Motley Fool Hidden Gems Investing - Meta Misses, Shopify Stabilizes

Episode Date: October 27, 2022

On a day when Shopify and Comcast gave shareholders reasons for hope, Meta Platforms slid to its lowest level since 2016. (0:21) Andy Cross discusses: - Meta's worrisome R&D spending metric - Low expectations helping to fuel Shopify's rise - Comcast beating tough quarterly comps, thanks in part to the Minions (13:41)  Ricky Mulvey talks with Scott Ford, CEO of WestRock, a "brand behind the brands" coffee business serving up 20 million cups a day. Companies discussed: META, SHOP, CMCSA, WEST Host: Chris Hill Guest: Andy Cross, Scott Ford Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

This family is on the brink of civil war. On September 18th, Mobland, the hit original series, is back on Paramount+. We are the Hartigans. Don't know them yet? Then Google us. From the underworld of Guy Ritchie... Do you want to step up the ladder? I want Comet dead. Starring Tom Hardy, Pierce Brosnan, and Helen Mirren.

Do I have to do everything myself? You want more? I'll give you more! Mobland, new season hits September 18th on Paramount+. Chris Hill. We've got e-commerce, entertainment, and a consumer goods stock you've probably never heard of. Motley Fool Money starts now. I'm Chris Hill. Joining me today is the Chief Investment Officer, Andy Cross. Thanks for being here. Andy Cross. Of course, Chris. Happy to be here. Thanks for having me. We're going to dig into this more

on Friday's show, but I did want to get your thoughts on Meta Platforms, because that company continues to invest heavily in building out the metaverse. Those investments absolutely affected their third quarter results, and shares of Meta are down more than 20% today. Chris, if you think about the investments that they're making, this has been an ongoing story, even though they're talking about right-sizing their employee base. I was just looking through some of the data, and you guys will talk a lot about this, I'm sure, on Friday, but with the actual results, the operating margin down to 20% from 36% a year ago, that's the lowest that I can remember their operating margin being, at least for years. Costs and expenses up 19%. What really

caught my eye, Chris, is the research and development expenses. This quarter came in at 33% of revenues. That's the highest it's ever been as far as I can remember and can find. It was 30% last quarter. Normally, that's much more in the low 20% level. As a percentage of revenues, they are investing heavily into the metaverse and into their people. Their operating expenses for the year, they think, for 2023, Chris, will be somewhere in the $96 billion to $101 billion range versus $85 billion to $87 billion this year. Now, they expect that to trend down over the year as they right-size the people, their employee base. But still, the investments that Zuckerberg is making into the metaverse, and this was a lengthy conversation

about the call, the returns on that, what are they going to get from that, when's it going to show up, are they being distracted from their core business that is also suffering? As we know, the advertising markets under a lot of struggle from what we saw recently from Google and some others, Snap, certainly, or Alphabet and Snap. So, their core business is suffering. Meanwhile, they're making these massive investments, and they have not yet seen the payoff. And there's a lot of doubt among the investing community. Altimeter Capital, which has been very vocal in trying to get MetaFocus again. So, when you see your revenues dropping for the second consecutive quarter and their costs exploding and their profits dropping. It just has their

free cash flow going to almost nothing compared to $9 billion a year ago. It just really sends a signal to the investing community of a lot of concern and doubt about what's going on with Meta. Now, hey, listen, Zuckerberg has run this business forever. He ostensibly knows it better than anybody. So there's a lot of those who have confidence that he will eventually get this right, but it could be a very costly investment in the near term. After a rough 2022, looks like we got some signs of life from Shopify. Third quarter revenue was higher than expected. Shopify's loss for the quarter was smaller than expected and shares up 18% this morning. Was it that good or was this a combination of

low expectations for Shopify and also the stock has been just hammered this year? Chris, yes. Both of those situations, very low expectations. Last quarter, their revenues grew 16%. This quarter, revenues grew 22%, which, as you mentioned, was above expectations. Lost two points due to the strong dollar. Gross merchandise volume was up 11%. That about matched what they were last quarter. I think when you look at what was happening with Shopify over the last few months, there was just so much concern and so much doubt they have lost their mojo, that the shift away from e-commerce that we saw the explosion of growth from 2020-2021 during the COVID pandemic has really slowed down, and that has really affected

