Motley Fool Hidden Gems Investing - The Once & Future Zillow

Episode Date: February 16, 2023

After spending a year getting rid of its iBuying business, how should investors regard Zillow Group? (0:21) Jim Mueller discusses: - How Zillow is (in some ways) at a fresh starting point - The growing skepticism around iBuying as a profitable business - 1 thing to watch when Redfin reports after the closing bell (9:25) Ricky Mulvey and Sanmeet Deo discuss companies that are flying under Wall Street's radar, in part because of where they're located.  Companies discussed: ZG, OPEN, RDFN, LULU, TSCO, SHAK, WINA Host: Chris Hill Guests: Jim Mueller, Sanmeet Deo Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm Chris Hill. Joining me today, Motley Fool Senior Analyst Jim Mueller. Thanks for being here. Thanks for having me, Chris. Zillow shareholders got some good news. Fourth quarter results were better than expected and shares of Zillow up a little bit today. CEO Rich Barton acknowledged the obvious, which is that the housing market was difficult last year, but that they got through it, they're focused on the future. Nothing particularly revolutionary from the CEO, but I understand why he said the things he said. Definitely. At the end of 2021, they announced that they're getting out of their iBuying business. And that was their big thing.

They were the iBuyers. And, but that kind of, they discovered that their algorithm wasn't working too well, was telling them, this is a good price. This is a good price. This is a good price. And they turned out not to be good prices to buy at.

And so they got out and spent last year reinventing themselves, basically. For the numbers, revenue was down. These are full year numbers. revenue down 8% to $1.96 billion for the year. Gross margin was down about 4 percentage points, 81%. Operating expenses were up 7.3%, led by general and administration and technology and development expenses, both up 18% to 19%, 20% or so. So yeah, that means an operating loss versus a gain in 2021, and a net loss versus a gain in 2021, if you back out that loss they had

on iBuying. So, one interesting comment, they really got rid of iBuying. They started 2022 with 10,000 homes in their inventory, about $3.9 billion worth. They ended the year with zeros. They got rid of all those houses. Good for them. And that brought in a huge chunk of change on the cash flow statement, about $3.9 billion, pretty close to the inventory value, just a shade less. And so cash flow for our operations looks really good at $4.5 billion for the year. And that's nice to see. But if you're paying attention, that's going to be a one-time boost, selling all those homes. So now we're going to have to see, did this reinvention work?

And are they going to be able to generate solid cash going forward? Yeah, it's interesting because we've seen this with other businesses in other industries where essentially they try something, it doesn't work, it's expensive, and it takes a while to essentially work their way through that. So if you're just coming to Zillow with fresh eyes and you look at sort of what they went through over the past couple of years, you know, it's understandable to say, all right, in some ways they are starting fresh and let's see what they can do. exactly uh they're they're focusing on rentals generating mortgage business partner uh selling through partner agencies uh virtual tours the last one sounds really intriguing at the end of last

year or the start of this year i'm not sure which they bought a photography and video company and they're using that uh to get really good shots of the homes as well as uh it's going to play into something they're calling real-time uh touring so that for the buyer you can sit at your computer and get a live tour of the house in a different city, which is kind of cool. Not so cool for the seller, of course, but when you're touring, when you're showing a home, you're not allowed in the house anyway. So there's that. But that may be a temporary advantage.

That's just a technology trick that I'm sure one of their competitors, Redfin, is going to latch onto fairly quickly. But they're becoming more a traditional online real estate company. One thing they did that intrigued me, they're still kind of related to iBuying. Last August, they announced a partnership with Opendoor Technologies. Technology? Technologies? Opendoor. And they launched that in Atlanta, I believe, just this current quarter. And they had some early comments on that.

Opendoor, of course, it's an iBuyer, makes a cash offer, but what they're doing is that cash offer will be fed to the buyer alongside a, what do they call it, a Zestimate, Zillow's estimate of what the fair market value would be, what they can sell the house for, and the buyer can choose which one they want to go through. If they go with Opendoor for the cash, Opendoor pays a finder's fee to Zillow, which will be nice. But I don't think Opendoor is going to make money off of this. So, iBuying might be on its last legs.

