In this podcast, Motley Fool Chief Investment Officer Andy Cross discusses:
- The short-term pain being felt by all investors.
- Shopify‘s (SHOP -1.37%) first-quarter results looking similar to Amazon‘s (AMZN 0.06%).
- Deliverr, the logistics company Shopify just bought for $2.1 billion.
- EPAM Systems (EPAM 0.54%), the IT services provider that surprised investors with a strong first quarter.
Motley Fool analyst Jim Gillies talks with Motley Fool producer Ricky Mulvey about MTY Food Group (MTY 3.68%), a small-cap Canadian food franchisor with potential.
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 May 5, 2022.
Chris Hill: Ever have one of those days where you can’t hit the ground with your hat, that’s what the stock market was like for investors. Motley Fool Money starts now. [MUSIC] I’m Chris Hill joining me today the Chief Investment Officer, Andy Cross. Thanks for being here.
Andy Cross: Hey, Chris.
Chris Hill: We’re going to get to Shopify. We’re going to get it to EPAM Systems. But can we just start with EPAM just for a second? It’s a little after 12 noon on the East Coast. The Nasdaq is down basically five percent in less than three hours and maybe that bounces back some before the end of the day. But for anyone out there feeling the pain a couple of things. We’re feeling it too. We’re feeling this pain, I’m feeling this pain.
Andy Cross: Yeah.
Chris Hill: This is the cost of doing business.
Andy Cross: Yeah. With investing as we’ve been experiencing really for much of the year for the past this calendar year but really for the past year or so of course investing is the markets. The markets sometimes can be unforgiving. In periods like this, when we’re going through this reset we had two years of a COVID period that was unlike any we ever saw before, Chris, and now we’re going through two years of this again. We’re going to have to come out of this. We see the Fed acting in ways they’ve never acted before. We see just some of the data that came out today on the economic side with efficiency and productivity way down unit labor costs way up. I mean numbers we haven’t seen in decades.
We’re starting to see the impacts of inflation and just the economic consideration that’s having an impact on valuations as interest rates are moving into a much more normalized environment and probably higher than many of us have seen in a long time. The markets are digesting this information and we do go through these periods of cycles. This one is very acute. Bill Gurley was saying the other day I heard him say it’s very much like a saw. Like you don’t experience you think markets maybe go more in like waves. When they go down they go down in saws like a solid blade and just it drops. When we’re going through that right now and it can be very painful. We’re empathetic to that to listeners and to our members.
Chris Hill: The only reason we keep going is because we know the longer you’re in the market, the more it’s going to pay off.
Andy Cross: Hundred percent yeah. There are down periods in the market certainly and bear markets tend to last much shorter than bull markets. There aren’t many down when you stretch out over any period, Chris, of going back decades and decades of 5-10 year period of investing. If you’re holding businesses in the Y case the US market most of the times almost 90 percent of the times the market that the stock price the least they generate some return if you add in dividends there. Now there’s a lot of churn inside the index as we’re feeling right now very acutely when you have so many stocks the average stocks down so much more than the index right now.
We’re feeling this very acutely. But over time they do match higher, but they do go through the pain of pain for those returns, there was 10 percent annualized returns in the S&P 500, Chris, that goes back 100 years that we’ve talked about and point too and the fantastic returns we’ve had over the last decade which you probably won’t have over the next coming decade but we should see some return. But in between you do see these periods of drawdowns. To get those returns you have to weather these storms. For new investors its certainly painful, but even for experienced investors like you and I and others it’s even hard for us to go through and you just have to continue to maintain that focus on the long term and owning the businesses that you want to own for the next 5-10 years.
Chris Hill: The unforgiving environment that we’re in leads us to Shopify because Shopify’s first quarter profits and revenue came in lower than expected. They said that revenue growth in the near term is going to be lower. They also spent $2 billion on a logistics company called Deliverr. The market is not going to forgive that combination of events and shares of Shopify down about 15 percent. Where do you want to start? Because whether we start there or somewhere else I do want to get your thoughts on this acquisition.
