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Beyond a Sound Investment

In this week's episode of Industry Focus: Consumer Goods, host Jason Moser chats with Motley Fool analyst Dan Kline about some news in the CG world. Amazon's (NASDAQ: AMZN) Prime Day pumped out a lot of sales, but that's not the point of Prime Day. Under Armour (NYSE: UA) (NYSE: UAA) fell on a weak report, but the company's long-term turnaround plan keeps chugging along, slow and steady.

And Beyond Meat (NASDAQ: BYND) shares continue to jump mind-bogglingly high every time a new partnership is announced, but there are tons of long-term problems with the growth stock story here. Is there really a demand for a Beyond Meat sandwich at Dunkin' (NASDAQ: DNKN)? How does Beyond Meat sustain a competitive advantage into the future? Tune in to hear more!

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 July 30, 2019.

Jason Moser: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. It's Tuesday, July 30th. I'm your host, Jason Moser. On today's Consumer Goods show, we've got more earnings to get to with Beyond Meat and Under Armour, neither of which is having all that great of a day. But first, we're going to dig into something a little bit less earnings related and a little more sales related. Joining me in the studio this week via Skype -- and actually, he should have been here in person, so I'm a little salty, but I'll let it go this time because I know he'll be here in a couple of weeks anyway -- fool.com contributor Dan Kline. Dan, what's up?

Dan Kline: [laughs] I had to push this trip back a couple of weeks. Sorry about that!

Moser: That's all right! Listen, you get my heart set on one thing... if anything, we are able to pivot and change and adjust here. Thankfully with the magic of technology, we can still get you in here.

We wanted to start today's show, obviously we're knee-deep in earnings season here and you've got like 500 companies per day announcing earnings over the next couple of weeks it seems like. A company that did release earnings last week, Amazon, we wanted to talk about Amazon, but not in the context of earnings. We wanted to talk a little bit more about its recent Prime Day. As listeners, I'm sure, know, every year now, Amazon has Prime Day. It's a way for them to get everything out there in front of us consumers, enticing us to click "buy" for all of the stuff that we really don't need. This year was a little bit different. Amazon Prime Day was two days, it was July 15 and 16th. Dan, while we're not going to see the impact of those sales numbers on this quarter that Amazon just announced, by most measures, it was still a very big two-day stretch for the company, wasn't it?

Kline: It's a huge success! Amazon likes to tout that it was bigger than Black Friday and Cyber Monday put together, but I think it's a little bit deceptive. When they say Amazon Prime Day, let's focus on those two words, Amazon and Prime. This is Amazon's tag sale. They are cleaning out the warehouse. They are selling all the junk they want to get rid of before they start stocking up for the holidays. And they're offering some good deals from partners and other people, which has forced all sorts of other retailers to offer sales, so it's great for consumers. But the real goal of Prime Day is to get people to either become Prime members -- that's the Prime half of it. With Prime memberships, they renew when that comes up. Or, buy Amazon devices. And by all accounts, it's the biggest day ever for Prime sign-ups, and all of the top sellers that Amazon listed -- admittedly, Amazon doesn't give numbers, they don't provide a lot of detail -- all of the top sellers were Amazon devices. And every time they sell you an Echo, a Fire TV, a Kindle, all they're doing is building out their infrastructure. They sell you a Ring doorbell, which they own, then all of a sudden, you have to buy the rest of their system. The purpose of Prime Day is strengthening your connection to Amazon or making people who aren't Prime members feel like, "Wow, I have to be a Prime member!"

Moser: Well, yeah. We're going to see Apple earnings come out here a little bit later today, actually. It's always been interesting to look at this divide between Amazon and Apple. You have on the one hand Apple, a company that's always made its money selling the devices to people. They sell these high-markup pieces of hardware. Whereas Amazon, Bezos has always been very clear, he wants to make money on us using his devices, not selling them. These devices all ultimately are just forms of engagement. That's why they can sell them for such a low price. Ultimately, it's not about selling you the device, it's about keeping you coming back and using that device and keeping you in that Amazon ecosystem.

