Motley Fool Hidden Gems Investing - Kroger CEO Kicked Out of Grocery Store

Episode Date: March 6, 2025

On the first call since Kroger CEO Rodney McMullen’s departure, not a mention of the former CEO was heard. (00:21) Nick Sciple and Ricky Mulvey discuss: - Kroger’s business results. - Why some investors are becoming more pessimistic about Abercrombie & Fitch. - A small-cap tobacco company playing in a fast-growing trend. Then, (17:22) Karl Thiel joins Mary Long to discuss advanced-robotics company, Intuitive Surgical. Companies discussed: KR, ANF, TPB, ISRG, GOOG, GOOGL Host: Ricky Mulvey Guests: Nick Sciple, Mary Long, Karl Thiel Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Why'd you leave the grocery store? You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Nick Seipel. Nick, we got a lot of earnings. It's good to see you. Thanks for being here. Great to be here with you, Ricky. So Kroger, the grocery store, it reported this morning, and if you didn't hear Dylan and Bill Barker earlier this week, Rodney McMullen resigned. I think it was on Monday. Kroger's investor relations department told investors basically everything he did not do, Nick. It had nothing to do with an employee at Kroger, nothing to do with the stock or financials. That's what we know. And on the call this morning, I found it interesting that McMullen was not mentioned by name. Usually,

if there's an outgoing CEO, we thank them for their service to the company and their shareholder return or whatever. But this was a clean sweep. Interim CEO Ron Sargent is in, and we're only focused on the future. Did you find that odd? What did you make of Kroger's handling of this departure? I'm of two minds here. The first one was, as you said, the company didn't involve Kroger Associates Financial Performance Operations reporting. You could argue maybe it's not material to what they're trying to discuss today with the earnings results. Maybe that discussion, discussing what had gone on, would distract more from what the business is doing relative to the value that it would get to observers.

Another angle I've thought about is, maybe there's a legal angle here. Reporting out there says the CEO has forfeited $11.2 million in compensation upon resignation. That's a lot of money, and that might incentivize you to maybe engage legal counsel to try to claw back some of that. Both from the perspective of maybe minimizing what you put on record from a legal perspective and keeping focus on what the company is actually doing, that probably explains why they decided not to address it directly. I think the lawyers may have been paying a little bit closer attention to this earnings call than they normally do, Nick. Let's look at the business results. Identical sales of 2.4%. Its alternative profit businesses did

about $1.4 billion in operating profit. That's more than a quarter of the company's operating income. Really hard to make a profit in the grocery space. And this alternative profit businesses, that's a lot of ads, customer data, putting ads in the grocery store, that kind of thing. And digital sales, still growing up 10%. We've talked about the drama at the corporate boardroom, but this is the business results. Anything here stand out to you? Yeah. The big one that stood out for me was the digital sales, delivery, and pickup. It's really the way that my family shops at Kroger. But more broadly, it seems to be that's where competition is heating up in the retail space, folks differentiating as much on convenience

as they are on price. We've seen it from Walmart over the past year or so, really gobbling up shares and hurting dollar stores and other retailers in the market through the success of their digital initiatives. I think in today's retail world, competing in digital is table stakes, and it's good to see Kroger trying to keep pace. One other thing going on with this company that is material is what happened after the failed merger of Albertsons. Albertsons saying, Kroger, you didn't try hard enough to acquire us. Kroger, in the meantime, has taken a lot of the money they would use for that acquisition and given it right back to shareholders through an accelerated share repurchase program. $5 billion worth of stock. A lot of that has

already been completed. Right now, the Kroger stock is at an all-time high. Nick, I'm wondering, Synthetic is the wrong word, but it's the word that comes to mind. There was a bunch of demand to buy up shares on the open market because they had a pile of money that didn't go to Albertsons. I think that might be a key contributor to this stock's performance. What say you? I think it's certainly a contributor. You see incremental purchasing in the market likely to drive up the price. If you look, ever since the Albertsons deal really got blocked by courts back in December, stock's up about 12%. There's also been a broader market trend, given the uncertainty and fear in