Andy Cross: Well we definitely want to talk about the Deliverr, a little bit more than $2 billion acquisition that really pushes them further into the logistics network. This has been rumored for a little bit, Chris. This is not a huge surprise. There was a news report out that they might make this acquisition and now it’s come true. But let’s just start before we jump into that we’ll just start about the quarter because like you said it was coming off the Amazon quarter. There’s a lot of similarities when you look at some of the e-commerce business, some of the threads that were coming out of the Amazon, you started to see with Shopify, their gross merchandise volumes of all the value of products going across their platform was 43.2 billion. That was up only 16 percent year over year.
Now Toby was very quick to point on a compounded annual basis over two years, that’s up 57 percent. I don’t think they made many comments like that in the past. It’s a little bit of a don’t look at us for just the past quarter look as over the past year. The 2021 first quarter was pretty exceptional, but still up only 16 percent. That’s a number we haven’t seen in Shopify in a while. Gross payment volume of 22 billion which represented more than half of the gross merchandise volume. That’s an all-time record. That was up from 46 percent in the first quarter of 2021. What that means is more people are using the Shopify payment network that are also using the Shopify platform overall. Merchant solutions revenue, Chris, is up 29 percent best Shopify payments, capital Shopify markets. But the subscription solutions was up only eight percent on the revenue side. You start to see the dynamics and that’s a big part of the subscription part of their business. Monthly recurring revenue up 17 percent. These are the numbers from Shopify.
There were not you’ve seen and what they talked about is just this environment, Chris, you pointed to at the start that we’re seeing as companies are normalizing, trying to figure out what their online offline commerce looks like. There was some commentary from some of the analysts that the point of sales is pretty good growth from Shopify. The social was pretty good spend on social. But when you start to bake it all out the general e-commerce business for Shopify was in the single digits and that’s like what the numbers like Amazon was talking about too. You see these threads showing up, Chris, for these big platform companies. It’s starting to show and what it means for the revenue growth. Then that impacts the profit picture too and the profits were much lower than analysts were expecting among the earnings side and the operating profit side. Because of the solutions business it’s not as profitable as the subscription business. You add up that environment, Chris, and that’s why you’re seeing a stock that this is reacting pretty severely in the markets today.
Chris Hill: We’re seeing this across e-commerce today you look at what’s happening with eBay, Etsy, Wayfair. Part of this for all of these businesses is inflation. Because if you look at the volume of spending that’s happening, people are still spending money, but things are more expensive. It’s not like people are buying a lot more in terms of volume, they just happened to be paying more because of inflation. Companies that have the ability to increase prices are doing that. In terms of the acquisition of Deliverr, again logistics company based in Denver, $2.1 billion. It sounds like you think, yes this is happening on a day when all those other news comes out about Shopify. Maybe that’s by design because it seems like it fits with the direction of where Shopify wants to go.
Andy Cross: Well it’s where it has to go, Chris. Certainly, we’re seeing obviously Amazon in the logistic network they have built out. There’s competition there. They are focusing and they’ve been talking about building out all the logistics. They talked about it on the call again how they continue to invest. By the way the cost structure going forward is going to continue to be high as they make these investments into their business in people, marketing certainly and also logistics including the Deliverr acquisition. Deliverr is going to add a few points to the sales line. Obviously, the costs they’re going to bring 400 people into the Shopify families.
There’s going to be cost there. It’s almost all the costs are almost all people. But it’s our technology. Tobi Lütke, the founder and CEO of Shopify talking about how it’s a technology first logistics company. It helps match up the various warehousing and the operations and logistics for various warehousing. It sits right with Shopify’s key warehouse management system and pairs together. From that perspective it seems like it would be a very good fit. The question is do they have to make that as an acquisition? Can they do a partnership? There’s lots of questions are like what is the return on that massive investments the biggest lever made.
