May 27, 2022

Y M L P-260

Business the wise choice

Tech Analyst Beth Kindig Talks About Finding Stock Opportunities

In this episode of the Motley Fool Money podcast, Motley Fool analyst Jim Gillies discusses:

  • American (AAL -3.40%), United (UAL -2.55%), and the other major U.S. carriers.
  • AT&T‘s (T -2.88%) timing with the spinoff of WarnerMedia.
  • How HBO Max is gaining subscribers.
  • Sleep Number‘s (SNBR -5.23%) cash flow being better than its stock price would indicate.

Also, Motley Fool analyst Deidre Woollard talks with Beth Kindig, lead tech analyst for the I/O Fund, about where she’s finding opportunities in the recent downturn among tech stocks.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on April 21, 2022.

Chris Hill: We’ve got airlines stocks, streaming media, and a conversation with tech analyst Beth Kindig. Motley Fool Money starts now. I’m Chris Hill, and joining me today from Motley Fool Canada, Jim Gillies. Good to see you. Thanks for being here.

Jim Gillies: Thanks for inviting me.

Chris Hill: We’re going to get to Tesla‘s results on tomorrow’s show. Today, I want to start with a different kind of transportation. American Airlines and United Airlines — both out with first-quarter results. They both had losses, but they’re both predicting profits for the second quarter. Shares of both up around 10%. A couple of ways we can go here, but just on the surface, what is your reaction to this move? Because it seems like we do this dance, we, collectively, as investors, do this [laughs] dance at least once a year or so, where we just get excited about the prospect of major airlines, and we bid up their stocks.

Jim Gillies: Yes, and I’m going to start off by saying that I am a cash-flow, value-style investor. That is how I approach pretty much all companies. But that approach has me looking at the airlines and essentially saying, “These are not long-term investments you want to make.” I understand that the market is very, very excited today. American Airlines, their revenue passenger miles nearly doubled year over year. They did lose money on a GAAP basis, but they lost less than expected, and they are predicting profitability this quarter. They are still burning cash, but they cut their cash burn by about 90%. Now last year, this is not really a fair comparison in a pandemic-restricted universe, but they burned about $7.2 billion in operating cash flow last year, burned about $770 million this year.

United Airlines, much the same story — they beat expectations. They are also saying, hey, we’re going to be profitable this quarter, Q2. In fact, their headline in the press release was they expect the “highest quarterly revenue in company history in Q2”. Some might say that’s bold, some might say, “Boy, that’s lipstick on a pig”, but they actually reported free cash flow this quarter as well. They generated $1.1 billion, stock is off to the races. This all sounds good, and of course, they’re part of the big four oligopoly in the U.S.

All of that said, I find the airlines uninvestable over the long term. If you want to play a recovery, I don’t think that’s necessarily a bad thesis. But please don’t be under the impression you’re going to buy and hold these things, and have multibaggers over a 30-year period. These are not companies to own for the long term. When they do generate cash flow — and they did, United generated about $11.5 billion in free cash flow from 2010. I’m measuring from the date of the Continental merger with United through to 2019, the last year untouched by the pandemic. They did about $11.5 billion in free cash. They spent nearly $9 billion on buybacks. The share count today is back around where it was at the time of the merger because they frittered away all of the goodwill from buybacks during the pandemic.

Maybe “frittered away” is unfair — it was a pandemic. But similarly, American Airlines, they’re free cash flow negative over that decade. They also went hard into repurchases, debt fueled. Their share count today is also back above where it was following the last time they went bankrupt, and I’m going to come back to that point in a minute. Basically, all of the cash generated — or in American’s case, debt — over most of the last decade, pre-pandemic, got spent on buying back stock, and long-term investors today are back to companies that are the same size, share-count wise, and you’ve got wonder: If I was a long-term shareholder, what did I get out of it? The answer is this is not a long-term value-creating industry. It’s cyclical, and these management teams have shown time and again that they will not put up reserves during good times that help them in bad times.

