Uber, Airbnb & The Future of Industrial Investing

   

TRANSCRIPT

Kyle Helton:

Welcome to the latest episode of the QPD podcast. I’m your host, Kyle Helton, Western Regional Director at Cambiar Investors, and today we’re thrilled to welcome Adam Ballantyne, a senior analyst who covers the Real Estate and Industrial sectors. With over 15 years of experience, Adam has been instrumental in adding innovative platform businesses like Uber and Airbnb to our portfolios.

In today’s episode, Adam will help frame what’s going on in the market, his thoughts on the sectors he covers, and where we’re finding opportunities and detail how he tackles the challenges of evaluating disruptive platform businesses. From the lens of a value investor, Adam, welcome to the show.

Adam Ballantyne:

Thanks for having me, Kyle.

Kyle Helton:

To get things started, the market seems to be digesting a lot at present, hotter than expected inflation policy uncertainty and an uneasy consumer sentiment. How are you thinking about these things as you evaluate both own companies and potential candidates for our portfolios,

Adam Ballantyne:

All three of those are major topics important to the stocks that we’re looking at and very complicated topics. I think the last four years, especially those topics have come front and center in terms of not just how we’re thinking about the future, but how they’ve fundamentally impacted earnings growth For a lot of the businesses that we’re evaluating as it regards inflation, we all saw an absolutely historic multi-decade increase in inflation, and then we saw that ebb back to more normalized levels, but still double the rates that we experienced in the pre covid decade and how we think about that and the impact on interest rates, which often impacts the duration, which we’re willing to go out and value these businesses. It’s ever present right now and given what we’re seeing with inflation, interest rates, fiscal deficits, we think it’ll be ever present probably years to come.

Kyle Helton:

In thinking about industrials as a sector that you cover, it’s typically been a somewhat target rich environment for us. Given the diverse nature populated with companies that possess some unique product or know-how, can you talk through what makes that sector interesting through Cambiar’s QPD lens and where you’re finding opportunities at present?

Adam Ballantyne:

The industrial sector is a fascinating one. From a historical perspective, and I’m talking 30, 40, 50 years ago up to today, there’s sort of a story behind every sub-sector within the broader industrial space. A lot of that includes a tremendous amount of consolidation of many industries that we continue to use today. Some we use a lot more, some we even use less, but the consolidation has grown scale, it’s reduced cyclicality, it’s grown margins, it’s grown return on invested capital. And just to point to a couple examples, when you think about the railroad industry, it was one of the worst industries 50 years ago and now it’s one of the best in the industrial space. A lot of that is not because we’re using them so much more, it’s because there’s only one or two ways to get a certain place on a railroad. And 50 years ago there used to be four or five in terms of the airlines space, the airlines typically traded at a five times PE ratio.

They’re undergoing pretty good times now, but they are trading and have sustained double those multiples on their earnings today because there used to be eight major airlines and now there’s just four major airlines. So that’s sort of a quasi consumer industrial space. But when we look at other things like elevators, Otis or air conditioners such as carrier, there’s most of these industries that we think in terms of larger cap front center industrial sectors have consolidated to just a few players and the amount of innovation that has gone into their products, cost reduction, benefits of scale, really top tier management, they’ve also allowed themselves to grow their exports to the rest of the world and sort of pass these benefits on. So when you think about the sector as a whole, and probably say this as well, for a couple other sectors like technology space, it’s upped the quality of the sector each decade over probably the last five or six. And that’s one of the reasons from our QPD perspective, we’ve been so overweight the space is because there is just so much quality to be found within it.

Kyle Helton:

I feel like we talk a decent amount about market structure here as it relates to the businesses that we own and that we consider owning. Could you expand a little bit more on that, how you kind of view the consolidation and the sub-sectors of the industrial space that you cover and identifying companies that you think are poised to benefit from that dynamic?

Adam Ballantyne:

Yeah, we focus on market structure religiously here. It’s the backbone of how we look particularly at industrial sectors and the industrial space because there’s not a tremendous amount of technological advancement in things like air conditioners and how fast a railroad goes or the manufacturing process behind a lot of the widgets we produce or the consumer goods that we have left to produce. In the United States, the focus is really on what the market share is in the certain end markets. They focus on the certain verticals, the geographies that they play in. And so those guardrails are what keep margins intact, pricing power intact, volume growth consistent with the end markets, market shares consistent or growing versus potentially smaller or weaker peers. And that’s kept winners winning and it’s what’s kept a lot of the quality sort of cap sort of on the larger cap side

Kyle Helton:

Diving into a sub-sector in the industrials land, we have a fair amount of exposure to transports and logistics companies, our domestic portfolios, Union Pacific, Expediters, JB Hunt to name a few. How do you manage the inherent cyclicality of the industry and what makes these companies that we own equipped to manage through various business cycles?

