Motley Fool Hidden Gems Investing - Time to Buy Zoom Video?

Episode Date: June 23, 2022

Most restaurant businesses operate in a single category, but not Darden Restaurants. (0:25) Jason Moser discusses: - Olive Garden driving the bulk of revenue - A comeback by Darden's fine dining segment - Capital decisions that we like (dividend increase!) and don't like (share buyback plan) - Rite Aid's stock pop and raised guidance still not being enough to get us interested in buying shares (14:41) With shares down nearly 70% over the past year, is Zoom Video a screaming buy or past its prime? Jason Hall and Ryan Henderson debate bull vs. bear! Stocks discussed: DRI, RAD, CVS, WBA, ZM, MSFT Host: Chris Hill Guests: Jason Moser, Jason Hall, Ryan Henderson Producer: Ricky Mulvey Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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BetMGM operates pursuant to an operating agreement with iGaming Ontario. We've got restaurant, consumer health, and a bull versus bear debate about the ultimate stay-at-home stock. Motley Fool Money starts now. I'm Chris Hill, joined by Motley Fool Senior Analyst Jason Moser. thanks for being here. Hey, thanks for having me. Darden Restaurants, wrapping up the fiscal year with some nice numbers, fourth quarter profits and revenue, both came in higher than expected for the parent company of Olive Garden. I hasten to point out these were not particularly high expectations,

but it does seem, Jason, like they are in pretty good shape heading into this new fiscal year. I say that in part because they're also raising their quarterly dividend 10%. They did, yeah. I noticed that. A 10% boost to the dividend from just a quarter ago, that's encouraging, particularly for a restaurant company in this market. Inflation was one of the themes of the call, and certainly Darden is not immune to the effects, but they've managed their way around it very, very well. The stock is holding its own here in a bear market. It's down with the market this year, but not much more, which you have to chalk that up as a win. But when you look at the numbers, total sales were up 14.2% to $2.6 billion.

That was driven by the same restaurant sales of 11.7%. Also added 33 net new restaurants for the quarter. Profitability is being challenged. Again, you go back to that inflation that so many companies are dealing with these days, but they are holding their own. I think this is really an Olive Garden story. We've talked about that before. Olive Garden represents the crux of their business, and those same-store sales were up 6.5% for the quarter. Longhorn Steakhouse, another big contributor to the business, those same-store sales were up 10.6%. When you put it all together, that's one of the attractive parts of Darden as a potential investment, is that they have these multiple revenue drivers. They pursue not only the Olive Gardens and the Longhorn Steakhouses

of the world, but they also have the fine dining segment, along with other concepts like Cheddar's, for example. When you put it all together, it's done okay. If you stretch your timeline out really long. You look at it for over a 10-year stretch, it's really done well. But again, in what is obviously a difficult time for all restaurants, Darden certainly continues to hold its own, which is encouraging. I'm glad you mentioned the fine dining, because that is one of the things I like about this business, just from the standpoint of us talking about it. We like to talk about restaurants, but restaurants overwhelmingly operate in a single category. And Darden Restaurants operates in multiple categories.

So they've got that. It's a smaller segment. You're right. Nearly half of their revenue comes from Olive Garden. But the same store sales in fine dining, Capital Grill, Eddie V's, up more than 34%. Granted, it's off a low base and it's a small segment. But that's still great to see the growth across the board regardless of category. Yeah. I think that just goes to show their ability to capture all consumers on the low end and the high end. Another one of the common themes in the call while they're dealing with this inflationary environment, they continue to really focus on bringing value to the consumer. Because of the Olive Garden Longhorn Steakhouse dynamic of this

business, that being really the crux of the business. They continue to price below inflation, and they really tout that on the call. They continue to price below inflation because they want to continue to bring value to their customers. They feel like this is exactly the time where they really need to be on message with that, and it's working. If you look at Olive Garden, for example, Mother's Day, Olive Garden delivered record performance, the highest sales day and the second highest guest count day in their history. That just goes to show they're able to really present a strong value proposition with something like an Olive Garden while at the same time servicing that higher-end consumer that's looking for a fine dining experience. You put it all

together and it's working out pretty well for them. It's not to say it's all sunshine and lollipops. They are going to have to deal, I think, with a very high inflationary environment here in the beginning of the new fiscal year. But they do see that abating as the year goes on, and that really could play out on the bottom line well for them. I think one thing, I'm going to ding them a little bit on their share repurchases. They've spent more than $2 billion on share repurchases since 2017. You'd like to see that resulting in the share count coming down significantly. That's obviously a lot of money. Their share count is down only incrementally. And that's a little bit of a problem. I'd like to see that share count come down more.