My solution here is, I just avoid the whole damn thing. I don’t go into airlines because … I did mention, talking about American Airlines — the last time they emerged from bankruptcy, which I believe was 2011. These are companies that routinely go bankrupt when they hit bad times because they don’t put up those reserves. I understand the pandemic is a once-in-a-lifetime thing, so I go back, — well, maybe they deserve some government support to get them through then, one does wonder what their excuse was the last time. In Canada, our flagship carrier, Air Canada, they last went bankrupt in 2004. Today, the stock is fine. But you don’t get the long-term multibagger returns that we, as Fools, want to buy and hold and achieve. The industry itself, it doesn’t like to provide that to us. We run into recessions, we run into pandemics, we run into hard times. My preference if you want to play in this space, I could suggest maybe — and I think this is a good place to go as well, especially in the wake of all of the support the airlines had to have, and the provisions they had to provide for the government for their aid. I kind of like the aircraft leasing operations. AerCap is the big dog in the space, AER on the New York Stock Exchange. They are the world’s largest owner of aircraft, and they are leasing it to the airlines. And the airlines aren’t going to have a lot of money lying around for capex, so they’re going to, at least for the next half-decade or so, prefer to lease these assets. Let someone else own them, we’ll pay rent monthly. And I think that’s a good place to be if you were one of the aircraft lessors like an AerCap, like an air lease. If you’re going to play in this space, I kind of prefer that end rather than the airlines themselves.

Chris Hill: Let’s move on to media then. [laughs]

Jim Gillies: Bury that one right away.

Chris Hill: AT&T’s latest results come with a side serving of irony because just as AT&T spun off WarnerMedia, which includes HBO, WarnerMedia comes out with the news that HBO and HBO Max added 3 million subscribers in the first quarter. Look, it was just yesterday that Tim Beyers and I were talking about Netflix, which was the story of the day, and one of the things we talked about was, companies like Roku and Disney, the shares of those companies being down. I get the logic here: There were some people on Wall Street who looked at Netflix as the clear leader in subscribers, and said, look if they’re losing subs, stands to reason that Roku and Disney might be in similar trouble. WarnerMedia sharing that, “No, we’re actually still gaining subs,” although granted, they’re gaining off of a smaller number than what Netflix has.

Jim Gillies: My take on it, because we talked a lot about Netflix as well yesterday on Motley Fool Live, for example, my take is the danger that I perceive with a Netflix — and I share the concern that was expressed that “If Netflix is getting whacked, maybe everyone else is and we should be wary of them.” My concern is Netflix might have stealthily turned into more of a long-term slow-grower incumbent play like a legacy cable company, that, of course, they were the ones who displaced them back in the day. They may have turned into that and we really didn’t notice. It’s one quarter, it’s not a great quarter. Marketing spend per net customer add, even after you take out the Russia thing, because most of their customer-add miss was Russia. The reactions in Netflix yesterday really looked to me like the market en masse saying, “Yeah, growth expectations are done here,” and they were revaluing it that way. It’s unfortunate if you’re a Netflix shareholder, obviously. As far as Disney+, as far as HBO Max goes, if these services are indeed growing, then to me, it also speaks to, we’ve become oversubscribed. I don’t know how many subscription services you’ve got in your house. I think I counted yesterday, I’ve got five. Before we started recording, you mentioned Apple TV+. I remembered I don’t have that anymore, but I have in the past. So I wonder if people are also doing a little bit of a la carte shopping. It’s like, “Well, I want to catch whatever the latest greatest show on HBO Max is, or I really love the show Always Sunny in Philadelphia. Hey, Disney+ here in Canada has got 13 seasons of that show on it. I’m going to subscribe there, I’m going to let my Netflix subscription lapse for say, four to six months, and I’ll come back.” If people are starting to do that a la carte shopping, I don’t think it bodes well for the largest player in the space, and certainly, I think Netflix said a few things about that.

But I do take the point, Chris, that AT&T spinning off WarnerMedia into Discovery, I believe shareholders got shares in the new WarnerMedia. Hopefully, they held it. But this feels like a very AT&T move. AT&T has not done much for long-term investors either. I’m starting to see a theme in my talking today. They’ve not done a lot aside from paying them a dividend, and I believe the stock price is, if it’s not down from where it was a decade ago, absent dividends, it’s close. So enjoy your dividends and I hope you kept the WarnerMedia shares.

Chris Hill: Real quick before we move on. Do you think we’re moving to a place with all of the streaming services … should the expectation for investors be, regardless of the streaming service, that churn is going to be an ever-present challenge to the point where — don’t expect great retention numbers? Say what you want about any of these services and the content they have. They all appear to make it pretty easy to sign up, and they all appear to make it pretty easy to cancel. So if they’re doing it on a monthly basis, I just wonder if all investors need to just recalibrate their expectations on churn.

