance form and technique. Those kinds of things might do us Kabata. I mean, to give it a perspective, it's, it's like those Bowflex dumbbells that you can change the, uh, the weights around. So, or things like fight camp, which offers us a standing heavy bag, Not huge, but that helps you. They have digital classes, they have an ability to track your punches, your calories, things like that. And then, I still believe in the limitless potential of smartwatches that are just tracking more and more fitness and health metrics to keep tabs on. But small hardware that you're not going to hang your dirty clothes on is basically what I'm most excited about. Smart hardware, that's funny.

Any companies besides Lulu that you think understand this new style of fitness in a compelling way? The name I've been hammering down everybody's throats that's a full listener is Exponential Fitness, mainly because I just believe that they're doing the omni-channel approach in the best possible way. They have small studios that offer numerous fitness classes amongst a variety of modalities that are staples yoga pilates cycling bar boxing things like that but they also have their digital apps that offer many of those similar classes on an app they also have an x-pass which lets you

use the digital app but also try out different brands amongst the exponential fitness platform so they're kind of combining all of that and they're meeting customers where they are in terms of where they want to work out. I look at exponential, too. Two things that I'm concerned about. One is that Goodwill and other intangibles makes up $300 million of its almost $500 million of assets. And its multiple expanded over the past year, exploded. It now trades at about a 34 PE ratio. A year ago, it was at 11. Yeah. Being a franchisor, it doesn't take on the capital intensity of opening the studios and all that. That's the franchisee. So as a franchisor, they are going to be a lot more asset light. And a lot of their assets resides in the

brand names and the trademarks and the acquisitions of brands that they've done. So that's one of the reasons why you see such a high goodwill and intangible portion of their asset base. So while it can look a little concerning. I'm not too concerned so long as their brand name is strong and it continues to do well. And in terms of the multiple, I mean, I think the story has kind of, you know, their metrics have been good over the past few quarters. They've survived the pandemic very well versus other fitness companies. They're expanding their studios, they're expanding their brands that they have to offer. Their metrics have held up very well throughout. And so, I think the name is just gaining more prominence, and so the valuation has grown.

Their potential for revenue growth, cash flow growth, margin expansion is still a little bit underappreciated going forward. I like to look at these companies on a five-plus-year basis, and I model them out as such. I'm still very confident in the company and its valuation on an out-year basis. Let's move on to Pickleball. that's probably the hottest health trend in the streets. A study from YouGov found that 14% of Americans played pickleball in the last 12 months. Do you follow health trends? Is this one with legs, or is it a flash in the pan? Well, in full disclosure, I am a pickleball player. I've been playing about two or three

months now with some friends. Every Sunday, we play. I was laughing when I first heard about pickleball. But then, when you finally actually play, it's surprisingly very addictive, fun, and doable for all ages and all demographic groups. I think it's here to stay. One of the things that really tells me that it's here to stay is the demand outstrips the supply. There's more than 36.5 million people that play pickleball from August 2021 through August 2022, according to a report by the Association of Pickleball Professionals. There's only about 10,320 places to actually play in the United States. And I've noticed anecdotally that these courts are packed.

You have to book them a week in advance. And I'm in Long Island where there's not that many indoor places to play. There's outdoor places to play if you put the lines on tennis courts. But then there's been some controversy with tennis players and pickleball players kind of saying, hey, you know, get your own courts. But I think it's here to stay. Luxury gym chain Lifetime Fitness thinks Pickleball is going to be their growth engine for their very large fitness centers. What's the strategy there for Lifetime?

When I think of investing in the Pickleball trend in the public market, Lifetime is one of those ones that comes to my mind first. They've deployed about half a billion dollars into Pickleball at 120 of their more than 160 locations. They have about 400 courts across clubs currently. They're hoping to have about 600 to 700 by the end of 2023. Participation, they said, is up tenfold in the past year. Even pro leagues like the Major League Pickleball and Professional Pickleball Association, PPA, I think it is, have partnered with them to host tournaments. They're going in on it. I do wonder if this is the new AI buzzword in the health industry. For Lifetime Fitness, I think they have a great product. I've been to

their gyms in the past, but I also question management's ability to deliver on promises. Back in 2021, in their S1, management set a goal of 30% return on invested capital, and it's S1 for new fitness centers. Boy, does that sound high. In quarter four of 2022, its return on invested capital was negative 5.5%. Sounds to me like a New Year's resolution, gone awry. Yeah. I do like Lifetime. I like what they're doing as a customer. I think it's pretty cool. They're trying to be a luxury athletic club, almost like a country club, I should say. But one of the issues I have with Lifetime is they spend a lot of money, and it takes a lot of money to maintain those clubs, build those clubs. Things like with

Pickleball investing in maybe different new trends and changing things up constantly. They're not a franchise company. They're a company owned by shareholders and the owners. They're going to continuously have to put in money into their business, and their returns aren't going to look as good as some other asset-light-type companies. I also think it's interesting where you're seeing the Pickleball froth show up on TV. One of the professional pickleball associations is sponsored by Carvana. To me, that might be a little bit of a symptom of froth. To the association, I'd encourage you to clear those checks quickly.

Do you think that's one symptom of froth, or do you think it's more widespread throughout the industry with pickleball? As an avid fan of pickleball playing, I have been skeptical about viewership of pickleball and how much that will become um but the interesting thing too is lately recently they had the first annual pickleball slam i don't know if you heard about this and i included mackinrow agassi michael chang and i believe it was one other former pro tennis player surprisingly it did very well um when viewed in kind of the context of their of an entire programming week the slam out delivered 13 nationally televised MLB games,

seven NBA matchups and five NHL games. So it was watched quite, quite, uh, quite a bit. Now, given these are professional former professional tennis players are taking on pickleball. So that definitely was part of the appeal of seeing tennis players and former tennis players of, of our, um, of our past that we used to love and admire playing this game. I think it's things like that with the, are starting to gain some traction.

And then also as a player, you know, if I want to improve myself as a player watching it also is going to help me improve. And that's kind of the nature of sport, right? You're like, you play it, you watch it, and then you try to imitate what you actually watched. I think it could have some traction. I'm still skeptical, but you know, Hey, look, you know, people, people not to take a dig, but people watch curling pretty avidly do. So you never know.

San Mateo. Always appreciate your time. Great. Thanks, Ricky. 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 Dylan Lewis. Thanks for listening. We'll be back tomorrow. Thank you.