Motley Fool Hidden Gems Investing - Retail & Tech Try To Transform

Episode Date: March 16, 2023

Adobe wants to be a customer experience platform, and a discount retailer is upscaling.  (0:21) Deidre Woollard and Asit Sharma discuss:  - Adobe’s quarter, and issues acquiring Figma.  - Tech companies rushing to launch generative AI.  - Five Below converting stores to Five Beyond.  - Labor issues for Dollar General.  Plus, (15:50) stock market madness continues. Bill Mann and Nick Sciple face off to pitch a stock in a better buy debate.  Companies discussed: ADBE, FIVE, DG, PAC, BWXT   Host: Deidre Woollard  Guests: Asit Sharma, Bill Mann, Nick Sciple  Producer: Ricky Mulvey  Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Because we have your number. Welcome to Motley Fool Money. I'm Deidre Willard, sitting in for Chris Hill, and I'm joined today by Motley Fool analyst, Asit Sharma. Hi, Asit. How are you doing today? Great, Deidre. How are you? I'm doing well. I want to talk today about a couple of interesting earnings and what they say about larger sectors. It's been a challenging quarter for tech in general, so I thought Adobe's earnings were a welcome surprise. I still tend to think of Adobe as the Photoshop company, but when I looked at the earnings, it's more about digital experience now, and that really seems to be growing.

Do you think Adobe is more of a customer experience company now? It's certainly trying to be, Deidre. It, over the years, had acquired many smaller companies to build out this suite of tools that now expresses itself as the creative cloud. This approach lets them keep acquiring pieces and develop pieces internally to plug and play. By broadening it out to experiences, they give themselves some latitude. If a new technology comes along which they're either not very good at themselves or haven't first seen, they can acquire that piece and lump it in with the experiences. I'm giving you a good segue into the next point we want to discuss because one of these pieces, interactive web collaboration,

they were okay in, but tried to find a solution last year. Yeah, exactly. That was a perfect setup for the next question, which what you're talking about, of course, is Figma and the deal to acquire that. On the earnings call, Adobe still seems pretty confident that the Figma deal is going to go through, although there are significant hurdles here from the Department of Justice trying to block the deal. What does it mean for Adobe if the deal doesn't go through? And if it doesn't, what happens next for Figma? For Adobe, in some ways, it's back to square one, which is looking at Figma as a competitor, which has the potential to take their incremental growth away. Figma is a rapidly growing product

and it's much beloved in enterprise companies where teams who have to put out content can collaborate remotely, do it quickly, storyboard things in basically a website. So dynamically updating your web presence and your content. Figma excels in that. We've used it here at The Motley Fool. I've been in a few presentations where we've whiteboarded stuff on Figma and it's great. It's very agile and promotes collaboration. Adobe's competing products, they're decent, but this is, again, the problem they were trying to solve for. Adobe has a long-term partnership with Microsoft to provide various tools. They don't want to lose that preeminence with Microsoft and other customers. That's what it means for Adobe.

For Figma, I think they're going to be okay. This is a company that was growing their annualized recurring revenue at 100% clip. They were boasting of 150% net dollar retention rates, and the company was positive on a cash flow basis. They didn't disclose in the deal, where we got a little bit of this information when this proposed deal was announced last year. But Figma did say that they were positive on an operating cash flow basis. So, I think this is a company that is, A, probably well-capitalized from its venture backers, B, is eventually going to end up on the IPO scene. When someone is able to wave a magic wand and wake up this market from it slumber. Deidre, I can't remember a big IPO that has come out in recent months that I have

looked forward to. That market has really seized up, as you might expect with everything that happened with interest rates and inflation last year. Yeah. It looks like it's going to be that way for a long time. I think there'll be a lot of independent designers that would be very happy if Figma stayed where it was. There was a bit of an outcry last year when the deal was announced. Adobe's got their summit coming up next week. They tease that a lot on the earnings call. Of course, they tease the thing that everybody is talking about, which is generative AI. I feel a little bit like some companies are rushing too fast into this space, not necessarily with Adobe. But how are you looking at every company trying to launch

generative AI right now immediately? I think every company wants to be at the forefront and not get left behind, but few really have the resources to do it right. Generative AI requires a lot of bandwidth. For most companies, you need huge resources to be able to allocate within a data center just for this function. In most companies of any size, you need some kind of team or at least a point person to work through the ethics of it, what it means for your current products if you overlay, let's say, a chatbot that's based on GPT technology, and to make sure you don't have some type of problem you create with customers down the road. So it's like this, I wouldn't call it so much a gold rush as people just stumbling down a slope, but they want to go