And maybe that's something they'll focus on as economic conditions ease. But again, I mean, just the dynamic of this business being able to serve really every consumer, I think is really a strong point for them that they continue to exploit. You read my mind because I was going to ask you about the, you know, in addition to the dividend hike, they announced a share repurchase plan of $1 billion. This is a $14 billion market cap on Darden restaurants. I thought, boy, that seems pretty high. This is the first quarterly report with Rick Cardenas as CEO. He took over for Gene Lee, who had been running the company for about seven years. It's always worth remembering that share repurchase plans are not necessarily a

a guarantee that they spend the full $1 billion. I don't know, maybe the new CEO was looking to make a little bit of a splash and send a signal to the market of, we believe in the future of this business. But I don't know, I feel like he could have done that with just a quarterly dividend hike. Yeah, probably so. But like you said, those authorizations don't necessarily mean that that money is going to be spent anytime in the near future. They absolutely are looking to reinvest back in the business. They foresee opening 55 to 60 new restaurants this year, forecasting about 7% revenue growth at the midpoint there, which is also encouraging. If they do see those inflationary pressures

continue to come down throughout the year, let's hope, because we're all feeling the pain there. But if that is the case, then I think that will really play out on their bottom line, which will be likely a good result for investors. The stock of the day appears to be Rite Aid, miraculously. First quarter revenue was higher than expected. They raised guidance. The shares are up more than 13% this morning. As I said to you right before we started recording, hey, Rite Aid, still alive, still alive and kicking. I don't know, I can see someone getting tempted here. This is consumer health, this is a needed service that Rite Aid provides, and this is not a big company. This is a market

cap of less than $500 million. I see someone looking at the pop, the raised guidance and thinking, oh, maybe I should pick up some shares. I think you and I are of like mind, which is like, maybe not, maybe don't. I feel like you think twice about that. On the one hand, I like the market that Rite Aid serves. This is ultimately a business that's trying to transform into a modern-day pharmacy, as they put it. In a modern-day pharmacy, I think you can equate that with more of a healthcare company. We've seen CVS and Walgreens do the same thing with, I think, a lot of success. From that perspective, the healthcare market is really attractive for investors. It's just so large. It continues to grow. Really, it's

something that we all need. Really, there's not enough of it to go around. A lot of companies are out there trying to figure out how to solve that problem for scaling healthcare as those services become more in demand. I like Rite Aid's strategy there in trying to become more than just a Rite Aid store. It's got the pharmacy services segment, which is ultimately their pharmacy benefit manager, and that's the Elixir pharmacy benefit manager side of the business there that they continue to develop, which could work out in their favor. I think they quoted serving around two million lives at this point in that segment, is okay, but when you compare it to the competition out there in CVS and Walgreens, Rite Aid is

just a distant third at best. It's not to say that they can't continue to gain some ground, but they really have a lot of work in order to be able to do that. They only have around 2,500 stores today, which is a much, much smaller footprint than CVS or Walgreens for that matter. You look at the numbers, not bad. Revenue is $6 billion, just essentially flat. They continue to work on whittling down that cost structure, which is ultimately something they're going to have to do. They're trying to differentiate themselves a little bit on that in-store experience with more alternative and holistic style approaches to medicine, which that could work out. I don't know. That remains to be seen really. But when you look

at the fundamentals of the business, I would say are still very challenging. The retail pharmacy segment of the business, that's essentially 70% of the business. That's prescriptions, that's people going into the store, and they are figuring out ways to deliver beyond just the in-store experience. They are offering new ways to do business. They announced a partnership recently with Afterpay. I think they were the first national drugstore chain to actually offer that flexible payment solution. That's good. You're trying to give consumers more ways to interact and ultimately do business with you. But again, you go back to the fundamentals of the business. It's one where growth is really challenged, profitability is even more challenged,

and it's just difficult to see how they can gain meaningful share over competitors like CVS and Walgreens that made these decisions seemingly light years ago. ago. They made these pivots a long time ago to become this more modern-day style pharmacy healthcare company. While I do commend Rite Aid Management for doing the right thing, I don't know that it's going to ultimately serve as an attractive potential investment. They are still financially very challenged. You look at operating income, it doesn't even come close to covering the net interest expense they have on the balance sheet. They've got a lot of relatively high interest debt still out there that's going to be coming due here over the next

few years. Definitely something to keep in mind for folks who may be looking at this one. The last thing before we move on, I want to ask you about the store count, because as you said, this is a business that has, just from a number of stores standpoint, it has gotten smaller over time. It is still just under 2,500 locations in 18 states. When you look at the market cap of $450 million, it still seems like too many stores. If I gave you either data point. I said, here's a retailer and its market cap is $450 million, how many locations do you think they have? Or I said to you, here's a retailer with 2,400 locations across America, what do you think their market cap is? They just seem completely out of sync with one another.

