Motley Fool Money - Follow the Cash: Celsius, Chegg, Nelnet

Episode Date: August 9, 2023

Earnings from Chegg, Celsius, and Nelnet show why it pays to watch cash flow and how businesses can shore up when there’s cash on hand.  (00:21) Jim Gillies and Dylan Lewis discuss: - Celsius incredible top and bottom line results, but why investors should pay attention to the energy drink maker’s relationship with Pepsi and accounts receivable. - Whether Chegg can harness AI for its education offerings. - Why Nelnet’s slow and steady Berkshire approach continues to pay off.  Companies discussed: CHGG, NNI, CELH Host: Dylan Lewis Guests: Jim Gillies Engineers: Dan Boyd  Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finale of any episode we've ever done. We are going to play Truth or Daredevil.

What? Oh, boy. Fantastic. You guys go hard, man. Daredevil Born Again, official podcast Tuesdays, and stream season two of Marvel Television's Daredevil Born Again on Disney Plus. We've got some interesting earnings updates, just not from companies you'd expect. Motleyful money starts now.

I'm Dylan Lewis, and I'm joined over the airwaves by Motleyful Canada analyst Jim Gillies. Jim, thanks for joining me. Thanks for the invite, Dylan. Of course. Today, we are going off the beaten path, Jim, and we are taking a look at earnings from a few lesser-known names. But we're going to start with one of the biggest movers. Celsius may be a company on people's radars if you're looking at big movers today. shares up 20% after reporting earnings. Jim, if you haven't heard of this one, pay attention

when you're in the beverage section of the supermarket. They are growing their presence there and some big numbers in the earnings report pushing that big stock pop today. Yeah, I mean, this is one I have heard of. I was briefly an owner back a few, a while ago, and it was just a small position that we were playing games with. But their earnings report, The headline news looks pretty darn good. I mean, I think revenue was up 112% year over year. That's okay. Gross margin was up 10 percentage points, not basis points, percentage points, up to 48.8%.

Net income was up 345%. That sounds good. Earnings per share is up 333%. Adjusted Ibidah is up 350%. To be blunt with those types of numbers, Dylan, I'm kind of shocked. stock price is only up 20% today. You don't see triple digit top and bottom line growth all that often, Jim. It doesn't happen.

Well, and triple digits in the earnings thing, where the first digits, not a one or a two. Yeah, it's remarkable. That's pretty good. And I think that should be celebrated. And I think that there is something under the hood that I think investors should be aware of. But a lot of this is tied to an investment that came from PepsiCo, you know, noted large beverage player, you know, half of a duopoly Pepsi versus PepsiCo versus Coke. You know, and so there's a lot of moving parts that are actually associated with that partnership for those who are unfamiliar with my style of investing. I'm very cash flow focused.

And so I really liked the numbers that are in the page to start with this. But once I started looking at the cash flows here, I started having some questions. Yeah, let's move past the headlines on this one because in prep, you built up the intrigue for me. You said, as you start digging in, there were some stuff that had you scratching your head as you were looking at cash flow. What was it? Right. Okay. So I'm just going to kind of operate on the first because cash flow statements are cumulative throughout a year when they reported. So we're halfway through the fiscal year. So I'm looking at the first six months here. So, in the first six months of the year, Celsius does just shy of $93 million in net income.

Okay. But the cash flow, cash flow from operations, which starts with net income and then you start adding back all the non-cash charges like depreciation, amortization, maybe stock-based compensation, and you do working capital adjustments. But generally, a quick rule of earnings quality thumb is you want to see cash flow from operations higher than net income because its calculation starts with net income. then you're adding back things. You know, so in the first half of the year, they do about $93 million in net income, just shy

of that, but they only did about $45 million in cash flow. So that's kind of, okay, that's the first kind of like, that's interesting. The second thing is year over year, the first half of this year, net income has sextupled, sixfold versus the net income in the first half of last year. And yet, cash flow from operations is flat. cash flow, so the simple definition operating cash flow minus CAPX, it's actually down from last year. Not much. It's just shy of 40 million last year. It's just over 38 million this year. Okay, so my next thing is, well, okay, with the Pepsi deal is the culprit, why is their

cash flow down? Why is their cash flow far below their earnings? And I'm like, okay, well, I wonder if that's because of the Pepsi deal. And it is, but it's kind of not the way I was expecting it to be. Inventory has actually been a source of cash this year. And usually when you push out inventory and Pepsi is obviously taking a lot of inventory from them. Where I found the issue is that accounts receivable in the first half of this year has been a massive $136 million use of cash. So someone ain't paying them for product. Okay. And would you like to guess who that someone is? Based on everything you've built up so far, I have to imagine it's Pepsi, Jim. It is absolutely Pepsi. Pepsi, in fact, accounted for 68% of their receivables at the end of the

