In this episode of Industry Focus: Consumer Goods, Emily Flippen chats with Motley Fool contributor Asit Sharma about some emerging trends in the sector. They look at e-commerce and some companies leading that space, how they are serving their consumers, and what they are doing to keep their competitors at bay. They also look at the effects of the pandemic on the consumer goods space, and how some big household names displayed their flexibility and adaptability during the crisis. In addition, they discuss super-comps, big-box wholesalers, and much more.
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This video was recorded on Oct. 13, 2020.
Emily Flippen: Welcome to Industry Focus. I’m the host of this Consumer Goods-focused episode, Emily Flippen, and today is Tuesday, Oct. 13. Today, I am joined by The Motley Fool’s one and only Asit Sharma. We’re going to be talking about some of the biggest emerging trends that we’ve seen in 2020 for consumer goods companies. Asit, thank you so much for joining.
Asit Sharma: Really glad to be here, Emily, and excited, as always, to talk about consumer goods.
Flippen: Well, I am just back from a week of vacation, and I’ve mentioned this before we started taping, but you have put a lot of prep into these four trends. And I don’t even know where to begin — your outline, I jokingly said it twice now, it’s like a dissertation, there’s so much material in here. But let’s start with what you call the rise of small-scale e-commerce. And I think the reason why this is a great place to start is because I think a lot of our listeners, I know myself, personally, I’m very aware of this 2020 trend for consumer goods, and I think it will resonate a lot with a lot of our listeners.
Sharma: Sure. Well, you know, Emily, it seems like the rise of remote work type stocks has crowded out all the idea space in the stock market, because a handful of really strong names, Zoom, what we’re using right now, those have really come to the fore in investors’ consciousness. And below that, behind the scenes, there’s a group of small, but not very small companies, well-known companies that have done extremely well. And so, two that I wanted to talk about and get your thoughts on this too are Etsy (NASDAQ:ETSY) and Fiverr (NYSE:FVRR).
Let’s start with Etsy. During the pandemic, those of you who follow the stock probably know that they did [laughs] a lot of business selling masks. They sold — I think the CEO on the last earnings call said that 110,000 of its users sold at least one mask [laughs] in the last quarter. And they had, I think, $346 million of platform value just on masks. So, this on one hand shows us how adaptable this platform is, to take a trend and jump in and have all the members on the platform really benefit from it.
But I also wanted to point out that Etsy did pretty darn well without mask sales. It had a $1 billion jump in its gross merchandise value; that’s just a fancy term for all of the dollar volume that went over its platform last quarter. So, it’s a 93% year-over-year gain. Mask sales made up just 14% of that. So, if you heard the headlines and thought, “Wow! You know, the mask component is just driving Etsy’s growth” — really, it was an important part, but not the central part. I think what this goes to show us is that Etsy is a platform that is geared toward unusual events that will help it gain more power in its network, meet demand, and also get some longer-term growth out of it.
One more point that I wanted to make and then get your insight into this is, this is just part of a rising trend of global participation of micro-sellers in the economy. So, these can be artisans. A lot of times you hear people talk about Etsy in the terms of an artisan marketplace, but more and more, platforms like this enable people like yourself and myself, if we want to pick up a little bit of extra income, we could sew a mask, throw it up on an Etsy store, which is really easy to create overnight, and start selling. Now, I didn’t make any masks as yet during the pandemic; I don’t know if you did, but what are your thoughts on Etsy as part of this trend of small-scale commerce enablers?
Flippen: I’m really happy that you called out Etsy’s performance without the mask impact, the fact that its core business performance was still so great. And, of course, it’s impossible to pull out all of the impact that the pandemic had on Etsy’s business, but I don’t think it’s a leap — and maybe it is, [laughs] but in my mind, it’s not a leap — to say that if the pandemic had never happened, Etsy would still be an amazing business today. It was an amazing business pre-pandemic; it’s certainly been supported by what’s happened over the course of 2020. But I think Etsy is probably one of the most misunderstood small-scale e-commerce outlets, because so many people look at it and they think things like, oh, it’s small-scale people just selling masks, how great can it really be? But the reality is, I think Etsy has its strength and its competitive advantage in the fact that it is top-of-mind when you as a consumer are looking to buy something handmade.
And it’s impressive, because Amazon, for instance, offers Amazon Handmade. There are sellers on Amazon’s platform that are doing the same thing that many sellers on Etsy are doing, but I don’t think to go to Amazon Handmade when I’m looking to get a really nice birthday present, for instance, or when I’m looking to get a really nice mask made. Etsy is top-of-mind, and I think that’s part of the reason why it’s resonated so strongly with consumers even during this pandemic, because they don’t have to pay as much money to tell people to go to their site, people are already aware of it. I think that within itself is really strong and really competitive, not to mention all of the work Etsy, as a business, as a company, has been doing to recreate the success at Etsy into other niches.