the market towards consumer staples. These are reliable. Everybody has to buy their groceries every week. And over the past 12 months, Kroger stock up 30%, while adjusted earnings per share and addressed operating profit, both flat to down. And that's when you're backing out the 53rd week that was included last year in 2023. So, it's certainly some non-fundamental factors driving the improvement in stock prices, just looking at those operating results. And the buyback's probably part of that. The other thing I'm hearing from management is that they're committed to this 8% to 11% total shareholder return. Kroger pays about a 2% dividend. And over the past five years, Kroger has performed well, about a 17% annualized return. I own shares in this consumer staple.

I'm from Cincinnati, where this company is headquartered. I have a little bias. It was one of the stocks I pitched when I was interviewing at The Fool. So, this is a company, Nick, that I hold dearly to my heart. And yet, when I think about the current situation, I think, we're at an all-time high. The stock's been on quite a run. Should I trim a little bit? For me, personally, I might consider it. As I've said, the market is crowded into these consumer staple stocks because of broader market conditions, I would argue. And that's despite Really limited fundamental improvement if you look at Kroger's performance. It's the biggest grocery store in the country, not going anywhere anytime soon. It's going to provide that safety.

But if you're looking for upside, I could argue that there's other stocks out there that would be more attractive at today's prices. Let's look at a cyclical stock. That's Abercrombie & Fitch, a company reported yesterday. It's really been on a nosedive since January, despite the fact that the company is still up 650% over the past five years. this. Long-term shareholders, don't be too concerned. The street did not like the sales and earnings forecast from management and CEO Fran Horowitz. You've also got a lot of big box retailers right now, Walmart and Target, in recent earnings calls saying that apparel sales are slowing down. This is one that I have had on my watch list for quite some time.

When you're looking at the actual business results of Abercrombie, what have you noticed in the earnings? Yeah. If you're looking backwards, the numbers look really great. If you're looking forwards, the numbers look pretty good, but not as great as what we've seen in the past. If you look at the full year, 2024, sales are up 16%. Comp store sales up 17%. If you look at the fourth quarter, overall sales up 9%. Despite the impact of one fewer selling week, which is a really big positive, comparable sales up 14%. A little bit slower growth in the fourth quarter as compared to what you'd see in the full year. If you drive in even deeper, sales at Abercrombie, the Abercrombie

brand grew just 2% in the quarter, while Hollister sales jumped 16%. Comparable sales at Abercrombie up just 5%, while Hollister comps up 24%. So, Abercrombie, which had really just been this significant performer, you're looking at sales starting to slow there. And that's reflected in guidance for full year 2025. Abercrombie expecting consolidated sales for the full business to grow between 3% and 5% in 2025. That's below the 6.8% growth expected by broader analysts in the market. You're also expecting operating margins to come in a little bit lower than market expected at 8% to 9% as compared to 12.8% expected out there. You still would expect earnings per share for the full year to be up. They're targeting the range of $10.40 to $11.40

per share, which at the end point is higher than the overall market expectation. We're seeing a business that's still putting up positive results. The top line, though, is starting to slow. And in the world of apparel retail, where we're always looking for, has this company lost the trend? Has this company taken their eye off the ball? That explains why you see the market sell off here. It's a concern that the really extreme growth we saw in the past just won't be there going forward. There's also an interesting news cycle angle on this. Two stories, one of which is very flashy and good to get attention. And that's the tariff reaction, which is that I saw on Yahoo Finance this morning, quote, Abercrombie & Fitch stock gets pummeled as it predicts a Trump

tariff hit, end quote. And then you look into the details. Okay, so is every retailer. And also the CFO, Robert Ball, did give commentary on this and basically said they expect if tariffs stay what they are, and this isn't including retaliatory tariffs, just if they stay where they are, The impact is about $5 million. Yes, it's a global supply chain, but they sell things mostly in the US and Canada. Meanwhile, there's another real story that I'm looking at that's less of a flashy headline, Nick, and that's the inventory story. $575 million in inventories. That is an increase of more than $100 million worth of jeans, dress shirts, and jackets. That is a lot, Nick. What do you make of these two stories, one getting a lot of attention and one not really

