Motley Fool Hidden Gems Investing - The Other Risk Powell Is Watching

Episode Date: July 11, 2024

Fed Chair Jerome Powell is keeping tabs on commercial real estate. (00:21) Asit Sharma and Ricky Mulvey discuss stress in the CRE market, Delta’s quarter, and Tesla’s 50% run-up over the last month. Then, (16:23) we play an audio-only version of “Scoreboard” from Fool Live, our member’s only livestream. Anand Chokkavelu hosts Lou Whiteman and Rick Munarriz to break down AT&T. Companies mentioned: DAL, VLY, TSLA, GOOG, GOOGL, HUBS, T, CCI Check out our sponsor at www.rangeroverusa.com Host: Ricky Mulvey Guests: Asit Sharma, Anand Chokkavelu, Lou Whiteman, Rick Munarriz Producer: Mary Long Engineer: Desiree Jones, Michael Schweitzer, Brandon Gentry Learn more about your ad choices. Visit megaphone.fm/adchoices

stop me if you've heard this one before even with high demand an airline stock is falling you're listening to motley fool money i'm ricky mulvey joined today by asit sharma asit it is good to see you in these few days we have before fool fest i'm excited to see you in person ricky coming up and it's thursday when we're taping so i'll see you what in about three days yes that's right it's it's going to be good to see in person let's talk first we got some macro stuff and dylan bill and ron tomorrow on the friday show they're going to go through the big macro the inflation data more of jerome powell's comments to congress but i want to i want to zoom

in on one part and that's when powell acknowledged the commercial real estate risk in his his remarks I'm going to paraphrase here. He said, quote, it's a risk that has been with us and will be us for some time, probably years. And later, quote, the conclusion is that the large banks can manage this problem and most small banks can too. End quote. Asit, you like hearing the word most here. That gives me a little, that can raise a flag a little bit. Well, Ricky, look, I'm here for the ride, but you know who probably didn't like hearing Jerome Powell say most? Treasury Secretary Janet yelling she's the one who has to swoop in when banks fail and make a decision on what kind of backstops there will be she probably was thinking jerome stay in your lane bro oof here's the thing

i'm watching with this story and this is we've talked about it before and i think it's worth continuing to talk about almost one trillion of debt linked to commercial real estate is going to mature this year in the united states that's according to mortgage bankers association sounds like they keep track of these things and then number two the second data point is that about seven percent of the mortgage-backed securities that are tied to an office are 30 plus days delinquent that is the highest in a decade and back in 2022 that number was at about two percent and we're at seven percent today asset these are some are these converging wins i know you follow some of the smaller banks? Are these converging winds hitting any of those smaller banks that

you keep an eye on? I think they're threatening to hit many of them, Ricky. This was a pretty safe place for banks to participate in for the longest time. And everything has changed since interest rates spiked, since we had the pandemic. It's a different landscape today. We don't know how many of these offices will ever achieve their former vacancies. Even multifamily is affected. so all parts of the commercial real estate market feel vulnerable here. If you're a small bank, you may find yourself overexposed to commercial real estate. Let's take an example of a bank which is commonly cited as a bank which has a lot of exposure. It's Valley Bank. This is a publicly traded company, a smaller regional bank headquartered in New Jersey. Ricky, they have a

very high concentration to commercial real estate in their portfolio. Right now, it's not so much of an issue, but if you look out to 2026, that's when a series of commercial loans come due for probably the next three or four years for them. What the bank is doing is talking to investors saying, look, we've got some exposure here and we've traditionally managed our portfolio much better than our competitors. Nonetheless, we're going to sell off some of these loans. We're going to reduce our exposure and be more diversified in the future. And I think that's key for many of these small banks that have the ability to do that. However, some community banks really don't have other entities they can offload commercial real estate loans to. So I'm very worried about