They’re clearly excited about it because of what Amazon is doing and has been building out. But Deliverr focuses on really getting products into consumers hands within two days. That’s their bread and butter and they do it from a software logistics side. But it’s an expensive acquisition for a company that right now is struggling to really grow in the way that we’ve been used to Shopify. Now I will say has been I will say, Chris, one of the bright spots is Shopify Plus the solution that serves larger clients. Big Fortune 500 clients. That is a part of the business that continues to do well. It’s just more of the I think the more of the mom and pops they’ve attracted over the last couple of years that part of the business is struggling a little bit. It’s a wider. It’s certainly more number of clients but the Shopify Plus because that flywheel effect because they can spend so much more into the merchant solutions part of the business as they grow. Some bright spots to Shopify Plus but and I think their Deliverr acquisition is something they’ve had to do to be competitive. But the jury is still out on those investments.
Chris Hill: Let’s move onto EPAM Systems. Not a household name although maybe it should be. It’s an IT services provider. First-quarter profits were higher than expected on a day when there is so much red out there in the market. Shares of EPAM Systems are up about seven percent when we started recording. This is one you own. What did you make at the business and what did you make at a quarter and what do you like about this business?
Andy Cross: Chris, between Shopify and EPAM this morning, I was not expecting the green from EPAM and the kind of range from Shopify. Quick refresher, EPAM is an IT consultant business with most of their employee base based in Ukraine and Belarus with some in Russia. They are very focused from a people perspective in Ukraine and Belarus. Their founders is Belarusian. Arkadiy Dobkin founded the business 1993. I found it for many years and based in my home state of Pennsylvania. He’s been very successful in delivering tech solutions and growing the EPAM business. The stock went from 600 down to a low of 200 right during the period of the Russian invasion of Ukraine because they didn’t literally know what their people could do, could they get services, they came out, they pulled guidance.
There was a lot of safety for their employee base in Ukraine. There’s a lot of uncertainty about what they will be reporting from earnings perspective and just how their business will evolve, let alone the safety of their employee base, which this company has been very successful over the years, serving very large clients, providing lots of different consulting services across travel, leisure, consumer, tech, healthcare, retail, lots of different spaces they help out. It’s very eager. The stock has rebounded a little bit, not just today because they came out maybe a couple of months ago and said, listen, we’ve been able to take care of our people, move them, redistribute them, for dawning into Ukraine, continuing to support Ukraine. They’ve been as open as they could be, but it was very interesting about what they report this quarter.
I got to say, Chris, this quarter was actually pretty impressive when you think about year-over-year revenue growth of almost 50 percent if you adjust for some of the strong dollar, was more than 50 percent, earnings per share on an adjusted basis up almost 38 percent. Both of those numbers be estimates guidance. Their cost structures are increasing of course because they have to hire people, they grew their staff. They still grew their staff during the quarter, Chris, their delivery staff, that technology delivery staff by more than 41 percent. Even with all that’s going on for this business, they may find people, allocate people, make the people still productive and still be able to serve clients. Importantly, by the way all of their divisions basically grew. Travel and consumer was up 91 percent as more travel companies look for tech solutions to be able to serve their population. But they really saw growth across all of their areas.
Financial Services was the next biggest growth and impressively, they saw growth in Europe and Middle East too, Chris. It was there first best-performing market and there second-largest market. But our guidance for the order, Chris, was really attractive with growth up about 29 percent. A little drop in earnings as to be expected, but that number was about what analysts were expecting. Overall, this companies, Chris, considering what they had to go through over the past few months has performed really admirably. It’s very respectful.
Chris Hill: Real quick before I let you go, who does EPAM compete with?
Andy Cross: Lots of different consulting companies that they compete with. All of like Cognizant Technology and Accenture and different providers like that. What EPAM has done very well, they outsource their technology services to programmers who are based in Eastern Europe behind the Soviet bloc because Arkadiy created the company when he came to the United States and he was looking for programming help. In the Eastern European countries behind the Soviet bloc when you are a developing programmer, you basically were on the clock. You had to develop under time because you had to pay based by the hour time that you were on the computer.
