Bull vs. Bear: Best Buy

In this podcast, Motley Fool analysts Asit Sharma and Deidre Woollard discuss:

• JetBlue‘s ( JBLU 1.09% ) competition with Spirit ( SAVE -2.97% ) to buy Frontier Airlines.
• Amazon‘s ( AMZN -2.16% ) plan to launch 3,000 satellites into orbit for its broadband internet plans.
• Restaurant brands in the metaverse.

Motley Fool analyst Jim Gillies and Motley Fool contributor Brian Feroldi take a “bull vs. bear” look at investing in Best Buy ( BBY 0.86% ), the company that was supposed to become Amazon’s showroom.

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.

https://www.youtube.com/watch?v=mTmbPrZyAD0

This video was recorded on April 6, 2022.

Deidre Woollard: I’m Deidre Woollard sitting in for Chris Hill and I am joined by Motley Fool senior analyst Asit Sharma. Today, we’re going to talk about the battle of low-cost airlines, Amazon’s fixed satellite move, and restaurant brands in the metaverse. [MUSIC] Let’s begin with the big story which is JetBlue’s move yesterday, they are announcing a proposal to acquire Spirit Airlines for $33 per share in cash, works out to a total of 3.6 billion. There was already a planned merger between Spirit and Frontier that was announced in February. This is really interesting because JetBlue thinks it’s offering a better deal than the offer from Frontier, which is true from a monetary perspective. Frontier’s bid would give Spirit shareholders a share of the combined airline as well as some cash per share. Really interesting because these are two very different types of airlines whereas Frontier and Spirit are more aligned. Asit, I’m wondering what you think could happen next and what this means for consumers?

Asit Sharma: Well, I’m going to be totally honest with you Deidre, I don’t know what’s going to happen [laughs] next because this counteroffer is going to have some regulatory scrutiny around it, but let’s hypothesize that the deal goes through. I think this means that for consumers, costs are going up. The reason is JetBlue has a choice to become more like Spirit or to make Spirit become more like itself, and I think the odds are that JetBlue tries to mold Spirit in its own form. You’ve got an airline here which has been pretty successful in JetBlue at offering some premium perks, it’s not quite the large carrier like those it wants to compete with, the Uniteds, American Airlines, and Deltas of the world. It’s an up-and-coming airline, it’s slightly smaller than a great regional airline, Alaska Airlines. If the merger goes through with Spirit, it will leapfrog that to become the next big carrier. I think what JetBlue is trying to do here is to really compete with these bigger carriers, it can’t recreate the whole hub and spoke network that the legacy carriers have, but what it can do is to really hone in on route density, which is what it gets in Spirit because both are East Coast Airlines and the thing that I like about this for JetBlue, not for myself and I travel, if my costs are going up, but what I liked for JetBlue is that in buying Spirit, it gets a really beautiful route density into Latin America, into Central America, into the Caribbean, routes it doesn’t have. Those are very lucrative routes, the travel in this area from Latin America to the US back-and-forth has been steadily increasing, took a hit during COVID, but long-term, that’s a great place to be. You buy, Spirit you get into a bunch of big cities in the East Coast and some other hub cities, you compete with the bigger carriers, you get great route additions. It’ll take some time. You can make the Spirit part of your business more like JetBlue which is not, again, a premium airline but think of it as a lower-cost carrier with some perks, not an ultra-low-cost carrier, just one or two steps above that.

Deidre Woollard: Interesting. I like what you said there about ultra-low-cost versus low-cost because that’s Frontier’s argument is that JetBlue is, in fact, prestige and so that it’s not a natural match. The other thing I think is interesting is JetBlue has tried some acquisitions before, they haven’t worked out, there’s certainly an antitrust concern here. Do you think that that’s going to be a concern? How are the regulators going to look at these two deals?

Asit Sharma: I want to say it is a shot from left field. If you’ve read any of the new stories around the story, many airline analysts, and I’m not an airline analyst, but I totally get this, they’re scratching their heads just because of the regulatory aspect. This is a move that is the opposite of a Frontier-Spirit merger in which costs could stay level for consumers. You got two ultra-low-cost carriers that would be merging. Here, how does this benefit the end-user? It doesn’t. Now, JetBlue can make the argument that in becoming a bigger airline, not quite as big as these huge competitors I mentioned before, we make that part of the airline segment more competitive, we come in and compete with bigger carriers. I think that’s a bit of a stretch but there is some logic there. I don’t know where regulators will land. I think this is indicative of a company in JetBlue that is really looking to grow but doesn’t have a great organic path to do it. They’re not grasping at straws here, but they’re going after propositions which aren’t natural fits. This is what happens in an industry like the airline industry where you have just decades of consolidations, just a few players on the big end. To get bigger in this industry is not so easy.