I know they recently acquired a company called Reverb, that’s essentially working in sales of used musical instruments. I mean, if they can create the success that Etsy has had in other industries, other little niches as well, I think Etsy can be so powerful, and already is so powerful.
Sharma: Yeah. That’s a great point about Reverb, by the way, I have to ask our colleague John Rosevear, who everyone knows as this amazing auto industry analyst, but he also loves vintage amps and guitars, me and him talking about Reverb pricing [laughs] on Twitter. So, I’m going to have to reach out to him on Slack and get his insights on this platform that Etsy acquired. But, yeah, I love that they’re extending that, and totally with you on how they have been able to extend their brand and just keep it front of mind. You’re absolutely right, when you think that you want to go and order something original for yourself or for someone else, I think first you think Etsy, and not so much Amazon Handmade. And it’s been impressive how Amazon Handmade never really took away appreciable market share from Etsy.
Flippen: Definitely. And you mentioned Fiverr, I have to be honest, I don’t even imagine Fiverr as an e-commerce platform, but I suppose it is. I think I’m stuck in the early ages, the stone ages of Fiverr here. When I think about Fiverr as an online platform where you go and you just pay someone $5 to do something really basic for you. But I see from your notes here that it may be much more than what I’m giving it credit for.
Sharma: No, I think actually you’ve got it right. And it’s not really e-commerce, so I very cleverly left out the “e” in my title and I called this “commerce enablers.” [laughs] So, we should leave the “e” out, because you know, that’s misleading. And I think this goes back to my bigger point that commerce itself is being enabled by this really big wave of people being stuck inside the house and having to move toward technology to get things done. So, Fiverr helps people get things done, but it is a platform that links up freelancers or gig workers with people who are looking for all types of services. It has a big competitor in Upwork (NASDAQ:UPWK), but my point here is that Upwork has increasingly focused on the higher end of the market. So, it wants to hit really big, growing companies. You might have heard of this company called The Motley Fool — they use Upwork as a platform to do all [laughs] kinds of things. Fiverr has had this really interesting focus on keeping people who are new to the game of offering services, while still trying to hit those upper segments of the market. So, the name comes from $5, a fiver. So you can offer a gig, and on this platform, most of the time it’s the sellers of the services who are posting what are called Gigs, they call them Gigs. So, you can start up with them offering a service for as little as $5 or $10, and then you can get more specialized.
It’s seeing its fastest growth ever during COVID-19, and the stock has really overtaken Upwork in popularity with investors. I believe the IPO was last year, so it’s relatively new to the market. But by keeping its focus also on the low end of the market — that’s people who are coming to the gig economy for the first time or are looking maybe just for a little bit of a supplemental revenue stream, they benefited greatly when everything shut down earlier this year and they’re still benefiting. In their most recent quarter, revenue grew 82% year over year, and they had a 28% increase in active buyers. Now, that sounds great and it doesn’t sound too removed from other companies that we see that really benefited from remote-work-type trends, but the difference is, this is actually an acceleration for Fiverr, it’s not just that it was able to maintain growth, it got this appreciable boost and also got a lot of mindshare this year.
So, just to wrap this one up, I think, like Etsy, we have a company that has extracted something out of COVID-19 that’s going to last a lot longer than the pandemic, because this really gives Fiverr a little bit of an edge over Upwork, it’s grabbed some market share, it’s expanded its network, so it gets those network effects going forward. So, if you’re thinking of this stock as we’re talking, maybe pulling it up, you’ll see the stock chart looks really daunting, [laughs] it has gone into the stratosphere. So, not really necessarily recommending this as a buy right now in this time frame, but it is certainly a stock to put on one’s radar screen.
Any other thoughts on Fiverr? And maybe, I don’t know, Emily, I think I’ve heard you in the past talk about Upwork in passing, maybe the difference between the two platforms.
Flippen: Yeah, I have, I suppose up into this point, incorrectly been a little bit of a skeptic of Fiverr, and potentially, by extension, Upwork as well. Because I think they’re inherently, kind of, pricing themselves in the market. We at The Motley Fool have mentioned, you know, we use Upwork, for instance, and it’s one of those necessary things that we need to pay people at the same time. People don’t like the middleman effect and it’s unavoidable to an extent. Of course, you’re going to get it with any platform, but that within itself, I think, kind of, fights up against itself. And in the context of Fiverr, I think in my mind the difference between something like Upwork and Fiverr is, Upwork is for the professional freelancers, if that makes sense, people who have — you know, for instance, with The Motley Fool, Asit, you are a contractor here at The Motley Fool, and you know, we pay you consistently over Upwork, whereas something like Fiverr is more, you go and you almost browse professionals, right? [laughs] You’re going and you’re looking for somebody to take a one-off job for you, which is not something we do when we tape Industry Focus, for instance. So, in my mind, there was that fundamental difference between the two platforms, but clearly, especially with Fiverr, I’ve been wrong with some of the long-term tailwinds that exist for these companies.