there. It must be some winter sport. Not coming to mind now that this is the equivalent of. I will say though that from the aspect of trying to invest in this movement, it's really difficult. There's a lot of hype right now in the marketplace. There are clear winners. I think Microsoft is going to be a winner and they will see a little bit of share they can grab from Google and Search, which incrementally means billions to them with each point of market share they can grab. I think Nvidia is a clear winner because they're at the forefront of this technology. They designed their next-generation chips. They've been doing this for years with the idea that some point down the road, people will pile into artificial intelligence,

and the architectures have always supported this use case. They just couldn't see it and none of us could. But outside of a few companies, it's like, what is really the investing payoff? I think many companies will stumble in getting caught up in trying to produce this really fun chatbot where we'll see, though, more persuasive applications. They're sort of boring. They're in the enterprise. You can use generative AI to summarize a meeting. You can use it to make lists and notes. That's where it's actually pretty strong and the risk is out of the picture. those types of use cases are sort of hard to invest in. So that's how I'm looking at it. If I sound skeptical, I'm not. I'm wowed by the technology. I just don't see right now the direct

path to make a lot of money as an investor in this. Yeah, I think that's a really good take on things is to also remember for every company you're investing in that has AI, AI is not going to be the core of that particular business for a long time. So it's important to keep that in mind as well. Well, let's pivot to retail, because whenever you and I are together, I want to talk a little retail, and we've got some recent numbers from Five Below and Dollar General. Let's start with Five Below. They reported yesterday pretty solid, good sales. What I was intrigued with this company is expansion, and not just expansion of traditional Five Below, but they're planning to convert some of their Five Below existing stores into what they call Five Beyond. This gives them

a little bit of leeway, a little bit higher up on the pricing scale. What is this signal in general about the demand for lower-priced goods? It's really hard to suss out what it means. For me, I think that time is going to tell with the new store format. This started as a store within a store. I read somewhere it started as actually a shelf within a store. This has been tested for quite a while. Five Below has been working with their price points. They found as they expanded space within stores, customers were taking up their proposition. The items are a little different though, Deidre. They're like small tech goods. They're small novelty items. I wonder if it means that people

with more discretionary income are dropping down to the Five Below to buy small tech goods or things they might normally buy in other places because their dollars are getting stretched too by inflation. I think that underlying demand for $5 and below price points is still really strong in the economy. I feel like consumers are exhausted. We've seen recent reports on the amount of household debt, which indicates that after a steep decline during the pandemic when there was a lot of stimulus money, it's back at record levels, which means the consumer is still looking to ring as much out of every dollar that it can. But that trend is going to be good for Five Below. This is a very strong company on its balance

sheet, no debt, very decent net income, as you point out, growing at high single digits, double digits. This is a trend they can certainly capitalize on. As far as expanding the concept into stores, I think they execute pretty well, so I don't foresee any trouble in working through newer inventory or different inventory types. Probably good for them, but man, just like you, I'm wondering, what does this really say about the consumer in general? What's interesting for me with Five Below, too, is that it's very popular with teenagers. So the discretionary income they're capitalizing on there. And I'm wondering if they're seeing as the teenager grows up that they have more income, maybe they're seeing

more opportunity for expansion there. That's a great point. Well, let's talk a little bit about Dollar General. They also reported today expanding even more aggressively, planning to open over 1,000 new stores, but also planning to spend about $100 million on what they called increased labor costs. And labor is something I'm hearing a lot about in retail earnings. We saw Home Depot mentioning it, Lowe's mentioning it. Everybody seems to be having trouble retaining frontline workers. Is this going to be an ongoing situation, or is this just a temporary situation as the unemployment is low? Unemployment is tightening up everywhere, which is good. The labor force is more at capacity than

it's been in a while. But on the retail front, we see these waves that seem to take four to five to six months to manifest. And the wave that I was looking at is the one late last year, November, December timeframe. And earlier this year, when lots of major retailers were announcing layoffs, they were looking to cut costs or they were trimming their workforces. So while you've got tight labor in retail, I feel like there'll be more available labor into the spring and summer as the market now reacts to some of those bigger companies that we're laying off. But for now, Dollar General, which has to employ people in primarily rural areas where it expands, if you look at where they're building their distribution centers, where those new

stores are, that labor force is not huge. So they have to be competitive. And I think that's part of their cost. There is, in some areas, also higher turnover that dollar stores experience among their labor. Those forces push them to have to allocate more to that incremental labor costs. I think that's what's driving their number. Maybe this is my day just to hedge on every question you throw at me, Deidre, but I think the economy is in such flux right now, it's really hard to extrapolate a longer-term trend vis-a-vis the workforce, especially the retail workforce, which, as you know, is quite volatile. It is. But one of the things I like about this trend and hearing these companies talk about it is the value of the human touch,

