Motley Fool Hidden Gems Investing - This Seat Is Taken

Episode Date: July 25, 2024

Open seating is coming to an end on Southwest flights. (00:21) Sanmeet Deo and Ricky Mulvey break down earnings from Chipotle and Southwest Airlines’ pressure from activist investors. Then (11:04) Asit Sharma joins Ricky to discuss one of Warren Buffett’s favorite metrics. Companies discussed: CMG, LUV, LULU, AMD, NVDA Learn more about the Range Rover Sport at www.landroverusa.com. Host: Ricky Mulvey Guests: Sanmeet Deo, Asit Sharma Producer: Mary Long Engineers: Dan Boyd, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

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i'm ricky mulvey joined today by sam meet deo sam meet how we doing hey ricky good let's talk chipotle because if the restaurant industry is hurting don't tell this fast casual chain chipotle just posted earnings uh yesterday revenue up 18 same store sales number caught my attention at 11%. Thank you. Pricing hikes for Chipotle shareholders. They also opened up 52 new restaurants in the quarter. And this is a smaller detail, but I like to see it. They achieved their goal of promoting 90% of people from within the company. Those are, those are some, uh, a menu of takes for your Chipotle order. What are your headlines? Yeah. So, you know, a component of that same store sales growth of 11%. A key part of that was transaction growth was about 8.7%.

And they're continuing to see that drive their sales growth. And they're seeing it in the next quarter with early signs in July. And this is a good indicator because it means that customers are buying more and their sales are being driven by that rather than just price increases. And they're seeing transaction growth across all income cohorts. So that was one big key takeaway. way. Another one was that they're seeing actually a very healthy consumer that's spending. And they're also very positive on the restaurant industry in general. So I like to see that kind of macro insight there. And they are pumping the brakes on price increases. They would prefer not to do them if they can. They will if they need to, but they did indicate on the call that

they're really not looking to. So more people are coming in while they raise prices. That's that's pretty good ceo brian nickel also sort of getting ahead of that social media trend where people had been filming chipotle workers to make sure they are getting proper portions kind of cyber bull is that cyber bullying sammy i'm gonna call it cyber bullying it's sort of it's an element it's a little bullying but basically nickel acknowledged that there is variance across their 3500 stores that's a lot of them and also said that the company is re-emphasizing training and coaching not putting any blame on the people filming and looking at especially the outliers where portion sizes are a little different what did you think of nickel's response here

yeah you know um i think he did a great job addressing this i mean he he addressed it head on right at the beginning of the call you know he wasn't dismissive of his customers and what their issues were um he took them seriously um then he said that they went back looked at the problem and and kind of analyzed the system see how they could improve it actually turns out that it was a relatively small percentage of stores, about 10% that were, that were not, you know, giving generous portions, which is something they feel, uh, is a very important component of the, of their, uh, of their business. Yeah. I mean, I feel it. I'm not filming anyone at Chipotle, but I feel it when they they're giving me my portion of chicken out past or steak.

And I see him do that little spoon shake to get, and I'm like, no, no, no. And there's something, there's something animalistic where I'm like, you're taking, you're taking away my meat. How dare you? And you just, just raised prices. Um, there was a big announcement for me, at least that chicken out past store, the limited time offer is out at the end of the summer smoked brisket coming back in the fall. Does this return meaningful to you? And you know, for a more businessy question, how did these, uh, limited time offers, what do they do for Chipotle? Yeah. Well, you know, when they announced that chicken out past store is coming back, I was super pumped. I love that stuff for, for, for the smoke brisket. I personally don't eat

beef, so I'm not as excited. But as a shareholder of Chipotle and a fan of Chipotle, I think it's fantastic. And I think these limited-time offers, is what they call them, are great for Chipotle. It generates enthusiasm, traffic to their stores. They even highlighted the Chicken Out Pass store as being a significant contributor to their traffic growth in the quarter. They prepare them well. They craft these items really, really nicely. And then they throw them out there for the wolves to to go after yeah i don't see the regular chicken compared to the al al pastor it doesn't hold a candle it's gonna be uh it's gonna be rough anyway the stock has you know we're long-term investors but the stock's kind of interesting right now really whipsawing on the results you