Deidre Woollard: Very good point. Just to wrap up, what are you thinking about the energy costs and airlines, prices seem to be going up for airlines, looks like we’re going to have a big travel summer. What are you thinking that we’re going to see on that front?

Asit Sharma: It’s so interesting, Deidre. The two biggest costs for an airline are labor, of course, and fuel. We’ve seen over time that airlines will go for utilization, they want to fill seats. They will deal with higher fuel prices in a number of ways. The best way, I think, over time to counter the effect of rising fuel costs is to add on ancillary services. This is something that JetBlue excels at. I don’t think that there is much that any airline can do in the industry just now, they’re going to have to absorb some of these costs, the rest, you and I are going to be paying more when we board. I will tell you one thing, I’m traveling this summer. [laughs] Please world, please universe, please cosmos, no more exogenous shocks, give me just even a couple of weeks of a window in which I can have some fun travel; I will get on a plane this summer.

Deidre Woollard: [laughs] I think you are not alone in that. Let’s move on from airlines to space. Amazon has announced ramping up Project Kuiper, which is its satellite operations. This is really ambitious, they are planning 83 launches over the next five years, they’re putting more than 3,000 satellites in orbit. Why? Because they’re going to try to provide broadband Internet for consumers, businesses, government agencies, some massive project. Really interesting to see, and I’m wondering what this means for Amazon’s core businesses for Prime, AWS, things like that.

Asit Sharma: This is a multi-year effort and it sounds like it won’t have much impact on Amazon’s business for a while because they’ve got to get the satellites into space. I believe that Amazon does have a little bit of an impetus to start putting it satellites into space because of some licensing requirements. They received licenses from the Federal Communications Commission in 2020, they’ve got to start putting up satellites within the next couple of years to keep those initial license grants. There’s nothing on the surface or in the immediate future that’s going to impact the other businesses. But, Deidre, I remember that Morgan Stanley had a projection, I don’t know, a couple of years ago which they said that this total space business, putting satellites into space and having consumer services is going to be potentially a trillion-dollar business for lucky few companies over the next 10 years. Now, who on earth has the capital to put thousands of satellites in space? Only a very few private companies or public companies can do this. While we look at this large opportunity that is going to cost, by Amazon’s own estimates, $10 billion of its capital, potentially they get a fraction of this market, say five or 10 percent, that starts to impact the other business lines. Let’s fast-forward, I don’t know, six or seven years in the future, and that’s where you start to get some incremental gravy that’s flowing to Amazon’s bottom line, it makes them better able to compete with that additional cash flow, to lower their infrastructure costs for stuff that we order here on earth. In that sense, it will potentially have an impact on those other businesses, it’s just not going to happen overnight.

Deidre Woollard: Yeah, I think there’s so much potential. One of the things I’ve heard about is the potential for data centers in space and things like that. There’s all sorts of interesting applications. You mentioned big companies. Well, the other one in this is, of course, Elon Musk and Starlink. There’s been a lot of talk, a lot of back-and-forth between the two, a bit of one upmanship about Blue Origin versus SpaceX. Is Amazon too far behind Starlink to catch up at this point? Starlink has already launched about 1,900 satellites, they’ve got a quarter of a million subscribers. Does this mean Elon’s got the jump on basis or what?

Asit Sharma: Yeah, you know Deidre, this is a G-rated shows. They don’t mean any innuendo here. But I was wondering seven years old, I walked into a friend’s garage and there was a sign that my friend’s mom had put in the garage and it was a common saying. This is just to think back to the early ’80s here, late ’70s. The only difference between men and boys is the size of their toys. The picture was of two boats; a little boat and, and a big boat in the water. This is what it’s boiling down to with all these billions of excess capital that Jeff Bezos and Elon Musk have created. They want bigger toys. They are in the never ending contest to see who can win here on the planet and in space. It’s a great question. I mean, has Elon just, in this part of the competition, just gotten the head-start and Bezos can’t compete? Actually don’t think so. Again, going back to the point I was discussing earlier about the capital required to put all these satellites, thousand satellites into space. If only a few companies can do this, it means that there’s not going to be a monopoly business in space. It’s probably going to be like a duopoly or oligopoly, is that right? We have more than a couple. There’s always time to catch up, especially if you’re relying on a consumer model. At the end of the day, these are consumers that are going to propel this. It could get into corporate business later, as you mentioned with say, data centers in space. But with a consumer centric monopoly regulators, just the idea of competing lent itself to another company, even if it takes a couple or three years more entering that. Now, do Amazon and Starlink between them have a business model that’s probably airtight, they don’t have to worry about much more competition? Yeah, I don’t see many more companies coming into the scale.

