Motley Fool Hidden Gems Investing - Powell Stays Put, For Now

Episode Date: September 21, 2023

Interest rates are paused but the hikes may not be over yet. (00:21) Bill Mann and Deidre Woollard discuss: - What metrics the Fed is looking at before its next meeting. - How FedEx’s business has evolved over time. - The traits a good chief financial officer should have. (14:52)  Tom King and Deidre Woollard explore how TransMedics is building a complete organ transplantation supply chain. Companies discussed: FDX, UPS, TMDX Host: Deidre Woollard Guests: Bill Mann, Tom King Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Hi, Bill. How are you doing? Hey, Deidre. How are you? I'm doing great. Bill, we have to talk interest rates. I think in the past, you've called the Fed's ability to change interest rates a sledgehammer. This time, the sledgehammer remained on the shelf, but Chairman Powell made it clear it's not being put away yet. We've got two meetings left in the year. What happens for it to go back in the shed for a while? Obviously, they're paying a lot of attention to the rate of inflation. A lot of people point to the core rate as being above three as being a problem. I actually don't think that it is, because so much of that is energy, and there's exactly zero that the Federal Reserve

can do about oil and gas costs. Ultimately, I think that they're looking at a lot of different measures. But maybe most importantly, they are looking at the type of capital formation activity and, you know, whether that has slowed down. And, you know, it really had on an equity level, but we've seen just a little bit of the animal spirits come out after the arm holdings and, you know, and Instacart IPOs in this last week that suggests that we're still a bit in a risk on environment. So, the Federal Reserve looks at a lot of things and a lot of the data that is not necessarily available to us. But at their core, I think that inflation and the rates of employment remain to be at the center. Yeah. And the jobs market's slowing,

but still pretty good. The 2% thing, Powell is determined to get to that level. Do you think that that's really realistic at this point? You know, I don't know. How's that for a great answer. Hey, let's go to some guy who knows things. Yeah, I don't know. But I think I don't know is actually a pretty good answer, because you have to remember that from 2009 until 2022, we were at the most accommodative rates environment that has happened in 900 years, which is kind of a long time. Just a little bit. It's really important to note that in 2020, there were $17 trillion of sovereign debt that was negative interest rate earning. People and entities, most likely banks, were paying for

the right to loan money to somebody else. The technical term for that is weird. That is a weird situation. We don't really know what is going to happen in a market environment when you have come out from a negative real interest rate environment. It hasn't happened before. I think that they've done a really good job in waiting for real inflation to happen and then attenuating it. I mean, people have laughed about the potential for a soft landing. I really think that they've done a pretty good job. Particularly, when I've called it a sledgehammer in the past, it's this. Nothing that the Fed does goes directly into the market. It takes about nine months for it really all to flow through. So, not only are they guessing every time they go to the rate board,

they're guessing based on information that doesn't even exist now and won't exist for another 270 days. Not an easy task. One of the things I thought was interesting was that Powell was asked about whether or not slowing consumer spending is something the Fed's looking at. He said no. It seems like that part of it, the inflation they look at, but they're a little bit More like, let's say fair, but the actual consumer spending. Yeah, I think that they probably, well, consumer spending is very much a lagging indicator. Probably, they are a little more interested in the fact that consumer loans and credit cards and auto loans, the delinquency rate has gone up very fast.

So, consumer loans are approaching 6% now, which is a place it hasn't been since about 2012, which was in the midst of their big rate-cutting environment. So, consumer spending isn't the top of the list, but the consumer spending within the context of how much debt consumers have and how much stress they are under very much is. But it's a lagging indicator. So, again, going back to that 270-day thing, that's something that doesn't, you know, the impact of what they have done in the past probably hasn't hit consumer tendencies and activities just yet. Let's take a little look at the larger picture. Bank of England, they also paused their rates. They had 14 increases in a row. They're seeing some signs

inflation is slowing. Not the same in some other places, including Turkey. As investors, we're mostly focused on what the Fed is doing, but how much should we think about other banks around the world? Well, the dollar has been strong against every other currency in the world for about the last six years, which makes it really interesting to think that in 2017, there were a lot of people who insisted on being paid in euros and then paid in other currencies outside of the U.S. The reserve currency here in the U.S. has been a very dominant theme internationally. It is a blessing for us that all of our debts are denominated in an instrument that doesn't move In every other jurisdiction, even the big ones like the Eurozone, the United Kingdom, even China, so much of their debt is dependent upon the movement against the dollar.

