Motley Fool Hidden Gems Investing - The Rate Hike Wall Street Expected

Episode Date: March 23, 2023

Just because things go as expected doesn't mean the ripple effects aren't surprising.   (0:20) Andy Cross discusses: - The Fed's 0.25% rate hike - Unfortunate timing around Chairman Powell's press conference and Sec. Yellen's public testimony - Why he's going to be paying more attention to annual reports in the coming weeks   (10:20) Nick Sciple and Jim Gillies face off in the semi-finals of our stock investing version of March Madness! Choose the winner by casting your vote in our Twitter poll @MotleyFoolMoney!   Companies discussed: RMAX, BWXT   Host: Chris Hill Guests: Andy Cross, Nick Sciple, Jim Gillies Producer: Ricky Mulvey Engineers: Steve Broido, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. It's rare that we offer unsolicited advice to the good people on Capitol Hill, but today is just one of those days. Motley Fool Money starts now. I'm Chris Hill. As promised, joining me today, the Chief Investment Officer, Andy Cross. Thanks for being here. Chris, thanks for having me. So, we got the quarter percent rate hike on Wednesday afternoon. This kind of went as expected in terms of the rate hike and the language around it. And when you look at the reaction on Wall Street and the investing community today, things seem good. I hate to generalize like that, but just in the moment, this seems like, Like, OK, this wind is expected and the market's reacting positively.

Well, I think if you have the chairman of the Federal Reserve, Chris, and the secretary of the Treasury testifying or giving comments at the same time on an announcement when they raise interest rates, I think most people would probably qualify or categorize that as that's pretty unusual. So that's what we had yesterday, Chris, and the markets did not react nearly as positively today because I think of the dual hit between an increase in interest rates and continued tough talk by Chairman Powell about making sure that the markets understand his commitment and the FOMC's commitment to fighting inflation with higher interest rates. At the same time, you had Secretary of Treasury Yellen testifying on the Hill that we don't yet have, or there's no plans yet to have a blanket coverage for all depositors. So that continued to put pressure on the bank stocks. Today, you have a little bit of a different story, Chris, I think as the markets are coming to terms with, okay, we do have higher interest rates than we had the day before. That was expected, 25 basis points, as you mentioned, was pretty baked into the markets and now just continued thinking that, wow, with tighter financial conditions that are

likely to come from the banking crisis that we're experiencing, that might mean the Fed does not have to be as aggressive raising rates. And so down the line, interest rates in the marketplace may be a little bit not as high as they are today. And that's got the markets, the stock market, excited to be investing. And we're not all that interested in politics, and we don't inject ourselves in political things. But on behalf of investors everywhere, I'm just going to say to anyone listening who currently works in the U.S. House of Representatives or the United States Senate, in the future, please don't schedule the Secretary of the Treasury, whoever it may be at that time, to testify at a public hearing, the same time the head of the Federal Reserve,

whoever that may be at the time, is giving a press conference after the Fed meeting. Because the Fed meeting, this was on the books. This was known months in advance. We knew when this meeting was going to be. So come on. Come on, people on Capitol Hill, scheduling these things with the Treasury Secretary. Do better in the future. Just do better. A little scheduling snafu, I would say. I don't know. Obviously, the chairman and the secretary have been in, I would imagine, daily conversations over the past three weeks since the Silicon Valley Bank situation and the other banks closing down. So I can't imagine they didn't know each other was testifying, but still a little bit of a scheduling challenge. But a little bit jokes

aside on that, I think what we are seeing now, Chris, is this reaction in the marketplace that Chairman Powell clearly knows about the banking industry and talked a lot about that yesterday in his 45-minute press conference. He came out and said that we will likely, this situation is going to make financial conditions tighter. Right now, in the data, he said, it doesn't really necessarily show that the financial conditions are tightening so much, but he admitted. He said that's backward thinking and some of it hasn't caught up yet. I think he's expecting, or at least the market is expecting, those conditions are going to tighten. And that might mean that the Fed is not going to be nearly as aggressive as maybe they were expecting or intended to do before