Kline: We used to talk a lot about owning the living room, the battle for the living room. That goes back to the days we talked about Sony versus Microsoft. Now that all of these digital assistants and smart TVs are out there, it becomes, who has that footprint? And there's not actually a lot of ordering that's happening. Technically, I could say -- and I won't say it, because I'm in the same room as the device -- "Amazon device, order me some paper towels." And if I said the proper name of the device, it would make the little bloop bloop and it would do that, it would order me some paper towels. Not a lot of people actually do that. That doesn't matter. Amazon will figure that out. Once they control all the devices, they will figure out how to get you to use those devices in the way they want to. Apple does some of that. If you're on a Mac or an iPhone, you're in a closed-loop system where you have to buy your media from them, you have to buy your apps from them. Amazon gets some of that. If I'm flipping around on my Fire TV and I want to rent a movie, I do that from them. If I am not a Netflix subscriber and decide to subscribe to Netflix, I could go to my computer, but chances are I'm just going to do it right from my remote control there. So this is like staking out your territory. It's like a mad dash for control. And Amazon has been very smart about it. Its devices are cheap. I have, I don't know, seven, eight Echoes and Echo Dots, a bunch of Kindles. I don't even use a Kindle Fire and I think I have three of them because they used to be a really good way to watch a movie on a plane. Now I just do it on my iPhone.

The success of Prime Day is creating a holiday that's all about Amazon. It creates the frenzy you get when there's a big Apple product release. I think even Apple struggles to do that. I don't think when the iPhone 11 or X-1 or whatever the heck they call it comes out in September or October you're going to see the frenzy you used to when there were major new features and big changes. But do you know anyone at any age that wasn't aware it was Prime Day for those two days?

Moser: No. I think most people were aware of it. Obviously with social media now, stuff gets around, whether it's Facebook or Instagram or Twitter or whatever else. To your point, it is all about marketing. It is just about getting that Amazon name out there and creating that awareness that pretty much Amazon can do anything that you need them to do at this point, and it's going to be at a pretty darn good price.

Kline: Yeah. They also did something pretty amazing. I wrote an article before Prime Day about what the benefit was to brick and mortar. This study -- I apologize for not naming or citing the study -- said that the biggest benefit to Amazon itself is actually Whole Foods. When you're looking at brick-and-mortar retailers, Amazon has done a wonderful job driving traffic to its own brand. They did something smart -- if you shopped at Whole Foods a few weeks before Prime Day, you got $10 to spend. I had actually intended to sit out Prime Day. I had decided there was nothing I needed, so I wasn't going to get sucked into a deal. What happened was, I went, "But wait a minute, I have $10 to spend." And I think I only spent like $14. I didn't spend a lot on top of that. But I did go to Amazon, I did buy something, they had a chance to get me to buy more. And that's a brilliant tie-in!

Moser: Oh, yeah! We see Starbucks see those same types of things. It's all about figuring out a way to create you to spend, whether it's a limited-time drink or a treat receipt or whatever it may be. They're figuring out ways to get you in there even when you don't need to. I'm like you. I actually don't think I bought anything on Prime Day because I didn't need anything. But I did look around to see if there was some stuff I might want. I always feel like I'm going to find that piece of home-improvement equipment that I've been longing for, whether it's this awesome nail gun or some type of chainsaw that I feel like I could benefit from. There's all sorts of stuff going on when you're a homeowner. And honestly, I didn't find a lot of that stuff. I was a little bit disappointed from that perspective.

But one of the things I was looking back here with Amazon, looking back at Jeff Bezos's letter to shareholders here in April, obviously Prime Day is all about Amazon. But increasingly, Amazon is also all about those third-party providers, those independent third-party sellers that are selling stuff on their platform. If you go back to 1999 and you look at the percentage, the share of physical gross merchandise sales sold on Amazon by independent third parties was 3%. You fast forward to 2018, it was 58%. So you have to figure those third-party sellers are starting to look at Amazon Prime Day and thinking, "This is a big chance for us, too."