the smallest of the banks, the community banks that have this risk factor that's just sitting there waiting for something to go wrong. And one of the things Chair Powell pointed out was that when you have these smaller banks they're really focused in in one community with their commercial real estate exposure and um you know can i can i offer you some class b or class c office space on the exurbs of denver right now asset what would you like to pay for that um this is also a place and you mentioned they're trying to unload these these commercial real estate properties the buyers are aware of this situation as well and and you're starting to see oak tree which is howard marks's shop come in they say they're looking for exceptional bargains in commercial real estate

and basically that this is a distressed area where they're going to be able to to scoop up some assets on the cheap our howard marks is a smart guy oak tree has a pretty good track record they had been sitting on their hands for a lot of that zero interest rate era you know what if what if this is a place where i want to follow their lead and and you know maybe this is the time to do a little bottom fishing, Asit? Well, if you have the prowess to do this privately, that's potentially a very good business model to look into if things head south. Howard Marks, of course, a famous value investor, buys at the right price, knows how to unload at the right price. So we could follow his lead. If you're a regular investor like you and me, Ricky,

there's still ways to participate. Three steps to this process. Number one, gather you some cash, put on the sidelines. Number two, be patient. And then number three, when it really looks like the worst is happening in the commercial real estate sector, you can evaluate commercial real estate heavy REITs, real estate investment trusts, and just zero in on cash flow. So they've got a metric funds from operation, commonly known as FFO. I would look at that, look at the debt service of some of these companies, you may find a few that are going to make it, where you can clearly see, yeah, they're troubled, but the whole sector is down, there's maximum pessimism here. This stock price is even more at a bargain, but I think this will make it through. You

can buy some of those companies at that point in time. For the note of caution, treat this as an investing side hustle, only invest what you can afford to lose in this idea. You're playing a little bit of a riskier game here. On Monday, next story, you talked to Dylan about the airline space. And one of the things you said is that they have this strange economics problem where demand is booming, but the companies aren't necessarily doing as well as investors would hope because as demand has grown, so have the number of seats. We're seeing that today as Delta Airlines reported and is down about 8% this morning, saying exactly that. even though travel demand is booming this summer, the carrier is discounting more fares

after adding more flights. I'll first give you the opportunity. Would you like to take a victory lap as airfare in June was down 5% from a year earlier? No, I'll tie my shoe. I mean, victory lap would be, you know, I was praising Delta and they rocketed past expectations. So I'm just tying my shoe on the racetrack. But to point out here, Delta had a really strong quarter. they really came through with the things I was talking about on Monday, great operational performance, stuck by their guidance, just a great cash flow positive quarter. This is a company that's hitting it on a lot of metrics. One thing they can't control is the cost factor. We talked about this, Dylan and I, you can only control so many costs in the airline industry. The second

thing they can't control is how demand plays out from quarter to quarter. And they've been strong on business travel. They've been strong on premium seats, but they're discounting on that basic economy seat and starting to have to play on price with more of their peers who are struggling more than they are. The stock is down, like you said, just a little bit today, I think around 6%. It's had a great year so far. So a little bit of selling at the margins, but pretty much a positive story for a well-run airline but i will say this may turn into yellow flag red flag for some other airlines who have not been at the top of their game as we see them report uh soon there's there's there's a interesting valuation situation going on with delta as well right now where on a trailing

basis the free cash flow was touted by ed bastian in the ceo's opening remarks they're going to make about three to four billion in that on the quarter if we look at a trailing basis it's a 25 times free cash flow multiple for the shares on a forward basis it's it's a third it's eight so we go from 25 to 8 is delta just getting very uh good about being profitable or investors having you know maybe some lower expectations about this company's ability to generate cash in the future I think investors, it's a little bit of both. I think investors really love the cash flow that Delta is throwing off right now, but it's hard in this industry to look beyond the next one to two years, so you can't hang your hat on that. If we were talking about a software

company with stable annualized recurring revenue, we'd be off to the races. But here, investors are like, we love it, but we're not going to value this company up in the sky because we don't know what kind of plane deliveries you'll have to take, what your legacy routes are going to look like a few years from now. We'll enjoy it while it's here. On the flip side, Delta is doing all kinds of great things, basically have been engaging in shareholder-friendly actions. While it lasts, it's good and it's nothing wrong in that that money can shore up the balance sheet. We all remember what happened to airlines when the pandemic hit and they were caught without spare cash in their coffers. So I think it's all around good for Delta. If you're a believer in this