grabbing headlines? I don't think it's a tariff story. I will give points to Yahoo Finance on going for an SEO-friendly headline. There's a lot of search traffic around tariffs here today. But if you look at its sourcing in 2023, it only got about 9% of its merchandise from China. It didn't really have significant merchandise from Canada or Mexico, which are the other markets that are being affected by a tariff. So I think the impact is limited. That said, at least the direct tariff impact. If you look at indirect tariff impact, consumer confidence is at its lowest level since 2021. That's partially driven by some of the uncertainty around tariffs and maybe the political environment and less confident consumers are going to spend less. And that's

definitely going to impact a specialty apparel retailer like Abercrombie. The inventory thing, you can tie that into maybe some concern around slowing demand. As I said earlier, Apparel retail runs in trends. It's natural for the market to look at one little bit of weakness and assume that this is a business starting to fall out of favor with consumers. You can point to some commentary on the earnings call if you want to make that interpretation. CEO Fran Horowitz mentioned that the company just didn't quite nail the transition to the spring line this year as they've done in previous years. If you want to view that as negatively as you possibly could, you could say that maybe this business is not resonating with consumers the way it is in the

the past. That's transitioning over into that inventory increase. Let me give you some valuation price tag metrics on this stock. I think it's interesting. For as much as this stock has been on a run, Abercrombie & Fitch is about eight times earnings in cash flow. Both of those measures have been cut in half since the summer of just 2024. We'll throw Roundt in there, which is something we look at at The Fool. It is a measure of operational efficiency that Warren Buffett really likes. For Abercrombie & Fitch, that is at 25%. So on the high end, you got NVIDIA, which has not a ton of tangible assets, but making a ton of money. It's 72%. Alphabet, it's 35%. And this dusty old retailer, Abercrombie & Fitch, at 25%, only at eight times earnings and

cash flow. So here we have the market saying that, Nick, this is a really mature company without much growth left. Do you agree here? Well, I'll just defer to my wife here. My wife says Abercrombie & Fitch is still on trend. I'll take her word for it there. If you assume that's the case and we just don't see the bottom fall out of sales and then really lose the ball, I don't know if you really need tons of growth here for the stock to work. If you look at 2024, The company did $527 million in free cash flow, spent about $220 million of that to pay down debt, spent another $230 million of that on buybacks that reduced the share count by about 3% versus where it was a year ago. The rest of that went to the balance

sheet. Now, you look at this company today, this has $888 million in cash with no debt on the balance sheet. That's excluding leases. That gives us a $3.5 billion enterprise value against that $527 million in free cash flow. That's about a 15% free cash flow yield if the company can just tread water from where it's been today. And if you think Abercrombie hasn't lost the trend, which if you agree with my wife, then I think it does look pretty reasonable here to me as a retail story. Let's wrap up with Turning Point Brands. This is a small cap company that you take a look at. Turning Point Brands, different from Turning Point, the political activist organization. I want to make that clear. This is a company that sells zigzag papers,

ALP nicotine patches. So this company reported this morning, when you're following this, you're saying that one thing really caught your attention. And that is this commentary that, quote, they're seeing another green wave emerge with the adoption of farm bill compliant hemp. And that quote, there are estimated to be 7,000 retail outlets in Texas that now sell hemp derived products in a state without a regulated cannabis market, end quote. So what this company is seeing, Nick, is basically a workaround for a lot of retail shops to sell weed that's kind of weed, but not the weed that's sold in dispensaries. Yeah, that's true. And you see this in a lot of the markets that have not yet legalized cannabis for recreational consumption.

