Motley Fool Hidden Gems Investing - The War on Checks

Episode Date: October 17, 2022

Home buyers aren't welcoming higher interest rates, but they are mostly good news for banks. (0:21) Deidre Woollard and Jason Moser discuss: - Bank of America's strong quarter. - BNY Mellon's move to hold crypto for its clients. - Why banks are pumping up their loan loss reserves. Advertising tech stocks have been hurt, but actual spend is holding up. (10:51) Ricky Mulvey and Asit Sharma look at the ad landscape, and one smaller player with a strong balance sheet. Companies mentioned: BAC, JPM, PYPL, SQ, V, MA, MQ, BILL, BK, TTD, MGNI, PUBM Host: Deidre Woollard Guests: Jason Moser, Asit Sharma Producer: Ricky Mulvey Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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to Motley Fool Money. I'm Deidre Willard sitting in for Chris Hill and I'm joined by Motley Fool Senior Analyst, Jason Moser. Hi, Jason. Jason Moser. Hey, how are you? Doing good. Bank of America is doing pretty good too. They announced earnings today. They beat earnings estimates even though profit was down. Banks like B of A, Wells Fargo, JPMorgan, they're all getting this boost from higher interest rate income even as deposits are slowing down. Are higher interest rates a good news, bad news situation for banks? Yeah, I think that's probably a fair way to put it. I would say it probably favors more good news than bad. You look at banks that are maybe a little bit more levered to mortgage

lending and maybe that dries up a little bit as rates go up. Generally speaking, we've been hoping to see this at some point or another with banks as interest rates continue to rise. We see ultimately the net interest income numbers for these banks this quarter really taking off. Net interest income, for those unfamiliar with it, it's the difference ultimately between the revenue generated from a bank's interest-bearing assets and the expenses associated with paying on the interest-bearing liabilities. Ultimately, as rates go up, we should see banks making a little bit more money in that net interest income. If you look at Bank of America, that net interest income was up 24% for the quarter. JP Morgan net interest income

was up 34%, Wells Fargo up 36%. So, definitely a nice thing to see, even though you probably don't like seeing your adjustable rate mortgage take up, I'm sure, but I think that probably speaks to the merits of getting a 30-year fixed mortgage. But yeah, I think probably more good news than bad. Well, one of the things that I noticed about the B of A earnings was that the consumer is still spending, it's slowing, but it's still strong, but banks are really preparing for the worst. They're pumping up their loss reserves. What does that mean? Is there a possibility that it could be too much? Can they over-prepare? I don't think they can over-prepare. Banks

obviously very heavily regulated industry. They have to keep a close eye on this always. Every quarter, we see either they're pumping up those reserves or they're releasing those reserves. Ultimately, that loan loss provision, it's something that banks set aside for potential uncollected loans and payments. It covers non-performing loans, customer bankruptcies, things like that. We always say you want to prepare yourself for a rainy day. This is the bank's version of preparing themselves for a potential rainy day. Definitely, we've seen a lot of these banks setting aside a bit more as opposed to releasing money recently. If you look at Bank of America, their net reserve bill was $378 million. That was versus a net reserve release

of $1.1 billion a year ago. JP Morgan, another bank that increased that reserve, they built up $808 million versus a release of $2.1 billion a year ago. Then Wells, they added $784 million to their loan loss reserves. It is something when you see banks doing this, it impacts earnings. When we see them setting this money aside, that is a little bit of a headwind two earnings. Conversely, when we see them releasing that money, there can be a little bit of a tailwind. It's something that just plays out quarter-to-quarter and year-to-year, and ultimately, you look for those tailwinds when you feel like they've got that money set aside if economic conditions are starting to improve. When they start setting that money

side that when they start building that reserve, it can be a little bit of a clue as to what they see coming down the pike. It feels like to me, they anticipate a potentially challenging situation here in the coming quarters. We hear a lot of talk about recession potentially hitting in 2023. A lot of people would argue that we're already in a recession now. I think it's one of those things you expect to see it with banks, whether they are reserving or releasing. But the fact that they're reserving does give us a little bit of a clue that maybe they see some challenges on the horizon. Those challenges are things like consumers that may be defaulting on their credit cards or things like that?