the banking crisis started. And that will mean they don't have to be as aggressive on interest rates. Of course, lower interest rates and the market continues to price in cuts later this year and expectations that the Fed will have to pivot. And that's lower interest rates. That's good for for stocks, especially technology stocks. Chris, finally, I'll just note that the Nasdaq 100 is almost up 20%, probably is up 20% now as of today from its lows last fall. Now, still down 15% from its highs, but it's up 20% from the fall. There's a lot of continued enthusiasm to be buying some of the larger cap growth in tech stocks in the marketplace in 2023. You and I were talking about this

earlier today. We've been at this a year now. You go back to March of 2022. I believe this is the ninth rate hike. What is your nervousness level, keeping in mind that you and I and every other investor in the United States and probably around the world, our nervousness level is made higher by, as you called it, the Silicon Valley Bank situation, which then extended to First Republic, Credit Suisse, and potentially others. Yeah, and not to make light of Silicon Valley Bank, and I've written a lot about this, and we've written a lot about that and the still unfolding crisis that that kicked off. I'll say, Chris, you look at the data, there's obviously continued worries that the United

States, if it's not in a recession, now will be in a recession, although I will note that the Atlanta GDP now forecast still has us for growth over the next year, but concerns about the recession. For the investing side, when we start to see those recession fears really kick in and we start to see market nervousness in place, you start to see maybe some capitulation. That's ultimately good for long-term investors like ourselves. And sometimes as hard as it is to be investing through those most difficult times, that's the best time to be a long-term investor. I don't think we're quite there yet. I still think, as you said, my nervousness twitching is still where it was kind of at the beginning of the year, just for now, different circumstances.

The banking situation especially just depends on what happens with some of the local regional banks, especially because they provide so much funding for commercial real estate loans. Banks that are less than $250 billion in assets, and anything above is a fairly large bank, but those less than $250 billion in assets account for 70% to 80% of commercial real estate lending in the United States. So there's still concerns around just the liquidity and the credit cycle going forward in this banking crisis and what's going to continue to come from it. But from an investing perspective, when I look out three to five years, interest rates at some point, the inflation curve starts to improve, the interest rate curve starts to flatten a little bit, get back to normal as the market comes to terms with where the Fed wants to be, and the Fed comes to terms with where the market wants to be.

And I think when I look at long-term, I still see a higher terminal rate than we had in the last five years. And that's going to continue to put pressure on valuations. But the best businesses that are going to continue to grow, you can buy and own those at good prices throughout the next six to nine months. And I think long-term investors will end up benefiting from that come 2025, 2026 and beyond. What are you going to be watching over the next month or two? keeping in mind we're basically at the end of this most recent earnings season cycle. We're going to have a couple of quiet weeks, at least on the earnings front, before things start picking up again in the second half of April. What are you going to be watching to

give you a sense of where these stories are going next? Well, I think the thing, Chris, that we'll be doing is we're already starting to see a lot of the annual reports and the 10Ks come through. There's a lot of excitement, a lot of interest and curiosity and a little bit of fear around chat GBT and how that is impacting business models. So I'm excited to kind of compare different annual reports from last year to this year to see which companies are talking more about that. Clearly, so much of the conversation is going to be around the banking crisis and liquidity issues and understanding what the Treasury Department and the Federal Reserve and the FDIC are doing to protect depositors. A blanket protection of all depositors requires

an act of Congress. I just don't know if they'll be able to do that or do that soon. We'll see how the banking industry continues to react to the changing dynamics, especially if interest rates stay elevated and bank balance sheets stay a little under pressure relative to what some of their assets were worth a year, year and a half ago and how the market digests that news. Those things from the analyst side is really digging into a lot of the annual reports from an observer's side, continue to watch what's happening at the Treasury Department, especially in the small regional banks. Andy Cross, always great talking to you. Thanks for being here. Yeah, thanks, Chris.