You see it right here in my market outside Nashville, where cannabis is illegal, but you see billboards for it everywhere. How is that possible? If you go back to 2018 Farm Bill, they left a loophole in there. Hemp in that bill is defined as cannabis containing 0.3% or less THC, the intoxicating chemical, and marijuana. That's measured on a dry weight basis. However, the law had a pretty big oversight. It didn't mention THCA. That's the precursor chemical to THC. THCA converts to THC whenever you heat it or burn it, which tends to be how people use marijuana products in general. That loophole has been used by folks in the market where cannabis is not yet legal, where you can sell products that are super high in THCA, but get

under that federal requirement of around THC levels. So, that's adding to the cannabis market. The U.S. today, 75% of Americans live in a state that has legal access to cannabis in their states, and that other 25% of folks increasingly are having access to these legal hemp products. Obviously, a benefit to ZigZag, rolling papers are complementary products to smoked cannabis. And But ZigZag has been a mid-single-digit grower for quite some time. I think this can add to their growth potential. And this is not just a company that plays in that cannabis accessory market. It also has Alp, which is a nicotine pouch.

I know this is an acquisition that you've paid close attention to, and especially the growth of those nicotine pouches. I didn't see much from the call on this, especially they closed the acquisition fairly recently. but is your following Turning Point Brands anything else from the call that you want to hit? Sure. Modern Oral Nicotine is really the growth vector for Turning Point Brands. That includes the ALP joint venture between Turning Point Brands and the Tucker Carlson Network that launched in December. Limited information on that, just given the confidentiality agreements in place. We do have a little bit more information on their free nicotine pouch.

If you look at this modern oil category, that's really where there's opportunities for rapid growth for Turning Point Brands as we enter 2025. In the fourth quarter, the company did $11.2 million in modern oil revenue. These are these nicotine pouch products. That's a triple-digit growth rate year-over-year. It's actually a 4X. 26% sequentially in the fourth quarter entered into new retail partners, including 7-Eleven. The really exciting thing is guidance looking forward to 2025. Guidance calls for $60 to $80 million in modern oral revenue in 2025. If you compare that to the $44.8 million run rate we're coming at out of Q4, that's a 56% growth at the midpoint. Also, interestingly, you mentioned the opportunities and this green wave in the

zigzag segment. There's some opportunities for cross-selling as well. Many of these retailers that are selling some of these legal hemp products in the market also sell significant amounts of nicotine pouches. Don't carry other traditional tobacco products like combustible cigarettes or dip, but they do carry these modern oral nicotine pouches. It gives us an opportunity to cross-sell those modern oral products into these alternative channels beyond just the traditional convenience stores. You've got the existing businesses, both ZigZag and the Stoker's traditional smokeless nicotine has historically been kind of low double digit to high single digit. Growers with this addition of nicotine pouches, I think you have an opportunity to

rapidly accelerate growth in a market that is expected to grow at a 30% plus rate through the end of the decade. Something to keep an eye on. Nick Seifel, appreciate you being here. Thanks for your time here inside. Anytime, Ricky. Stop wasting your nights on a mattress that doesn't get you experience the most comfortable mattress in the world the sleep number smart bed at the touch of a button you can personalize your comfort choose firmer or softer adjust cooler to warmer and right now save up to twenty five hundred dollars during our massive labor day event hurry into your local sleep number store today because we have your number Up next, Carl Thiel and Mary Long discuss Intuitive Surgical,

one of the most advanced robotics companies on the face of the planet. We are shining a light on what we expect to be some of the biggest fields of the future, and one of those industries is robotics. A big player in the robotics world is Intuitive Surgical, a company that makes minimally invasive surgical systems. Its flagship offering is called the Da Vinci Surgical System. Carl, what does the system do to live up to that storied namesake, Da Vinci? Leonardo Da Vinci would have been absolutely fascinated by and delighted by this system. Leonardo Da Vinci actually made sketches for something called the Mechanical Knight back in the late 1400s. And it was discovered later and actually built by several people. And it was