They became very efficient programmers. These are the tap-in into his old network and realize they could be working overnight, different hours and I could be working with them to develop those skills. He just carried it into growing EPAM from 1993. They went public, I think in 2012, so he’s been at this for a very long time. What they’ve been able to do is serve their customers in a very technology first way, in a customer service way, by embedding with their teams and providing technology services at a far lower costs and having to hire full-time tech employees. But the risks you get with that is you have a large workforce that’s based in parts of the world that sometimes are unstable certainly like we’ve seen over the last few months.
Chris Hill: Andy Cross, thanks so much for being here.
Andy Cross: Thanks, Chris. [MUSIC]
Chris Hill: Today is the day when the Nasdaq is crossing. Can I interest you in a little pizza and ice cream? Our man, Jim Gillies, is taking a closer look at MTY Food Group, a Canadian food franchisor with brands like Cold Stone Creamery, Papa Murphy’s pizza, and Blimpie submarines. If those franchises don’t exactly excite your taste buds, Jim talks with Ricky Mulvey about why they should as an industry. [MUSIC]
Ricky Mulvey: Jim, before we started recording, you said this is the great unknown Canadian success story. What leads you to that conclusion?
Jim Gillies: Well, Rick, they own about 80, just over 80 different banners across Canada and increasingly across North America and even internationally. They’ve done that by a combination of starting a lot of their own concepts early on, which tended to be different ethnic cuisine. Here’s your Chinese offering, here’s your Indian offering, here’s your Japanese offerings and they would quite often, you’d go to a food court at a mall and you wouldn’t realize that half the concepts in the mall were all owned by the same company. They started out with these different concepts.
Once they started getting some success with those, they started buying additional concepts. They bought banners like cultures and countries though tired third and fourth tier brands to be honest in Canada. But the important thing was, the management here are very savvy and we’ll get to them in a bit. The management here always paid very cheaply. One of their concepts that they own is called Baja Fresh. Baja Fresh used to be owned by Wendy’s, which you may have heard of back when Wendy’s owned Tim Hortons, they had that third brand, Baja Fresh. They paid about 300 and so million dollars worth. It wasn’t as successful as Wendy’s, wasn’t as successful as Tim Hortons. They ultimately threw it over the side at some point and MTY picked it up a few years later for 30 million dollars. Like a tenth of what Wendy’s had paid. What they’ve done is they’ve progressively added concepts, added, like I said, third and fourth tier brands and then as they got larger, they started adding first and second-tier brands.
Ricky Mulvey: You mentioned that they have 80 different brands, 80 different banners under MTY. That might sound good on the surface, but is it possible to have too much diversification and essentially too many brands going at once?
Jim Gillies: I don’t think so because essentially you’re dealing with individual customers and so Ricky, you might want a Cold Stone Creamery. But our man behind the glass, Rick Engdahl, he might be really a believer in Papa Murphy’s, the take-and-bake pizza concept. It’s the same business. I’m selling you a franchise. I’m selling you a concept. They are franchisors, they are not running so they have these concepts and they have staff dealing with each concept at MTY headquarters at Quebec. But they are not spread thinly because an individual client might only want one or two brands, might want only one or two banners. They’ve gone from these concepts.
They made an acquisition called the best quarter in 2017, I believe, which is a lot of sit-down table dining. They bought a concept called Turtle Jack’s, which there is one here in town, which are sit-down. So they’ve moved up from food courts to third and fourth tier, non-food court brands to brands that are first or second tier two table-dine. So now they have across the restaurant spectrum. Out of the 6,700 stores they have or roughly 6,700 stores, less than 100 are company operated. Everything else is franchised and franchising is a fantastic business model in the restaurant space.
