Why Investors Are More Bearish About Best Buy, More Bullish About L Brands

Specialty retail companies Best Buy (NYSE: BBY) and L Brands (NYSE: LB) reported on their fiscal first quarters Thursday, and both carried a few surprises for investors. At the electronics chain, profits were solid, but management's guidance was cautious as it looks to the U.S./China trade war and sees the troubles hitting its own bottom line. At L Brands, the Victoria's Secret chain continues to lose its luster, but the sweet smell of Bath & Body Works' rising comps was enough to lift the whole company into profitability.

In this MarketFoolery podcast, host Chris Hill and senior analyst Ron Gross consider all sides of the stories for these retailers, put their latest numbers into context, and discuss the investment theses for their stocks. They also respond to a listener's question on value traps, and share some barbecuing tips you could use to upgrade your Memorial Day grilling. 

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on May 23, 2019.

Chris Hill: It's Thursday, May 23rd. Welcome to MarketFoolery! I'm Chris Hill. Joining me in studio, the one and only Ron Gross.

Ron Gross: [laughs] There can only be one!

Hill: There can only be one! Were you in Highlander? I'm all in for a Highlander reboot starring you.

Gross: TV show or movie?

Hill: Oh, movie!

Gross: I watched every single episode of the TV show. And it was fantastic! I really loved it!

Hill: I'll take your word for it. We're going to talk retail, we're going to dip into the Fool mailbag. And it's Memorial Day weekend, so of course, we have some grilling tips. We've got some grilling tips.

Gross: Are you hosting anything this weekend? Are you having people over? 

Hill: No. How about we do the business stuff first, and then we'll get into that? 

Gross: Fine. [laughs] If we have to.

Hill: Let's start with Best Buy. Second-quarter profits for Best Buy looked good. Shares down around 5%. I'm assuming that's because of their guidance?

Gross: Yeah, it's all tariffs nowadays. You know, Chris, when you look into the future sometimes, and you just don't see it right? This is one of those things, with me and Best Buy. I didn't get it. I didn't think the company was going to succeed. But you know what, they've done a nice job. They've really turned the business into one of tech support, help, to a certain extent subscription services, and online sales. And I saw none of it. I just didn't see it. You can't see them all.

Hill: You've got plenty of company in that regard. 

Gross: Yeah, for sure. I mean, even with the stock weakness today, Best Buy's up 25% year to date. And that's because of Hubert Joly doing a nice job turning the business. We actually now have a new CEO coming on board. She'll be the fifth CEO in company's 53-year history, Corie Barry will come on. All indications that she will continue to focus on these higher-margin subscription-based services, things like Geek Squad, things like tech support, and the company perhaps may be able to continue with this momentum. 

Hill: I'm not just saying that to make you feel better. There were a lot of people who looked at Best Buy five, six years ago, before Joly came in as the CEO, and thought, "Gosh, this is a big box retailer that is Amazon's showroom." Joly made investments in the stores, made investments in the Geek Squad, and it shows up. You look at the gross margins in the second quarter, they're expanding. That is directly the result of, as you said, the high-margin business of the Geek Squad.

Gross: For sure. Also they identified things that were not going well. They made tough decisions. They got rid of the 105 Best Buy mobile stores, they got rid of 12 of the large format stores, and they doubled down on what they thought they could do to improve margins. And so far, it has worked. 

I think that one of the things us investors sometimes fall prey to is, we jump on the bandwagon if something's not going well, and we project that it will continue to not go well into the future. It's human nature. I think we often do it. The great investors out there can look a little further into the future and perhaps see a turn. You can make a lot of money if you're able to identify those opportunities.

Hill: Now, let's go to what's not happening right for this company at the moment. You mentioned the tariffs. That is part of what we're seeing with Best Buy today, because they slightly raised their guidance for Q2, but they kept their guidance for the entire fiscal year flat, which is one of those things that always makes me scratch my head. Inherent in a move like that, isn't that the company saying -- look, if you're going to raise your guidance for the second quarter, it stands to reason that you would raise it for the full fiscal year. If you're keeping it flat for the full fiscal year, doesn't it stand to reason that they're like, "We're holding open the very real possibility that in the second half of our fiscal year, we're going to have to lower guidance"?

Gross: For sure, you nailed it. It's all about the math, right? If second quarter goes up, if the math just carries forward, the full year should go up, too. But, I think they're doing the right thing here. If these trade wars don't get cleared up quickly, there will certainly be an impact. They're being conservative, which I think is the appropriate thing to do. Now, they're not lowering guidance. They're not seeing things getting crushed in the second half. But they're being a little tepid in what they think the second half holds in store for us.

Hill: And as you said, in 2019, this is a stock that's been on a really nice run. Today, it's at a 52-week low, and it's dropping another 5%. 

