Motley Fool Hidden Gems Investing - The Overlooked, Obscure, and... Undervalued?

Episode Date: October 31, 2024

If you want to find market-beating stocks, sometimes you have to go where few others are. (00:15) Jim Gillies and Ricky Mulvey discuss: - Why the market may be overreacting to Boot Barn’s CEO departure. - A niche-grocer that’s seen its stock 2x in the past year. - Finding “growth at a reasonable price.” Then, (16:44) Larry the Werewolf joins Ricky to take a look at Hershey and offer up his top three favorite candies for Halloween. Companies discussed: BOOT, SFM, AER, HSY Host: Ricky Mulvey Guests: Jim Gillies, Larry the Werewolf Producer: Mary Long Engineers: Rick Engdahl, Austin Morgan Learn more about your ad choices. Visit megaphone.fm/adchoices

we've got a misunderstanding and an overreaction no we're not gaslighting you you're listening to motley fool money i'm ricky mulvey joined today by award-winning podcaster jim gillis jim how you doing i'm not sure i'm award-winning well i'm i'm part of a very large collective i guess we're gonna add this to everyone's email signatures fantastic but i wanted to talk to you today mainly because i hadn't talked to you in a while and it is big tech earnings week we we had meta we had microsoft we could talk about you're making me look at earnings from boot retailers and airplane leasing companies why sir why because um i'm not a i'm not the world's biggest tech guy i don't know if you've known noticed that i will say i've got lots of exposure i i i've got about

40 of my family's money in in uh in index funds and of course the magnificent seven have really been driving the main index. But my take on it is, look, I'm going to add precisely nothing to the conversation about Microsoft or Meta or pick your large tech company, because there's so many eyes staring at those types of companies. My incremental contribution is going to be negligible at best. But where I believe I can add value is in the small, the obscure, the unloved the misunderstood hence the tickers i threw at you today perhaps perhaps some halloween theme obscure spooky misunderstood let's go to the barn western retailer called boot barn with more than 400 stores announced pretty solid quarter two earnings five percent sale same

store sales growth that's not bad for a retailer in uh this kind of sort of recession however we got a problem and that is that the horse has left the barn ceo jim conroy is leave jim don't shake why are you shaking your head? That was one of my better ones. I got more to say. That's good. Okay. Continue. CEO Jim Conroy is leaving for the greener pastures of Ross stores. The discount retailer seems to be better. Chief digital officer, John Hazen, stepping in his place. Mr. Market says that this swap is worth about 750 million of boot barns, roughly $4 billion market cap let's start with uh let's let's start with assuming that the market is right because usually the market can be wrong but usually the market's right what needs to be true about mr

conroy's leadership for this drop to be uh worth it well i mean that you know i'm gonna see if i can on the fly come up with some uh horse and western uh puns like yourself it assumes that he is the show pony. He is the reason for their success over the past decade. And I do not hold to that. I'm going to give you what they just report. I'm going to give you more detail here. For the quarter, they did $426 million in sales. Their guidance, which was raised by the way, but their guidance was for $405 to $412 million. They did $40 million in operating profit. Guidance was for $33 to $36 million. Same-store sales of almost 5%. The guidance was originally negative half a percent to maybe 1.4%. They pretty much tripled that. Earnings per share of $0.95. Guidance

was for $0.81 to $0.87. Operating profit margin, 9.4%. Guidance was from 8.2% to 8.7%. They bumped their full year guidance substantially, which is the second time in two quarters of their fiscal year, so 100% of the time so far, they bumped their guidance. This was a great quarter. And yet, since reporting that, the stock is down 22.5%. And you've identified the one reason why I think the market is reacting this way. And again, I think the market's wrong. But I will do another little reason oh go ahead a second the market is is reacting poorly and yet you say nay i can't top that ricky i'm just i'm gonna let you out i'm doing a boot retailer earnings i gotta work to get the listeners attention all right keep well and i even tried to get you to

do contour brands which is jeans and western which would have done you wanted four have you ever recorded with yourself this is gonna take 15 minutes exactly at least okay so the other reason why I think Boot Barn probably sold off a little bit is because in spite of all that excellence I've just talked about, cash flow took a bit of a step backwards. Cash flow was actually negative for the quarter. Now, this is entirely attributable to a sharp uptick in inventory, which I think will reverse in coming quarters. And I think it should be expected, right? Because they've had two excellent quarters so far in this fiscal year, and they've really substantially raised their guidance. They sell boots. They need more inventory. They spent it in this quarter for