Ricky Mulvey: Let’s talk about that franchise model. You’ve described MTY as a check cashing machine. What brought you to that? Then also, what’s MTY’s relationship with franchisees look like? How do they make money from franchisees?
Jim Gillies: Sure. A franchising businesses, I have a system. I have a menu, I have ingredient list, I have products you buy, I’ve everything branded and I sell you the system. You want to open up down the street. You’re opening your very first Cold Stone Creamery. I give you an entire restaurant concept, and you pay me a franchising fee upfront, let’s say 50 grand or whatever. But you also pledge, as part of being in my system and we start it out, let’s say a 10-year deal. You are sending me six percent of your sales off the top. Off the top, I’m getting six percent of your sales as a royalty.
You are responsible for the operating of the business, you are responsible for paying the rent, you are responsible for buying the food. By the way, I’m going to specify what food, what ingredients you buy. You’re responsible for buying your apartments as your cups, your napkins, etc. Then you’re also going to pay me for advertising, so you’re going to give me between typically 1.5-3 percent depending on the concept. You’re going to give me X dollars, X percent of your sales that I’m going to be using for my pooled advertising. I’m getting your 6 percent of your sales every month. You got to write me a check regardless of how well you manage your business. Plus you will also pay your own advertising through me. [MUSIC]
Ricky Mulvey: Many of MTY restaurants were beaten up by the pandemic a little bit in the 2021 annual filing, MTY said it had about 834 million in total debt, 300 million in net debt. You said previously that you can expect that the company is going to continue to throw cash into acquisitions. A question, are you happy with how the company is handling capital allocation right now?
Jim Gillies: One hundred percent, I’m going to challenge you on the number of debt. We use Capital IQ, which will makes what I consider to be the Cardinal Financial mistake of equating operating leases with debt, and that’s one of my particular bugaboos. I understand the finance prof argument for why you should consider it, but I do not consider operating lease payments to be debt equivalent. The actual debt they have outstanding is up just over $360 million in the most recent quarter. Again, it’s just over 52 million in cash. They have actually taken down their debt by a couple of 100 million during the pandemic because they haven’t been able to buy anyone.
They’ve only recently completed an acquisition of a company. I’m going to mangle the name called Kuto-Comptoir a Tartares, it’s a chain of Tartare restaurants which next time in Quebec, I’m going there on day one because I love tartare. But their debt is fine, their debt is low cost. This company makes a tremendous amount of cash flow. For their lenders, their lenders have no concerns about getting repaid here. What this does is it gives them significant dry powder for making acquisitions. One of the things that MTY does is they can borrow or they can sign a lease with an implicit interest rate lower than you or I can as individuals. What MTY does a lot of is once I sell you a franchise and I set you up we’re going to locate it here.
They take the lease, they turn around and basically do a pass-through and lease to their franchisee. That’s a win-win. It lowers the borrowing costs, lowers the residency costs for the franchisee. For the franchisor being MTY, it helps set them up to be more successful. That ends up, as I said, it’s a win-win. I’m not worried about the debt at all here. To be honest with you, they could repay it quite easily. They got through the pandemic, the worst of pandemic where a lot of their stores, they’ve got a lot of restaurants in Ontario and Quebec. Those were closed for a significant amount of time. They navigated through that quite nicely. I don’t think the stock now that most of those stores are pretty much open for full business, full sit down, full takeaway. Stock market hasn’t returned the stock-price to where I think it should be given the performance of this company is.
Chris Hill: Let’s talk a little bit about company leadership. I know you love the chairman Stanley Ma, what should investors know about this company’s management?
Jim Gillies: Here is Stanley Ma, started the precursor company that grew into MTY. Believe started the first concept, I’m trying to remember the first restaurant concept and failing miserably. I think it was Tiki-Ming, but it helped develop that as this Chinese food courts and had a large-stake. Has a large stake to this day. But what was really interesting, I believe in mid-2003 with the company much smaller than it is today. Stanley Ma went and bought 25 percent of the company on the open market using his own money. Here’s the thing, MTY today is about $52 Canadian.