look through the transcript of the call and almost all of the analysts are congratulating chipotle on the great great quarter it looks like they have some great comps same same store sales So what's the street reacting to? So this is, you know, I saw the results and I was like, this is awesome. And then I saw the after aftermarket results of the stock and it was up at, at one point up to 14%. And then it slowly started coming down, mostly likely profit taking. And then as a call progressed, there's a single comment where they said margins are expected

to be under pressure for the next couple of quarters. That seemed to bring the stock down even more. I think the streets worried about higher food costs, lower margins. They were at about 28% for this quarter. They're looking to see it come down to about 25%. Management thinks this is a seasonal issue, nothing that's too worrisome, and that they can offset it with investment efficiencies and even prices if needed. But this is a classic example of, with analysts congratulating them, classic example of fundamentals doing very well, stock not reacting in the way you might expect it to, which for me as a long-term investor,

lights me up. Congratulations in the front and sales in the back. You're a long-term investor. So, uh, why do you plan on holding your Chipotle shares for a while then? I mean, I think this, this, this company is just, is knocking the ball out of the park with their, with their promotions, with their, um, food, their quality, their, their growth Chipotle has about over 3000 stores and they're looking to get to about 7,000 in North America and they're growing internationally. I think they just opened their store in the Middle East. I think it was Abu Dhabi or Dubai. I can't remember which one. Canada, they have one that's opening. So they still have a long runway for growth. And these results actually made me interested in

not only holding, possibly even buying more at some point when I can. Let's turn to Southwest. Another big story. They reported earnings, but the bigger news is that they're going to get rid of the boarding process where you don't have an assigned seat. So before we dig in, do you like, do you like having an assigned seat when you get on a flight? I like having a science seat. I don't, I don't like, uh, I think the flight, uh, the, uh, traveling, traveling is stressful as it is enough to worry about as it is.

And when you have kids, you're, you're managing them. The last thing I want to worry about is having to get on board of the plane and fight for a seat from somebody and then have more issues. And I like the comfort and the convenience of knowing, all right, this is my seat. This is where I'm going to sit. maybe because it's like maybe it's because i don't have kids i like the action i like i like there's there's some weird social dynamics going on you really gotta lock in when you get on a southwest flight especially i'm a want to get away flyer so i'm back in c and and you got to make

some reads as soon as you get on anyway southwest reported earnings this morning big news ceo bob jordan says the airline is now now i'm quoting taking urgent and deliberate steps to mitigate near-term revenue challenges end quote the big news on that is implementing assigned and premium seating so i know you don't like you don't like the open seating but what do you think of this sudden move by southwest i don't think it's that bad of an idea i don't really see customers as being so gung-ho about southwest having like open seating that they would just move away from the company and not use them for flights but i think it also helps to expand their revenue in terms of their seats and taking advantage of different locations different pricing and kind of help

their revenue and create some more uh demand there yeah what southwest is responding to a couple of things one is uh elliot management which has taken a big stake in the company although you know what ceo bob jordan on cnbc saying that this move has nothing to do with the activist shareholders There's absolutely nothing to do with them, but its profit is down almost 50%. So what's happened at this airline that created this problem? I mean, look, like I think their, their revenues are generally okay. All airlines from the little I know about them have just faced increased costs when it comes to fuel, labor, planes, issues with planes like Boeing, not getting deliveries

of those planes, just tons and tons of issue. I can't imagine how difficult it must be to manage an airline business. So, you know, they, they need to do whatever they need to do, um, to, to kind of get their profits, um, going again. And, you know, a lot, there have been a lot of airlines that have been profitable because they've done all kinds of things like premium seating and, and charging for bags and charging for God knows what, um, it's, it's probably overboard. customers don't love it but it's helping the the businesses and you know look the ceo bob jordan is is on the hot seat while he says elliot has nothing to do with it clearly they have something to do with it also clearly elliot's calling for him and the chairman uh kelleher to be booted and kelleher