So, when you see the Bank of England deciding to cut rates, it is making a call essentially on the value of the pound sterling as much as anything else. and what they would like to see is for the pound sterling to rise a bit against the dollar. Let's turn to some earnings. We don't have a lot of earnings this week, but one I wanted to talk about was FedEx. It's interesting, I see it a little bit for a symbol of how e-commerce and shipping in general are doing. Revenue is still down, but man, they're cutting their way through. Operating income was up 25%. The consolidation is good here, but how much can they cut? How small can they make this business? So, I think that there are probably two questions here. The first of which is, are they cutting services in order to get to those savings? So, back in,

I think it was March or April, they unveiled a program called Drive. And it was essentially a program that was going to take FedEx Freight and FedEx Ground and FedEx Air and all of the different entities for FedEx that had worked basically in their own fiefdoms and integrate them into a single company. They thought that there was a pretty substantial number of efficiencies that they could wring out of that. I always question whether a company, if they're wringing efficiencies out, that always kind of rings an alarm bell for me. Like, this is not something that you noticed earlier, that this was something that maybe you should be doing all along. Be that as it may, it seems like the cutting that they're doing for things that people as

customers don't necessarily sense has gone pretty aggressively and pretty well. I don't actually get a sense, other than that top-line number that says that there are 6% fewer things, 6% less revenue. And that's not because they've been dropping costs. I mean, they are as inflationary as every other company in that space. They have raised their prices. So, for there to be 6% fewer revenues suggests to me that maybe they're operating in an environment where they have bid fewer large shipments and contracts, ones that they would have taken in the past that would have been lost leaders or at least something close to break-even, that maybe they are making some choices, some more difficult choices in terms of what type of market share they would like to have

in the segment. It is still ultimately a growth segment. Yeah, absolutely. They're not cutting prices. In fact, I think it's about a 6% raise that goes into effect in January. You mentioned the three fiefdoms. You've got ground, express, and freight. Freight's not doing so well. Express also not doing so well. Ground doing really well. Margins are increasing, revenue up. They managed to drop the cost per package by about 2%. This is a different company now. FedEx, I remember the old commercials, when it absolutely, positively has to be there overnight. It's not that anymore, is it? No. That's certainly a core part of their business, but they have moved much more into being a full logistics company with

less than load and full load applications. It was a segment, I'm always a little bit mindful to read too much into a quarter, because if you recall, we are not that too far removed from there being 77 ships off the coast of Long Beach waiting to port. The supply chains were so distended for a certain period of time. The fact that there was a lot of shipping in 2022 may not be a surprise, because a lot of that may have been catch-up. This company, I think, like a lot of companies that provide a branded commodity service, you have to be a little bit mindful about the environment that we are in. And so, I like the fact that they're making hard choices. It is noteworthy, as you say, that the area in which they seem to be doing the best is their

ground shipping at this point. So, it may just be that they're moving away from bidding contracts that don't end up helping them on the top or the bottom line. Well, and the ground thing is kind of interesting because their biggest competitor is UPS. UPS just had that union deal, which works out to about an average of $170,000 per driver. Pretty attractive. FedEx ground, the workers aren't unionized. It's this complicated network of small business contractors that tie into FedEx. Does this become a risk for FedEx? Did some of those workers start seeing those UPS contracts and thinking, maybe I need to get into a union. So, FedEx is based in Memphis, Tennessee. Of course, they've got offices and facilities all over the world. It is not for nothing that many