Kline: This is a massive advantage for Amazon over Walmart. They've been able to get this huge base of sellers. In most cases, they get paid for the warehousing, they do the shipping. It really is like Amazon getting to have a bigger inventory, and not only not having to buy that inventory, they actually get paid if that inventory doesn't move. It's a win-win-win-win. I don't know how many wins, but a lot of wins for Amazon. And as a customer, that made Prime Day better. Again, I didn't buy anything. But some of the things we looked at were better deals from third parties, there was some more interesting stuff. Had I not just bought a Roomba, I might have bought a robot vacuum from a third-party seller. There was some interesting stuff there. And yeah, these are more important. And Amazon has to show traction for those people because both Walmart and eBay are trying to lure those third-party sellers away.

Moser: There's no question. And don't forget about Shopify either. I think that's going to be a legitimate competitor here in that space for many years to come.

Let's take a little bit of a different direction here. We're moving beyond e-commerce and going into the market of meat substitutes. I'm still not used to saying that, but hey, we'll figure out how we can make this work. When we talk about Beyond Meat, obviously a tremendous first few months here in the market after its IPO. The stock has been on fire. Their first-quarter results came out last night. It was a lot of what we expected. Tremendous top-line growth. They're not profitable. The stock now is trading at around 55 times full-year sales estimates. In virtually any market, that's crazy. But we also understand the reason -- there's a lot of excitement around this company and what they're doing.

Kline: People like the product. They also like the momentum it has. We're going to talk very briefly later in the show about Dunkin' Donuts. Dunkin' Donuts added a Beyond Meat sausage, and that got an enormous amount of attention. What's not going to get an enormous amount of attention is the very tiny amount of people that go to Dunkin' Donuts and order a Beyond Meat sausage sandwich. Yes, there's a certain person who maybe is at a Dunkin' Donuts that's the customer for that. But we've seen over and over with McDonald's that a pivot to healthy is rejected by consumers. You don't go to McDonald's for healthy. A lot of the places, it's like, yes, it's very good when an upper-end restaurant adds a Beyond Meat product because then you're serving a wider audience. But when a fast-food chain does it, that's a gimmick. I really question whether someone who really takes care of themselves and makes good food choices was going to McDonald's -- McDonald's isn't actually serving this, but Burger King is, or Dunkin' Donuts -- just to get this. So yeah, maybe there's some incremental sales in "person who's stuck at the airport looking for a healthy choice," but I'm not sure the underlying excitement of all the places that are picking this up is going to translate into long-term sales. And I've said this before -- I eat largely gluten-free, and a lot of places add gluten-free items, and then six months later -- again, Dunkin' Donuts is a great example -- they had a gluten-free donut, and it sold through once and then it went away and you never saw it again. I worry about that for Beyond Meat. I do feel like it's a gimmick. If you're a vegetarian, I'm not sure you want a cheeseburger.

Moser: I agree with you there. I'm not a vegetarian. I would imagine that a vegetarian would be looking at something other than a burger anyway. When it comes to the restaurant, you do have to wonder, longer term, is the juice worth the squeeze here? We know that when it comes to restaurants, the more dynamics you add to that menu, the more you have to manage. And when you're talking about a meat substitute, obviously very new to the market. They haven't even gotten their supply chain figured out fully either. But to your point, too, I don't think people are going to a fast-food restaurant for that type of transaction. Yeah, I agree, they're not going there to eat healthier.

Now, the flip side of that is, I do think feel like in a lot of cases, it seems like to me with these types of offerings, the fast-food industry is probably where it's the easiest to make that switch. In other words, I feel like your meat substitute is probably going to be something that's fairly similar to the meat that was already being used in the product before. It seems like you probably wouldn't see the difference.