Deidre Woollard: One last thing on this subject, I am a little bit concerned about the potential for things being crowded. There’s already been talk of not necessarily space junk, but when these things, when they exceed their usefulness, they have to be disposed at some way. They can come to earth and burn up in the atmosphere. We haven’t seen a lot of crashes or things like that yet. But do you think going forward when we have thousands of satellites in orbit, is that a potential risk?

Asit Sharma: I’m worried. I’m no expert on objects in orbit, but we noticed from reading the news that the number of satellites which have been put up ever since the first one launched into space in the ’50s, just that tiny number of satellites creates its own ecosystem of space debris. So you think about multiplying that even if these are much smaller satellites. We should think about multiplying the number of objects by so many magnitudes. It just begs the question, that this potentially isn’t that great an idea in terms of efficiency? So yeah, I think me and so many other people who are watching this story evolve or worried and you as, well, hopefully the technology that’s being invested, will be able to anticipate this, but I have my doubts. I’m a little skeptical on that front.

Deidre Woollard: Well, I think it may create a new business in the future. But let’s move on from space. I feel like we’re getting gradually further and further out. Let’s go into the metaverse. Wanted to talk a little bit about a Wall Street Journal article about Restaurant Brands setting up shop in the metaverse, Wendy’s and Chipotle. We’ve already seen McDonald’s talk about ordering your food in the metaverse through so much excitement from brands. But the interesting thing in the article was that there was a study from Forrester that showed 43 percent of adults would avoid a brand sponsored experience in the metaverse. That’s not great news. Is this a smart move for brands to get started in the metaverse? Is this where we’re headed?

Asit Sharma: It depends on the brand and what your objective is and who your customers are. Thinking in some cases it makes a lot of sense. My typical example is Nike creating an experience on Roblox, which is good for its culture, for its fans, they can go and experience Nike land. So this is an example and I know, Deidre, you have some thoughts here. I’m really interested to hear your thoughts on these. I want to just finish this short opinion by saying, in some cases short, it makes a lot of sense and in others. It’s like that song. We’re not going to take it. We’re not going to take it anymore. Brands try to sell to us in every conceivable location and we’re used to this, but they are selling to us on social media. They are selling to us in the subways. So do I really want to be sold to in the metaverse? Maybe more pertinently, if your quick service brands, like do I want to be dragged into the metaverse just to place an order for delivery? Not me personally. I don’t think it makes as much sense for brands that have a quick service model in the restaurant industry. These two examples of McDonald’s, especially with Wendy’s and Chipotle is in there as well. But, yeah it can be valuable to some companies. Now, I’ve tried to stay a little neutral there, but you’ve got thoughts and opinions. I know on this. What’s your take on this, Deidre?

Deidre Woollard: Well, I’ve been studying the way that luxury brands are getting in. Specifically, they had the first metaverse Fashion week recently in Decentraland. Part of it was that Dolce and Gabbana had this $300,000 metaverse tiara. Neiman Marcus recently announced that they’re working on NFT. So I find it fascinating from the luxury perspective and I think that may be more of a natural fit for the metaverse at this point than some of the more mid-market brands. Just because really the people that are interested in the metaverse, it’s a small group, but it may be a more sophisticated group of consumers. So I’ve been fascinated by seeing just how many luxury brands are getting in, makes me think a little bit of second-life for those who remember that happened. What was that about a decade ago and all brands rushed in. Second-life is still out there. Their CEO recently came back, but Second-life never became what we thought it was going to be. So there’s a little bit of concern there.

Asit Sharma: Yes. There’s another arguments that younger consumers, the digitally native consumers, are going to embrace the metaverse, and so you need to your expression of the metaverse in now because it’s only a matter of time before, let’s say someone in their teens grows up for few years and they have their own spending money and they’re going to spend it. They’ll be the people going into the metaverse to order from McDonald’s, but I’m not so sure. I mean, there’s part of the metaverse that’s still seems very much like a transient thing. We’re always trying to pin the next technological innovation and say, this is how the world is going to work. We were talking about 3D just before the show, Deidre. We were talking about visual 3D, but I was also thinking about 3D printing. I remember just a few years ago, we were going to print everything we needed from our homes. Like if if something broken your house, you just go to your 3D printer, print it up and put it, let’s say replace a couch like that really never came to fruition. Although 3D printing is in various parts of the economy in it’s more serious expression of additive manufacturing is there, it exists, but it hasn’t overtaken our lives. I have my suspicion that even for younger people, the metaverse will be the dominant place that we exist, interact and transact in the future. 