company, maybe that's another positive part of your investment thesis. All right. There's a few other stories that we were talking about yesterday and wanted to hit in the segment, but we don't have time to go into the depths of it. And honestly, there isn't a ton to go into for some of these. So I've got three stories lined up and the way you want to pitch this or the way we're going to pitch this is surprised or not surprised. So I'm going to give you a headline and you're going to tell me if you're surprised or not surprised. We're going to start with one. Tesla is up more than 50% over just the last month. And oh, by the way, its delivery numbers are still down from a year earlier, even though they beat Wall Street expectations.

A little surprised on this one, Ricky. I thought the stock was getting oversold, but the industry itself is like just undergoing so much change right now there's so many headwinds i didn't expect this this shows that maybe people were over shorting this company and also forgetting that the real demand structure is going to play out over a long time and tesla has a lot more going for it than just the the vehicles the energy business looks good so we'll see a little surprise them. Number two, Google is shelving its effort to buy HubSpot, a customer relationship management tool. The stock for HubSpot is down about 14% over just the past five days. Yeah, not surprised. I mean, this is a really fine company, a smaller company. They were a pioneer in the concept of

inbound marketing and have turned into a decent SaaS company with what they call hubs, different hubs that help with customer relationship management, operations, etc. But a company that might be at a crossroads with the advent of generative AI, it's harder to see now where they go from here. So investors liked maybe a win-win situation, not so happy that Google may be shelving this deal. If you are a large tech company, I would imagine that if there's any ideas for mergers and acquisitions going on, you might say, let's see what happens in November. No need to not wait right at this second why rush this let me turn the tables on you though ricky as we proceed okay all right so a private company called athletic brewing its valuation has doubled from two years

ago in this latest round according to the wall street journal this non-alcoholic brewer has received a valuation of 800 million dollars this is the number one non-alcoholic brewer ricky surprised or not surprised um i'm gonna give you i'm gonna say both so i actually have a uh i have an athletic brewing can right next to me i like it um i at first thought this is stupid who wants to drink beer that doesn't have any alcohol in it but i have to say after a after a run or some games of pickup basketball it's really nice to have uh have a beer and not have any alcohol in it on a you know tuesday or thursday night i will say that the valuation is not surprising in part because i have no idea um and it's become more popular however the thing that is surprising to

me is that this small company is the number one non-alcoholic brewer right now and they are competing with constellation brands they're competing with the boston uh boston beer company anheuser-busch and also coarse and this small company this disruptor has been able to beat all of them by really focusing on the taste of of non-alcoholic beer having and having an interesting marketing approach to it as well which is really focusing on active people giving away samples at triathlons marathons that kind of thing yeah i love it i think small beverage brands are having a moment, Ricky. I mean, you've got companies like Olipop, Liquid Death, which have come out of nowhere and have major shelf space. So this is still an industry in

which you've got some opportunity. If you've got a great idea and you've got a great brand, you know how to market it and it tastes good. I think it also says a lot about those larger companies and maybe their inability to disrupt themselves. And now they're all kind of racing to catch up. So on Tuesday at 9am, Asit, we're going to be at the Ritz-Carlton doing a live show of Motley Fool Money. It's me, you, Bill Mann. And what we're going to do, we're not going to do a news of the day thing because we got a whole convention going on. But what we are going to do is a CEO draft, picking a basket of CEOs to beat the market in different categories, like a good capital allocator, turnaround story, growth story, wildcard. Just wanted to check in,

what's your prep looking like what's your game plan looking like yeah my game plan ricky is to come up with some lesser known ceos i want to i want to be competitive in this really fun game that we have going so i can't talk about any of my candidates yet but i'm focusing on lesser known names so no jensen huang for me although i'm such a fan of his i'm going to look through some of your recent recs just so because i want to bring in sort of a blocker approach i want to i want to use if i can if i can go first i want to i'm trying to throw you and bill off um and i do have to say you know just as a heads up we're going to be at the ritz this is a very fancy place with very fancy people no shenanigans can you make that commitment i can