Don Mullen, who's the operator of Pretian, which is, I think I got that right, the country's biggest residential landlord, said iBuying will probably disappear within the next two years, mostly because iBuyers are forced sellers. They can't hold onto the, they shouldn't have to hold onto that inventory too long, which means you better get that purchase price right. Yeah. The partnership with Opendoor is, on the one hand, interesting to me, just because you can look at it through the lens of, hey, they used to be rivals in this space, and now they're teaming up. On the other hand, I'm still coming back to the point you just

alluded to, which is, iBuying, as a business, doesn't seem to be a particularly profitable And so, maybe this is a slight net positive for Zillow, but is it fair to assume that if this partnership is a net positive for Zillow, it's not a growth engine that shareholders or potential shareholders should be counting on? I don't think so. I think we're going to move more back to, I mean, the cash offer was certainly convenient and nice and good to have for the house seller uh but it would probably be less than what they could get on uh on the open market because of course the ibuyer has to make a profit right uh but we but that whole that whole idea kind of forgot the lessons of the housing crisis back in 2007 2008 where we've discovered that hey

house prices can fall and that's what happened when the mortgage rates went uh doubled uh doubled in the first six months last year. So yeah, when house prices fall, it's not a fun business to be in and house prices are probably still falling, maybe stabilizing a little bit as mortgage rates settle in, but it's still a really unknown. It's going to be an interesting year. Let's put it that way. It absolutely is. Real quick, you mentioned Redfin earlier. Redfin reports after the closing bell today. What is one thing that investors should keep an eye out for when looking at Redfin's results? Real quick disclosure, I own shares, and I'm following along with the options investment idea that I put in on Redfin. With that out

of the way, I'm going to be looking for what their rental business is doing. They bought rent path in April 2021 out of bankruptcy. They put in a new place, a new CEO, and they've spent the past year, a couple of years of reinvigorating in that business and tying it into their online business and thinking and knowing that renters become buyers and buyers and sellers can become renters. And so, there's a lot of nice cross-selling. Zillow is doing the same thing as well. But I want to see what, did they actually show a profit in the fourth quarter like they were supposed to? Like I think they were going to say? No. I'm sorry, it was cash flow positive in the fourth quarter and see if that actually happened and see how much integration that's

happening for Redfin. We'll keep an eye after the closing bell. Jim Mueller, thanks for been here. Thanks, Chris. Let's face it, as human beings, we tend to focus more on what's right in front of us. If you're a Wall Street analyst, you're forgiven for paying a bit more attention to companies that are closer to New York City. But for investors, that just means there are opportunities in good businesses that are under-followed in part due to where they're located. Ricky Mulvey caught up with Motley Fool's senior analyst, Sandy Deo, to take a closer look at a couple of businesses between the coasts that are serving investors well. Do you think investors pay a price for cool? I guess the second question is, is that price

ever worth it? Yeah, definitely. You look at a company like lululemon and you know their products are trendy they're hot they're they're pricey they're they're seen all over um in in in um you know hot fitness concepts they're also not just used for fitness they're used as athleisure they they pretty much um launched almost the athleisure category so when you see that logo it's almost been iconic and you know that's a that's a expensive piece of clothing there, the person that's wearing it is kind of cool. They're kind of trendy for wearing it. I would imagine that Lululemon's stock benefits from a little bit of a cool premium. Whether it's worth it or not, it depends on how the business does.

Lululemon has been a good business. They sell their premium-priced products. Their demand is hot. They have expanded their categories, expanded their line, and made companies like Nike and other competitors really take notice and launch their own brands in those categories. For Lululemon, it's definitely been worth it. For some, maybe not so much. It really just depends on how the business performs. The person wearing Lululemon, I would say, is trying to be cool vs. is cool. Or they could be, you never know. Hard to say. Hard to say who's cool. Speaking of things that are uncool, a lot of good investments are very uncool. We were chatting earlier on Slack where there's this

idea of a Wall Street lag, especially for businesses that primarily exist outside of the coasts. Yeah. This is something that's been written about primarily. I know from the first I ever heard of it, it was Peter Lynch, the legendary investor. He wrote about one of the edges that consumers have when they're looking for winning companies and stocks amongst smaller-cap-type names is that store that you come across in your local neighborhood, or the product that you buy that all your other friends or people that you know are buying. When you're able to identify that, and then you dig in and see, is this an investable company, or is this a company that's actually doing well, you may be able to catch that trend

before Wall Street does. Wall Street might notice it later, at a later stage of their growth. He labeled this as a Wall Street lag. One primary example of that was The Limited. It was based out of Columbus, Ohio. It went public in 1969. By 1974, they only had two Wall Street analysts covering it. By 1975, T. Rowe was the first institution that actually bought the company stock. That's when they had about 100 stores open across the country. And even in 1981, when there were 400 stores, there were only six analysts that covered the stock, and The Limited became a pretty big winner for Peter Lynch in his investment fund. I mean, that was also the case with restaurants, too, like Chipotle.