You may not like them, in the same way you may not like Live Nation or buying your tickets over Ticketmaster for a concert, but when push comes to shove, I guess you need them. And so, it’s one of those businesses that may not get the most glowing reviews from the people who use them, but when push comes to shove, you have to use them.
Sharma: Yeah. I think in the end result, they’re linking up buyers and sellers, and because they’ve got traction in the marketplace, it’s a great point, that’s where you’re going to go. Whether you love the platform or not, you’re going to go there first to see what’s available on either side of the transaction.
Flippen: And I’m interested in your next, kind of, trend here. We talked about Etsy, we talked about Fiverr and e-commerce. There’s something that goes along with e-commerce that needs to be built out by companies that are looking to become dominant players, and not just e-commerce, but online commerce, and that’s supply chains. And your second trend you have written here is, “supply chains becoming smart all over again.” I’m curious by the all [laughs] “over again part,” I feel like I’ve been hearing about supply chains trying to be smart for a decade now. Are we there yet? Are we never getting there?
Sharma: [laughs] I don’t think we’re ever getting there, Emily. And me, the same, I mean, how long have we been hearing buzzwords like IoT, the Internet of Things, automation, artificial intelligence applied to supply chains, especially, you know, let’s shift for a moment from small e-commerce and commerce platforms to big, multinational consumer goods companies. We’ve been hearing for so many years that this is going to be the key that helps these sprawling enterprises start to grow a little bit more quickly again and throw off better returns for shareholders. That buzz died down a little bit in the past couple of years, I think, mostly because investors just got tired of hearing all the hype. [laughs] And so, the focus seemed to shift toward brands. So, big companies, what are you doing with your brands? Are you competing with upstart brands? So, example: Nestle, are you putting out another ice cream that can compete with this suddenly hot small brand that came out of California called Halo Top? We sort of forgot about all these technological investments.
So, it’s come back into vogue because of COVID-19. It’s forced a lot of companies to have to make those investments, and if they’ve been making them, to really pay attention. So, management has had to listen more closely to IT departments, because we’ve seen real-time supply chain issues with so many companies. As a consumer, gosh, I think all of us have had the experience, at least once or twice during the pandemic, of going to the store and seeing a cleaned-out shelf or not being able to get toilet paper. So, this has forced the issue for many companies.
I want to talk about two today that have done pretty well because they never really let up on their investments. And one of them, I’m actually not that fond of as an investor, but the first one I want to talk about, I’m curious to know what you think of this company. But the company is Procter & Gamble (NYSE:PG). It needs not much introduction because it is such a household name and its brands, like Tide, are such household names. They’ve been investing in intelligent supply chains all along. The company is known for a big research and development budget, part of that goes into brand. So, part of it is Procter & Gamble coming up with an idea that, “Hey, let’s take Tide out of boxes that you pour into your washing machine, and let’s make these pods, you throw the pods in.” They spent a lot of money doing that, but they also spent a lot of money on automation, on flexibility, adaptability in their supply chain, and we saw that during the pandemic.
They shifted all the way back in February. They sort of saw what was coming down the pike and shifted production to churn out more Crest toothpaste, because they knew that home hygiene [laughs] was — which, I have to wonder, how did they make that deduction? Was it because they knew that people with lots of kids are going to be home? Suddenly their parents would be there saying, now you have to brush your teeth; it just wasn’t kids rushing off to school. I don’t know where they came up with, we’ll have this big [laughs] demand for Crest, but they did.
Another thing, though, more pertinent to their financial, their economic equation, is that they have been, for years, trying to invest in this idea that we want to be able to get our product to consumers within about a day of manufacture, if possible. And that’s just sort of an aspirational goal. In truth, it’s always going to take more than one day from the time you finish packaging a good to getting it to a point-of-sale. But they’ve been building this really cool automated factory, they called it the factory of the future, in Berkeley County, West Virginia. So, this is a digitized automated plant, and it is soon going to be the largest facility that Procter & Gamble has. It’s located very strategically in West Virginia, because it can service the Midwest, the East Coast, it’s not far out of proximity to places like Tennessee, which is a FedEx hub, to get to the West Coast. I really like this move that they made, and I think it helped them take advantage, Emily, of the shifts in demand that occurred during the pandemic. They were able to very quickly start overproducing on household goods and hygiene items, and they pulled back a little bit on stuff that was nonessential.
