How Restaurants Are Starting to Come Back

In this episode of MarketFoolery, Chris Hill chats with Motley Fool analyst Maria Gallagher about the latest headlines and quarterly reports from Wall Street. They dig into the numbers of an auto dealer and a multi-brand restaurant operator to find out how these companies are doing as the economy is beginning to open up again. Also, a strong player enters the space with an IPO.

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This video was recorded on September 24, 2020.

Chris Hill: It's Thursday, September 24th. Welcome to MarketFoolery. I'm Chris Hill, joining me from the financial capital of the world, it's Maria Gallagher. Thanks for being here.

Maria Gallagher: Thanks for having me.

Hill: We've got restaurants; we've got a recent IPO. We're going to start today with auto sales, specifically used auto sales. CarMax's second quarter profits and revenue came in much higher than expected. And the last time I checked the stock, it was down 12%. I was surprised by this, because this was a really good quarter for CarMax and I didn't see anything in their guidance to indicate that the next three to six months is going to be particularly perilous.

Gallagher: Yeah, I was also surprised that they beat expectations, revenue was up 3.3% to $5.37 billion. Earnings were up 28%. Last quarter they had implemented cost savings, they had furloughed 15,000 workers; the CEO, Bill Nash reduced his salary by 50%; they stopped new store openings. But like you said, Chris, this quarter was really good for them. Their sales had bounced back by around June, we saw revenue growth. They're hiring 750 people at their customer experience center. They're planning to open stores again. The stock is up 21% since the beginning of the year, so I don't know if it's more trying to temper expectations for the future, but it was a solid quarter for them.

Hill: We've certainly seen that with other companies in other industries where they come out with results, they are somewhere on the spectrum of good to great, but not jaw dropping perfect, and we see a little bit of a sell-off just because year-to-date the stock is doing well. I don't know, you know, CarMax, the last vehicle I bought was from CarMax a couple of years ago, had a very good experience, I would absolutely [laughs] go back there again, because I feel like they have -- I don't want to say, they have solved a pain point, but they have certainly made a pain point a lot less painful, and I'm referring to the process of buying a car, which for most people, it's just transactional. We just want the car that we want, and please don't make me go through the whole haggling kabuki theater thing, because that's just awful.

Gallagher: Yeah, I have never bought a car, I don't have a driver's license, but I will say I was [laughs] interested in how they might have done in the last recession. So, you can see, if there are people who are listening who are economic experts, if you look at the demand curve, for normal products as income increases the demand for a product increases, but with inferior goods or inferior products, they do well in a recession, because as income decreases, demand for this product increases. And since CarMax sells, 85% of their revenue is used cars, it seems likely that they would be considered an inferior product. So, if we see a recession in the future, they would be a company that would do well.

And so, I looked at how they did in the last recession, and if you look at the stock from March 20, 2008 to, like, September 2015, it returned 204% compared to 50% for the S&P 500. So, I think looking forward and thinking long term about CarMax, if you're thinking about the impacts, the long-term recession impacts of COVID-19, this might be an interesting thing to think about as those inferior products versus those normalized products.

Hill: Well, particularly in urban areas where you're -- for people who have the means, they're probably going to be spending less time getting on subways, if they can avoid it. I got to say, inferior goods as a categorization just sounds pejorative. That sounds like something that the new auto dealers of America came up with.

Gallagher: [laughs] Yeah, it's not the nicest term. And when you study, they'll say, like, a bus is considered an inferior good to a car or a plane, so it's kind of insulting. But that is the technical economic term.

Hill: Shares of Darden Restaurants (DRI -0.04%) up 5% this morning, despite the fact that first quarter revenue fell nearly 30%. Darden is the parent company of Olive Garden, Capital Grille, a number of restaurant concepts. Is the rise we're seeing from Darden, is this because of the guidance, because certainly their guidance for what the next quarter is going to look like improves upon the revenue loss that we saw in this latest quarter?

Gallagher: Yeah, I think so. So, looking-forward they're predicting sales will be down about 18% next quarter as opposed to they were down about 29% this quarter. Another thing is, they've reinstated their quarterly dividend, which shows management has faith moving forward, so their quarterly dividend is $0.30. And so, they're reopening restaurants, they're planning to open 35 to 40 new restaurants through the rest of the year. And I think it's just more the talk about how restaurants are starting to come back. There are more and more people being able to dine-in. And I recently learned, and by recently, I mean when I was doing research. Did you know there are 892 Olive Gardens?

Hill: I learned that earlier this year. And I don't know what the number I had in my head was, but it wasn't closing in on 900.

Gallagher: That's so many more than I thought.

Hill: So, speaking of research, you may be aware, what is the beer brand that they have, it's like a taproom brand. What is the name of it?

Gallagher: It's called the Yard House. So, Yard House is really popular to-go. I went to school in Boston and there was a Yard House right near Fenway Park. So, it was really popular to go there during Red Sox games. There are tons of TVs, a bunch of beer on tap. I personally don't like beer, but I am a fan of spinach artichoke dip. And they had very good [laughs] spinach artichoke dip and really good happy hour deals. So, my friends and I really liked Yard House.