Yeah. When you look at recessionary times, obviously coupled with inflationary times, the consumer is really in a pinch right now. Credit card balances are at historic high levels, consumer savings rate, the personal savings rate is around 3.5%, which is historically very low level. It's a consumer right now that's in a little bit of a challenging spot and the banks are saying, hey, things might get worse before they get better and we may have some loans out there that ultimately won't get paid. We need to put this money aside to make sure that we have our business order and we're meeting those capital ratios that regulators expect to see. Jason, you're famous for talking about the war on cash and Bank of America saw 44%

more Zelle transactions than checks written. Are we also in the midst of a war on checks and which FinTech companies are going to be the beneficiaries of that? Yeah. I hate having to write checks personally. Every once in a while you got to do it, but we're seeing more and more now that's becoming an old way of doing business. and I think you see the obvious suspects to me, you've got PayPal and Block, they're going to keep winning from this trend. With PayPal, obviously, they also own Venmo. You see a lot of money moving between PayPal, Venmo, and the Square Cash App. Those are the obvious winners. Visa and MasterCard, I think, do a wonderful job of finding positions in this value chain to help

continue moving money around. They have partnerships, obviously, with companies like Block and PayPal, so they'll benefit as well. I think maybe some names that folks might not be as familiar with, you look at a company like Marketo, which is ultimately a cloud-based API platform that helps companies. They are a modern card issuing company. They have big customers like DoorDash and Uber. They help these companies build their own personalized payment programs for their workforces. We recently saw a neat new relationship Marketa forged with Uber and I believe it's MasterCard. But again, I think that that is another company that continues to benefit from more money moving digitally. Then another one

that focuses more on the enterprise level, you look at a company like Bill.com. They're helping to digitize and automate the back-office financial operations for small and mid-sized businesses, taking the paper out of doing the business and making it more electronic as well. I think that those are some companies that should continue to benefit for some time to come. I will add to that all of those companies I just mentioned, I actually own shares in all of them myself, So, I'm sort of sticking by what I say here. I'm a big believer in all of those businesses. That's that war on cash basket at work. We're expanding the basket, Deidre, we're expanding the basket. Well, speaking of expanding in

financials, BNY Mellon, they recently announced that they're going to start holding crypto for clients. How much should we think about this as a potential game-changer and are we going to see more uses of crypto. Is it finally going to become practical in some way versus just a trading mechanism? I'm still not sold on crypto as a medium of exchange. That's really the question we've had to answer for so long is, is it a store of value? Is it a medium of exchange? Is it something else entirely? It feels like it's a difficult argument to make that it is a medium of exchange. Most people just aren't using crypto to buy things, it doesn't seem like it's really an effective store of value

these days. A lot of folks were arguing that it was a nice hedge against inflation. It doesn't seem to be playing out that way. Now, it's not to say there's not a future for crypto. Obviously, it is here to stay, and the purposes that it serves, I think will evolve over time. But I think this is ultimately a good thing for crypto enthusiasts in that it adds credibility to the space. I think the Bank of New York Mellon, one of the oldest banks still out there exists, one of the most important banks in our banking system, one of the big eight, they say. This is something that adds credibility to the space. To me, we likely see more banks dabbling in this as time goes on, but ultimately, I think it's

a fairly low-risk way for Mellon to bring crypto into their world, learn more about it, learn more about its use cases, and ultimately, like I said, I think it just adds credibility to the space, which is ultimately, I think, what crypto enthusiasts want. Absolutely. Crypto enthusiasts, yes. We'll have to see about the rest of us. Yeah. I think most folks know I would not call myself a crypto enthusiast. I'm a little bit more of a skeptic. But hey, listen, like I said, it's a space that continues to evolve and it's here to stay. I think we're going to find some use cases as time goes on. Right now, still just not very clear. Yeah, I would agree with that. Really appreciate your time today. Oh, my pleasure. Thanks for having me.