Well, you're right. It does feel like it's a lot of stores for the numbers that they continue to return. I think that's going to be one of the bigger challenges. That really does go back to to the strategies that CVS and Walgreen undertook years ago and really making those stores become more than just your local drugstore where you go in and you get your prescription filled and you can buy various grocery items that you may need. They've focused on turning those stores more into healthcare centers. Offering things like virtual healthcare and whatnot, ultimately turning those into little healthcare centers. It's true, there are a lot of folks in the United States where they live far away from these types of locations. There needs to be a

physical footprint, but you got to make sure that you place those physical locations very strategically. You go back to the competition in the space and they just are well ahead of what Rite Aid is doing now, which I think it's just going to make it very challenging. I think you're going to see Rite Aid continue to close underperformers while trying to open new stores, and that just becomes very costly over time. Jason Moser, always great talking to you. Thanks for being here. Thank you. Up next, we're going bull versus bear on Zoom video. Shares of the signature stay-at-home business are down nearly 70% over the past year. But with so many companies still

on the platform, is the stock a screaming buy or are its glory days in the past? Ricky Mulvey has more. Welcome to Bull vs. Bear. We find a company, find some analysts, flip a coin, they get a side, and then give you their case. Today, the company is Zoom. In the Bull corner, we have Jason Hall. Jason, how are you doing? I'm great. I'm really looking forward to this. And in the Bear corner, we got Ryan Henderson. Ryan, how are you feeling? I'm doing good. I admit I was hoping for the other side of the coin, but uh, I, I think I can argue the other side. You don't want to tell listeners what, what, what, what side you actually want. Then they're going to think you're not,

you don't believe your side, man. No, no, you can't. Are you tapping out this early? No, I can make the case. It's just, uh, I I'll, you'll see, I'll, I'll give it a try, but there are certainly some risks and I think Jason will concede to that. They're real. All right. Well, let's hear about the bull case starting off. Jason, you have five minutes. We're ready when you are. For those of you that don't know Zoom, I want to know where you've been for the past three years, and if it's possible for me to go there. But for the rest of us, Zoom has been the company so many of us use to communicate with the world. Whether it was Zoom happy hours, whether it was the way

that you did your work, whether it was the way you were tied into volunteer groups that you were a part of. Zoom became the way the world works for a couple of years. And the reality is that as much as that's been the case, Zoom is starting to change. Zoom is still a growth company, but it's now a growth company that's helping the enterprise integrate their communication tools to better serve internal and external stakeholders. So we think about that core Zoom video app that everybody has on their iPhones or their desktop, their laptop they're using for work. And now there's products like Whiteboard, Zoom IQ, Zoom Phone, guys, which by the way, passed 3 million seats last quarter. You go back two years ago, it didn't exist. And now

they've got 3 million seats. We have Contact Center. These are all things that are built on that core Zoom video app to make it more useful and to help solve more communication problems that are the result of what's happening. We have these multiple unconsolidated products that your sales force is using, that your customer service people are using, that you're using internally. They make it more difficult and more complex for all of your stakeholders that you're trying to communicate with. The result, revenue is still growing at double-digit rates, even though maybe we're not using Zoom as much at the small business level or at the solo level. Revenue is still growing at double-digit rates. In the first quarter of fiscal 2023, it reported that in May,

revenue was up 12%. Now, that might not sound all that impressive, but we peel back the layers. We see it's really attractive what's happening at the enterprise level. It now accounts for more than half of sales. I believe it reached 52% in the first quarter. Sales in the enterprise revenue was up 31%. The number of enterprise customers grew 24%. This isn't a COVID story anymore. Net dollar expansion rate was 123%. That means that it's customers that spent $100 last year, they spent $123 this year. The enterprise is telling us with its dollars that Zoom is increasingly important and increasingly valuable to them. No less than Gartner, in its magic quadrants, says Zoom is one of the three leaders in this space. Besides those three leaders,

it's not even close who else is there. Still looking to build more tools. This is a company whose founder says, we're going to continue to spend money. Made an acquisition to help boost specifically artificial intelligence for communications. Bought a company called Solvee. I think we're going to see Zoom continue to do things like that, to continue to build its tools, to solve more problems, help its enterprise customers do more and more with how they communicate. Today, you can own all of what I expect to be a company that, if you look at the next five-plus years, is going to still grow earnings per share between 15% and 25%. I think 30 times earnings. 2023 expected earnings is what you can buy that for.