I’ve been dinging Procter & Gamble for years because it spends so many billions just to buy back shares and it’s never really focused enough on growth [laughs] in my opinion. Stock is up about 15% this year. What do you think about this move? And more importantly, before we move on to the next one, I’d love to hear what you think about Procter & Gamble, in general.
Flippen: [laughs] Well, if it’s any indication, I’ve been hosting The Motley Fool’s Industry Focus: Consumer Goods podcast for about 10 months now, and I have managed to avoid talking about Procter & Gamble [laughs] until this point. If that tells you anything about how I view this sort of business. But as you were speaking here, I pulled up on my second monitor, the performance of Procter & Gamble versus the S&P 500, and over the past five years, it’s actually outperformed the market by about 20%. And so, they’re clearly doing something right, even though this is a $350 billion company. So, it’s a behemoth, right, it’s a big conglomerate. They’re buying back their own shares, they’re issuing a dividend — things that would indicate to me that it’s not really a great growth opportunity the way that Etsy or Fiverr is, that we already talked about, while at the same time, it’s outperforming the market. So, clearly, they’re doing something right.
And I think you may hit the nail on the head there when you talk about their digitization efforts. You forget how necessary products like Procter & Gamble’s are until you’re in the [laughs] middle of a pandemic and suddenly you remember that you’re supposed to be brushing your teeth twice a day, right, just really basic things. These are products that don’t go away overnight. I’m not sure if I see this as a market-beater over the next five years, I should probably knock on wood when I say that, just because of the size of its business, but this is definitely stronger than I give it credit for.
Sharma: Yeah, sure, and I’m with you there. Actually, I think over the last 10 years, if you take away the near term, it’s been a pretty poor performer. But, hey, it’s a solid play, it’s a dividend play. And I actually want to shift now to a company which is another sort of slow-growing dividend play I like a lot better, although truth be told, over the last five-year period, this company I think has been stable for owners but it has underperformed in terms of total return. Still has great potential, though, for dividend investors. This is PepsiCo (NASDAQ:PEP), which again needs little introduction.
I followed PepsiCo for a long time, and one of the things that really intrigues me is that, while they still call themselves PepsiCo, the strongest part of their business isn’t beverages anymore. That’s the largest part of their business — Pepsi still sells more beverages than anything else. But it’s got this really strong snack component, Frito-Lay North America. And Frito-Lay, although it’s the second-largest segment by revenue, it contributes more profit than any other segment to Pepsi’s bottom line. And one of the things we saw during the pandemic was this great ability of Frito-Lay, sort of like Procter & Gamble, to shift to where consumers’ preferences were headed.
And I should start this by saying that, interestingly enough, over the years, PepsiCo has chosen an extensive distribution model versus central warehousing, it’s called Direct Store Distribution (sic) [Direct Store Delivery] or DSD. And what this simply means is that the company will send trucks out from the point of manufacture, and then those trucks will stop at different stores and load up inventory on shelves. In this model, the tech involved is a little more sophisticated to be able to manage all this inventory this way. And the manufacturer takes more responsibility for what’s going on the shelves than the grocer, which is sort of the flip side of what happens when you’re using a central warehouse.
So, why I’m getting into the weeds here on how they do their distribution is simply to say that this really helped them when consumer preferences shifted overnight, suddenly we wanted the comfort of those big, fat Lays potato chips. I will confess to having bought a few bags of those; and I don’t think anyone else in my house is listening, a bag of Doritos on the sly here and there. So, we really wanted comfort food, and PepsiCo is able to supply it. They notably had very few disruptions in their supply chain. So, this model really worked out because they’ve made the investments in intelligent supply, automation within their distribution centers. And also, just a lot of great software to help them decide when those drivers of the truck, with usually another laborer component, like, one partner, when they get to the store, how exactly they should be filling up those shelves. It shifts all the time. So, good for PepsiCo. I noticed they were able to hit mid-single-digit organic growth, which, hey, if you are a big packaged goods company, that’s like double-digit [laughs] growth for anyone else, if you can hit the mid-single-digit.
Flippen: [laughs] I like how you emphasized the difference of the direct store distribution model, because maybe not the best comparison for Frito-Lay, but a pretty good comparison for the core Pepsi business is Dr Pepper Snapple over this pandemic, that really struggled with distribution. Notably, for Dr Pepper addicts, like myself, who were looking for some of that [laughs] fix, right, maybe you weren’t able to get that during the pandemic for exactly the reasons that you mentioned, the inability to keep up with their supply chains. So, hats off to Pepsi in this case.