Deidre Woollard: Coming up next, Jim Gillies and Brian Feroldi are going to take a bull versus bear approach to a company that Amazon was supposed to knockout years ago. Best Buy, Ricky Mulvey moderates and you get to decide who made the better argument by voting in our poll on Motley Fool Money on Twitter. 

Ricky Mulvey: We got Bull versus Bear on Best Buy today. You know the electronics retailer, it is within 10 miles of 70 percent of the US population. They sell computers, games, whatever you want, Best Buy’s got it. Taking the bear case, we got Brian Feroldi. Brian, you got a book out just came out yesterday. It’s called Why Does The Stock Market Go Up? But looking at the risks to a company that’s not unfamiliar to you, you like putting stocks through the gauntlet all the time.

Brian Feroldi: Yeah, I’ve made plenty of mistakes with investing and I’ve learned the hard way that you need to know the bull case for a business just as well as you know the bear case for a business if you want to make an informed decision.

Ricky Mulvey: We’ve got the returning champion, the Canuck Jim Gillies. Jim, you also have a book that came out a few years ago that you’d like to plug.

Jim Gillies: It’s my masters thesis on bringing environmental aspects to a chromium plating shop. There are four copies in existence, no one should read it.

Ricky Mulvey: Books are available on Amazon but let’s get right to it on Best Buy starting with the bull case. Jim, you’ve got three minutes.

Jim Gillies: Cool. Well, I know that Brian, my esteemed opponent, likes company mission statements and so I thought I would start with one of his favorite tricks and I’m going to call out with Best Buy’s purposes, they state their purpose is to enrich lives through technology. Now the important thing here is this is an adaptable company. This is a service company that sells hardware technology, yes, you can go to Amazon or eBay or wherever you buy your electronic and online stuff but their customer service model that Best Buy offers is essentially impossible for Amazon to copy. Amazon is for people who know exactly what they want, want it at a better price for example and will implement their own technology solutions for themselves and God bless them. People think of hardware and technology as something of a commodity, the reality is it’s more nuanced. Sometimes people don’t know what they want, sometimes they would choose differently or might want something completely different if they had a better understanding, there’s different fulfillment or installation options, sometimes my parents want someone to hold their hand when they’re getting their technology setup or what have you and that is the service that Best Buy provides in the guys of a big box store. You can get in-person consultations online, on the phone, pickup and delivery, curbside pickup, home visits delivery, the point is its flexibility and adaptability to customer needs and it has worked.

Best Buy is one of my favorite types of retail company stories because people, including my esteemed opponent, have been writing this one off for well over a decade. Would you like to take a guess as to what the best year in company history was in terms of free cash flow generation for Best Buy? If you guessed fiscal 21, the year ending in January 2021, aka the year stricken by shutdowns for the pandemic, you are right. Of course no one is going to guess, the pandemic year was the best year free cash flow production in Best Buy’s history, they made $4.2 billion. If you want to guess the second best year in the company’s history, it’s in the year that’s just ended where they produced $2.5 billion in free cash flow. Now, true, I think fiscal 2012 was about $25 million more or $12 million more but that was a 53-week fiscal year, there’s some calendar chicanery so still last year’s second best year. Over the past decade, Best Buy has averaged a return on capital of 19-and-a-half percent as per CapIQ well above their cost of capital and I will argue that the return on capital numbers for Cap IQ and Best Buy is actually too low because they put operating leases into the capital that’s an argument for another time. We’ll let it stand. Return on capital has also been increasing over the past decade. Also over the past decade margins are resilient and rising, gross margin has averaged 23 percent over the last decade, operating margin averaged 4.9 percent over the last decade and 5.8 percent in the last fiscal year. They have produced $17 billion in free cash flow over this decade, returning 14.3 billion to shareholders in the form of dividends and buybacks. Their dividend is up 5.5 fold over that decade, going from $0.64 a year to $3.52 a year and it’s a 3.7 percent yield today.

Their buybacks have reduced our shares outstanding by a third, the rest of the cash regenerated went to shore up their balance sheet, they went from a-half billion in net debt a decade ago, today have $1.75 billion in net cash today, this is a capital allocation success story and poky Best Buy that everyone knows is Amazon showroom. That’s going to go away just like GameStop. How did that work out? Best Buy, 10 year annual return with dividends reinvested 18.6 percent annually a market smasher, oh and by the way if you happen to pick it up at its low in December of 2012, a time that I’m sure Brian remembers, you are sitting on a 26.8 percent annual return. That’s not bad for Amazon’s showroom and the final point is, no one today is surprised by, oh Amazon is going to eat their lunch. That argument has been around for over a decade, it’s priced into the stock and here’s this thing trading at 10 times earnings with I think blue skies and clear sailing ahead of them going forward.