Kline: Yeah, it's the difference between offering chicken or beef. It's a very simple switch from a production line point of view. But you also have the question of, are they going to order it -- and I don't want to sound super negative on this company. I think from all accounts, it's a good product, there's a lot of growth for it. I think the home market for families that have vegetarians and nonvegetarians to be able to throw a veggie burger on the grill next to the regular burgers -- maybe a little bit away from the regular burgers -- I definitely think there's a very strong market for that. But look, their sales increased by 287%. I don't think that's a sustainable growth rate.

Moser: Coming off a small base, too, let's be honest.

Kline: Right. And they have a position, and it's a very challenging position, where they have to make capacity decisions. And at some point, they're going to say, "Let's hold off a little bit," or they're going to build too much capacity. They've done a very good job so far of managing growth, keeping their loss very tight. But this isn't a small business where they can build out capacity as needed. These are factories, essentially. It is a very expensive game to play. I think there's a nice product line here. I think it's a good acquisition target when the stock crashes. I'm not sure it's a high-growth company the way investors are treating it.

Moser: Yeah. You said "when the stock crashes." I tend to agree with you there. I feel like it's just a matter of time. It's a valuation that makes zero sense, particularly in a market where there are so many substitutes out there. I'm not talking about the company out there that's trying to make the same type of product as Beyond Meat. I'm talking about all of the different dietary options that are out there. There's a million substitutes out there.

Kline: You mean, not even meat?

Moser: Not even meat, or a black bean burger, or whatever. There's a million different ways you can change your menu to accommodate whatever you're trying to do. I guess there are some questions as to the general health benefits of this product at this point. There is still somewhat of an unknown when it comes to the real health trade-off there, isn't there?

Kline: Yeah. Look, I don't want to compare this to vaping. Obviously, we're pretty sure that bringing anything into your lungs is bad for you. But this is one of those ideas that, because it's plants, it's good. Do you remember when everyone thought, "Oh, wow, McDonald's and Wendy's have salads! Those must be good for you!" Then you realize that they're salads with bleu cheese dressing and fried chicken. The study would come out like, "A fast-food chain salad is actually worse than eating two Big Macs." I'm not saying that's the case here. But this might turn out to not be as beneficial as people think it is to their health.

And obviously, eating less meat is good for the planet. There's lots of benefits to this. But there is another shoe that's going to drop, and that is that about 3.25 million shares of stock are being put into the market partially by insiders who want to cash out, and a very small amount -- about 250,000 -- by the company for added proceeds. While that's only 3.25 million in about a 60 million float, it's still a sign of the insiders going like, "Hmm, maybe let's get while the getting's good." That has to make you a little bit nervous.

Moser: I think that's a very reasonable way to look at it. OK, Dan, another company that is having a less-than-stellar day. Let's talk for a minute about Under Armour. The results came out this morning before the market opened. There was some good news and some bad news. This is a business very much in transition, trying to rebound a little bit from a strategy snafu --

Kline: Under Armour is facing some retail headwinds. There's a couple of things. There's the overall negative brick and mortar retail that's creating problems for brands. There's the bigger headwind of companies like Dick's Sporting Goods, which is a pretty important chain for Under Armour, have decided to devote more floor space to their own owned and operated brands. That means that Under Armour has a couple of choices. They can build out their distribution network. I have an Under Armour outlet down the street from me and I shop there all the time. As I'm sure you can all tell by my physical condition, I am dedicated to the Under Armour. But that said, they're not as front-of-mind as, say, a Nike with as many people. So what they've been working on is growing their direct-to-consumer sales. And that's been working. That's about 35% of their business, and that number was up. So, yeah, people are reacting badly to the overall revenue number -- basically even in terms of revenue, up 1%. But I think the reality is, the company has a plan, and it's executing pretty well on this plan.