Sharma: Yeah. And I’m actually a fan of Dr Pepper Keurig, I think, symbol DPZ (sic). [Keurig Dr Pepper, symbol KDP] But you’re right, they struggled a bit. And interestingly enough, they never lowered their guidance at the beginning of the pandemic, because they saw a lot of demand, but they had some kinks midway through their most recent quarter. They’re getting it together now, but certainly for you Dr Pepper lovers, that’s a stock you can explore. If you’re an income investor and also Dr Pepper lover or, let’s say, a Keurig machine lover, [laughs] you can look that stock up.
Flippen: And what’s the Warren Buffett mantra? Invest in what you know. A good dividend-paying company for a product that you consume, doesn’t get more Buffett than that, right?
Sharma: That’s right. [laughs]
Flippen: And I see you have our third trend here, and this might be my favorite trend that you have on the list. It’s the super-comps trend. I cannot talk people’s ear off about this enough, which is the pain that is going to be 2021 [laughs] for companies that are reporting comps growth after this amazing year for e-commerce sales. Talk us through what this trend means for you?
Sharma: Absolutely, and really perceptive, we will definitely bat around what’s going to happen next year. But, yeah, I call these super-comps, because to me it’s like a superpower [laughs] of a lot of companies I envision. If comps, so comparable sales, that means how you did within, let’s say, a store base this quarter versus the last quarter, forget overall revenue, but how did a cohort of, say, stores performed versus last year, those are called comparable sales, same-store sales, abbreviated as comps. I see these as, like, superheroes this year, because we are seeing lots of companies in the consumer good space, the ones that were set up for the pandemic — I’ll get to that in a second — they are throwing off huge comps.
So, if great comps in this industry are, I don’t know, anywhere from 5% to 10% growth, you’re seeing some that have their e-commerce components growing 60%, 70%, 80%, and overall comps near 20% or above 20%. One that comes to mind is Target (NYSE:TGT). Target did an absolutely wonderful job in retrospect of deciding that we are going to have our e-commerce fulfilled mostly out of stores, so instead of investing in a huge amount of warehouses, again, almost reminiscent of a Pepsi but in a totally different context, they decided that they would train employees how to fulfill e-commerce orders in their spare time. They had also had their “buy online, pickup in store” model in place, so that worked out pretty well when they had curbside delivery. All this came together, plus the fact that Target was really well-diversified among a number of categories that did extremely well during the pandemic. For example, they have cheap office furniture, they have cheap home office furniture, they have electronic games, they have toys, they have groceries, they have clothes. So, these big categories all got a real boost out of the pandemic.
The interesting thing here is, what’s going to happen with super-comps relative to next year, which Emily is going to walk us through? And also, what’s going to happen relative to competition. So, I follow Kohl’s (NYSE:KSS), [and] Target, symbol TGT. Kohl’s has been claiming that they’ve got a lot of opportunity in the coming quarters to grab market share because a lot of clothing retailers are going out of business. We’ve seen a lot of those bankruptcies this year. But Kohl’s isn’t grabbing any market share. Now, their comps are down, the same with peers like Macy’s and Nordstrom, they’re seeing their comparable sales go south, while Target’s are going north. Target actually called out clothing in its last earnings call as one of its brightest areas.
So, what’s really happening here? The implication is that some of the companies which are experiencing these super-comps are going to hang on to some of this gain in the form of market share they stole from competitors next year. So, in other words, my super-comps equals your negative comps. I am taking your market share. And, Emily, when we fast-forward a year from now, what’s going to happen to companies across the board that are reporting 30% comps growth, for example, this year?
Flippen: I actually think that companies, especially you mentioned Target, maybe the same is true for Walmart, I think these companies don’t post great comp growth next year. I think that they are too big. I think there are some players that maybe actually retain so much market share that they will grow on top of the numbers that they had this year. And while I do think that Walmart and Target and such picked up market share as a result of the pandemic, I think they give some of that back. Now, does that make Kohl’s or Macy’s or whoever more attractive? No way, in my opinion, because I think that once those customers are gone, they’re kind of gone. And hearing a company like Kohl’s say, “oh, well, because our competitors are going out of business, we’re automatically going to get market share,” it’s almost reminiscent of me to the big foul that you’ll hear from people running companies, which is, you know, “we operate in a $30 billion industry, so if we only get, you know, 1% of that. we’ll be a huge company.” And the reality is, [laughs] is that that’s not how that works, right. Just because you’re in a big industry, doesn’t mean you’re successful. I think the same can be true for this. Just because your competitors are going out of business, it doesn’t mean you’re successful. In fact, hearing that makes me think that it could be the opposite that’s true.