Shopify and their long-term value. I think this quarter, when you look at some of the returning growth, they have their deliver business that they acquired for $1.7 billion net of some cash that they closed and have started to recognize this year, this quarter. When you start to see some of that growth return, I think you start to see a little bit of sparks maybe show up that, hey, listen, Shopify, that's one of the largest, by some measures, the second largest e-commerce platform in the world behind Amazon. They have some potential to right this ship. Now, as you and I have talked about and we talked about after the last quarter, they still have a lot to prove. They are still making investments. They are still not making

nearly as much money as they should be. They still have a headcount issue that they are starting to right-size. Their costs for the rest of the year will continue to go up, but they expect that to start to trend down through next year as their headcount gets resolved a little bit more normalized. They are still making big investments, Chris. I mean, we talked about investments with Neta. Shopify is still making big investments to compete with Amazon in fulfillment. There's a lot of question marks on that regard, whether they will get that right, whether they could have done that in a different way. But regardless, they are making those cash outlays. They still have a very attractive balance sheet with almost $5 billion in cash versus $1 billion

in debt. They have the balance sheet to make these investments, but I still think there's a lot of questions. Will they get this right? This is not a 50% grower company like it used to be, Chris. We're talking much more in the high teens to 20 level. If they can get there and get the profitability curve going right, paying six-time sales, I think shareholders will be okay with Shopify over the next five years, but it could take a little bit more lumps in the short-term. This was a nice quarter, maybe a little bit of a surprise to the upside, but it sounds like you're saying, this is great. We'd like to see this a couple more times. We'd like you to do this for two, three, four quarters in a row.

I think that's right, Chris. When they talk about this, the merchant solution growth will be two times higher than the subscription solution growth. Subscriptions, when you join the platform, you pay a fee for that. Then they have their merchant solutions, things like payments, Shopify payments, Shopify capital, Shopify logistics and shipping, those things, that's part of the merchant solution. Those are far lower margin businesses. So as those businesses grow faster, they expect their gross profit growth will be, and I quote, meaningfully trailing revenue growth for the foreseeable future. So that means that profitability curve that many of us want to see from Shopify is not going to happen likely any

time in the very near term. But longer term, will they be able to continue to grow their customer base and continue to provide them with solutions that allows them to be an independent provider, to fend off the likes of Amazon and others, to provide that platform to entrepreneurs that sell their goods, and will that benefit Shopify shareholders? I think there's still some question marks that we need to see from Toby Luecke and his team that has had some executive level turnover that we expect to see them for us to become really excited, at least me, to be really excited to be a buyer of the stock at this price. Third quarter profits and revenue for Comcast

came in higher than expected and shares of the cable and entertainment company up 7% this morning. I was a little surprised by this just because there were some things to alike in Comcast results, it wasn't an amazing quarter. On the positive side, this was a tough comp when you consider that this quarter last year included the Summer Olympics and how important that was for Comcast's business. Chris, if you see the NBC Universal deal which includes so much of their media business, sorry, the NBC Universal business unit. The revenues in their media department were down 23%, but it was actually up 4.5% if you back out the Olympics revenue they got from the advertising last year. Comcast

is a much different story than what you have in either Shopify or Meta. It's a very stable business. It doesn't grow tremendously fast. They are losing a lot of their paid TV subscribers down another $560,000 this quarter. They've lost, gosh, more than $1.5 million just this year alone, but they make that up by adding more and more broadband users. I think they saw 14,000 new broadband customers added this quarter to take it to more than $32 million. You see this balance shaping up. It doesn't lead to a really robust, fast-growing company, but very profitable, generates a lot of cash, has a free cash yield of more than 5%, a dividend yield of more than 3%. You're paying about 10 times earnings for this kind of business.

They buy back some stock. Part of the NBC Universal business that I found so interesting, the studio's business, the revenue was up more than 30%. Jurassic World, Minions, Rise of Gru, and the movie Nope, I have not seen either, any three of those, which doesn't speak anything to Comcast, more to me. But they did see some releases, and that helped the lumpy revenues there. But their theme parks, Chris, the theme park revenue was up more than 42%. They mentioned attendance and spending increasing. Universal Orlando had the highest cash flow ever in a quarter. Universal Beijing was started finally seeing some profits this quarter. So you're starting to see the theme park business come back a little bit, much like we've seen with Disney,