is a founder so that that's that's big time a lot of pressure yeah they're they're they're making some moves including seats with extra leg room adding overnight flights and they're facing pressures, as you mentioned, with Boeing not delivering the planes that they have ordered from them. When you look at these moves from assigned seating, adding overnight flights, do you think these are going to be enough to appease the wolves over at Elliott Management, which has a $2 billion stake in the company? I mean, if they're able to generate some profits from it, then maybe they will. But I think it's going to take, they're going to keep drilling into them for sure. All right. Final question. They've taken away the seats. Do you

think that free bags are next on the cutting room floor for Southwest airlines? I don't think so. A big part of their promotions is bags fly free. Um, they're one of the only us, they're the only us carriers carrier that doesn't impose fees to check two bags. Um, the CEO has said they won't, they won't charge for checks bags and they're not contemplating a change. So, um, it's, it's actually a pretty important point for customers as I know I would be very, very hesitant to to fly if they're charging me bags. We'll see what happens. All right, Sam Miteo, appreciate your time and your insight on this. Thanks, Ricky. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask

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rippling.ai slash fool. All right. Up next, Asit Sharma joins me to take a look at one of Warren Buffett's favorite investing metrics. So Asit, something our CEO co-founder Tom Gardner discussed at FoolFest was this metric that I really hadn't looked into before. And I wanted to get to the bottom of it more with you. And it's called RAUNTA, which is return on unleveraged net tangible assets. How's that for a word salad? Here's why you should pay attention though, is because this is said to be one of Warren Buffett's favorite metrics. I'm struggling. Where do we start breaking this down? Should we start with the net tangible assets part?

Because, you know, I want to understand what Buffett's looking at, but I want to be able to get this in a, in a clear way. Yeah, I think we can start there. I mean, some of our listeners will be familiar with a term called RONTA, which is return on net tangible assets, which is conceptually easier to understand. When I start thinking about RONTA in my head, a song comes to mind, help me RONTA, help, help me RONTA. So here we go. Let's start with the net tangible asset space. I think that's pretty easy to understand. So when you are a publicly traded company or when you're a private company, you're going to have hard assets on your books. think cash, think receivables, inventory, and fixed assets, then you're going to have some

intangible assets on your books. Maybe you acquired a company which had some intellectual property and you paid more for the intellectual property versus the hard assets on the books. Accounting forces you to put the value of the intangibles you required on your own balance sheet in the form of goodwill. You can also acquire intangible assets in other ways. You can even develop them in-house. When we think about the asset world in accounting and translate that to business, there's always a tension. Certain investors want to focus on the hard assets that are returning that economic value. Accounting standards and other investors want to focus on everything, the whole soup, whether the asset is intangible or tangible. Net tangible assets

means we exclude goodwill, other things like intellectual property, and just look at those hard assets that I was talking about before. So it's a more concrete way of getting an asset base for a company, which if you have Disney and you think about the trademarks and intellectual property, they may have, could be an issue. But generally, we're talking about rules of thumb here. The second thing that this gets rid of is the debt. So when we get to this return number, Why are we getting debt out of this thing? Okay. So let's now extend net tangible assets by one letter, unlevered net tangible assets. And that is getting rid of the debt. If you're actually performing this calculation, you're adding debt back to the equation. And why is

that? So conceptually, Warren Buffett thinks that companies shouldn't necessarily be penalized for having a lot of debt, because his focus is on the assets on the top of the balance sheet that are making the money. Sometimes companies borrow quite a bit of money to acquire intangible assets or to make an acquisition where they've got goodwill. In Buffett's mind, this goes back to how we should think about intangibles. Accounting treatment says you should start amortizing those every year. You should wind the value down by a certain amount each year. Buffett says no, they contribute economic value to the balance sheet. You could just sort of ignore them. So let's think about Disney, right? Disney has all this intellectual property. So it's recorded