commit to semi-decent behavior well that would be all right that's good that's we'll see all right that's a good place to stop it asit thank you for your time and your insight appreciate you being here thanks so much a lot of fun you just found out that your sales team is at risk of missing quota don't panic just ask rippling ai since it's built on your real-time people and business data rippling ai can pull metrics from rippling and salesforce into a meeting ready dashboard showing quota attainment headcount plan and monthly revenue to quota by region in seconds you'll see exactly what's behind your quota risk and fix it before it's missed. Question answered, action taken, crisis averted. When you

have critical business questions that need answers, don't just file a ticket and wait weeks for an outdated report. Describe what you need and have Rippling AI build it instantly from your live people and business data. Whether it's a dashboard with detailed charts or automated workflows with the right triggers, conditions, and approvals. Ready to rule your business? Head to rippling.ai slash fool to get the only AI built to give you full visibility and take complex actions across your entire organization. That's R-I-P-P-L-I-N-G dot A-I slash F-O-O-L. Sign up for exclusive access today, rippling.ai slash fool. So we've got a show on Fool Live, our members only live stream. It's called Scoreboard, hosted by Anand Chakravallu, where Anand and some

analysts go through a company and look at their business model, management, valuation, and assign scores to them, all in about 12 minutes or less. Members love it, and they've done more than 150 episodes, and we're going to play one today. It's AT&T with Lou Whiteman and Rick Maneras. I think you're really going to like it, and if you'd like to check out more, go to live.fool.com. Rick, tell us more about AT&T, including the bull bear. Yeah, obviously, along with Verizon, the leading wireless carriers, Ma Bell. To me, the bull case here is that the 5G revolution continues to boost the business of all wireless carriers, including AT&T. A leaner and cleaner AT&T can now focus on what it does best, and

that 6.5% yield rewards the patient. The bear case is that AT&T's substantial debt can be problematic, even in good times, and devastating in bad times. And the 5G revolution, it hasn't yielded much in terms of the hyped-up revenue growth that we thought would happen years ago. We're waiting for that to happen, and maybe it never does. Lou, Rick gave a good overview of AT&T's business. Let's dive in deeper, including industry and competition. One to 10. 10 is invincible. One is hopeless. We're right down the middle here. I'm a 5. AT&T controls the pipes in an era where we are beginning to figure out more and more ways to bypass the pipes. There are still advantages

to being an incumbent here, and ways the evolving landscape can benefit AT&T. This household dumped Comcast for AT&T Fiber, so that's the evolution happening. But there just is so much disruption, so many alternatives, so little sustained pricing power, and importantly, still a ton of R&D going into ways to further disrupt this business. It used to be this looked like a monopoly. Those days are long gone. It's hard for me to get too excited about this business. I accept the advantages of being an incumbent, but I also see a lot more storm clouds ahead. Yeah, it's seven. I do see many of the storm clouds that Lou sees. But this is historically a cutthroat business. The carriers are subsidizing devices to wrestle customers away from rivals.

T-Mobile joining forces with Sprint four years ago means that AT&T is now facing just two major competitors instead of three. But this is still a business that requires a lot of capital invested in infrastructure, upgrades, and promotional campaigns. I still went with the seven because all these things that make this such a challenging business also make it a substantial moat for any new player. Smartphones and connectivity aren't going away, and neither is AT&T. We are stuck with AT&T, Verizon, and Team Hope. Lou, how do you rate AT&T's management? Scale of one to 10. 10 is Buffett, One is Homer Simpson.