I think it’s probably worth north of 70, but that’s another story. Today it’s $52, when he went out and bought it was 25 cents. The man sat on and it’s been as high as I believe close to 80 or if not over 80 before the pandemic. The man sat on a multibagger for years, never sold a share, took a modest salary. It’s almost comical to read the proxy statement because it’s like, here’s Stanley Ma CEO taking a fairly modest salary for what he’s built and the all and then you look on the lines and we would also we pay for a car. It pays for his car lease. You see the amount of money involved in you’re driving a Ford Crown Victoria. Like there’s been fancy car here. But he’s just interested in creating value for shareholders because he’s the largest shareholder. The only time that I’ve ever seen him sell was about a year-and-a-half ago, I believe. I believe it took about 20 percent of his money finally off the table. Today, he’s no longer CEO. He has kicked himself upstairs to executive chairman. He’s in his 70s now, so I suppose he is allowed to retire. But Eric Lefebvre is CEO who is a long time CFO, COO of MTY. There’s been some really great continuity there. They are still very stingy with their equity.
Ricky Mulvey: Any considerations for Americans you may be interested in this company. I know it trades on the Toronto Stock Exchange. We would have to go to an over-the-counter market.
Jim Gillies: It’s always funny to me because Canadians can trade on the NYSE or the NASDAQ as easy as we trade in the TSX, Just every broker has that ability. First I would say check your broker, maybe you can trade on the TSX. I believe Interactive Brokers allows you to do that and so it’s easy you can just simply buy MTY, the ticker on the TSX. But if you have to go OTC, that’s where the ticker is, MTYFF. You want to look up three things before you go buy OTC, because the volume and liquidity OTC is of course, much smaller than on the TSX. The first two things you want to look up, you want to look up the Canadian price.
Next you will look up MTYFF, the OTC sticker. The third thing you want to look up is what is the present spot exchange rate for the Canadian to US dollar. You want to take the Canadian price and you want to multiply it by the present spot rate. You’d put a limit order for roughly what the price of the Canadian stock price multiplied by the current spot rates and you try to get that felt. It’s a little bit more work. But you’d want to do that because essentially you are buying and basically the same thing from OTC than you would like buying on the TSX, but the liquidity thing has a bit of an influence. You might have to pay a quarter-over percent higher or lower depending. But first, checkout if you can actually transact in the TSX first before you need to go to this extra stuff.
Ricky Mulvey: Ultimately as we put a pin in this, why is MTY Food Group interesting company to you? What’s the best fish for a tartare?
Jim Gillies: [laughs] I make a pretty mean trout tartare actually, so that’s come on up we’ll feed you. I bluntly think this is an undervalued company today, I have because at the check cashing machine, it’s a capital light company. Capital-light companies tend to justify higher valuation multiples. What I’ve always been traditionally I’ve been willing to pay up to 12 times EBITDA for this business. Today, you’re paying under nine. I have said that the cash flow they generate, they are probably going to generate this year, I’m going to ballpark it about a 135 million in free cash flow. I strip out lease payments from that. They’re going to about a 135 million. Again, it’s a one point just shy of 1.3 billion Canadian. They are going to spend that money on dividends. They’ve raised their dividend about fourfold, I think over the past decade. They’re going to buy back some stock and they are very selective about buybacks. I’m hoping they’re going to find some additional acquisitions because 6,700 stores in North America sounds like a lot until you realize it’s less than one percent of the restaurants in North America. There is a lot more ground for them to conquer. What more do you want? Good cash-flowing story undervalued with great management. What do you need? Only pays you dividend await. [MUSIC]
Ricky Mulvey: Jim Gillies, you know him from The Morning Show, he runs Hidden Gems Canada. Jim, good to see you. Thanks for coming on.
Jim Gillies: Thank you. [MUSIC]
Chris 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. I’m Chris Hill, thanks for listening. We’ll see you tomorrow.