Up next, we've got our second semifinal matchup in our investing version of March Madness, and you get to pick who advances to the finals. After this episode, vote for the analyst that you think made the stronger pitch in our Twitter poll, at Motley Fool Money is the handle to look for on Twitter. Today, it's Nick Seipel facing off against Jim Gillies. We have our second semifinal matchup for Stock Market Madness. Nick Seipel and Jim Gillies returning. Nick has a nuclear energy technology stock.

Jim, you've got a home brokerage stock or a real estate brokerage company. And the way this is going to work is Nick's going to have two minutes to recap his stock. Jim's going to have five minutes to recap his stock and offer a rebuttal. And then Nick gets to finish it off with a three-minute rebuttal. And with that, we will get started. Nick Seipel, you've got two minutes to recap BWXT technology. All right, friends. Great to be back here.

I am Nick Seipel. As Ricky mentioned, my company is BWXT Technologies. BWX, if you might have heard on the previous episode, is a provider of nuclear components and services to the defense industries, the commercial power industries, and the healthcare industries. In the defense business, they are a monopoly provider and have been for longer than I've been alive of nuclear naval propulsion systems for aircraft carriers and submarines for the U.S. Navy. There's new opportunities opening up in advanced microreactors and also exporting of nuclear defense technologies to countries like Australia in the commercial

side of the business, really benefiting from upswings in demand from nuclear power, particularly small modular reactors, where they are partnered with GE Hitachi that now has the leading design on the market. It's going to be the first one deployed in North America. It also has a long-term trajectory towards deployment with the TVA in the U.S. Then also the healthcare side of the business is set to really start producing for the company. It's been a drag on capital for the past several years that they've got their nuclear isotope reactor design up and running. Now that is ready to be approved by the FDA and it's going to start producing cash for the business. So you're going to see free cash flow increase fourfold in 2023 from where it ended

2022 from about $50 million last year to $200 million this year. Tailwinds behind all parts the business, free cash flow about to swing up in a meaningful way and a long-term plan to return 50% or more of free cash flow to shareholders. That's why I like the stock and why I think BWX Technologies is a company that can do very well in March Madness. Nick Seipel, thank you for the recap. Jim Gillies, you've got REMAX and you've got five minutes to do whatever you want. Okay. Yeah. So my company is REMAX. They are a franchisor of real estate brokerages and lesser extent mortgage loan origination brokerages under the Model Mortgage brand. They kind of buck the mold in terms of the traditional

broker-agent relationship, and that is, most of the time, a traditional broker will take 25%, 30%, 35% of an agent's commission in a real estate transaction. REMAX gives to its franchisees, they have what I call an agent-favorable commission split, where the agent keeps 95% of a commission and the broker takes just about 5%. They also are taking monthly fees and annual fees as well as various fee-based things that franchisors like to take. But what this little secret sauce does is, it's a powerful incentive for the best of the best agents to gravitate towards a RE-MAX banner because they can bet on themselves. For an example of how this works, they publish every year a table in their annual report showing the average number of transactions

for REMAX agents, it was 16.5% in 2021. And for competitor agents or competitor banners, the average agent does about 7.6% transactions of the most recent one of these graphs, this variance has been there for years. So, we have some very definitive evidence that this special agent-friendly model works. But of course, as a franchisor, we're very happy to get the annual dues per agent, the fixed fees per agent, the broker fees, that's the 5%, franchise sales and monthly fees from the motto offices. The financial picture is obscured a little bit by the fact that there's a dual-class share structure here, but right now the macro wins of the real estate industry are such that after a real gang-ho 2021, 2022 kind of fell into disrepair. A lot of

real estate companies are down significantly, RE-MAX is no exception because the number of transactions has fallen off significantly. And I think that smells like opportunity to me if you have the requisite long-term viewpoint here. You actually have, to start with, you've got founding management still here on the board, former CEOs on the board, it's a husband-and-wife team who for about seven, eight years in this public company's history took no salary bonus or other comp, they just got paid on dividends on their dual share class structure. They own about 41% of the total enterprise because the company has been both paying a very attractive dividend, about 5.3% today, as well as buying back their own stock at this very nice low valuation. Share