is that as much as all of these retail companies are looking at technology and streamlining things on the back end, they're also realizing how much value is in people connecting with people. And if foot traffic is there, which it certainly has been since the pandemic, you need people. And I think that's kind of a positive thing. It is. As you were saying that, I was thinking about Five Below again, which is increasing the number of self-checkouts. But here's a trend that I've been seeing just on the ground. I don't know if others have noticed this as well. Stores that converted to self-checkouts, I mean, there's so many grocery stores, Targets, et cetera, over the past 10 years. That touch is different now. You seem to be one to two people that are

stationed at self-checkouts these days to help you out. Because I fumble with things and I see my fellow shoppers fumbling around. So this point can't be understated. You still need the labor to help with the tech and to help your margin stay intact. Yeah, absolutely. Well, last quarter with retail, it was all about the inventory. Everybody had too much inventory. Everybody had to mark down their inventory. What are any of the themes that you're seeing as you listen to this quarter's earning calls? Deidre, I feel that this quarter, inventory is still big, but I feel like cost pressures are something that have become more prominent. You see so many retailers with thinner gross margins, and hence we have most everyone saying, we're doing very well. Our comparable

sales are up vis-a-vis last year. Although for most every big retailer you see, it's like mid-single digits, maybe high single digits. It's not like they're coming out guns blazing. But on the other hand, so many CFOs are talking about labor productivity, talking about cost cutting initiatives, just trying to bring those margins in check. And why are they doing this? Because to keep that top line healthy that they're boasting about, they've got to keep shoppers coming to stores. We've seen a lot more of a promotional price mix, I think, over the last two quarters versus the beginning of 2022, for example. So this is the theme that I saw. And it maybe wasn't the biggest theme, but it's the one that struck me most. Lots of people talking up

their top line being strong despite this high interest rate, high inflation environment. But speaking out of the other side of the mouth, too, which is sort of saying, yeah, but we're discounting some to bring people into the store. Yeah, absolutely. It seems like the forecasts for sales are cautiously optimistic, but definitely aware of the price pressure. Yeah, for sure. Thank you so much for your time today, Asit. Always a pleasure. Yeah, so much fun always to hang out with you, Deidre. Look forward to the next time. It's our last quarter final matchup for Stock Market Madness. Eight Motley Fool

analyst pitching stocks in better buy debates. Bill Mann explains the case for an airport operator in Mexico. And Nick Seifel presents a nuclear energy play. Our March Madness stock competition continues. Eight analysts, eight stocks. And this is our last quarterfinal matchup. Bill Mann and Nick Seifel. Bill Mann, six minutes is yours. Okay, let's go. The longest part of my pitch is actually going to be the name of the company. It is Grupo Aeroportuario del Pacífico, which I'm now going to shorten as PAC, which is the stock symbol. It is 12 airports in the Pacific Coast of Mexico. It it is Tijuana, Mexicali, Hermosillo, La Paz, Puerto Vallarta, maybe most importantly, Los

Cabos, Cabo San Lucas. It also has the monopoly for a concession for two airports in Jamaica, one of which is Kingston, the capital, the other is Montego Bay. The company was founded in 1998 when Mexico decided that it was going to privatize the operations of its airports. They did so by breaking them into four companies. PAC became the provider of services at airports on the West Coast. There are two others, but there are actually three others. The only one that never came public was Mexico City. They make money two ways. They make money from aeronautical services, which if you ever look at a plane ticket, you'll see landing fees, you'll see fees that are added into the ticket, and those are higher for international

passengers worldwide, but particularly in Mexico. They also make money on things that are called non-aeronautical services, which is actually the remainder of the operations at the airport itself. For those, you can think about renting out stores so you can get your Jamba Juice walking through or your Starbucks or whatever. If you forgot to get an obnoxious t-shirt, those places all exist at the airport. The airport operator receives rent, of course, and in some cases, it also receives a take on the amount of revenues that they've generated. Maybe the most important part about a thesis on PAC in particular is the fact that it is on the west coast of Mexico. There are a couple of other areas in the non-aeronautical services that I

think are really important. Recently, Mexico has been defined as a lifetime opportunity for investors. Why might that be? The most important reason is that following COVID and following what is absolutely a decoupling of China from global finance, from the global supply chain, companies all over the United States and Canada and in Mexico are nearshoring. That means they bringing their manufacturing home, they're bringing parts of their supply chains, not necessarily to places like El Paso, but they're bringing them to places like Hermosillo, and Mexicali, and Cabo San Lucas, which has a huge amount of space. On the non-aeronautical side of the business, I see opportunities for spectacular growth for the most geographically

closest place in Mexico to the United States as well as to Asia. I think that that's where PAC is going to make its money. They have about a 4% dividend yield at the moment, which is nice. This is something that was structurally put into place by the government of Mexico. They wanted to make sure that the people who are in the region had the opportunity to benefit from these airports. And the most important thing to note about airports around the world is that they are monopolies. So, the Mexican Airports Authority has given PAC 30- and 40-year concessions to run these airports. They have been renewed. They're going to come up in a couple of years. They come up one or two at a time, the Jamaican government as well. I think that PAC offers an incredible