Jim Gillies: Agreed. They make it very easy to get in and get out. Paradoxically, you know what the tool that I found, personally, for keeping me a customer is? Two of my streaming services will allow you to pay for a full year up front, and the price is equivalent to paying for 10 months instead of 12.

Chris Hill: I was just going to say, if all of these services aren’t looking at that, I just remember when Disney+ launched and they had the monthly price and they had the annual price, and the annual price was something like 20% less, maybe more?

Jim Gillies: Now that I think about it, I’d actually got three that I pay by the year, and they mix that with content I actually want to watch, which I’m increasingly finding on Disney+ and the Canadian service that supplies HBO. I’d be wary if I’m a Netflix. Some of the stuff that Netflix was talking about going after — the ad-supported levels? We went to Netflix to get rid of ads. Going after password sharing? I don’t think you’re going to convert those people who are used to paying nothing for your product. I don’t think you’re going to convert them to the highest level of your product. I was wary after yesterday’s release on Netflix.

Chris Hill: I did an interview earlier this week on another show, and the host asked me for a couple of thoughts on the earnings season that we are just starting, and one of the things I said was, the phrase “supply chain issues” is going to be a phrase we continue to hear from companies, and we heard it today with Sleep Number. Their first-quarter profits were lower than Wall Street was expecting because of supply chain issues. Sleep Number is… for people who have been around the Motley Fool for a long time, this is a stock that has been on the company’s radar, on your radar. You and I were chatting earlier this morning: Do you get a sense that the business of Sleep Number is in better shape than the stock price would indicate? Because the stock is down 10% today, and I think it’s half of where it was maybe a few months ago.

Jim Gillies: I think it’s actually about two-thirds off or maybe more now. I’ve followed Sleep Number on and off for the better part of two decades now. It used to be called Select Comfort. It was a multiple recommendation back in ye old classic “Hidden Gems” of the mid-2000s. And back then, they had some issues. Look, they grew very well during the housing boom, and, of course, people said, “Yeah, you’re selling beds in a housing boom. When the housing market turns, you’re going to sell less beds.” And they’re like, “No, no, we have data that says we’re not tied to housing starts. We’re fine. We are a growth company, and look at how confident we are.” They were debt-free in the early 2000s, they built up a nice cash hoard, and when things started rolling over, they spent the entire cash they generated in the seven or eight years before on buying back their own stock.

And then they took a lot of credit and they maxed it out to buy back more of their own stock because “we are not tied to the housing market.” Housing market rolled over. Turns out, they were tied to the housing market, and the stock went from $25 to 25 cents at the bottom. Basically, the only reason they did not go bankrupt is because the bankers wouldn’t have been able to run it any better, so they gave them more and more rope. What ended up happening is they issued some new shares, they took on some vulture financing, they got through the credit crisis. All the shares they bought back up flooded back onto the market and then some. But they started to recover. They did survive. The one thing that I really like about Sleep Number as a company is that they are consistently cash-flow positive even though we understand — “supply chain” — actually, I’m buying that as an excuse. There’s a couple of companies I could point to that I’m not buying that as the rationale, but I’m buying it here because they are making a reasonably complex product, sourcing parts from around the globe, and there is a supply chain snafu right now. So Sleep Number, in their second act, say, from about 2011 onward, they’ve generated .. this is just barely over a billion-dollar company. They’ve generated about $1.1 billion, $1.2 billion in total free cash flow over that period. And it’s been growing. It’s grown about 3.5 times over the past, I think, 11 years since they emerged and had their second act. They’ve bought back nearly $1.55 billion worth of stock. They’ve basically taken all their cash flow, again, kind of got them in trouble before the housing market rolled over a lifetime ago. But this time, it’s been a real drop in their share count. They have bought back 60% of their stock.

The difference between the amount of cash they’ve generated and the amount they bought back has been debt-fueled, but their credit line is a lot better this time in terms of it, and they are still very, very cash-flow positive. So I know the stock is down today, it’s down about 10%, 12%. I know it’s significantly down from where it was a year ago. People are clearly looking at what happened the last time a market rolled over, a housing market. This time, it’s people have been stuck in their homes for two years through the pandemic. They put money into their homes, “Hey, let’s buy a new bed.” I think people are inferring the same thing’s happening, and I’m looking at this going, “I’m interested in the stock for the first time in probably a decade.” I’m now interested again, because again, the stock price is about double where it was, where it maxed out in the pre-housing crisis days. But the share count is 60% less. So it’s almost like the share price today is arguably, or the market cap is less today than it was. And they have demonstrated they can generate and grow their cash flow. And that, to me, in any investing environment, is very interesting. And today, you’re paying about 10.5 times free cash flow for this business. I guess I’ll end on a happy note there.