price is basically the lowest it's been in its public history, aside from the brief period at the start of the pandemic. Valuation, we're trading about seven times this year's expected the EBITDA 14 times this year's trailing free cash flow. We know that they are buying back a significant amount of shares at this present price. Basically, it's not a sexy business, I'll grant you that, but we are going to see houses bought and sold this year. We see houses bought and sold in every market, regardless of whether it's a hot market or not. I don't it's going to be terribly hot for a while, but that's okay, because it gives them a chance to buy in a significant portion of the shares, as well as you get paid 5.3% to wait.

Now, while of course I like my stock better than Nick's, I have to say it's only slightly more than Nick's, because what most folks might not realize is that both of these companies are recommendations in the service I lead and the one that Nick contributes to significantly, both are recommendations in Hidden Gems Canada, so I feel like I truly can't lose here. But my concern about BWXT, which I do like, and I have an office actually within about a 20-minute drive of me that way, what I'm a little concerned about is a lot of their success is tied to government contracts, government standing up and doing that. And I just have a long history of thinking, well, Well, you know, when the government says they're going to do X, Y or Z in whatever timeframe,

it generally takes two or three or four times as long timeframe-wise, it's always kind of pushing it off, a bit of a waiting for Godot thing. That's my major knock on BWXT as an investment, because it would change what the valuation is you're paying now, because some of the goodness, I think, is going to come a few years from now, but frankly, that's pretty light sauce. So, other than that, I think these are two excellent companies for Fools to consider. Light sauce from Jim Gillies. Nick Seipel, you've got three minutes to offer whatever sauce you want. Sure. Maybe we'll make it a little bit spicier. Who knows? As Jim said,

both these companies are in hidden gems. Canada, I think both of them have strong prospects going forward. Now, why should BWXT survive in advance and the Remax folks go home? I think if you look in the NCAA tournament, you really need to have multiple ways to win. You need to be able to have your best player, maybe not have the best game, and still be able to grind your way through. And I think BWX Technologies has a few more ways to win than REMAX. You mentioned the defense business, the nuclear subs, as well as services, servicing NASA and DARPA and some of these other military agencies. We also can win through increased growth in the commercial side of the business. We also can win by becoming the sole supplier of some really key medical isotopes

to North America. As Jim laid out, for REMAX, what you need for this company to win is transactions to turn up in the real estate business. There's going to be a steady state number of transactions in the real estate business, frictional people moving from job to job or that sort of thing. But given the current state of the market and mortgage rates, I think it's fair to say, Jim laid this out. REMAX is going to be beholden to the macro economy for a period of time. Another thing that is, there are some differences between these two companies. As I laid out, BWX Technologies is a monopolist in many of the areas of the market that it serves. There's lots of other real estate brokerages out there doing a similar thing to what REMAX does. As Jim mentioned,

the way that many of these brokerages compete is, I will charge a little bit less fees than than the brokerage across the street. There's a little bit more competitive intensity there in that market. Both of these companies are going to be subject to the macroeconomy. In the case of RE-MAX, it's what's going on in real estate transactions in the market. In the case of BWX Technology, it's really, what is the governmental political will behind defense spending or behind nuclear power deployments? Both of them have questions about how much of that demand is going to materialize in the future. But for me, I will take the company that is a monopolist, that has had upturns in its industry over the past couple of years

behind the company, and a much more competitive industry that is facing more headwinds. Nick Sciple, thank you. Jim Gillies, thank you. Now you get to decide who made the better case and who's moving on to the finals of Stock Market Madness. We will have a poll up at Motley Fool Money on Twitter. Make sure you vote, and that way you'll have a say. you both. And I'll see one of you next week. Thank you. Thanks so much. Fool on. 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. Don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.