Hill: I think it's going to be very interesting to watch what Darden Restaurants does in the next 12 months with Capital Grille. Because if you dig into the numbers of this quarter, we saw the revenue down, we saw the overall comp number down, their fine dining section, which is essentially Capital Grille, that was down nearly 40%. And there was a point in time in the past decade where a catalyst for Darden Restaurants was selling off Red Lobster, so that they could focus more on their other brands, including and especially, Olive Garden. It really is not going to shock me if at some point in the next six months we start to see stories that they are looking for a buyer for Capital Grille, because -- it's not to say Capital Grille can't come back, I just think the turnaround is going to take more time. And you're not going to see, you're just not going to see the type of pickup and delivery with a Capital Grille that you're going to see with Olive Garden.

Gallagher: Yeah, exactly. Especially with those restaurants where a lot of the things are specialty prepared. If you get them at home, a lot of times people need substitution, additions, and then, by the time it gets to you, it's not fresh anymore, and if you're paying that much money, you want it to be fresh. So, I think those types of eateries and restaurants will be hit hard. I think you're definitely right; I wouldn't be surprised if they tried to spin it out. I mean, half of the revenue is from Olive Garden. So, as long as Olive Garden keeps trucking along, hopefully they'll be able to bounce back, but I definitely think that fine dining section is going to lag for a lot longer than the Olive Garden and the LongHorn Steakhouses of their repertoire.

Hill: Is it your Italian heritage that keeps you from going to an Olive Garden?

Gallagher: I genuinely think my grandma would have a heart attack, [laughs] if I told her I ate at an Olive Garden.

Hill: Our email address is [email protected]. A question from Sam in California, who writes, "I know it wasn't as splashy as Snowflake's IPO, but Unity Software rose 40% on its opening day last week. Any thoughts?"

Yeah. I mean, Unity Software and JFrog basically couldn't get arrested last week with their IPOs, because there was so much attention paid to the Snowflake IPO. Unity Software, do I have this right, it is a platform for video game developers?

Gallagher: Yeah. Unity Software is actually super-interesting, I think. So, they help developers build games. They have two different revenue streams. So, they have Create solutions, and then Operate solutions. So, within the Create solutions, they help make that game engine, so that's the software that provides game creators with the features to build games quickly and efficiently. So, the things that won't differentiate the game, things like the way players walk or the physics of how an arrow or a gun shoots, all of those things, that will be already done, so the developers can work on the things that do differentiate the games.

And then you have Operate solutions, which help developers manage what comes after building the game, so that's things like ads or in-app purchases, analytics on player behavior, enabling text and voice chat. So, they really do a lot. And if you are a big gamer, you'd probably be familiar with Unity's platforms or Epic Games' platforms. And Unity has 50% market share, it serves 53% of the top 1,000 mobile games. 50% of games across platforms, 93 of the 100 largest game studios by revenue. And every month, 1.5 million creators use the tool, and 1.5 billion devices download content built with Unity.

So, it's really coming in as a strong player in the space, it's not really a small player, it's really strong. It's basically Unity and Epic are fighting out for those developers.

Hill: Well, and Epic, they've been in the news recently because of Fortnite and the whole legal battle with Apple and Google, [Alphabet] right?

Gallagher: Yeah. So, Epic has been battling with Apple, and Unity has not. So, that is a check in Unity's favor, because Unity works really well within the iOS platform. So, developers like using Unity for mobile games, specifically.

Hill: All kidding aside. I mean, I'm not making any predictions in terms of how that is going to play out, but when you own shares of a company, whatever industry they're in, the minute they are involved in significant legal battles, again, it's not to say it's not going to haunt them for decades to come, [laughs] it's not to say that it's going to send them into bankruptcy, but it absolutely goes in the negative column. It doesn't go in the plus column, it goes in the negative column, because they're spending time and resources and energy fighting those battles. I'm sure the folks at Epic would much rather be [laughs] focused on trying to take out Unity Software.

Gallagher: Yeah, I definitely think so. And also, something I think is interesting to note about Unity, moving toward, so like I said, they're already a big player in this space, but they claim they have a lot of use cases within the AR space. So, within architecture, engineering, construction, transportation, automotive, film or TV, so they can create that platform for all these different people to use as AR becomes more and more integrated in all of these different areas. So, I think that's also, kind of, interesting to think through. So, what Epic might be doing in five years versus what Unity might be doing in five years I think is pretty interesting.

Hill: This is a company that just went public last week. All things being equal, as an investor, as an analyst, do you have an amount of time where you want to see how a company does as a public company? Because it's harder to be a public company than it is to be a private company for a number of reasons. Do you like to see how they perform for a couple of quarters or if the business is good enough, you believe in the story enough, are you someone who is like, no, I'll jump in right now?

Gallagher: I hate giving this answer, but I do think it depends. Because I think it depends on the stage the company is in, so if they're proven or not proven yet, where they are in their lifecycle and their management. And then also, within the public markets, how do they do? So, if they had a Snowflake-esque pop and got to a valuation [laughs] that's kind of insane, or like a Beyond Meat pop too, where you saw that level out. But Unity was up about 40% last week, so it didn't have this insane pop. So, I'd be more likely to think about it.

So, I would consider where that company is, and then as they make their debut into the public markets, how they're received. If I think they are received with a little bit too much excitement or if I think it's, kind of, warranted excitement.

Hill: Maria Gallagher, always good talking to you. Thanks for being here.

Gallagher: Thanks so much for having me.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill, thanks for listening, we'll see you on Monday.