future quarters. So I think that should have been seen entirely as predictable. But I understand why the market might have gone like, oh, you know, not cash flow positive. The second one, of course, is if you talk about is Jim Conroy. Put yourself in his shoes, though, okay? They reigned, they being Ross stores where he's going, they reigned money on him, okay? The comp package is going to be about $25 million in year one. It's going to be about $75 million, assuming Ross Storr's stock price doesn't move. It's going to be about $75 million over the next five years. His pay last year at Boot Barn was very generous. It was about $7 million, but $5 million of that was restricted stock and performance-based stock units, which will surely be forfeited because he's walking

out the door. He's going for a $4.5 billion company before the earnings release came out to a company 10 times that size. He's in his mid-50s. I think this is the case that he wants a bigger challenge. He's been there for, I think, 12 years at Boot Barn. Are we going to begrudge him this big fat payday and a bigger challenge? Again, I'm going to quote you, I say nay. I would like to think most companies I follow. First off, show of hands, how many people could have named Boot Barn's CEO before that news story came out. I'm an owner. I've recommended the company. I'm not sure I could have, without a little bit of thinking, remembered his name. I like to think that most companies that have had the success that Boot Barn has had,

quarter in, quarter out, year in, year out, I like to think there's a bit of a bench strength. And I like the fact that the gentleman who's responsible for Ascent, I think he's the chief digital officer i i like that they are that they're giving it to him frankly for now for now he's it's interim tag i should put that we know very little about this cat we'll see uh we'll see what happens um a couple a couple comps i want to point out so uh boot barn making more in same store sales than dick sporting goods which is a market favorite and also tractor supply which plays in a similar ish but kind of different space tractor supply actually having negative same store sales growth. One of the themes we're going to hit with another company later is growth

at a reasonable price, something you like to focus on. Does Boot Barn count as growth at a reasonable price? It does. And when I actually recommended the name in the first place, it was with a GARP growth at a reasonable price thesis. So they have 426 stores. I think they had somewhere in the 300 stores when I first wrecked them. And they've got a pretty good layout of what they're looking for in new stores. They think they can get to 900 to 1,000 stores in America by fiscal 2031. We're in fiscal 2025 right now. At that point, I think one of two things can happen. One, they'll say, well, if we could do 1,000 stores, we can do 1,300. But as well, I think the concept works beyond the borders of your fine country. Have you been

to Alberta or Saskatchewan. I don't recommend them in February, but there's one or two cowboys up there. Latin American cowboy culture is a thing. I think there's a lot of legs here. If you look at the cash-on-cash returns for their stores, the payback periods on a cash-on-cash basis is like in the 1 to 1.4 years. When you have that kind of return and that kind of very short payback period. It arguably makes sense to grow as fast as possible as long as you can retain those metrics. That's number one. Today, though, they're trading for about 17 times operating profit, 23 times PE, but they're going to continue probably through at least fiscal 31. We're talking about growing the top line, low teens, operating profit, mid-teens probably,

because you pick up operating leverage as you grow, at least you should, and they have. And I think one of two things can possibly happen. I've already talked about, you know, once we get past their 10-year expansion process, as I mentioned, they could decide to continue growing, which I think there are opportunities for that. Or they could flip the chain to what I call cash cow mode, where they don't put any more stores and all the cash that's been going and investing in new stores suddenly starts falling to the free cash flow line.

Home Depot has been a fantastic example of this over the years. And at that point, I think this company does $350 to $400 million a year in free cash flow. And you're buying it today for $3.8 billion, including a full enterprise value. So, you know, I think we're going to get past the CEO defection. I can't blame Conroy for, you know, here's $75 million and you don't have to come to work every day. I mean, who among us wouldn't take that, right? So, again, I think this is an opportunity. And, well, I'll leave it at that.

I'm going to make one reference. I don't think you'll get as a Canadian, but Cincinnati college football, it's a stepping stone where there are a lot of coaches that would go to Cincinnati for a few years and then they move on to a bigger and better opportunity. The fans were always upset about it. Shout out Luke Fickle. Shout out Brian Kelly, Brian Kelly. Anyway, I'm going to make an audible here.

Speaking of football, we're going to Sprouts Farmers Market because this is another growth at a reasonable price question mark. Sprouts Farmers Market is a company you followed for a while. This is one where my Lynchian senses have betrayed me, because I went to one. It's not quite Trader Joe's, not quite Whole Foods in my view. I haven't been back. I'm wrong. A lot of people love it. And that's why their comp sales growth is up 8%. Placer AI measures the foot traffic. That's not just pricing. They say the foot traffic is matching up with that. Earnings per share for a grocery store, a grocery store, Jim, earnings per share up more than 4-0, 40%