Still get about $5.7 billion in cash on the balance sheet to fund a lot of that growth. No debt. Still generating well over $1 billion in cash flow. I think it was $1.5 billion over the past four quarters. You have a cash cow business still growing. The enterprise is telling us with their money, it's more and more important for them to have a company like Zoom that's working for them. For 30X earnings, I am a big bull. And that's the bull case from Jason Hall. Now, on the bear side, we have Ryan Henderson. As I alluded to earlier, I'm fairly optimistic, but I don't own the stock. There are a few reasons or a few risks that I want to touch on. The first one, and this

is probably the largest one, I think Jason will probably concede that this is a concern as well. COVID was certainly a pull forward in demand. I don't think that's any secret. But a lot of the smaller customers that bought seats, there's a good chance that they won't end up renewing, or maybe they'll go back to in-person, or there'll be some sort of change to their contract or their subscription. Secondly, during COVID, they were understaffed. This is something they've talked about. They've been hiring a lot since. During that time, since they were understaffed, they were also over-earning. There was a lot of bookings during that time period, so cash flow margins or profit margins looked much higher or more elevated than they expected to be long-term.

As they've come out of COVID, they've been investing heavily in various operating expense line items. Research and development costs during the last quarter were up 105%. Sales and marketing was up 40%, both outpacing bookings and revenue. A lot of that expense has been trying to expand their product suite. So, trying to become more than just Zoom meetings and trying to be, like Jason mentioned, the contact center, the Zoom phone, the whiteboard. I think they call it communications as a service, or UCAS, I think is the abbreviation. But the risk here for me is that they spend a whole bunch of money, a whole bunch of operating, or invest through the income statement, through those operating expenses, and try to cross-sell those solutions. But at the same

time, as we've seen, a lot of businesses are tightening their purse strings. They are trying to cut expenses where possible right now. You're going to have elevated expenses with a customer base that isn't necessarily as eager to sign on. That's potentially going to lead to lower cash flow over the coming years. The second one for me that's a big risk is the stock-based compensation. I've talked about this with a lot of companies. This is something that management talked about a lot during the most recent conference call. Over the last couple of years, Zoom has hired tons of employees. As I mentioned, they jumped from, I think it was 2,000 total employees to around 7,000 total employees. A lot of those employees took restricted stock

units or options as compensation at much higher prices than Zoom trades at today. In fact, over the last 12 months, they've paid out just under $600 million in stock-based compensation. Now, moving forward, those restricted stock units will not be worth nearly as much, I imagine, as employees thought going into it. The stock is down around 80% from its highs. That's a natural part of the stock-based compensation cycle with employees. There's a number of things that I think this could potentially lead to. The first one would be either potentially greater employee attrition. Employees may be looking for other places to go. They think they can make more money somewhere else. Anytime you have to retrain employees or recycle through your

employee staff, it's going to be costly. The second one is, Zoom may be having to issue more stock in order to get to the same level of compensation for those employees. That's not great for outside shareholders. And then the third one would be employees choosing or asking for cash compensation instead of stock-based compensation. That would also lead to lower cash flow for the company over the coming years. And so, those two things that I mentioned, yes, I do think Zoom looks cheap on trailing cash flow numbers. I think it's at an EV or a market cap to free cash flow of around 19 times trailing. But I think there's a very good chance that cash flow over the next few years is lower than they generated previously.

You have to value it on that basis. That's obviously what investors are paying for. The last two that I'll mention, Jason mentioned this, they are signing a lot of enterprise customers. However, the higher margin customers are the online ones, the ones that sign up on their own. And those have actually been decreasing a little bit. That's kind of natural because they had that COVID benefit, but it's going to hurt margins a bit. And then the last one I'll say, and I'm not the biggest believer in this, but it is a real risk, is the competition. Microsoft does offer a compelling bundle, especially if you already use some of their services. That doesn't necessarily mean Zoom customers are going to leave, but I could very easily see that hurting Zoom's pricing

power over time, just because if you try to raise prices too much, they'll say, well, we got a substitute that we can go with. Ryan Henderson on the bear case, Jason Hall on the bull case. You can decide who made the better argument at Motley Fool Money on Twitter. We'll have a poll there. Why should you vote? Well, because one of these contestants is going to win a fabulous prize package. Steve Broido, take it away. A lovely dining room set from Bassett. Eighty square feet of shag carpet from Galaxy Carpet Company. The remaining $9.27 on a Cracker Barrel gift pack. 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 Chris Hill, thanks for listening. We'll see you tomorrow. Thanks for watching!