Sharma: Yeah, absolutely. I see for some companies, they’re going to have to back off their comps growth, just because they’ve had such a big jump this year, but where you might expect others to accelerate. I think, Emily, you have a point. And, you know, you shouldn’t draw investment analysis from anecdotal observation, but we do it all the time. [laughs] And this pandemic, we’ve been to Target a lot more than we have been to Kohl’s. Now, why my family goes to Kohl’s, they actually built a store really, really close to us. So, we were never a big Kohl’s shoppers or fans before, but it’s been convenient. So, you know, not a super-regular basis, but every now and again, we go and we pick up some clothes there.
Target, because we thought of them mostly for, like, groceries, we haven’t been as big of Target shoppers. But just personally, our Target visits have well outnumbered Kohl’s visits during the pandemic, just because Target has a little bit of everything that you need. And they also are conveniently located to us. I don’t know, maybe in the comments, everyone can let us know what you’ve personally experienced or where you’re going during a pandemic.
I will say that surprisingly to me, but maybe not to some of our smart viewers and maybe not so surprising to Emily is, the warehouse club is seeing a lot of business, they’ve also had very strong comps. And for some reason, I thought that, you know, these big-box environments, they’re so crowded with people, that shoppers would avoid them. But BJ’s and Costco seem to have really gained some traction, I guess, they do help with pantry-stocking, because everything they sell is, like, 10 of one thing. [laughs] But are you a member of a club warehouse by any chance, Emily?
Flippen: I’m not. I’m getting a chuckle out of the fact that you brought it up, because I believe it was two weeks ago Dan Kline and I taped an episode just going over these big-box wholesalers, and after listening to him talk my ear off about how amazing Costco is and all the things that you can get bundled into a Costco membership, even though I live in a household of two plus a cat, [laughs] I’m almost tempted to become a member myself, just for the experience. But you’re definitely right in the fact that it is semi-counter-intuitive that these businesses are so successful during the pandemic, because while people are stocking up and these businesses live themselves well to the concept of stocking up. At the same time, Costco has notably not invested in things like e-commerce and things like pickup. And while they’re expanding in those areas, they still want the majority of their members walking into their stores, pandemic or not. And it seems like people who are members of those stores, and not that they don’t care, but in their opinion, the experience of Costco is worth it, the same way it is going to a grocery store, for instance.
Sharma: Yeah. I know. My parents are Costco shoppers. We used to have a membership, but there was never as much of a pull for us. I don’t want to say there’s two kinds of people, you know, club warehouse shoppers and other shoppers, I can’t — [laughs] quite true, but …
Flippen: You’re going to get some emails now. [laughs]
Sharma: Yeah, I know, some angry emails. At this stage in my life, we just shifted more toward buying as much local stuff and just patronizing the grocery stores, etc., that we like, but different strokes for different shoppers.
Flippen: [laughs] And before we sign off here, let’s talk about the final trend that we’ve been seeing here in consumer goods for 2020. And I’ll let you lead off this, I’ll let you present it the way you want, since I’ve, kind of, stolen your thunder on the previous three. But I will say this, I am looking at your notes and I’m already very excited, because I think my favorite company is listed here in those notes, and that might give our listeners an idea about what this trend may be.
Sharma: I want to say, Emily. So, on Live, which for frequent listeners to the podcast, if you are a subscriber for Motley Fool then you can also watch so many amazing episodes. I was doing a session on Chewy, and we heard later, Brian Feroldi and I, that this was a favorite stock of yours. And so that bumped it up in my opinion. So, I’m much more positive now that you are a fan, but we’ll get to that in just a second. This trend is called small e-commerce brands, heavy capital investments. So, if you look at those remote-work stocks that we were talking about, at the beginning of the show we mentioned Zoom, there’s so many others. There is a class right below them of companies that, for their stock appreciation, [laughs] they look just like remote-work stocks. And these are the specialists in the e-commerce space. Three stocks: Chewy (NYSE:CHWY); Wayfair (NYSE:W); and Carvana (NYSE:CVNA). These all sell things online. We’ll work through each of them briefly.
But what we’re seeing is that each of these stocks has really pummeled the market this year, they’re almost scary to look at for purchase now. Each of these stocks at least doubled year-to-date. But my point here is that they capitalized on a trend, again, similar to the idea of investing in your supply chain with those big consumer goods multinationals like Pepsi; here you have companies that have been investing in their own distribution and distribution centers.