from the prior year e-commerce sales up more than a third now that's 15 of the business for this niche grocery store highlights from the quarter why am i why am i wrong about this company you're not wrong about this company i've recommended this company twice and hidden gems canada i love this company you're absolutely not wrong this has been a or at least you're not wrong in in in praising and bringing up the things that have done really well yeah sales up 14 comp sales same store sales, 8.5% in this quarter. As you mentioned, EPS up 40. New store openings were a little light, but that's because they had two stores in the pathway of Hurricane Milton. So we understand why they didn't open those. But they have just been crushing it for the better part

of three years now. And like I said, we've got them on the scorecard twice at like $24, $25, and I think $33. We have just been enjoying this one. And it was, again, like we talked about Bupart. This was a growth at a reasonable price thesis, but with the added benefit at the time we recommended it, and I feel this is where we're going to segue through here. When we recommended it, the way I termed it was, it was a best-in-class in their industry, best-in-class grocery store, trading with multiples, and best-in-class meaning in terms of margins, earnings growth, cash generation, what they were doing with that cash generation. It was a best-in-class operator trading with a worst-in-class valuation. And part of the success that this company has had

is because it's no longer being treated as a worst-in-class operator. It's kind of best-in-class operator now, which it should be. Yeah, maybe some of the analysts had a similar experience to me, and we've all been wrong about it. The stock's up more than 200% over the past year. We talked about Boot Barn. You made the case that it 10 times cash flow for the future. This seems like an opportunity here. Let's talk about Sprouts. Let's bring this theme through to Sprouts. Is Sprouts still growth at a reasonable price with all of this boost in the valuation of Sprouts Farmer's Market? It's still growth. I'm struggling with reasonable price, I will admit. I expect 10% store growth for the foreseeable future. There is lots of real estate for them

to grow in the U.S., plus I think the concept will work beyond your borders. I don't see any worries on the growth side of things. The problem is, as mentioned, when I wrecked this thing both times, valuation, I mean, I was struggling. I'm like, look, stocks trading at $30. I think the fair value is $45. And management, they had more cash than debt. They were tremendously cash flow positive. Management were aggressively buying back their own shares. Share count is, in fact, down more than a third since 2015. They've also paid off all their debt. I don't count operating leases as debt because I don't like to capitalize operating expenses. And I admit there's a certain amount of anchoring here. I will admit to that. But when I look and

see what I recommended when it was trading at six and seven times EBITDA is now trading for 21 times EBITDA. When I recommended it was trading at 13 or 16 times free cash flow, now it's trading at 36 times free cash flow. It was trading at 11 to 14 times with a PE, now it's trading at a 43 PE. These present multiples are as high if not higher than Whole Foods back in the day. I'm not sure it's deserved. I also run a discounted cash flow for this company. In the past, it was tremendously undervalued. Today, I'm struggling to get a fair value calculation, above 75-80 range kind of thing. And it's trading at, I think, about 130. So, look, DCFs are guaranteed to be wrong, but they are useful signposts. And again, I love this

company. I own this company. Obviously, I'm invested in it because I've recommended it twice. I love what it's done for our members. But I think management might be agreeing with me they're a a little hot because they have spent, as I mentioned, they were aggressively buying back their own stock and usually spending any money they weren't spending on opening stores, they were buying back shares. This quarter, they did $156 million in free cash flow. They spent just $25 million on buybacks. Rest is just gathering dust on the balance sheet, which is nice, but I think it kind of indicates management here are kind of going like, yeah, we're a little pricey And I can't disagree with them.

Follow the money and see where it goes. I know you have a bunch of notes on AirCap. I don't think we have time for it. But for members of Motley Fool Services, where can they find your thoughts on AirCap? My thoughts on AirCap can be found easily in Hidden Gems Canada. I will be discussing them in more detail probably in next Friday's column. Spoiler. I will simply say about AirCap, this is a cheap business run by the best in the business,

that would be CEO Angus Kelly, trading for one-time book value and about eight and a half times earnings, both of which are understated based on what they do. They are an aircraft lessor that is in the sweet spot for their industry. And aside from the growth at reasonable price stories we just talked about, I'll just leave you with this. I think AirCap is undervalued today and I don't know that I own enough of it. All right. Are you mad you didn't get big tech talk? We got that on Friday with Apple, Amazon, Microsoft, Meta, Jim Gillies. Thanks for being here. Happy Halloween, man. Happy Halloween to you too. All right. Every year I check in on the candy industry with Asit Sharma on Halloween. This year, though, he canceled on me at the

last minute and sent someone else instead. Every year, Asit Sharma and I check in on some candy companies. This year, though, Asit is unavailable, and he's brought in his buddy Larry the Werewolf. Larry, how are you doing, man? uh i'm doing great uh thank you very much mr mulvey this is indeed an honor it's a privilege and i'm so excited so much so that i i just have to do this although your producer told me not to because it would blow out the levels in the mic but here we go uh where wolves of london oh this is i can i can feel more people tuning in right now um you know Larry, werewolves are known for a lot of things, usually around full moons.