While some advertising tech companies have been cut in half, actual advertising spend isn't slowing down like you might think. Ricky Mulvey has more. Advertising spend isn't slowing down as much as you might think, but the ad tech disruptors sure are beaten down. Joining us now, Motley Fool Senior Analyst and Contributing Learner, Asit Sharma. Asit, good to see you as always. Ricky, my friend, good to see you today. I'm excited for this topic because there might be some opportunity. We'll find out. We might be in a recession vibe session, whatever you want to call it. But according to some studies, ad spending is slowing down a little bit, but still growing.

So the World Federation of Advertisers found that 29% of major advertisers are slowing spend next year, but a similar amount are increasing their spend. A different study from a company called Martech, found that 77% of chief marketing officers expect to increase their spend next year. And a media agency called Magna Global expects that overall ad spend will still increase by about 5% in 2023. So, Asit, I just threw a lot of data at you. Is any of it meaningful to you? I mean, yes, Ricky. It's meaningful in that it's so confusing, right? Are people cutting back? Are they spending more? I will say, in general, when the business climate withers, companies start to pull back on their variable costs. The ones they can immediately curtail without having too much

of process change. Across a lot of industries, whenever you get a palpable decrease in demand, it makes sense to cut the variable cost of marketing and advertising. You don't want to overspend past some equilibrium demand level. When you see a high inflation, high interest rate environment, marketing and advertising budgets are some of the first to get squeezed. Now, why this picture is mixed has something to do with advertising efficacy, which I'm going to return to in a bit here, as you have a very interesting quote to discuss in a moment about this. Well, we got two teases thrown in, but you said why companies would, it makes sense that the common knowledge of company, we're uncertain about the future economic climate, we're going to slow

down on hiring, but it does seem that a lot of these major public companies are very hesitant to slow down on advertising spend. I think this is because publicly traded companies have a finer needle to thread in an environment like this. They have to meet investor expectations. If you're a growth company and you have to show your investors that you're growing, even in a difficult time, you're very loath to cut that marketing advertising budget because you don't want to mess up, even though some of that spend might be over that demand level that I was talking about. If you're a mature company, you want to meet those earnings per share targets. You don't want to whiff on earnings day, so you will

second guess pulling back on those particular variable spend line items on your income statement because you're juggling the idea of maybe having an effective spend or ineffective spend versus investor angst and anger if you really miss. So you might lean towards keeping that marketing budget in place, maybe even increasing a bit if you can cut another cost somewhere else and still hit the earnings per share that investors want to see. From what the advertisers are seeing, the ad buyers are looking for something a lot more measurable. Maybe you'll see a little less brand spend. The Trade Desk's chief financial officer, Blake Grayson, said in the latest earnings call, quote, while the macro environment has created some uncertainty and we are not immune

to it, we continue to gain more share as more and more advertisers seek efficiency and measurable results in their ad spend, particularly connected TV. There's two questions with this. I think there's a larger conversation about connected TV and how much of an opportunity there really is there. But the first question is, why do you think the Trade Desk is able to see so much more efficiency than other advertising platforms? I think for the Trade Desk, they're realizing the fruit of much investment over the past several years. And part of the answer is in your quote above. They're doing very well in connected TV. They offer this capability to a wide array of multinational companies. And that's an advantage over an internet walled garden like Google.

So part of it is just this. It's a big part of the industry and they've been playing in it for a long time. The second, I would say, is their UID 2.0. So this is the company's answer to cookies. It's a technology that ensures more privacy to the end user. Trade Desk has led a consortium of other players in the industry to develop the technology. And there's some evidence, and it's fledgling evidence, okay, so take this with a grain of salt, that UID 2.0 actually provides some pretty robust analytics back to the companies that decide to use it. And so there's a business case that's extending beyond just privacy and offering a competitor to cookies, which Google keeps saying they're going to do away with. They keep pushing back the date at which

they're finally going to kill cookies. The third thing that I will say about the Trade Desk is they have developed a really good analytics platform. It's called Solomar, and this helps you measure your spend a little bit better. Ricky, as you point out, spend should be measurable. If you can show a company that through using our platform, you're going to get a higher return on your advertising dollars, then that is a case during an inflationary period to keep that business and actually to have some marketing dollars that companies may spend in non-measurable endeavors like brand promotion pile in to programmatic advertising where they can prove back to their CFOs that there's some result on this money.