So, let’s start with Chewy — small brand, big spend. Chewy has invested a ton in its distribution. Their stock is up 122% year to date, but you know, they wouldn’t have been able to get there, Emily, if management hadn’t committed to building these really big distribution centers. There is one that is on the way for me to Charlotte, I believe it’s in Salisbury. If you’re in North Carolina, maybe you can chime in on the comments, but this is like a 100,000-plus square-foot gleaming distribution center. And from the start, the one knock I’d had on Chewy, it’s got really poor gross margins. So, it’s going to make money in the future through volume, not necessarily pricing power, although its products are premium products.
And their products, for those of you who aren’t familiar with this stock, they are pet products which they sell online. Even Pet Rx products. And they have seen great growth this year. But I always worry about that margin. And management’s consistent theme over the last several quarters has been, look, we’re investing in our own distribution, so that we’ll be closer to customers, that we’ll cut down on our operating margin drag, it’ll make our margins more efficient. And I think they’re sort of proving this out, Emily. They’re still running at losses, but man! They have done very well in terms of revenue growth this year, only because they had this distribution in place, is my point.
So, let me get these figures, if you’re at all interested. They have averaged $44 million a year in their capital expenditures. The brunt of this has gone to these distribution centers. This year, they’ve already allocated $70 million to capital expenditures in just six months. So, I will just quickly work through these next two, and then maybe we can get back to Chewy and start from there just to talk about these to wrap up.
So, No. 2 is Wayfair, symbol W; which I mentioned. They have invested in a couple of things. They have these big distribution centers. They call it the Wayfair Delivery Network. They’ve got a wide footprint over much of the United States now, and they’ve been investing in Germany, building distribution centers in Germany. They are focusing increasingly on last-mile delivery, because they’re bringing couches and big-ticket items into the homes — mostly furniture, but increasingly accessories, furnishings. So, rugs, small tables, etc. Their capital expenditure jumped from $100 million in 2017 to $271 million last year, and they’ve invested about $104 million in all of this capital expenditure for distribution centers, etc., this year for six months.
And then lastly, let’s talk about Carvana. So, Carvana is not necessarily an [laughs] e-commerce play, but it is, it sells used cars online. And I’ve got a friend who is younger than me, a millennial, who bought a used car off of Carvana and told me when we had coffee recently that he’s never going back to buying a car where he’s going to go and kick the tires [laughs] and talk to a dealer. It really worked out for him. I think this is true for a lot of millennials. Their sales have been through the roof, but again, Carvana, like Wayfair and like Chewy, has only been able to realize great sales during the pandemic because it spent the last several years investing in distribution.
Now, its distribution investment looks a little different, I’m actually not talking about those really big vending towers. If you’ve ever seen Carvana’s all-glass vending towers which have cars parked in them; they’re a couple of stories high. It’s a really great image; you should maybe google it on the internet. What I’m talking about are their reconditioning centers. And this is where they take in cars that are in inventory, and they make them really nice and shiny, they clean them up, so when you look at that car online, you’re ready to buy it, and they’re ready to roll it out to you. They send it on to the point-of-sale which are the pickup centers. And again, we see a pattern here.
Year to date, they have invested $171 million, six months, $171 million in these centers mostly. And that is a jump from $78 million for the whole year of 2017. So, you can see how all three of these companies are investing pretty big numbers. Now, what do sales like that, just to get a relative comparison, annualized sales for Chewy and Carvana, I think they’re in the $5 billion to $6 billion range, and Wayfair is slightly bigger, I think they’re around $11 billion at this point. But to spend in the hundreds of millions, to enable you to take advantage of a spike in demand, that’s a sign of a sound management company.
I sort of like all three of these companies, but they’ve soared so much this year, again, they’re hard to pick up. But anyway, having got through all that. Let’s talk Chewy and their investment. Any thoughts on that, Emily, I know you like the stock and I’m gradually being won over? Despite the providence. [laughs]
Flippen: [laughs] I actually came back from vacation this morning and I’m going to throw Aaron Bush under the bus here for a second. He’s a hard person to get approval from. So, anytime you hear something positive about a company you like from Aaron, that’s how you know you’re getting somewhere. And Aaron messaged me this morning, and said, “I’ve been looking at Chewy, am impressed.”
So, I feel somewhat more justified in my opinion about Chewy, now having a little — somebody else who is also looking at it and not thinking, oh, this is terrible. But I think one thing that I want to clarify, or maybe not, “clarify” is not the right word, but highlights between Chewy and Wayfair. I like both of these businesses, but Wayfair, I feel like this pandemic has erased all of the issues that Wayfair was — the very real issues that Wayfair was experiencing at the beginning of the year. This was a company that couldn’t be profitable to save its life. And management came out and said, look, we really should be getting at least 10% net income margins here, but we’re just not, we’re spending way too much money.