too. So, you have the balance of all these businesses, relatively low-growing, fairly stable, although they can be lumpy any quarter to quarter. You're not paying a lot for their business. Their Sky business over in Europe is just kind of, I don't know, just kind of meh, just kind of marching along a little bit. Yeah, they had a pretty big write-down of the Sky business. Yeah, it's the smallest part of their business, but still yet to be seen. I mean, for a dividend-yielding company, I own Comcast shares myself. I don't actively buy them. It's not one that I just buy. I just let it sit there and it collects a little dividend for me. I think that can be a fine investment for those kinds of investors who are looking for that type

of investment to fulfill that part of their portfolio. I think it was in The Wall Street Journal a couple of months ago. It may have been another publication, but my memory is that it was the Journal, an article about movie franchises, how they can be valuable. You think about the classic franchises, James Bond and Star Wars and Harry Potter and that sort of thing. This was an article about the Minions franchise. It laid out a pretty compelling business case for whatever you think of the Minions movies and that sort of thing. From a business standpoint, the Minions franchise is a cash machine for Comcast. I think, Chris, if on Monday night, Halloween here in the United States, if you are handing out candy to those who come knocking on

your door, I know one of my daughter's best friends is going as a Minion. I think you will see plenty of Minion trick-or-treaters out there. It just gets to the importance of their Peacock business, which showed paid subs up more than 70% and now 15 million people on the Peacock side, subscribers access to Peacock. That's a big investment they're making to be able to benefit from those kinds of franchises that you mentioned tied to their Universal business, whether it's the studio side or the theme parks. You start to see that flywheel effect that takes lots and lots of investments that Disney has honed over so many years and done so well, and we're starting to see others like Netflix and now obviously Comcast take that same approach and

hopefully long-term while it takes a lot of investments, that can be fairly profitable going forward. Andy Cross, great talking to you. Thanks for being here. Yeah, thanks, Chris. Even if you're a coffee drinker, you probably have not heard of Westrock. even though it's possible you've already consumed a cup at a quick service restaurant or a travel center. Westrock is one of those brand behind the brands companies, and it serves 20 million cups of coffee every day, albeit under more established labels. Ricky Mulvey caught up with Westrock CEO, Scott Ford, to talk about coffee trends, the company's value proposition,

and why this former telecom executive started his business out of anger. Well, I found myself in Rwanda through a long story that we would go into another time, but I was looking around at the economic activity, and I realized that coffee was the largest cash crop that was sold by, for the most part, people that live in rural countryside and lived what they call smallholder farmer lives, and it's largely a barter society. People grow extra vegetables and trade and things of that nature. And the cash crop was coffee, and it was 40% of the money, hard dollar currency, that came into the country.

And it happened to be purchased by these two individuals that financed the local mills, and they were only two mills. And coincidentally, through just, I'm sure, a bad stroke of luck, they offered the same price every day, and that price was half what all the coffee in that region of the continent sold for where there were multiple competitors. I was angry that two guys were profiteering on the backs of some of the poorest people in the world. I said, let's build a coffee mill. That's how Westrop Coffee was born. Multiple businesses have been born out of your margin is my opportunity. When I've heard you tell this story, did you ever interact with

the coffee buyers that were setting the prices? I can't imagine that they were delighted to have someone kind of come in and mess with their market. Yeah. So I remember we'd been up for a couple of weeks and the guys that were running the factory for me, they called and said, well, we got this strange phone call. They kind of welcomed us to the market and they reminded us that the price was something other than what we were offering. And they said, what do we do? And I said, ignore them and raise the price you offer on the street. So another week went by and this time, they were really mad. And they said, what do we do? And I said, it's easy. Ignore them and raise the price again. Eventually, they'll understand that we're not going to talk about

that. And then the third time, somebody got threatened, and it got ugly. And then we took the price to $0.90. So we'd started at like $0.55, went to $0.65, $0.75, and then we're at $0.90. Well, six or eight weeks later, they finally matched our price, but only after they were sure that we weren't going anywhere, and they weren't going to bully us back out of it just because they didn't like our price. We'll skip forward a few years. Now you have a company. It's on the market, and it's a dual-purpose business. What does it mean to you to be running a dual-purpose business? I think any business that's going to really survive and thrive has to be a commercial enterprise first. Anything that is dependent

upon charity, as I tell people all the time, you know, charity is great, but it sucks as a business model. So the one time that you really need money, if you're out and you're asking for people to either pay you a premium, which is a form of charity, or subsidize your losses, which is a form of charity, then you really aren't running a sustainable business. And so if you just follow that logic, sustainability equals profitability. Now you get to the question of, well, what do you do with your profits. And that's the great part of the free trade system is you, as the generator of the profit, get to decide what you want to do with it. We reinvest ours back in farmers, farmer education, agronomy training, expanding the footprint. We started in Rwanda. We're in