Moser: I don't disagree, actually. I come from the perspective of, I've been a fan of this company for a long time. We enjoyed it on the way up. You have to take your lumps on the way down. Certainly, there were a couple of years ago, Kevin Plank made a conscious decision to boost inventory levels in the name of trying to get product out to people as quickly as possible. On its own, that seemed like at least an idea. We all had our questions regarding it. And it really didn't work out. The numbers I was saying to watch out on Market Foolery a couple of weeks back, North American sales. If you look at North American sales this year, in the first quarter, they were down 3%, and this quarter they were down 3%. A year ago in those same quarters, it was flat and up 2%. But here's something that's interesting. I was talking about that inventory strategy. When you look at this quarter, inventory levels for the company were down 26%. That sounds like a lot, and it is; it actually is a really good thing when you consider last year, the same quarter, inventory levels were up 11%. And if you go to the first quarter, inventory this year was down 24% versus being up 27% the same quarter a year ago.

Kline: This is Under Armour recognizing -- which it didn't at first -- that it's in the apparel business, not the sports --

Moser: Lifestyle business?

Kline: Yeah. Under Armour could probably stock an endless amount of plain black shirts with its signature material. It's always going to sell those, they're always going to be a big hit. But a big percentage of its business is going to be trendy, it's going to be designs. It's going to be what an athlete that endorses it wears. And the life cycle for that isn't forever. They have to identify their perennials. When you go to a Nike store, you can always buy a black T-shirt with a Nike logo and a swoosh on it, which is actually what I'll be changing into after this show. [laughs] You can always buy that. It doesn't matter how many Nike has, they'll eventually sell them out. Under Armour has figured out that it's OK to run out of certain things. In fact, when it comes to sneakers -- Under Armour is not a big player in sneakers, but they do sell them -- it actually is good to run out of stuff. It creates value and scarcity and makes people shop quickly. Managing your inventory tightly keeps you from having to discount. It's probably going to make my outlet store less of a good deal. But for the company, it helps them.

Moser: Absolutely! That's one of the big drivers of this revenue stagnation in the near term, is the fact that these inventory levels are coming down so quickly. A lot of that means they are discounting, they're trying to get stuff out of the way here, because they are moving back to that strategy of trying to focus a little bit more on a premium product, going back to what the business was founded upon in the first place. I can certainly see the market's lack of patience in today.

Kline: Yeah, and they took that money and used it to pay down debt. They paid off $591 million of debt in the quarter. The less debt you have, the more flexibility you have. If an opportunity comes up, they're in a better position to go after it. And they're going to have to do some advertising, whether that means traditional advertising or athlete sponsorship or venue sponsorship. There is still a lag between Nike, who's almost certainly their top competitor, and Under Armour in terms of every day nonathlete. They have plenty of inventory that are not that athletic, sweat-wicking material, they're just T-shirts. They need the nonathlete to think the brand is cool, or they want to wear it because the quarterback on their team wears it. That's something you have to do strategically. Obviously, Nike does it incredibly well, if you saw their post-Women's World Cup commercials or their Tiger Woods post-Masters commercial. Under Armour has to figure some of that out. But they're maintaining their ability to do that, and their international sales were up 12%, which is a strong sign as well.

Moser: Yep, slow and steady. I feel like they're making the right steps here. But it's going to take a little time, for sure.

All right, Dan, before we wrap it up here, let's give our listeners One to Watch over the coming week, talking about a couple of stocks we have our eyes on here with earnings continuing to roll out. What's a stock that you've got on your radar this coming week?

Kline: You actually suggested this to me, but it's Dunkin'. The reason I'm watching Dunkin' is, it's hard to figure out where they sit in the marketplace. Are they the low-cost alternative to Starbucks? Are they the blue-collar brand? What you have to watch is, they just spent a lot of money revamping their espresso platform. In theory, that should steal some business from Starbucks and ramp up check size from existing customers who say, "Instead of having an iced coffee today, maybe I'll try an espresso-based drink." So you want to look at same-store sales, but you want to also look at foot traffic and average revenue per check or average revenue per user and see where they are. I'm not overly optimistic. I think they're going to tread water. But they've surprised me in the past.

Moser: Dunkin' has always done a great job executing on the food side. We've always been a little bit critical of Starbucks from that perspective. But I tell you, one thing I noticed in Dunkin' the other day, man, those drinks have many calories. You really have to be careful with that these days. Those menus are going to get out of control.