I've heard the how. Do you do stock analysis? Well, I do do some stock analysis. I do securities analysis. I've been working on this for quite a while. I had this she-wolf girlfriend who said, Larry, you'd be better working on your own insecurities analysis. You'd make more money, but I got rid of her.

I don't know if I'm sorry or if I'm happy to hear that. But I am ready, speaking of being ready, to move on to this discussion about Hershey. Because on Friday's show, Dylan, J-Mo, and Ron talked about the supply side, the cocoa shortage. I'm hoping we can get more to the demand side. And I don't know, is Asit your roommate, just your friend? How does that work?

He's a friend. And you know how this whole werewolf thing works. We don't get around much. You know, we sort of transform. And usually people keep us undercover. but I met Asit years ago at the very end of a day on Halloween in a grocery store. I didn't scare anyone because everyone thought I was in costume. We struck up this conversation by the Moz candy bars and he was just such a great guy and he got me interested in investing. And you

know, since then, it's just been this great fun relationship. I've learned a lot and I'm just so eager to spread my own investing knowledge here as we talk on Mr. Multi. The last time I spoke with Asit around Halloween, we talked about Hershey and it was at that point, it was a top dog and its biggest questions on this were about its move into snacking. Now it's got the cocoa questions. It's also got more, I would say weight loss drugs, questions, people becoming more concerned about those ultra processed foods of which Hershey makes a lot since it's moved into snacking over the past year. Have we gotten the diversification that was promised? What's the state of Hershey right now in 2024? Yeah, well, this is a little surprising, Mr. Mulvey. I mean,

Hershey's management talked this big game about diversifying into snacks. They have this North American confectionery unit now and the North America salty snacks unit, which is, of course, from buying those snack brands like Amplify. But if you look at the numbers, they've lost some share in both confectionery and in salty snacks. So what does this tell us? probably that they didn't know a lot about snacks when they bought these businesses or they knew a lot about snacks,

but have yet to bring the innovation to the fore. The new SKUs that customers want to grab off the shelves. The question I'm most excited to ask you, this is what I've been looking forward to to get an answer from you, Larry. What are your top three favorite Halloween candies? Well, I have made a list. I have written it down, Mr. Moldy.

The first that I want to talk about, I'm going to let you in on a little secret here. I'm not really looking for a secret. I'm looking for, like, this is a fun way to end the segment. Just, like, quickly, what are your top three favorite Halloween candies? Fine, then. The first is dog treats. That's not a candy.

It's so delicious. In fact, the Greeny brand peanut butter flavored pill pockets, which you can get off Chewy in a value pack, are delicious. That's okay. Is there anything we can swap that in with? Because that's, you know, that's a dog treat. That's not like a, you know, we're thinking, we just talked about chocolate. There's some easy options in there. You could look for gummies, nerds gummy clusters.

That's a big one. That's hot in the streets. Another chance to try again. Sure, sure. How about Frozen Blood Pops? So, as you know, two main classes of scary types around Halloween are vampires and werewolves. I have many vampire friends. We've become polarized.

I like to reach across the aisle. Keep a cooler Frozen Blood Pops for little vampire children in the neighborhood. Because, look, at the end of the day, we have something in common. We all want to scare the hell out of humans. So, Frozen Blood Pops. Okay, there's things with sugar, cocoa. I'm trying to get your mind working here. Sugar, cocoa, maybe like a lollipop, some sort of taffy.

You can really go to a lot of places with this. So what you got? So I got for my number three and most favorite treat of all is Hall's mentholiptus triple action lozenges because werewolves have terrible breath and you get a two for one, Mr. Mulby. You can sweeten your breath and you can soothe that throat

that is so sore from howling all the time. We're so close. You got to something that I think has sugar in it, but we're not there yet. What is just literally, dude, I'm sorry, not dude, werewolf, just one Halloween candy that you like to eat.

Silk and tofu, Mr. Mulby. I cut it up into little squares and put toothpicks in them. I put them out on the porch for the kids. That's savory. We were in sweet and you went savory. So great. You could put a little bit of a teriyaki sauce on them. If you like the sweet sort of the equation, you can do that.

Okay. I'm looking like dark chocolate Reese's cups, nerds gummy clusters, Tony's dark milk chocolate pretzel toffee. I'm giving you the answers. Just literally pick one. Meh. All right. Larry the werewolf.

Appreciate you breaking down the stock. Maybe one of these years you or anyone in your household will give me a favorite Halloween treat. As always, people on the program may have interests in the stocks that I 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. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Motley Fool only picks products that it would personally recommend to friends like you. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.