an inspiration for some early robotic systems, including, you know, at least by anecdote and rumor, some of the original designers of the DaVinci robot itself. What the system does is it allows a surgeon, rather than being in direct contact with the patient, to sit behind a console and by a series of controls, operate remotely the arms of a surgical system that can make extremely precise and extremely nimble movements through a very small port. So instead of having to open up a patient to the point where you can get your hands inside, you're doing it with a narrow surgical instrument, but getting some of the same visualization and some of the same or even sometimes better flexibility and reach. So what kind of surgical procedures is it that

the da Vinci is helping doctors with? Intuitive surgical really made its name in urology procedures and more specifically in prostate removal. That was one of the first procedures in which they were able to establish that patients had less blood loss, they recovered a little quicker, they got out of the hospital a little quicker. And so that overall, this was actually a really cost-effective option, even though the direct price of doing a da Vinci surgery was slightly higher. From there, it grew into a lot of gynecology procedures, and these continue to be some of the main uses of it. The biggest category now is just sort of lumped together as general surgery. And that encompasses a whole wide range of surgical

procedures that are done on the da Vinci. Everything from hernia repair to gallbladder removal and a lot more. I want to talk more about the da Vinci, but maybe before we get there, it's important to highlight another intuitive offering, which is called the ION. So this is another robotics platform and specializes in minimally invasive bronchoscopy or peripheral lung biopsies in cancer patients. This will make clear why I didn't end up in medical school. Why do you always need different systems to complete different types of surgeries? Why does Intuitive need to build out wholly separate robotic systems for different types of surgeries? In this case, because the ion is just doing something radically different from

what the da Vinci robot is doing. The da Vinci robot has actually proven to be very, very flexible in what it can do because it's sort of acting as surgeon's hands in a sense, but going in through narrow ports. The ion is doing something completely different. It's using extremely flexible, extremely narrow catheters to wind their way inside of the lung in order to grab bits of tissue that you can use to biopsy and make a cancer diagnosis. There is no equivalent of that that you do manually. And so, the use of those flexible catheters is just such a different approach than the core da Vinci system, that it makes sense that it's a completely different surgical system. The da Vinci surgical system was created in 2000. So, okay, flash forward 25 years

and where we're at today. How has that platform changed in the quarter century since it first came out? When the da Vinci robot was originally conceived, they got some early funding from DARPA from the Defense Department, and the Defense Department was really interested in it because they had the idea of this as a remote surgical system. In other words, the surgeon could be sitting in one place far away from the actual robot, and they saw this as a way to do potentially even battlefield surgeries. Another thing that they had really hoped was that it could be used for a lot of cardiac procedures. Interestingly, neither of those things have really been the main use of the da Vinci. It is used for some cardiac procedures, but we'll get to that more maybe in

the context of the ion and what they can do in the future. And it tends to not necessarily be used as a remote system. The surgeon is kind of sitting right next to the patient. But over the years, they've been able to add instruments to it. They've been able to add extra arms to it in order to be able to hold back more things, do more manipulations at once. And with the latest model, the DaVinci 5, which is really just being rolled out right now, one of the big innovations is force feedback, where using a whole lot of data capture and haptics, the surgeon can really kind of feel the tension of tissue that they're working on with the instrument. And that data is all being collected, and there's probably going to be a lot of AI work that goes into getting new information

and data out of what works best and using that as feedback for the surgeons who do the procedures. What does the future look like for Intuitive moving forward? Because we've talked about these two different platforms, the DaVinci and the ION. Does Intuitive have to make a choice between building out the versatility and the universality of something like the DaVinci platform and maybe a path that focuses more on diversifying their portfolio with a number of different machines that can do highly specialized surgeries, do they have to make a choice between those two paths? Or is there a world in which both are possible? I think that what they have generally done is improve on the core capabilities of the core da Vinci system, which has proven to