Ricky Mulvey: We are a minute and 26 seconds over, but a strong [laughs] bull case for Best Buy.

Jim Gillies: That’s pretty good for me. [laughs]

Ricky Mulvey: Shocker. Jim Gillies goes a little bit over the title of it.

Jim Gillies: Brian, feel free. [laughs]

Ricky Mulvey: Who could’ve predicted it? Brian Feroldi, you’ve got the risks, the bear case for the company whenever you’re ready.

Brian Feroldi: Well, as Jim pointed out, this is a stock that I have been precisely wrong about having, giving it the red thumbs up, the thumbs down in caps, pretty much at the low which was a 10 bagger ago. Now why was I bearish on them about a decade ago? Jim hit the nail on the head and then ordered Amazon and Best Buy was becoming a showroom for Amazon’s shoppers. People would go into Best Buy, look at the items, check the price online, buy it online, and Best Buy all but admitted that this was a major problem when about 10 years ago they offered a price match guarantee. If you showed them the price you could buy it online they will be forced to match it there. Now, how could Best Buy compete? Amazon doesn’t have any of the overhead of the showrooms that Best Buy does. Amazon has counter positioning against Best Buy and they could offer the exact same products at a lower price. Moreover at the same time we’ve seen a lot of other companies, the device manufacturers themselves increased their director consumer preferences, me, the consumer can go to apple.com, samsung.com, sony.com, whatever and buy the items directly from the companies. Why go through a retailer? Now, is that still a problem today? Well, how’s this stat? Last year, five suppliers, Apple, Samsung, HP, LG, and Sony, were more than 56 percent of this company’s total sales and just 20 suppliers accounted for almost 80 percent of total sales. When you combine those things together I figured it was a matter of time before Best Buy joined the likes of Circuit City, Twitter, Crazy Eddie, Fredder, The Whiz, HA Creg, etc., in the retail graveyard. Now, as Jim pointed out, my thesis for this company was precisely wrong. This has been a fantastic investment over the last 10 years. But I think a lot of the things that I was worried about actually have come true. Best Buy has been modifying its store layouts. It’s been forced to cut prices to match those of Internet retailers and this is a company that had almost 1,800 stores in 2013, currently they have 980 stores. The number of stores that this company has, has been falling, sinking like a stone. That’s a big problem if you’re going to be investing in a retailer because that’s one of the major ways that a company grows, is by opening new stores that’s no longer on the table. Moreover, over the last 10 years, while returns on capital have been good, this company’s same-store sales, a key metric haven’t exactly been barn-burning, they were negative from 2012-2014, barely positive to 2015-2017 and they’ve been hugely positive over the last couple of years. Why is that? In a word, COVID.

People have been scrambling to build out their home offices and to make themselves electronically savvy at home. I asked this, is that something that’s going to repeat? I mean once my home office was set up, why don’t I have to buy any of the same items again? Make no mistake, this company even today, despite having a strong service business, 75 percent of sales come from computing, mobile phones and consumer electronics. The services business at this company that bowls are pounding the table on that was just wait for it, five percent of revenue last year, five percent of revenue. Now the company does have a couple of growth initiatives in place, they have a subscription plan growing out, they’re getting into the telehealth business because when I think Best Buy what I think is healthcare, of course. I think by myself as a consumer, when I go in there and shop at Best Buy, the only thing that they want to do is talk to you about signing up for a credit card and selling me a protection plan. No thanks, I will just shop on Amazon myself. Now, if we look at the most recent quarterly results, we see a topline declining. Same-store sales are declining, gross margin down, sales and advertising expense up, and adjusted earnings-per-share down 21 percent, management all but admitted that they should expect exactly that over the next two years. Yes, this stock is cheap today but when I think of the long-term no store openings, challenging same-store sales. COVID is now a headwind supplier, concentration the retail landscape is changing, margins are going to be under pressure, and services are just five percent of sales, it’s a hard pass for me.

Ricky Mulvey: Gentlemen, thank you so much. That’s Bull versus Bear. You can decide who made the better argument at Motley Fool Money on Twitter. Brian Feroldi, you got to book out real quick. Where can people find it?

Brian Feroldi: Everywhere that books are sold, including Amazon, Best Buy’s enemy.

Ricky Mulvey: Why Does The Stock Market Go Up? Jim Gillies, Brian Feroldi, thank you so much.

Deidre Woollard: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Deidre Woollard, thanks for listening, we’ll see you tomorrow.