Gross: And it's only 12 times earnings. They're a profitable company, and only 12 times, which is theoretically cheap. Similar companies, peers, trade at a median of around 13 times -- 12 and 13 are similar, let's not split hairs. But neither of those two are expensive, and that's because these businesses are tough, and they ebb and flow. They have good years and good decades and bad years and bad decades. You're not going to ever see them trade for a premium to the market. But 12 times, might be still a good entry point here. 

Hill: Good luck to the next CEO! Tough act to follow.

Shares of L Brands are up 13% this morning. This is the parent company of Victoria's Secret, Bath & Body Works, and Pink. I guess first-quarter results were much better than expected, although expectations were pretty low for L Brands.

Gross: Very low. Even with the pop, we're still down on the stock year to date about 5%. That's because this Victoria's Secret chain just cannot get out of its own way. It continues to struggle. Comp sales for Victoria's Secret down 5%. Over-discounting, falling same-store sales for Pink. Pink, a youth-targeted line, things are not going well there. That's really a drag on this company. 

The bright side is the Bath & Body Works side, where comp sales were up 13%. That's a strong number. One would think that this would perhaps be a stronger company if Bath & Body Works was a stand-alone company just in and of itself, because the demand from consumers seems to be pretty steady there, whereas Victoria's Secret is having some trouble.

Hill: I mean, I make fun of the $25 candles that they sell at Bath & Body Works. But if you're looking for high-margin stuff, that's a high-margin item.

Gross: For sure! They did raise guidance. They actually raised the lower end of full-year guidance, but that's still a raise. That's a positive indication. This one's only trading at around 9 times. We talked about Best Buy, specialty retail in the tech space, trading for 12 or 13. This one's only at 9 times. Even more of a specialty retailer in my mind. You don't want to pay up for a premium like this. Median companies trade around 11, so it's trading at a discount to its peers, which is probably appropriate, because Victoria's Secret's just not getting it done.

Hill: You crunch the numbers a lot more than I do. But 9 times still sounds high to me for L Brands, for the way that it's performing. I get that this quarter was better than expected. But it was basically an expectation that they were not going to make any money at all; they weren't going to turn a profit. And they did turn a profit. If you told me L Brands was trading at 4 times, I might start to get interested. But this still seems high for the structural problems that they're facing.

Gross: You make an excellent point. When your guidance is for breakeven and you exceed that guidance, well, that's good. You're profitable, and profits are great. But with the snap of a finger, they could have either been breakeven or negative. What are you really paying up for? What are you buying? To pay 9 times earnings, as you indicate, it's still 9 times. If you owned 100% of the company, you bought 100% of the company, it would take you nine years to break even if you put all of the earnings in your pocket.

Hill: Well, particularly compared to something like Best Buy. I look at Best Buy as a company that is maybe not firing on all cylinders, but they're firing on a lot of them. The fact that it's 12 times versus 9 times ... anyways.

Our email address is Question from Alex Bayer, who writes, "I'm a big fan of the show and all the other Motley Fool podcasts as well as the Stock Advisor service." Thanks!

Gross: Nice!

Hill: We love love that! "I'm curious to hear if any of the Fools have been caught in a value trap, when they thought they were getting a great value stock, and what some of their most memorable examples are. Please keep up the podcasts. I recommend them frequently, and later, I hear raving reviews."

That's wonderful! And thank you for that, Alex! Thank you for helping us spread the word! And hey, if you want to leave a rave review on Apple Podcasts, Stitcher, Spotify, wherever you can leave reviews, we would love that!

Gross: Oh boy, yes, Alex! [laughs] 

Hill: [laughs] In a word, yes. This is a question that we get from time to time. When we see a stock drop, we get this question from listeners. And we ask this of one another: "Hey, this stock is down 30%, 40%. Is it a value play or a value trap?"

Gross: I've been a value investor, Chris, for 30 years. Unfortunately, I've not escaped value traps. They're just part of doing business. The ones that I've fallen prey to really fall into two categories if I look back over specifically my hedge fund career -- actually, at The Fool here as well. Two categories. One is, I thought a business was temporarily impaired, the market was overreacting, and that it would eventually come back and I could scoop it up at a cheaper price, or a price that is less than I thought the company was truly worth, which is what a value investor is trying to do. Theoretically what all investors are trying to do. There are occasions where I've just been wrong about that. Listeners may remember me speaking about Ampco Pittsburgh or Horsehead Holdings, two value traps that I fell into.

I am hoping that Titan International, my beloved Titan International, is not a value trap. However, it's taken years longer than I expected for this to turn. Even if it does work, my rate of return on an annualized basis will not be what I had hoped it would be. So in that sense, it has become a value trap. I'm still holding out hope that it will turn, but this could end up being one of those as well. 