And so, they had this thing, what they call the Valentine’s Day massacre and they laid-off a bunch of their corporate employees in February. And then the pandemic hits, and it’s almost like it didn’t happen, it’s almost like they went back on that and they’re spending all of this money and trying to reinvigorate, I guess, investors and customers.
Whereas a company like Chewy — and I always highlight this about Chewy — is, while it’s unprofitable in terms of their net income, not only is this a cash-generating company, but more importantly, they could easily become profitable, if they just scaled back their marketing spend. And it’s not a matter of, well, scaling back their marketing spend means they lose all their customers, it just means that they scale back the rate at which they acquire new customers. And the reason why they haven’t scaled that back is because they really closely tracked the lifetime value of their different customer cohorts. And they make so much more money in the lifetime value of those customers that it makes sense for them to spend as much as they can on marketing. Whereas a company like Wayfair spends a lot of money on marketing, they said this, management has said this, that they think that they do not need to spend as much money on marketing as they are, because the people who should be revisiting their site are existing customers.
So, the difference, in my mind, between a Wayfair and Chewy is, the customers that Chewy gets, stick with them, right? Almost 70% of their sales are auto-ship sales, whereas a company like Wayfair is having to reconvince people who’ve already purchased on their site that they need to purchase again, and that ends up being a lot more of an expensive value proposition. But that’s not to hate on Wayfair as much as it is just to tout how much I like Chewy here. [laughs]
Sharma: Absolutely. And I think this is really, really astute. Sticky, you mentioned that customers stick around. That’s what I see when I look at Chewy. It’s got that emotional component to it. It’s a participant in the pet humanization trend. And pet humanization is a fancy term just to say that we love our pets as much as we love our fellow human beings, and we’re willing to spend a lot of money on them. Their customer touches are really great. Chewy is known for great customer service and making you feel like you’re part of this family.
And once you get into the ordering cycle — I am not a customer of Chewy, but I have read a lot of reviews — it’s something that you just feel good about ordering, their products are good, increasingly they have their own branded products. So, there’s so much that’s going well for this company. I think, over the long term, you’re right, Emily, when they’re cash flow positive, they could be probably even more cash flow positive or slightly positive on a net income basis, coupled with the trend of building out these distribution centers which makes them more efficient, over the long-term, I don’t think they’ll have trouble becoming profitable.
You know, we saw Wayfair have a hugely profitable quarter and they’ve been throwing up losses for years. A little bit of skepticism on that, though, how much of that is one-time and driven just by the trend of so many people being home and deciding, yeah, you know, this would be a great time to buy those couches that we’ve been thinking about. Once you buy those couches, you know, they’re in your living room [laughs] for six to eight years. So, I don’t think they have quite the recurring aspects, to your point, and I think that for them, for Wayfair, it is more of a game of volume. They are expanding in Europe, as I mentioned, it’s global volume and just trying to make sure that they can improve those operating margins to the best that they can.
Carvana, interesting company, we won’t talk too much more about it here, except to say that it’s trying to prove out a business model that, again, got this wonderful boost from the COVID pandemic. The only hitch there is that, again, this forced competitors like CarMax, which is more in a physical environment, to really focus on their e-channel, so they got some sudden competition as well. They’ve been dusting the competition in regards to this. Basically, total online models, viewing the car, investigating the car, everything online, and then purchasing it. But I think that their competition will stiffen. I do like the fact, though, that Carvana has seen an increase in its gross margins over time, because it also participates in the financing of the vehicles [laughs] that it sells to companies, which is typically a good business model.
But, yeah. But to wrap up, all three of these companies, again, put the money where they needed to, and threw off a lot of their own cash flow, and in Wayfair’s case, took on some debt to build out their ability to get product to customers. And that’s going to serve them for years to come.
Flippen: And if you’re listening, we put out a lot of companies in this episode, and a lot of episodes like this that are company heavy, if you check the description of today’s episode you’ll be able to see the companies we talked about and their ticker symbols in there, in case any of these companies were unfamiliar to you as an investor. So, definitely check that out.
But, Asit, thank you so much. This is a long, but enlightening episode, I love it when we end up in big conversations like this, and I love it even more whenever somebody tells me they like Chewy [laughs] as an investment.
Sharma: Yeah, this was great fun, Emily, I really enjoyed it. Thanks a lot.
Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions, you can always shoot us an email at [email protected] or tweet at us @MFIndustryFocus.
As always, people on the program may own companies discussed in the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear.
Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen, thanks for listening, and Fool on!