of the fastest growing states in the United States, including Tennessee, are right-to-work states. And so, they do not tend to have very powerful unions. So, I'm not sure that I would draw a thread through and say, well, the UPS drivers are now getting X, so therefore, FedEx should worry about retention. It's definitely possible, and I'm sure that there are individual decisions. I mean, why on earth would you go to work every day were it not for some form of compensation? So, it would be crazy for me to say, well, you know, the compensation doesn't matter that much. But ultimately, those two companies do not have the same footprint with each other. I think that that's actually pretty meaningful. Yeah, good point. Last thought question

for you is, they've got a new chief financial officer at FedEx. We all have expectations when a new CEO takes over. What do you look for when a new CFO takes over? You can't necessarily look at the top of the business, you have to look around a little bit. I think math skills is at the top of the page. Obviously, yes. I think that if you think about what a CFO is, they are meant to be at least slightly a counterbalance for the CEO. Because the CEO's job, in a lot of ways, is to be inspirational and to have the big ideas.

And it's the CFO's job. And in that person, you want someone who is able to say, these are the things that we can pay for, or these are the ways that we can fund the things that you are talking about. So, CFOs, in a lot of ways, we think of CFOs as being the No. 2 role of the company. And it is. A lot of times, when you see a CFO roll into the CEO role, it's a little bit of a tough transition. When I am looking for a good CFO, though, I do want someone who is intensely entrepreneurial. Someone who has worked in an environment where there's a lot of ambiguity. They have to come up with creative ways to push the company forward, at the same time, not putting the company in a deep financial situation,

in financial strife, which is a tough balance, because it requires someone who is able to and capable of saying no a lot, because big ideas and big idea people really don't want to be told how much it costs. They just want it done. And so, in a CFO, and I think that you're seeing this with the DRIVE program at FedEx, that's absolutely positively a CFO-driven project to save money by eliminating redundancies. There's no visionary on earth to whom that's exciting, but to a CFO, I think that that's the kind of thing that you really want to see. Yeah, absolutely. Thanks for your time today, Bill. Hey, thanks, Jared.

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and change lives. Tell us a little bit about it. Transmedics is a medical device company. They have three FDA-approved devices for the transport of organs, specifically hearts, lungs, and livers. And the purpose of these devices is to keep these organs in as close to a body-like environment as possible during transport. So it keeps them supplied with blood. It keeps them functioning as close to what they would be like in the body, so that lungs are inflating, deflating, and so on. And the purpose is just to extend the lessen the damage to the organ during transport. Well, and that's really interesting because a lot of organs don't get used. And so we think of this idea that every organ that gets donated finds a host and contributes

to someone else's life, which is a great thing, but it doesn't always work out that way. So that's what Transmedics is trying to solve, right? Yeah, it's a pretty sad situation. Only about 60% of livers that are donated are actually transplanted, about 28% of hearts, and about 18% of lungs. And the reason for this is that the distance between the donor and the recipient has to be fairly close because there's a limit on the amount of time that these organs can spend outside of the body before they sustain too much damage to actually be useful. So the purpose of transmedics and its devices, which keeps these organs supplied with blood, is to extend their life outside of the body so that they can be

transported further, which would allow more of these donated organs to be transplanted. Let's talk about the transportation part, because we have this image from medical TV shows of the cooler and the person getting on a plane. That is part of it. The thing that I found interesting about Transmedics is they're building an airline network, essentially, because they need to get these organs to people. Why is Transmedics in the airline business? Because part of their strategy, part of the service they intend to offer their customers is not only the actual medical device, but the whole end-to-end solution. So actually collecting it, harvesting it, is what they call it from the donor, getting it into an organ care machine, putting it on a plane, and flying