35 countries now. We underwrite the daily price for millions of farmers in 35 different countries from the work that we do on the ground. But the way we do that is we sell a commercial product, Better product, better price, better service. And we win so that we are assured of making a profit, so that we're assured of being on the ground again tomorrow with fresh money to buy tomorrow's crop. You've chosen to be the brand behind the brands. Very often, if you're drinking a cup of Westrock coffee, you probably don't know it if you're at a quick service restaurant or at a convention center or a gas station. When you saw the market opportunity, what was the advantage in not really building your own brand as Westrock, but rather supplying others?

Yeah, that's a great question, Ricky. In all honesty, we were just fumbling our way forward through it. But what we learned that cemented this was the right path for us was really two things. Our business model is built around creating volume, what we call a vacuum, to pull coffee up into the supply chain. Because the bigger the demand we have, the bigger the demand pull, the more lives we can impact with a fair price on the ground in more and more countries. So that's the reason for the business. That's what we chose to do with the profits that we made from the sale of Altel. It's what we chose to do with the profits that we generate in West Rock Coffee. That's the mission. Well, if then so happens, and I wouldn't really have forecasted

this. It happens that other people like buying from major brands, like buying from someone that's not in the brand competition business with them. The major restaurants appreciate the fact that they don't care if we sell to other restaurants. They actually know that we get scale. That helps them have a better price point. We develop new products. That helps them expand their menu. But they don't want us on the store in the shelves competing with them. And that ripples through the retailers, the private label business we do. We did it for the reasons of creating the broadest demand pool we could. It just happened to have been reinforced by the fact that people like you treating them like they're the customer and not just somebody you take

care of if you've got excess volume. Let's talk about the fully digitally traceable supply chain, because that's one of your key differentiators at Westrock. Why is this important to you as a brand? Very often, if a customer is drinking Westrock coffee, they don't know that it necessarily came from you. Why is it so important to you in having these digitally traceable supply chains? What's the customer uptake like on that? So, it goes back again, Ricky, to what's the reason for the business? Well, the reason for the business, we wanted to make an impact in the cash income and therefore livelihoods of literally tens of millions of smallholder farmers around the world. That's the purpose of the business.

but I'd hate to spend my whole back half of my career and not know whether I was having that impact or not. So we created traceability, not just so that we could see who owned it, but we wanted to know, did we make a difference in our income? So we did a bunch of studies on, well, what did they make before we got here? And then what happened to their quality of their crop and the quantity of their crop, the price that we were able to get for it. And then we, of course, we started originally balancing our books, if you will, when we were looking at the volumes we were We started with a text message. Literally, out on the border of Congo and Rwanda, the guy would go around and buy coffee in the morning and get to a high spot and text

message back into Kigali, who would then send me an email, and then we would take a counter position in the futures market. That's literally where our digital traceability started. Today, one of the largest retailers in the world has been collecting this data for years. They put a bag of coffee up. You can scan it with a QR code, and I can tell you the farmer's name, whose coffee's in it, their name, the price that we paid them, the quality that they brought in, the quantity, whether they brought in a better or worse crop last year, whether they've been through agronomy training, whether the farmer's been inspected that year or not. So there are big customers that have been collecting that data from us. Now you go back again to the same thing.

Why do we do it? Well, I don't care if we get credit for it. I want the volume. So if I have a better product, a better price, and a better service, and then I give them that kind of digital traceability, I have armed the largest retailers and restaurants in the world with the right to demand of everyone else in the coffee supply chain to see their digital record all the way back to the farm. Because if we can do it, they can all do it. It took us six years and we took a team and we moved them two years in the US, two years in Africa, two years in the UK, and then back. But if we can do it, they can do it. That's why we do it. The fact that no one knows it's us, I don't care. My customers know it's us, and that helps us pull volume up in the supply chain.