be very, very flexible. I mean, it's useful in all kinds of procedures. There is a system called DaVinci SP, which SP stands for single port. You're going in through a single incision rather than three or four that you might use with the main DaVinci system. Again, that works for certain kinds of surgical procedures. It's nice to make only one cut if you don't have to make three or four. We talked about how the ion is fundamentally different. I think they have some interesting things in their future. I think the ion is maybe an underappreciated platform in that what they're really working with is a catheter technology. And there are a lot of surgeries that are done using catheters, everything from clot removal to a lot of cardiac procedures, things like

angioplasty, things like some cancer work, and even going into the brain. And so, I think with the way that the ion works, it's an incredibly sensitive and flexible and manipulable catheter. I imagine that they're working on thinner diameters that can get to places where the current 3.5 millimeter ion can't yet. And so they're going to open up a lot of new possibilities for themselves there. So those two sort of basic platforms, you can do a lot more with them just by innovating around what you have. One way to kind of get a glimpse of what might be in Intuitive's future is perhaps by looking

at their research and development spend. That only gives us so much information, though. But for fiscal 24, Intuitive spent just shy of 14% of their revenue on R&D. How closely do you watch that number? Are there other metrics or hints that you take into account when trying to keep tabs on how they're planning for and thinking about their future as a company? One way to think about Intuitive is as a company that has enjoyed near-monopoly presence up to this time and how they approach that. That could certainly lead a company to maybe be lazy or inattentive. And looking at how much they're spending on R&D is one window into that. I think there's very, very little evidence that

that is going on in any way at the company. And so, I think competition is a looming issue. I mean, they're definitely seeing it in China. There are some systems that are on the market in China, a little bit in some other areas of the world. But at this point, there's these long reported emergence of systems coming from Verb Surgical, which is a joint venture between J&J and Verily out of Alphabet, and from Medtronic. But these haven't really fully hit the market yet. and Intuitive just continues to innovate ahead of them. I'm not saying that those can't make any difference or gain any market share, but Intuitive has really, really been able to keep on top of its game. You gave us an overview of the competitive landscape, or lack thereof,

depending on how you look at it. But one of the ways that Intuitive would maintain their near-monopoly in this industry, even amidst growing competition or growing whispers of competition is by just maintaining and retaining awesome engineering talent, I would think. As an investor, how can you keep tabs and make a judgment, an educated analysis on the kind of talent that is behind these robotics machines that Intuitive is putting out onto the market? On the plus side, Intuitive has some really top-notch management. And Gary Gutthart has been, I mean, he was one of the original designers of the system.

And he's been an incredible leader by just about any metric that you'd care to imagine. I mean, Intuitive Surgical also pays out a lot of money in stock-based compensation. I mean, certainly the people who are there get very richly rewarded for it. That's not always necessarily what you want to see is a ton of SBC, but it's certainly a measure that the people who are there have been rewarded between that and obviously a rising stock price. drugs have to go through a pretty long and arduous fda approval process in order to make it onto the market medical devices have to go through a similar process what should investors

know about the research development and approval process for medical devices like the da vinci or the ion etc so there are two main pathways for medical devices one is called pre-market approval or a PMA. That's a very arduous procedure, similar to drugs, to getting a brand new drug on the market. Then there's what's called a 510K approval. That's more equivalent to getting a generic on the market after the innovator drug has already been approved. It's a much shorter and easier process because what you're doing is you're saying, this is substantially the same as this other thing that's already on the market, so you don't have to examine it to the same depth. DaVinci has gotten almost all its approvals through a 510k pathway. That is an advantage

to them going forward as well. It certainly seems that if Medtronic or VIRB want to get their systems on the market, that's going to be a PMA pathway, which is just harder and longer. The fact that they are on the market and can put these forward as being incremental innovations on top of what already exists means that they can use this easier pathway. Carl Thiel, thanks so much for the time and for giving us an inside look at the very, very cool stuff that is happening at Intuitive Search Gold. Appreciate it. 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 stocks based

solely on what you hear. All personal finance content follows Motley Fool editorial standards and are not approved by advertisers. The Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.