quarter, about $135 million, which of course is the increase, roughly equal to the increase in the accounts receivable. And so it's also been a couple of like Pepsi's been getting paid by Celsius here. First off, the investment that Pepsi made in them is in a form of convertible preferred shares. And those preferred shares have a dividend. So of the, of the, free cash flow that Celsius has generated for the first half of this year, about a third of it went to Pepsi in the form of the dividends on those preferred shares. The other thing is there's about, they gave some, Pepsi that is, gave Celsius some cash that they had to use as they're doing their distribution network conversion over

to Pepsi that they were carrying on their balance sheet. There was just over 30 million, 34 million, I think, if I don't have the balance sheet up on my screen. That all got returned to Pepsi during the quarter as well. So Pepsi's a drain. And the other thing too is the only reason that Celsius has positive operating cash flow in the first half of this year is because if you look through the line items, there's a $57, $58 million source of cash, which is basically unpaid taxes.

So if they actually paid their taxes, say, on June 29th versus, say, July 2nd after quarter was closed, these guys have negative cash flow. you're going to have to pay your taxes. Yeah, so that's a matter of timing more than anything else. It's a timing issue. So all of this makes me go, you know, so my take, and I have no stake in this company or Pepsi for that matter. And again, I really like the headline numbers here, but there's something weird going

on under the hood with cash flows. And look, any of my concerns go away if Pepsi pays these receivables by the time Q3 is reported, Right? Like, if this has been a timing issue. But it strikes me, there's a, when I, again, because I'm a cash flow guy, when I see stuff like this, it makes me very, it gives me some qualms. I'll put it that way. Now, I ultimately think the ultimate play here is probably Celsius goes away at some point is gobbled up entirely into the great maw that is Pepsi. We saw this a few years ago with Soda Stream. They made an initial investment in Soda Stream. ran a partnership for a couple years and ultimately acquired the whole thing.

I think that's probable what happens here. And I think Celsius, I mean, they have a very recognizable brand. They have relationship with Costco. They have a relationship with Sam's Club. But right now, just be aware the cash story is not as optimistic and bullish as the press release earnings income statement story. So, Jim, to back that out a little bit and kind of put a bow on the way that we're looking at Celsius and Celsius's quarter, sounds like looking forward.

you need to be watching the Pepsi partnership. And I think the story for the business, whether it's quarters or years, is, does this partnership become something that becomes less of a partnership and more of Pepsi just owning this business outright? Yes, I think that's a fair comment. So certainly a lot to follow with Celsius in the upcoming earnings report, and really for the next couple of years. Jim, we also got an update on Chegg. This is the online education company and some kind of interesting after-hours movement

with this company and its earnings report, share shot up 30% after the company reported and is now basically back down to prior to reporting, what happened there? People, I think, got a little enthusiastic that it wasn't a sucky quarter, and I'll explain why I'm going in that direction in a minute. And then I think the last couple of days,

it's just in general markets, something kind of bleh. And so I think people are giving it back. The story with Chegg starts about three months ago, or at least my interest in the story with Chegg. It starts about three months ago when they reported Q1. Basically, I'm going to paraphrase, but essentially they said, hey, remember how we weren't terribly concerned about AI impact on our business? Yeah, well, by the way, it's going to have an impact on our business.

But hey, don't worry, we're going to co-opt it for our benefit. The market didn't believe them. Stock fell almost 50-50% in a day. Management here and the story they were telling there and the story they are telling in the most recent conference call as well is that they're kind of treating AI and the move to AI as more of a tailwind versus a headwind. They were talking last quarter about their virtual tutoring tool, which they're developing in cooperation with Open AI. They were calling it Cheggmate. Thankfully, a name that seems to have been dropped because that is a terrible name. It's a bit hokey. Well, look, the name Chegg itself is hokey, right?

It's a portmanteau of chicken and egg, you know, which came first, right? You need a job to, you need a degree to get a job, but you can't get a job without a degree. Anyway. No, I think they are, they have made some good progress in this quarter. They made some progress in terms of, they're saying that, you know, what their research is telling them and what their experience is telling them, and especially with, as they've released this first iteration of their virtual. tutor is that students are looking to chat GPT and looking to Chegg for separate things.