Yeah, I doubt many people know John Stankey off the top of their head, which maybe is his part here. I'm going with a four on Mr. Stankey. Credit where due. CEO since 2020, his job has been to unwind some of the terrible, terrible decisions that was made by the people who came before him. DirecTV, Warner Brothers. Props to that! But it is worth noting that he has been with the company since 1985. He was the chief strategy officer during part of the time when all of this was being put together. So, I don't want to be too forgiving. I'm not just going to give him a pass here. He's not Homer Simpson, but it feels like his job is to continue to invest in what works and stay out of trouble.

It is a complicated capital allocation job. I don't mean to be too dismissive, but I also don't think investors are rallying into AT&T shares because of the job stank he's doing. It's a little, just not quite par for me so far. Yeah, it went with a six. And as Lou mentioned, obviously, the Time Warner and the DirecTV fiascos happened just before he became CEO. He actually came in, and a year later, DirecTV was cut loose. The year after that, Warner Bros. Discovery in 2022. And annual bread regrowth finally turned positive last year. So, he hasn't been doing great, but business is trending in a good direction. So is the stock lately. With one thing, Stanky does

have an embarrassing 49% approval rating on Glassdoor. But I don't think that's fair. most of the tens of thousands of reviews are likely retail or frontline employees who never dealt with Stanky in any way directly or just had a problem with their supervisor in an industry where historically high turnover. So I don't take that rating as serious as I would if it was for a smaller company. But to me, I think a six is fair. He's done well with the bad hands that he was dealt. And I want to see what he does next. Right. Financials, Lou. 10 is a fortress, 1 is yikes. Yeah, I'm a 5 here. Look, there is massive debt here, $126 billion in long-term debt, $155 billion total. But to be honest, you do have

solid operating cash flow to sustain that debt, fund the dividend, currently yielding over 5%. So that's nothing to sneeze at. And I don't think that that's in trouble. This is not the balance sheet of a company that is in trouble, but it is the balance sheet of a company that is bloated enough that it has limited flexibility, and the balance sheet does get in the way. It is what it is. The company just did report better than expected quarter. Maybe there's some reason for hope or upside from here. But in reality, the balance sheet is this big iceberg that they just have to navigate around. So, it's a five. Yeah, and I'm going to high-five Lou with my five here. Taking a look at the financials of

Ma Bell is enough to have you cry, Uncle. As he mentioned, $126.5 billion in long-term debt, that's enough to make you reach out and touch someone. But to be fair, Verizon actually has more debt on its balance sheet, so it's an industry thing. Throw in lackluster growth with ho-hum subscriber trends and a 5G revolution that failed to deliver the boost in average revenue per user that most people were expecting, and you have financials that should be introduced by an incoming spam call warning. Alright, Rick, let's put this all together and talk valuation, how well will AT&T's stock do over the next five years? Yeah. I went with 5% to 10%. I own some AT&T. I don't think it's going to be a monster

growth stock. But now that it's narrowed its focus to what really does well, I think the dividend should get back on track to growing again on an annual basis. So, 5% to 10% assumes that most of that gain will come from the 6.5% current yield as an alternative to being parked in a 5% money market that will only see the payout decline in the next year or as rates ease up. I'm comfortable with AT&T here. I went 5% to 7% on what Rick said, very much a reflection of that 6% dividend yield and its impact on total return. This is a stock that's actually lost one-third of its value over the past decade. By comparison, hey, if the stock is just flat over the next

five years, let's party, let's celebrate. Maybe I'm being a little harsh, but perhaps maybe AT&T will suddenly gain some pricing power in its core businesses, perhaps some of these competitive headwinds will go away. I wouldn't bet on it. You buy this for the dividend, you only buy it for the dividend. Rick, maybe there is upside, but I would bet you're almost getting a bond-like return and you're hoping to get your principal back. Part of valuation is safety. When we're talking bonds, safety is important. Scale of one to 10. Rick, 10 is a short thing. One is a lottery ticket. Yeah. I'm going with 7. I know the financial is lousy and it's a mess, but AT&T,