Yeah. It's funny, because Chipotle was one of the names that, when I was in college, we used to go to all the time. I went to college at the University of Texas. In Texas, plenty of places to eat Mexican Tex-Mex, burritos, tacos, whatever you want, local places. Chipotle was thriving. It was doing well in a college scene, in a scene where there's plenty of competition. I thought the food was quite good, very easily accessible, reasonable at that time, at least. It was a name that I followed. It turns out they started in Colorado, started expanding out across the West and other states before they finally did hit New York. I remember I was working at an investment firm when Chipotle

announced that they were going public. And most everyone was like, well, burrito chain, how could you have a whole burrito chain as a public company? Will it do well? And I thought to myself, the thesis is as simple as, well, it did pretty well in Texas against pretty stiff competition, and it has a translatable business model and food. So, I think it could. If you can sell burritos in Texas, you can sell burritos anywhere. This is irrelevant, but I'm near the first Chipotle. it's a quarter of the size of all the other Chipotle's. I had this magical thinking that the food would be significantly better, and it's just a regular Chipotle, so I've started

to go to others now. The location thing is interesting. I don't think that trend has necessarily died, especially for a company like Shake Shack. I'm not trying to be a hater. It's trading at two to three times sales, which seems relatively-ish reasonable for a restaurant company. But it's got a forward PE multiple of more than 400. I think some of the hype and some of the coverage is due to its locations. It started up in New York, so you figure there might be some Wall Street analysts who are more familiar with the brand because they can eat the burger. Oh, absolutely. It was started by a famous restaurateur who owns a few different really fancy fine dining establishments in

New York City. I would think it could be as easy as analysts go down the street to their local Shake Shack, try it out, and say, hey, this is a pretty good product. Turns out they're actually going public. I think they'll do pretty well. It turns out Shake Shack was almost like the next Chipotle. There's been a lot of next Chipotles, but Shake Shack was definitely one that they thought would lead the fine-casual category. While it's done reasonably well, it hasn't been the blockbuster success that Chipotle has been. I'm still surprised by the coverage. It's about a $2 billion company. It's got 20 analysts covering it, according to Yahoo Finance. To me, that seems a little high.

For context, a restaurant that is, I would argue, significantly less cool, but still tasty as Cracker Barrel. I think it has more locations, smaller market cap, and it has about half the number of analysts covering it than Shake Shack. I think it drives to this question that markets are efficient sometimes, but do markets become less efficient when you have fewer analysts covering a company? It would seem so when you have fewer eyes picking the number of gumballs in a jar, if you will. Yeah, for sure. A lot of investors will rely on Wall Street research and an analysis on what this company is doing, how it's performing, whether it could be the next big thing.

Everyone's picking it apart. When you have a company that isn't followed by many analysts, it may not be talked about as much, it might not be in your neighborhood, but it might be one of those local niche favorites, whether it be a restaurant or a retailer or whatever have you, that is doing successfully in its niche and its area of expertise. It's definitely, small-caps and companies that are less followed are definitely less efficient. That's actually one of the things that Peter Lynch himself, too, talked about investing in, where you could, as a consumer, as an everyday individual investor, could gain an edge. I think one case for that right now might be Winmark. It's a resale franchisor.

We've talked about it on the show a little bit. They do Plato's Closet, Play It Again Sports. They do not have analyst conference calls, although they release regular reports. Its market cap is around $1 billion, and it has exactly zero analysts covering the company. For Windmark, I would assume they like flying under the radar like that and having fewer eyes on them so they can just basically continue to perform. Absolutely. This is a billion-dollar market cap business, almost, with over 1,200 stores in many locations all across the country amongst their four or five brands that they have selling secondhand items from sporting goods, children, teen clothing, musical instruments, women's

business and casual attire, a hodgepodge of different products that are secondhand items. Not very cool, I guess. You're not cool if you're buying secondhand stuff. It's based out of Minneapolis, Minnesota. It's in the middle of the country. I even looked up a couple of their brands. I live in Long Island. Even in New York itself, there's just a handful of some of their brands. Not well-known, either, and not probably written about in the journal or other publications. But they're cash flow positive, high returns on investment, franchise business that is consistently knocking it out of the park. Great place to buy a softball glove. Difficult company to talk about often on a daily show.

It's just like, yeah, they're chugging along and people are still buying resale stuff. I want to talk about some other companies. We were kicking around some companies that maybe failed the cool test but passed the good investment test. One name that has been an old, full wreck that's done very well is Tractor Supply. They're based out of Brentwood, Tennessee. Retailers servicing recreational farmers, ranchers, selling all kinds of products, feed for farming. They have about 2,000-plus stores with an annual revenue of over $14 billion. Their concentration of stores are most in states like Texas, North Carolina, Pennsylvania, Tennessee, Georgia, Michigan, Ohio.

the stock has annualized over 25% over 25 years. It's been a fantastic name that had you held for over a long period of time. It's done phenomenally well. But how cool is ranching and farming equipment and supplies? I don't know about you guys in New York, but out here, it's pretty cool. It's one of those businesses, too, where it's selling a lot of need-to-haves, not nice-to-haves. This is where you're getting your chicken feed and replacement parts for things. So, I think that's something that we'll continue to do well. Samir, always great catching up with you. Yeah, thanks for having me, Rich.

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. Thanks for watching!