The other times that I have fallen prey to the trap is when I fell in love with a balance sheet. Back in the day, especially, value investors could actually make investment decisions, valuation decisions, by focusing on the balance sheet. It's more difficult now, at the end of an 11-year bull market, to find those kinds of opportunities. But certainly, back in the day, they were. And there were times where I would fall in love with a balance sheet and didn't focus enough on an operating business. One comes to mind, Concord Camera. It was a company that made disposable digital cameras, you know, the kind that used to be on the table at a wedding. Selling at a discount to its book value, discount to its net worth. And I thought it was a real opportunity. I failed to see, however, that the world was going digital, and the iPhone would be invented, and no one would ever need a disposable camera ever again. So I fell in love with a balance sheet. I didn't think enough about the business and the future. And the company actually went bankrupt.

Hill: We're off on Monday for the Memorial Day holiday. Please check out Motley Fool Money this weekend. Our guest is Nell Minow. Of course, we talk summer movies. She's got a couple of recommendations of under-the-radar movies you don't want to miss, and at least one big-budget blockbuster movie that really seems like we're all going to want to skip. Definitely check that out this weekend. 

Memorial Day weekend is not only the unofficial kickoff of the summer movie season, it's also the official kickoff of summer grilling season. 

Gross: You betcha!

Hill: Do you have a grilling tip for the dozens of listeners? You're an experienced chef.

Gross: I do have one -- 

Hill: I have one as well!

Gross: OK. Calm down! [laughs] Everyone, get your pens out. I'm going to recommend Nippon Shokken black pepper sauce. It's a marinade. It's soy sauce based, peppers, garlic, black peppercorns. Fantastic! You can use it on steaks, pork tenderloin, chicken. It is unbelievable! If you don't like it, I'm not going to pay for it, I'm not going to guarantee it, but email me and let me know because I would be shocked. Specialty retailers, Whole Foods, Balducci's, you can find it in places like that.

Hill: Spicy?

Gross: It is spicy because of the black peppercorns, but not like a Buffalo wing. Not that kind of heat. But there's a kick to it.

Hill: Alright. Nippon Shokken black pepper sauce. I did actually jot this down. 

To answer your question from the beginning of the show, no, I'm not entertaining, I don't have guests over. But here's my grilling tip. It's a reminder to myself. Invest in some metal skewers. 

Gross: I've done that recently! Wow, I can't believe you said that!

Hill: Really?

Gross: Yeah!

Hill: Invest in some metal skewers because kebabs take a little bit of work, a little bit of extra work than just putting together burgers, dogs, sausage, that sort of thing. But they're so worth it! And, my grill game is not quite up to par with yours. I'm pretty good at grilling. I'm not a master griller like you. But I find that when I do kebabs, metal skewers, perfect every time.

Gross: Sure. I'm going to give a shout out to Dan. I think I'm right about this. I in the past was mistaken that you should do your kebabs with vegetables and protein on the same kebab. And I was like, you'll be fine. It'll be fine. They'll be able to regulate the temperature. You won't burn this or that. I was wrong. You should separate them, in my opinion. I think it came from Dan, if I'm not mistaken, our engineer here. If you separate the vegetables and the protein, whether it be for the chicken or the swordfish or whatever, they'll come out much, much better.

Hill: Well, let's go to our man behind the glass, the immortal Dan Boyd. Dan?

Dan Boyd: Yes, you're right, Ron! I certainly didn't make up this idea. I may have been the one to deliver the news to you. But, yeah, it's a lot easier to get correctly cooked vegetables and meat when they're not all on the same skewer together. Especially if you're cooking chicken, like a chicken kebab, you have to cook that chicken for a long time, longer than you want to cook the onions or the peppers, whatever. 

Hill: I'm thinking about all the times I've seen pictures of kebabs. Of course, usually, it's steak or chicken, and colorful vegetables, red and green, yellow peppers, onions, that sort of thing. What do we think? Do we think they're doctoring those photos?

Boyd: You can still cook them like that, and they'll probably be delicious. But I'm talking about optimizing the deliciousness. And if you're going to take the grill out, you're going to clean it off, you're going to fire it up, you're going to do all those things, you might as well cook the food correctly.

Gross: There's nothing wrong with a little char on a red onion or tomato.

Boyd: Absolutely not.

Gross: And you can do that, if you want, separately. But you'll have the choice, then, versus having no choice because you have to make sure your chicken doesn't kill everyone at the barbecue.

Hill: You're not getting advice like this other business news podcasts. You're just not!

Gross: No, you're not!

Hill: Ron Gross, thanks for being here!

Gross: Thank you, sir!

Hill: 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. That's going to do it for this edition of MarketFoolery! The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Tuesday!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Chris Hill owns shares of Amazon. Ron Gross owns shares of Amazon, Apple, and Titan International. The Motley Fool owns shares of and recommends Amazon and Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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