that somewhere on its balance sheet. But what's really driving the returns is the combination of the brand, the intellectual property, and the cash on its balance sheet, the theme parks, the cruise ships, hard assets. And Buffett likes to think in those terms. I get that intellectual property piece. I get the IP piece. I get the goodwill, but I want to see what those physical assets are returning. And that starts to make sense to even a lay investor. So we're putting the return on top of this thing. We're looking at the net income, basically on top of these hard assets. What is this number? What is this whole thing tell investors about a company? Yeah, it's pretty simple. Let's think about net income. That's easily understood by

every investor. It's the money left over at the end of the year after a company has pulled in its revenue and paid all its expenses out. There's one little tweak here. Buffett says, look, that amortization piece, that non-cash theoretical charge against earnings that we each year push against total assets, we should ignore that. We're talking about real returns. So, you remove amortization from net income, and that's the top of your equation. That's your return piece. On the bottom, you're thinking about those net tangible assets. If you've got debt, add that back so you're focused as an equity base on the stuff that's

producing the real-world economic returns. And that's the gist of how we conceptualize this. So, in theory, it's pretty simple, but surprisingly, Ricky, it's obscure. Now, as you pointed out, our CEO, Tom Gardner, has alighted on this as a metric he's looking very closely at. For those listeners who might have attended FoolFest, you heard him talk about this. If you go out on the web and try to find out all about Rounta, R-O-U-N-T-A, there's not much written on it. Here's the reason. Warren Buffett has never clearly defined what he means by Rounta. The investment community has backward engineered this and pieced together what he means.

I went through our in-house AI model to get an Excel formula to find this thing. Is there an easier way to find this? Like, where am I supposed to go looking for this asset? There are a couple of articles that, if you read through them, will sort of summarize this conceptually for you, but they're sort of tense reading also. You could go to Warren Buffett's shareholder letters over the years, and there are certain years in which he sort of crystallizes the concept. But I'll say this.

Look, it's a lot like return on invested capital. There actually is no single definition for ROIC. Other people talk about ROIC all the time like it's crystal clear. It's not. If you talk to one investor, he or she might have a slightly different version of that than another investor. I think it's going to be one of these things, if more people look into it and use it, that's accepted and conceptual, just the way you and I have talked about it rather than, here's the specific formula. This is the way you always calculate it. I have my way of calculating it. I'm sure you have your way. The AI probably has a way. To each his own, as long as conceptually we arrive at the same place. My way of calculating it is very closely

aligned with the AI's way of calculating it, Asit. For listeners, there was one change where I had the interest expense, Asit had the amortization. We got in the same ballpark for most of the companies but as we're talking about ballparks what's we've just described this complex metric for a company that says what they're returning on their hard assets what's a good round to we do all this stuff it pops out a number what's a good one i got like i got 40 for lululemon and just 11 for your beloved amd nvidia is really high my measure was 97 but i've seen metrics that are way way higher than that yeah i think it's a great question so first of all we may have to make a differentiation between pre-tax and after-tax round two.

Oh, this is fun. Are you having fun, Asit? I'm having so much fun. I know I've got to raise my voice. I just got a visual cue from you as we're recording on Zoom to raise my voice. We wake some people up here at the halfway mark, but I'm actually enjoying this conversation so much. So yeah, let's think about that. Actually, we won't. We'll just assume it's all after-tax. A good after-tax number is sort of ballpark where Lulu is. I would say 30% and above, you start to get a sense a company is doing something really nice with its assets. Now, we should point out, we were just chatting before we taped, Lululemon actually doesn't have any long-term debt, and they

don't have much of anything in the way of intangible assets. When you crunch their normal net profit margins or operating income versus Roundtip. The numbers aren't that all different, but it says something about Lululemon. It's a highly profitable company with a great brand. Their stuff is pricey. So they bring home a lot of money at the end of the year. And I do want to come back at you on AMD, but you may have a question or an interjection first. Just 11%. On my calculation, I just got 11% for your beloved AMD. You're a big fan of AMD. you were upset in the CEO draft when, when my team got Lisa Sue and yet they have such a low round to, do you take that personally? No, I take it in context. And here's