Chris Hill: I was going to say, are we going to end on a potential buying opportunity?

Jim Gillies: I’m liking this one. Because the other thing is, too — people who I’ve talked to, and I know people you’ve talked to, and we know a couple of people in common who have bought this product. Most people really like this product when they buy it.

Chris Hill: Yes.

Jim Gillies: That’s not nothing. [laughs]

Chris Hill: It’s not really the repeat purchase of, say, razors and blades, but yeah.

Jim Gillies: Sure. But it’s still … I could go down a dark path, saying, “Well, after the pandemic is over, maybe you’re expecting an uptick in the divorce rate, so people will need to buy a second bed,” but that would be dark and we’re not going to go there.

Chris Hill: We’re going to end on a happy positive note. [laughs] That’s why I love you. Jim Gillies, thanks for being here.

Jim Gillies: Thank you.

Chris Hill: Patience is a requirement for long-term investing success. And over the long term, patience gets tested. Take the last six to 12 months, for example. If you own shares of companies listed on the Nasdaq, yeah, your patience is probably being tested. Beth Kindig is the lead technology analyst for the I/O Fund and The Motley Fool’s choice for tech investor of the year in our 2022 Women in Investing awards. Recently, Deidre Woollard sat down with Beth to talk about where she sees buying opportunities during this downturn, and how she’s managing long-term expectations for her investments.

Deidre Woollard: Yeah. I think you’ve hinted around the fact that it’s been a bit of a bumpy road for tech recently. Certainly, investors who were heavily invested in tech are feeling that. Of course, we always feel like there is opportunity in there, too, and it’s all about the good companies. What are you thinking about tech right now in some of those valuations you’re seeing?

Beth Kindig: I’ve been a buyer. The I/O Fund has been buying, nibbling. When we see a quality company being down in price, we try not to overthink it, because there will probably be a day where we will talk about the prices of 2022, meaning that they were so low. That is, the probability that 2022 was oversold is pretty high at this point. It was just an extreme reaction to the downside, as part of 2020 and 2021 was an extreme action [in] the opposite direction. Extremes are a good moment to pay attention to what’s going on, and think of the opposite of what the market is doing. So we’ve been buyers, and the reason that I’m a buyer is because I’m part of the 2030 club. I’m fully invested in tech, minimum through 2030, and I can tell you that I’ve always said, no matter what market it was — especially during the height of the exuberance — that you need to have, bare minimum, a 3-year hold [and] ideally, a 5- to 7-year time horizon. I can tell you that my 2018 class of stocks, the entries that I have in 2018, they are doing phenomenal right now because I held for three-plus years. Those entries are just crushing it, there’s some up near 500%. 2019 as well, they still are holding well, a lot of those entries. The more challenging year was obviously 2020. That’s the year that everyone was so excited, people were willing to pay anything, but if you even have 2020 entries, by 2023, you’ll probably be doing pretty good.

I think people just get really emotional and they are very afraid of failure, they’re very afraid of losses. So they’ll see arbitrarily, they’ll look from November to April, which has not been very good. But whoever said you could hold tech stocks for five months? Whoever told you that, is the last person you should be listening to because it’s just not a five-month industry. It’s actually a 7-to-10-year holding time horizon for the best tech investors, which are venture capitalists. Why is a retail investor or an individual investor thinking they can make money in tech at a fraction of the time horizon as some of the best tech investors in the world? I think just staying really firm on the time horizon is absolutely essential, and that’s what piece has most been forgotten lately.

Deidre Woollard: Yeah, totally agree. At the Motley Fool, we have a rule about holding things at least 5 years — 5 to 7  absolutely makes sense with that longer tech cycle. I wanted to ask you — we’re starting to head into earnings season. I wanted to find out what you thought about the last earnings season, where we saw a lot of companies posting some pretty strong results and the market just reacting negatively over and over again. Did that represent an opportunity to you, and how much attention do you pay to earnings in general?