I am curious if the opportunity in connected TV is a little overrated, though, because it's not like ad inventory is sold out right now. If you watch something like ESPN+, it's frequent that during the commercial breaks, you're just seeing the banner headline that we're in a commercial break, we'll return in a few minutes. And my first thought is, boy, I bet the Disney company would like to sell that space? And then the second is, you're going to see even more inventory open up when Netflix introduces its ad tier. And does more space create more opportunity? Or is this a case where the greenfield might be a little too large? I mean, this is one of the questions of the day. It's something that I, not being this absolute

expert in the industry often wonder, how much is the demand out there for connected TV? It certainly has been a growth vehicle for so many companies in this newish industry. But at what point do we reach this imbalance between supply and demand? I've had that same experience. I'm sure many listeners have. For me, it's usually during the NCAA tournament where I'll buy a subscription to ESPN2 and then cancel it after the tournament's over. But yeah, you're sitting there seems like ages waiting for the activity to pick back up. Doesn't someone want that space? Now, I should say that part of this evolving relationship between the trade desk and Disney is supposed to answer that question. They're supposed to be putting more ads up on their

various streaming properties. So, we'll see. But at some point, I think we'll see the industry hit this happy medium. We're going to see more connected TV ads. I'm not sure it'll ever reached that space where it's similar to normal TV in the real world? I think one question is how local businesses are able to take up the connected TV opportunity. At least for me, I'm not seeing a ton of local car dealerships advertising in that space. It might be an education question, it might be a cost question, but it's something I'm watching. While the Trade Desk is buying ads, you got two smaller players on the sell side. Both are also beat up this year. Magnite down about 61%, and the other is Pubmatic. As you're

looking at these sell-side providers, which are selling the ad space on behalf of publishers, what are the key differences for investors to know? Magnite is a player that I think most listeners will be more familiar with. They've been around longer. They were the Rubicon project, became Magnite. They've grown a lot through mergers and acquisitions, Ricky. Play very well in the connected TV space. One of the characteristics that I like about Magnite is that they are good at supply path optimization. That means just reducing the number of intermediaries or middlemen in a sell-side equation, so you have more direct from the publisher as inventory to the platform to the buyers. Pubmatic is a smaller company that has been around for

quite a while now. The key difference between Pubmatic and Magnite is that Pubmatic invests in its own infrastructure, they own most of their own servers, and they built this specialized global cloud infrastructure to serve publishers. They do this extremely well. I will say as well as Magnite does supply path optimization, Pubmatic is even doing that a little better. I think that they are really making a case for publishers just to deal directly with them and they're helping those publishers roll up their own supply chain ad inventory streams. The final difference between the two, I think, is Pubmatic just has superior financial characteristics. The CEO and CFO, in fact, the entire management team of Pubmatic,

has always wanted to run a profitable company, so they have positive operating cash flow. They do invest a lot of money in their servers, so cash flow could be better, but it's growing. But you look at the margins of these two companies, Pubmatic has gross margins around 72% versus 54% for Magnite. Pubmatic has a positive operating margin of 22%, Ricky. And the Magnite typically loses money in operations. It's got a negative operating margin of 13%. So that is a big differentiator between these two companies. Both still have a lot of growth ahead, but I like Pubmatic for its platform, how sophisticated it is, its relationships with publishers, and the fact that it makes money. Awesome, Sharma. Always appreciate

getting together with you. Thanks so much, Ricky. This was a lot of fun. 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 Deidre Willard. Thanks for listening. We'll see you again tomorrow.