Kline: It's actually something Starbucks has done very well compared to its competitors. If you go to a Starbucks and order through the app, you see exactly what the calories are, and you can make substitutions -- I want sugar-free syrup, I want skim milk instead of heavy cream. The default at a Dunkin' Donuts tends to be cream and sugar. That's just how people order their iced coffee. It's a New England thing. I'm from that area, so my whole life, you have to really ask for milk if what you want is milk. And I don't think their customer base thinks about that as much. But as they push into espresso, I wonder if they should be clearly marketing a skinny version, making it a little bit easier. While they have a decent app, they don't have the flexibility of the Starbucks one or the transparency that Starbucks does. So yeah, it's a ton of calories, and you might get a donut with it. And honestly, I think they execute breakfast sandwiches very well, but I think their doughnuts have gotten progressively worse and smaller over the years. Again, I don't eat a lot of donuts. I'm largely gluten-free. But their donuts don't look like what they used to. And OK, they took the word out of their name, but to most people, they're still Dunkin' Donuts. Maybe it's time to revamp that and put a focus back on donuts.

Moser: Not a bad idea. Not a bad idea at all! I'm going to keep an eye here on Kraft Heinz. Kraft Heinz earnings hit later on Thursday. This has been a train wreck of a stock for some time here. It was all based on the whole rolling of Heinz into Kraft. You remember Buffett and 3G with Berkshire Hathaway and 3G. They had a big investment there in Heinz. I always was a little bit hesitant there with that one. I feel like Buffett maybe relies on those old state brands and assigns them a little bit more value than he does. But hey, maybe I'm wrong here. There are certainly a lot of brands in that portfolio that still have a lot of shelf space in the grocery store. But when you look at the business, generally speaking, you look back to February, they had to slash their dividend by 36%. Wrote down about $15 billion on two of its biggest brands in Kraft and Oscar Meyer. They had an SEC investigation. There are a lot of question marks with this company that are still very much unanswered. Again, I'm not sure they still have the same brand resonance that they maybe once did when we were growing up, but I could be wrong.

Kline: I think the challenge facing them is, the brands are staid. When they put out a new product, are you that excited about a new macaroni-and-cheese package? Or, now it's ketchup, but it's mixed with mayonnaise? There are a lot of brands out there that, if they introduce a new product, it can be a huge deal. A new cereal from Kellogg's can get mainstream news coverage. Other than some of the Kraft Heinz products getting coverage for how stupid they seem, I don't feel like they can move the needle in terms of, "I have to get to the grocery store to get this new Kraft macaroni and cheese, it's slightly more yellow, and it's faster, you can cook it in 8 seconds instead of 10." I don't know where they could go. But it feels like these brands need a revamp and some more --

Moser: Talking about new cereals out there, Dan, don't sleep on the new Pop Tarts cereal. I'm telling you. I've had the strawberry one, strawberry frosted Pop Tarts, and there's a brown sugar cinnamon one. I've had the strawberry, it was really good! You may want to give them a shot.

Kline: Call me when they have marshmallows.

Moser: Dan, thanks a lot for being with us today! It was great talking to you again! I'm looking forward to seeing you here in the office in the next couple of weeks!

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. Today's show was produced by Austin Morgan. For Dan Kline, I'm Jason Moser. Thanks for listening! And we'll see you next week!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Daniel B. Kline owns shares of Apple, Facebook, and Microsoft. Jason Moser owns shares of Amazon, Apple, Nike, Starbucks, Twitter, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of and recommends Amazon, Apple, Berkshire Hathaway (B shares), Facebook, Microsoft, Netflix, Nike, Shopify, Starbucks, Twitter, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has the following options: short October 2019 $37 calls on eBay, short January 2021 $200 puts on Berkshire Hathaway (B shares), long January 2021 $200 calls on Berkshire Hathaway (B shares), long January 2021 $18 calls on eBay, long January 2021 $85 calls on Microsoft, short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool recommends Dunkin' Brands Group and eBay. The Motley Fool has a disclosure policy.


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