I'll switch gears a little bit then, because you're in the commodity business. I'm sure there's other people selling coffee out there. Let's say I'm a quick service restaurant with 300 locations across the United States. What's the value proposition? Is it the traceable supply chain? Is it consistent pricing? Who are your competitors for this kind of deal? Yeah, super. All right. So first of all, you're in business to make money. So the first thing we're going to come up to you do is say, how do we help you make

more money? So you've got to make more money by selling more volume, or you've got to be able to sell it at a higher price, or you've got to buy it cheaper. That's it, right? So what you're going to want to explore quickly is we can all make cheap coffee, hot black coffee, and sell it to you cheap. There's no margin in that business, right? So then the question becomes, well, what else are you going to sell up and down the counter?

And there are people who go and say, we're going to give you the equipment to sell all sorts of sugary syrupy drinks, et cetera, or you'll run into people like us who say, you know what we're going to do? We want to expand your portfolio, Mr. Restaurant Chain, not only for hot black coffee or iced tea, we're the largest provider of iced tea, but we'll also do extract drinks. So you want to make a mocha shake, a coffee shake, you want to do an espresso-based drink, you can do cold brew coffee or iced coffee with cream in it out of a pump bottle. So this whole concept of taking coffee and bake it and basically distilling it to a syrup that you can then

rehydrate in any form factor makes it easy for you because you don't have to have employees making it. It's in a pump bottle. You hit the pump twice, you put the ice cream in it, or you put the cream in it and the drink is ready to go out the door. And the margins for you as an operator on that beverage are some of the highest margins you're going to make. So we've got an entire team of product development and marketing insight people who are available free of charge to you 24, 365. Let's help you develop a product set that'll help you win against your competitors down the street. And when we develop one of those products, we make more money on one of those products than we do all the hot black coffee ground business because there's no margin in it. It's just a

commodity processing exercise that you go through. It's working as a market research group in some ways. One key area I've heard your company is capitalizing on is ready-to-serve cold brew drinks. In late 2021, Westrock purchased more than a half-a-million-square-foot plant in Conway, Arkansas. I believe you're also expanding it in Malaysia. What are these expansions going to allow your company to do, and how are they going to help you better serve your customers, particularly in that quick service space? The quick serve restaurants, the C-stores, and frankly, this is one of the things that people don't really appreciate. We make a lot of coffee and coffee-based drinks for

other coffee brands. Not only restaurants that you might drive through, but coffee brands that you go to Walmart, Kroger, Safeway, and buy off the shelf or out of the cold section aisle of the grocery store. So what we're going to do in Conway is we're going to build the world's, we think, largest roast to ready-to-drink facility. So we will bring it in green, clean it, roast it, grind it, extract it, concentrate it, add milk, sugar, flavors, et cetera, put it in a can, 8-ounce, 11-ounce, 15-ounce can, regular size, slim size, put it in a multi-serve bottle, put it in a glass line, et cetera, and ship it out the back door to your distribution center. So restaurants, as they've moved from everybody comes and eats in to they

drive through or they order it delivered, they can't sell a drink with their meal anymore. That's the highest margin part of their ticket because you can reheat your sandwich, but you can't unmelt your drink. So all of a sudden customers are saying, I love your iced tea or I love your mocha frappuccino, but not in that styrofoam cup. And so, restaurants are talking to us about putting their products in cans that they can push through the drive-thru or the delivery system. But most of that is our consumer products, group customers, other coffee brands that are gearing up to sell through retailers and C-stores. Makes a lot of sense. We've got a lot of investors in the audience watching right now who are looking at the financials. And Westrock is profitable

on an operating income basis. That's not something that a lot of your coffee competitors can say. But Westrock is not profitable on a free cash flow basis. A common drumbeat for investors right now is, I'm not investing in unprofitable companies. So, what do you say to those investors watching right now? Well, by the time you figure out that we're free cash flow positive because we've built the facilities that we're building around the world and we've filled them, it will be too late. right? Because you can buy us right now at $10 a share. If you run through the math that we've shared with people about, if we build these facilities and we've already oversubscribed Fildom. So if we build them and we execute against the model, by the time we do that,

we will pay all our debt off in two years. And the stock will have long since eclipsed anything that people today would have looked around and said, hey, I should have bought it when. But you know what? That's normal. When I was at Altel, everybody hated on us because we were a sub-regional and we weren't Verizon. We killed them in stock price appreciation while being kind of fool-slapped the whole time because we were smaller or because we were investing in a network at a more aggressive level than some of our competitors. But that's the nature of the game, and that's okay. Chris Hill As always, people on the program may have interest 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. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.