long-term opportunity for investors who are looking for a lower-risk, long-term capital appreciation opportunity. Nothing says I remembered you for my whole vacation quite like an airport t-shirt from Cancun, Bill, man. Thank you for that. There's nothing better than something that was obviously bought from the airport. I think that part of this thesis is built on the someone went to Cabo and all I got was this stupid T-shirt trade. Fair enough. All right, up next, the nuclear energy stock, it's Nick Seipel. Hello, friends.

Great to be here with you. My March Madness stock pick is BWX Technologies. Technologies. It's not Cabo, but I think it has a lot of the characteristics that it takes to win in the NCAA tournament. To win in the NCAA tournament, you've got to have defense. You've got to have a strong performance from your senior players. You've got to have young players ready to contribute, and you've got to have everyone playing at their best at the right time. I think BWX Technologies has all of those things. As Ricky teed off for me, BWX is a leader in nuclear technology, providing nuclear products and services to the defense,

commercial power, and healthcare industries. Over three-quarters of the company's revenue and its earnings come from its defense business, where BWXT has been the monopoly provider of reactors and fuels for the U.S. Navy, nuclear aircraft, and submarines for over 50 years. In addition, BWXT works on cutting-edge nuclear technology for the government, Department of Defense, NASA, things like projects to put nuclear plants on the moon or to power spacecraft with nuclear thermal rocket engines. Most recently, BDMXD was selected by the government for a $300 million contract to build the first nuclear micro-reactor in the United States. That's a reactor that's going to be built and completed in 2024, small enough to fit in a shipping

container and can deliver one to five megawatts of power. If you think about applications in space or in remote military installations, lots of opportunities. There are also new opportunities opening up outside the United States just this month. The leaders of the United States, the U.K., and Australia announced their plan for the trilateral U.K.-U.S. military partnership. Among other things, that's going to allow Australia to buy three to five U.S. Virginia-class submarines over the next 10 years, which is going to boost the order book for BWX Technologies. Also, long-term, there's going to be a jointly developed nuclear submarine technology with all three countries that is likely going to leverage quite a bit of BWXT's

business. Also, so that's the defense part of the business. Another 15% of sales comes from the commercial nuclear power business, where it manufactures fuel and components that service the can-do nuclear reactors in Canada and across the world. It's also North America's sole manufacturer of a lot of large-scale components in need for nuclear reactors. If you've been following the news, energy security is back in the public discussion and nuclear power is having a renaissance. Beginning this year, the company is expecting to start generating revenue from next-generation small modular reactors. They've got a publicly announced a partnership with GE Hitachi, which is going to deploy North America's first small

modular reactor in 2028, Canada's Darlington site. They've also announced a partnership with TVA, where TVA is looking to potentially deploy up to 20 small modular reactors in the 2030s. Just for context, BWXT thinks they can get about $100 million of revenue for each one of these small modular reactors. You've lined a site to basically the whole company's revenue if we reach some of these targets just in the TVA, and that's not looking across the world in some of these other markets. Then finally, the remainder of sales come from their healthcare division. That's a business that started in 2017. They made some acquisitions. They've made investments to develop what's called a technetium-99 reactor. What it does,

it produces medical isotopes for partners like Bayer, also can act as a contract manufacturer for nuclear medicines. These are things for cancer treatments and scanning, things like that. Also, there hasn't been a consistent supply in North America of these isotopes since 2016, so this is going to really be able to serve all of North America's needs. As of February, that reactor has been installed and is awaiting final approval by the FDA. As this gets underway, management sees opportunity to double sales in that segment over the next several years. Also, with the healthcare business up and running, the capital expenditures this business needs to deploy are coming down significantly. They peaked at 15% of revenue

in 2021, going to fall to a low single-digit percentage this year in 2023. You're going to see free cash flow increase fourfold this year for about $50 million last year, up to $200 million this year. Over the medium to long-term, management intends to return 50% of free cash flow to shareholders, so you can expect capital returns to increase going forward. You've got cash flows set to inflect higher for this business. Tailwinds behind all sides of the business, defense, healthcare, and the commercial side. You've got the company basically trading at the same valuation it was trading before, what I would call the nuclear face turn or the nuclear renaissance. Lots of opportunities for earnings to swing up. I think in March Madness terms,

I think the committee is underappreciating PWX Technologies, and I think it's a great company to back today. Rick Seifel, thank you for that high-energy, nuclear energy pitch. 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. I'm Deidre Willard. Thanks for listening. We'll see you tomorrow. Thank you.