Beth Kindig: We pay really close attention to earnings. I would say that when a company has a really strong report and the market sells off, that is usually a buying opportunity to us. That’s the best buying opportunity. because I’m looking for facts. I deal with facts. I don’t want to deal with opinions. I mean, we have to deal with opinions and sentiment, it is baked into the technicals. We have another person at the company who does technicals. What I’m saying is, as a long-term buy-and-hold tech industry analyst, I am really looking for facts. I’m really looking for management to tell me what the outlook is. That is way worth its weight over an analyst trying to give me a buy target. I greatly prefer to listen to management teams, and I like to listen broadly.

So it doesn’t matter if I own the stock or not. If I’m in the adtech industry, if I have adtech stocks, I will listen to heavyweights in adtech, their calls, just because they are usually giving you a really broad look. They have visibility that we don’t have. Analysts can obviously go into channel checks, but channel checks aren’t nearly as good as having the visibility at the company, and the right management teams are trying to build trust with investors. Even if there are headwinds or whatever it might be, they will clearly articulate what the forward outlook is. And when the market penalizes them… I’ve actually written about Roku lately. They reiterated their full-year guidance, but they weren’t able to meet Q1 because of supply chain issues. Those things are big buying opportunities to me because we foresee supply chains as transient headwinds. We were buying, in some cases not recommended. We bought going into earnings, a couple of times that worked out well; one time, it did not work out well. Then the others, we were buying within the week after when the market was penalizing them, and we feel very good about those entries.

Deidre Woollard: Yeah, Roku is definitely one that’s been on people’s minds lately. You mentioned the term “channel checks.” Can you define what that is?

Beth Kindig: Is just an analyst who will be able to talk to vendors, talk to people within a supply chain, for instance, and see what their take is. So a supplier for iPhones might be able to tell you what orders are looking like. Or, they might be able to talk with other bigger customers, and see: Are orders being canceled? Are they being doubled? It’s just channel checks around the health of the underlying business in the supply chain. For instance, in this case, we had a downgrade on Nvidia because analysts had done some channel checks in the supply chain and they think there could be some cancellations coming, but ultimately — this is one I’ve had to address recently — ultimately, I think management probably has that visibility, and so I’m siding with management. And that was across the semiconductor management teams: AMD, Micron — they all said flattish PC units, and their forecasting has taken that into account. Channel checks again, versus management-level visibility — I usually tend to lean heavily toward management.

Deidre Woollard: Interesting. Yeah, the semiconductor industry right now is fascinating because it’s generally so cyclical, and yet we’re in this backup period with so much demand. Looking forward to next quarter’s earnings across tech in general, what are you looking for? Certainly supply chain is going to come up. What other things do you think are things to pay attention to in tech?

Beth Kindig: That’s a great question. Speaking on the supply chain, we really think there’s going to be a rebound in the second half of the year. We’ve pulled tons of data. We have a great team, strong team — Bradley and Royston help me with that, and we’ve published some pretty convincing data, so check it out if you haven’t seen it, it’s published for free on our newsletter and our website — and there was a very big, historically big auto inventory rebound in Q4. We’re hoping that funnels through by the second half of the year. If so, all kinds of industries will start to be positively impacted. Adtech, especially, I would say is one where if it can’t come in the current guide, we really are watching it for the Q3 guide, which would be an adtech rebound due to supply chain issues easing. That’s one to look for. What we try to remind people is that perfect timing is impossible. We can give you a broader like, could it be Q2 guides, could it be the Q3 guide, I don’t know, but we think it’s coming. We think that supply chain will start to ease.

Then the other one that our team has dug up, the team of analysts is the capex spending from big tech. That’s where flattish PC units, anything Russia, China, that is being filtered through on the semiconductors. Can that overcome the fact that all of FAANG plus Microsoft is spending heavily on capex, which filters down to semiconductors? That was something that Bradley actually has written extensively on as well, is Facebook, Amazon, Google, Microsoft [are] spending hand-over-fist right now on datacenter, so we’re hoping that keeps our semis strong.

Deidre Woollard: Yeah. Have been watching the datacenters and seeing them pop up in small towns. The difference between some of like Google building datacenters versus also leasing datacenter space is just fascinating. I wanted to just zero in on something else you said there too, which is it doesn’t necessarily matter if it comes in Q2 or Q3 if any, I think that reiterates what you just said about the long-term hold, that if you are a long-term investor, it doesn’t matter when that rebound is coming because it’s coming if you’re there for the long term.

Chris Hill: 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 stocks based solely on what you hear. I’m Chris Hill, thanks for listening. We’ll see you tomorrow.