And they are saying that, you know, we can leverage our, you know, large giant, giant database of, you know, solution sets and answers and just teaching tools, marry that with, you know, a conversational AI interface that actually improves educational outcomes for for students. Now, if you're a student who's looking for a chat GPT to write your essay for you, okay, well, that's another, that's another thing to talk about. But, you know, everything in the conference call and in this quarter says that they are making progress on leveraging AI for the value of their shares. And as for the market reaction, Dylan, I think it's fair to say the market reaction says the market

doesn't believe them, right? Yeah, I was going to say, I mean, so much of what we're. looking at with the impact of AI is near-term roadmaps and initiatives that at least show companies are thinking about it, but the reality that a lot of this is probably being pushed out to 2024 and beyond in terms of material business impact. Is that how we have to be looking at anything for Chegg here? Well, I mean, we are very, I mean, it's the summer. So, I mean, in the present quarter. So, yeah, like the impacts on their reported financials will really start to roll in, probably

with Q4, because Q3 is going to be light because all the universities and colleges are, you know, kind of empty right now, or at least, you know, much lower, much lower student basis. But yeah, like this, I think for me, where I'm kind of going with this is here is a company, like we've seen investors over the past, I'm going to say nine months-ish, get really excited 3D printing style, SaaS style, cloud style, about potential AI investments. And I hope you heard the cynicism dripping from my voice there. Just a bit. Just a tad.

And so here is a company that, you know, I will argue, has to embrace AI. I mean, let's be honest, they kind of have to. And so they are. And they're actually reporting some pretty decent results. And they're also taking some pretty good capital allocation moves. And paradoxically, they're not getting rewarded at all. So what we've got here is a company that is embracing AI. The market isn't believing it.

And so they're doing some interesting things to set themselves up. What are they doing? They are actually making a not small amount of cash. And again, we just finished talking about Celsius and my concerns there. I'm kind of sitting opposite here for Chegg because over the past four quarter, including the quarter, the Q1 of this year, where, you know, again, 50% down. And then this quarter, which was perfectly fine, they have generated about 180, I'm going to say about 181 or so million dollars in free cash flow.

Okay. That's interesting. What have they done with it? Well, they have been deploying all of their cash wealth and a lot of the free cash generation. They've been buying back stock. Okay. So they're buying themselves on the cheap. They have been buying back their debt. And that is interesting to me because this is convertible debt. They're essentially paying nothing on. So why are they buying it back? Because they're buying it back at a discount. You love to see that. I love this. This is like this is my favorite

capital allocation move when I see companies doing this kind of. of thing. If you, because, you know, if, I mean, Dylan, if, if you owe a thousand bucks in your credit card and your credit card company says, hey, we'll take 750, who among us would not immediately pay that 750, right? It's a great rate of return. Yeah. I mean, yeah. And well, writ large, that's what Chegg has been doing for a few quarters, but really dialed up in this most recent quarter. I think they bought over 400 million dollars worth for about 360 million ballpark. So that to me is, I love that move because when that debt eventually comes due, and I hate convertible debt for a number of reasons, but we won't bore people with that right

now. But the fact that they're buying it back at a discount, love that move. Fantastic. Guidance this summer doesn't look bad for the summer term. It's the lowest seasonally adjusted term, but it doesn't look bad. Their margins look okay, even though they are spending heavily to make their AI solutions ready for prime time, if you will. And here is the thing. At this point in time, today, at today's price, as you say, after they've given back everything, this is a company that is trading at about six times trailing free cash flow. And that's really, really cheap. And you know what? Even if they're only half as successful as they plan, plan to be if this thing moves from six times to 10 times, which would still be cheap, in my opinion.

You know, you get a two-thirds, you get a 67% return on your investment before actually, if they actually start growing themselves. And then the question I ask is, well, what if this actually works? Yeah, what if it all comes together? Yeah. So this is a potential, we're going to call this a potential double play, although double play is negative in baseball terms, but like, in terms of you, if you get actual growth, this thing works. And, and, you know, and, you're And as a result of getting that thing working, you get a higher valuation multiple. This one could turn interesting. It's always nice when not a lot has to go right for something to materialize for you.

I much prefer stepping out. What's your hurdle? I like when the hurdle's on the ground, I can just step over it. Yeah, it's a beautiful thing. Jim, our final company that we're going to check in on today is NellNet. And a company that you call a slow and steady one in show press. and kind of a slow and steady quarter, a muted response to the results from this company. They're generally known as a financial services business specializing in student loans, but they

kind of do a little bit of everything. What jumped out to you in the results? Namely that, again, it was very slow and steady. So NellNet is a company I've known for a while, recommended for a while. It is a student loan servicing company. It's a professional services company. It's a consumer loan originator. They got a bank stuck in there somewhere. They're a payment processor. They're a telecommunications company. They're a K to 12 and higher education, you know, helping payment processing. Oh, and they're a private equity group. So I mean, yeah, they're everywhere.