They're not likely to be a hang-up call in the next decade or two. It's been through wars, depressions, and the mother of all regulatory breakups. There are risks. A year ago, there were concerns in the industry about lead-sheathed cables that could pose a public health risk, something that would be costly to replace at a potential litigation minefield. But those concerns have mostly subsided, even if the EPA has not really let that go just yet. But in the meantime, you have chunky dividends out of both AT&T and Verizon, and that's going to continue to be big draws to income investors. Ugly but safe is why my wife married me 33 years ago. So if I was good enough for her, I think AT&T is good enough as an ugly

but safe stock for me. Wow. All right. I don't know what to do with that. So I'm just going to go ahead. I went to five here and I'm going to try and use Rick's words against him here because one of the things that kind of gets me about AT&T, yes, they have been through wars and depressions and a ugly regulatory breakup. Worth noting that most of those wars and depression were when they were protected by that regulatory structure where, yeah, they had to be broken up, but they were also a monopoly. Those days are over, and I think we have to stop thinking about the company like that. Looking at it for me, I said the dead load is sustainable. I stand by that, because the company is generating a lot of cash. But competition is not going away.

I think there's more that can go wrong from here than can go right from here. I'm not too worried about it all crumbling down, but I'm not ready to call this anywhere near safe. Like I said before, I wouldn't be surprised if Flatline is the best we're going to get from the stock and lean more not-safe than no-brainer. It is kind of amazing how that mother of all breakups where you got all the baby bells out there and then kind of reconfigure like Terminator 2 or Deadpool or something back into pretty much what it used to be. Most of it's back together again as AT&T.

um but without that monopoly status yeah right right yeah um let's play on for a ceo rick if you're running at&t what are you doing yeah if i'm running at&t at&t 1000 at&t 2000 what was the terminator one i forget which one it was one of those two numbers but t2000 something like that some a thousand at whatever at&t infinity so uh they have 71.6 million prepaid phone subscribers right now, a decent increase of 1.5 million over the past year. Churn hit a record low for the first quarter, but I wouldn't rest on those laurels. To me, I'd take a page out of T-Mobile, make being an active subscriber more rewarding. T-Mobile subscribers get excited every Tuesday because they are offered unique deals at different businesses. They host in-store

promotions to keep you close. It has to help with both retention and brand endearment for an industry that people hate their wireless providers for the most part. AT&T has to give us more than just literally from AT&T. So, yeah, as alluded to above, I am an AT&T Fiber customer, and my advice is learn how to cross-sell. They do cross-sell, but they do not know how to cross-sell. We were cord cutters. When we got AT&T Fiber, no one said, do you want DirecTV broadband? Do you want anything else? Forming a partnership with YouTube. About a month and a half later, we got an email saying, did you know that you can stream with us? After we had made all those decisions. They used to suggest, again, Keystone Cops, get out of that 70s regulatory environment,

get into the modern age, learn how to market, learn how to cross it. All right, let's try to top it. Rick, is there a company in AT&T space that you like more? Yeah, so I like AT&T and Verizon as dividend plays. I own both. I like the smaller rival, T-Mobile, as a long-term growth play. However, just to mix things up, I'm going to go with Crown Castle. It's the country's second-largest provider of telecom towers, with more than 40,000 cell towers across the country. To me, the wireless carriers pay Crown Castle. They all pay Crown Castle to house the antennas that they need to expand their coverage. Crown Castle's 6.5% yield is comparable to AT&T and Verizon, but you don't have the lead

sheath cables risk or have to give away iPhones to new customers. It has plenty of problems on its own, but it doesn't have to deal with that competitive market climate that the wireless carriers themselves have to worry about. I'm going Alphabet here. And before I'm accused of cheating, you look, Google Fi is my cell phone carrier. That's an AT&T competitor. They have fiber. They have TV, too. They do all of the same things. And I mean, I don't mean to be controversial here, guys, but I just much rather own Alphabet than a telecom. So I am looking for an asterisk to get out of it. If I'm cheating, I do like Verizon better than AT&T. That's sort of just pick your poison.

But seriously, just buy Alphabet. 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 anything based solely on what you hear i'm ricky mulvey thanks for listening we'll be back tomorrow