it to the transplant hospital where it's transplanted. So they actually want to control the whole end-to-end process. Currently, they're just selling the organ care system, the device, plus the consumables that go along with that device. But they are trying to move towards a total end-to-end solution. So that's why they need planes, because they can't rely. way. We all know how unreliable domestic planes can be these days. Apparently, it can be similar in the charter airplane industry. Charter planes might not be available, whatever the

case may be. So, they say, we need to have this infrastructure in-house so that it's available all the time. So, this is still an emerging market. There's clinical trials involved with the stock. And, of course, there's some volatility priced in here. I noticed that there was about a $60 per share difference between the 52-week high and low. So, if you're an investor, should you prepare for this to be a bumpy ride going forward? Yes. Well, the focus right now is this transportation part of their business, what they're calling the National OCS Program, which they commonly abbreviate to NOP. So, that is going to require a lot of investment to set up.

We've spoken about how they're buying planes. They've bought two so far. I think they intend to add between 10 and 15 more over the next year. So that is certainly going to be a lot of expense, plus hiring of all the people to fill out that team. We're also dealing with a very heavily regulated industry. There's only one entity, these organizations called organ procurement organizations called OPOs.

They are the only entity legally allowed to harvest organs in the United States. So, they sort of, as far as I understand, they kind of outsource this responsibility to Transmedics when they hire Transmedics, so they can kind of transfer that right. What we have to appreciate is that this is a very heavily regulated industry, and if regulations are negative for Transmedics' business, those could happen. So, it sounds like there's a lot of investing needing to happen. So, in terms of profitability, it's running at a loss. It's been paring some of those losses back, but would we expect this company to run at a loss for a long time? Do you see this as a growth company that has to have

losses for a certain amount of time? Well, things have certainly improved. Their first product was their OCS lung, their lung transport machine, which was approved in 2018. They started earning some revenue from that. Then they had two devices approved in 2021. So, that was the OCS heart and the OCS liver. So, once the revenue from those devices started coming in, the profitability picture improved significantly. It went from sort of the minus 60% to, I think, about the minus 20% or so, around about now. So, it improved significantly.

But they are still very much in the investment phase with regards to Knopp. Makes sense. I can understand what the growth thesis here is and how it disrupts the existing system. Is there anything that could disrupt the disruptor? Could it be new methods? I know there's some research on lab-grown organs. Is there anything else that maybe could hurt transmedics in the long run? Well, there are two competitors to transmedics.

but one is an England-based company, another is, I think, a Swedish-based business. They have competing devices for particular organs. I think one has a lung device and one has a liver device. Transmedics is in the position of having all three devices, so they can cover this range of organs. So that, I think, certainly strengthens their position. Let's say you're a transplant hospital or an organ procurement organization. You can buy one machine from this group and another two machines from Transmedics. Why not just get them all from Transmedics?

And you're dealing with one vendor. I think that makes sense to me as an outsider to this industry. So I think that puts Transmedics in quite a powerful position in the organ transplant industry. You know, there's the lab-grown organ industry. I don't know too much about that. I do get the feeling that's a pretty long way off. I think it's a pretty remote possibility of disrupting transmedics in the next five years. So I don't think we need to worry too much about that.

And then the CEO of the company, he's also the founder, a doctor by the name of Walid Hassanein. He's been with the company since 1998. He seems pretty committed to the company, but he could always leave. There's all sorts of reasons people might decide to leave. but it seems like a pretty remote possibility to me. Yeah, it definitely sounds like a really interesting company with lots ahead of it. Yes, we recommend it in a couple services. I think it's certainly doing a lot.

It's fixing a painful problem for people. It was really shocking to me when I was researching this company was how few organs are donated. That was really surprising to me. I always thought the constraint was not enough donors, but that is part of the problem. But another massive part of the problem is that donated organs don't get to where they get to recipients. So, it's helping to solve that problem, and I think that's a good thing. Awesome. Thank you for breaking this one down with me, Don.

Thank you, Deidre. 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 Deidre Willard. Thanks for listening. We'll see you tomorrow.