This is a very dense company to have to kind of pull apart and look at. But fortunately, we've got a shorthand for these types of companies. And because it's financial services and financial numbers are very, very prominent. you know, book value is generally a pretty good metric to be using. And so, I mean, there's a lot of cash flow that's flowing through here as well. And you can get a really good history. They do an annual letter every year, which I heartily recommend reading. I like to call NellNet the second most famous holding company out of Nebraska because, you know, that one up in Omaha is pretty big deal. Yeah, sticking with our off the beaten path theme, if you're in Nebraska and you go a little off the beaten

path, you find your way at NellNet instead of Berkshire. Yeah, you go to Lincoln instead of to Omaha because these guys are in Lincoln, which is like an hour down the road from Omaha. But, you know, it's their book value, these guys IPO mid-2004, I think, last third of 2004. They've compounded their book value. So, again, this is the Berkshire argument, right? They watch book value. They've compounded book value at 16.6% annually since IPOing.

And they're trading right now at about 1.1 times book value, which very nice valuation. Periodically, you know, the market will give you just a tad below one times book value. So I do tend to, you know, like to add to my holdings on those dates. But you know, I think there's nothing wrong with it. One point one here. It's a cash flow story in that they have their operating businesses that are generating cash flow for them. They also, so that would be the loan servicing business.

That would be the payment processing and helping manage it. educational institutions, business as well. They also have a bunch of private equity style investments. Notably, they own, they're the largest independent shareholder of a business called Huddle, which is a sports performance analysis platform. So, you know, for analysis of high school and college sports and, you know, occasionally professionals, but also athletes who are looking to maybe become professionals. I always like mentioning Huddle to fellow fools who have kids who are, you know, are on that athletic track because they all immediately, there's a couple we work with, they immediately go, oh, I love Huddle. I love Huddle. So I'm like, at some point that's

going to IPO and that's going to be real interesting. And they're the largest investor in Huddle. But they also own this big giant pool of student loans from a prior program that no longer exists. That's slowly flowing through the cash flow statement. And it's probably going to deliver them just shy of $1.4 billion over the next 13 years. 13 years, but about two-thirds of that is going to come in the next five years. And so all that cash flow is kind of running through their finances, and then they apportioned it out. They pay a dividend. They buy back stock. They make these private equity investments. They grow their other business. They got their loan servicing business. They've just had their

contract renewed. There was a couple years there where it looked like their ability to service a lot of the federal loan programs was taken away from them. They didn't get the contract contract. And then I kind of think the government figured out there's no one else who could do it, but we already pulled your contract. So what do you do? Right? You know, because no one, everyone wants to save face. So they changed the name and they kind of put a different spit shine on it. And the, of that type of contract. And then NELNet won that contract, which is basically the old contract that they lost. And so they've got that for the next five years. Plus they've got, I think, two five-year options after that. So there's a lot of moving pieces here. But, you know,

probably to distill it down. Lots of cash flow. Those cash flows get to invested in various places. It distills down to a book value number. That book value number has been growing neatly, and it's trading at a reasonable price to that growing book value. I don't know a ton about this business, Jim, but because of where it operates and because of what I know is looming in the student loan servicing space, I do want to ask, you know, interest on student loans is set to resume this fall? Is that something that impacts this business at all? A little bit. First off, the servicing contracts and stuff. I mean, you know, you're

just the servicer, right? You know, you're earning fees on how many transactions go through or what have you. So I'm not terribly worried over there. I'm not terribly worried in general, but yeah, that giant, you know, melting iceberg of loans from that discounted or discontinued, I should say, program from a number of years ago. Borrowings are at generally fixed rates, although there is some floating. And yes, there's some swaps out there somewhere to kind of adjust it, but whatever. But then they're mainly financed through floating rate securitizations. And so what has happened with rates going the way they've gone?

That has crimped some of the profitability there. There are some outlevers for them to actually recoup some of their profits. But the spread, this is a spread business or that part of the business is a spread business. That spread has narrowed in the most recent quarter, but I don't think that should have been a surprise, right? I mean, the headlines have been, rates are going up, rates are going up, rates are going up. So I don't think it's that much of a surprise, and I, you know, what's the cliche? Things that are known tend to be built into the share price. I think that's built into the share price here.

But it is something to be aware of also to, I think we're probably closer to the end of the share price. the rate hiking cycle than to the beginning. I think in Canada, where I am, I think we're done. I think you guys might have one or two more hikes to go. Wouldn't be surprised. Wouldn't be surprised, but also, I don't think you have eight or ten hikes to go. We'll put it that way. Let's hope so. Well, Jim, thanks for taking us off the beaten path today and being our guide along the way. Appreciate talking with you.

My pleasure. As always, people on the program may own stocks mentioned. 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 Dylan Lewis. Thanks for listening. We'll be back tomorrow.