a thing like any one metric that you look at, whether it's, I know some investors talk about the price to earnings growth ratio. Others are focused on Ford, uh, manifestations of free cash flow, everything in context and AMD actually over the last year was at the bottom of its cycle in all the businesses that it operates in, which is a wide part of the semiconductor industry. You can look back two years and three years ago, and it would have a much higher round to score. Now, I'm going to take a little issue with your calculation. I'm just going to read these numbers out for anyone who still might be awake and happens to be interested in this stuff. To show you my derivation real quick, $68 billion total assets. You're going

to take out the intangible assets of $45 billion, gets you to $23 billion in adjusted total assets. You're going to take out $11.7 billion in liability, add back 1.7 of long-term debt. Your base is $13.4 billion. Now, I know no one listened to that, but just to make a point, if anyone has a calculator in hand, when you take the last year of earnings for AMD and add back some amortization expenses, not more, you actually get $3.6 billion. They have a large amortization component on their books. Actually, I misspoke. So that leads you to a 27% return on unlevered net tangible assets for the last year. You go back two years and it's way higher. So AMD is doing all right. NVIDIA is really the one that stands out as it's just super high. And

we can, we can chat about that. So I know you can't see this, but asset when he's doing his numbers his face shifts he's going hard in the paint at that point yeah the blockbuster is nvidia i got 90 or more than 90 i've seen it way higher okay regardless of the calculations we got nvidia's roundta is way higher than amd it's one of its direct competitors so what what story does that tell you about nvidia well first ricky it tells me that NVIDIA has amazing pricing power. This is a company that really burst onto the scene. We all knew about it, but with generative AI, it's supplying GPUs at a name-your-own-price level to hungry hyperscalers and enterprise businesses. The margins have exploded. Also,

it doesn't have a lot of long-term debt on its books relative to its base. That doesn't affect the calculation much. But here's the kicker, why Roundt is even higher than you might expect. They've done all of this without much of intangible assets versus the rest of their hard asset base. Total assets of $66 billion, Goodwill of only $4.4 billion, and intangible assets of only $1 billion. You're talking about a company which has developed everything in-house for a long period of time, and suddenly is able to capitalize on that. Every bit of cash, accounts receivables, inventory, prepaid expenses, you name it, that just has so much more of a yield versus a company that might have had to acquire all this intellectual

property and take on debt to make that happen. This company's built stuff in-house, they're naming their price, and so their round is through the roof. Alright, so let's wrap up with this. You went through the calculations for the people that are holding on to a calculator, for the people that aren't holding on to a calculator as they listen to this show. Are there any other financial metrics that pair nicely with this, that can give investors an idea of how good a company is at generating cash on its assets without maybe pulling up the Excel spreadsheet? Yeah, you named it, Ricky. I mean, Cash is so important in investment. That's what we really value companies on. A company with a

high round-to score often will have increasing cash flows over the same time period that you calculate round-to. Sometimes those, though, will get diminished by the fact that, as you were chatting just before the show, there's interest expense on the debt. Round-to can't give you everything. But I think looking at cash flow metrics, if you want to compare forward cash flow to a company's enterprise value, so that's common stock, market capitalization, plus the debt piece, those are not bad to pair together. But I like that theme that everything has to be taken into context. If corporations had straightforward balance sheets and they were all the same, you wouldn't need a world where you had to distinguish between Ronta and Ronta

And Buffett's great insight when he was much younger that he developed over the years, and again, has never really clearly stated in the terms we've sort of had to piece this together, is that you shouldn't penalize a company necessarily if it has a lot of debt. A lot of investors think if a company is way leveraged, avoid that. But Buffett's like, no. Look at what it's doing with the other side of the balance sheet. What does that look like? That could be pretty persuasive.

They could generate the cash to pay down that debt over time. All right, Austin, I appreciate your time and your insight on this. And if you're listeners, I appreciate you making it through this. This is something I'm curious about and glad, glad for you to be here, Austin. Yeah, totally. And Ricky, I mean, you told me we'd get one esoteric financial concept a year. We've used it up, but I'm already looking forward to 2025. It's almost August. Yeah. See you next July. All right. See ya. 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 Baldy. Thanks for listening. We'll be back tomorrow.