Adam Ballantyne:

So just to go back to sort of the first question and answer in terms of the quality up of the industrial sector over the last few decades, one of the components that has also been very evident are controls that have been placed within supply chains to reduce cyclicality of the costs that run through a supply chain. Lemme give you an example. When Boeing makes airplanes and there’s a very large dispersed global supply chain that spreads throughout the whole world. And so when materials prices go up 40 or 50% in a few years and labor negotiations shoot up wages 20 or 30% over a multi-year period, the price of the planes doesn’t move that much at all over that arc of time. If it did, we would all be paying quite a bit more for a flight. And so how it works is there are safeguards around what the most upstream producers of materials, the raw materials are able to charge and pass on to their customers.

And there are within each tier, tier one, tier two, down to tier three and tier four OEM on down the supply chain, there are safeguards on how much volatility is allowed to run through them. So what does that have to do with transports? That means that when you see a tremendous amount of volatility running through truckloads, volume shocks that run through railroads or through, we own some intermodal companies that will take truckloads and take them to the rails and then pick them back up again a thousand miles away and take ’em to their ultimate destination. Well, when those volumes can have pretty dramatic double digit shifts on a year to year basis, their contracts, and so the customer and the business that they contract with that we own, whether it’s a hub group or a JB Hunt, they have a handshake agreement to sort of limit that volatility both on the cost side and on the volume side. That’s taken decades to create that sort of a peaceful dynamic. Usually it’s just one entity is winning dramatically and then in five or 10 years that entity is losing dramatically at the expense of the other. And so that creation of that reduction in volatility is spread out not just through transports and distribution, but in a Cisco a food distributor that we own is a good example of that, but also just throughout the industrial supply chain when it comes to goods manufacturing as well.

Kyle Helton:

Is there something unique about JB Hunt or Hub Group that allows them to have these sort of relationships with their end client to really kind of spread this volatility out across an elongated of time that you referenced?

Adam Ballantyne:

Yeah, I would point to a couple of things. The history of these businesses spans many decades, both Hub Group and JB Hunt and that history and consolidation of the intermodal industry has created very high market shares. So they don’t talk too much about market share anymore because they are very, very high, but we know that they’re significantly over 15 or 20% and probably less than 50%. And in the industrial world, those are borderline oligopolies when you sort of get that high. And so those kind of go back to those safeguards and sort of back to market shares, but the history of the relationships with the consumer as well as the market shares that they’ve maintained has given them tremendous pricing power and sort of consistency and gaining talent, whether it’s through sales, through their operations, attracting great management at the top at the helm to negotiate these contracts which are very complex in nature.

Kyle Helton:

Pivoting to another area of your coverage, a recent print showed a decline in housing starts, which has often been a precursor to recession. We’ve certainly owned successfully some home builder and construction names in the past, but have largely trimmed those exposures. Can you walk through what you’re seeing in the space and what potential catalysts may be out there to revitalize sentiment in this industry?

Adam Ballantyne:

Yeah, we’ve some housing exposure across our portfolios, but it’s really minimal versus what we’ve had in the past. And part of that reason is probably obvious to many with inflation, very high interest rates very high at 15 to 20 year highs in terms of the mortgage rates and sort of a pinched consumer have created a pretty difficult backdrop for housing starts. And so it’s really hard to sell a $450,000 good to an individual even when it’s a perceived need for most. So that’s a very difficult backdrop. The reason why we love the industry still and why we continue to evaluate it at all angles is because homeowners have never been healthier than they are today in probably the last 40 years. Whether it’s the incomes at the median homeowner generates relative to the value of their home, whether and probably most importantly, the amount of home equity that the median household has as a percentage of their home, that is such a tremendous balance sheet asset that most tens of millions of households rely on when it comes to just their net worth as a family and a balance sheet that they can use as a bank during tough times for over a small period of time.

So that sort of homeowner consumer health is tremendous. It’s part of the reason why we’ve seen, I think consumers withstand these tremendous interest rate increases in mortgage increases so well versus the history, specifically the 1970s. So when we think about this space, one of the reasons we love it is because on the product side there’s a lot of remodeling, there’s a lot of repair work we’re involved with. MASCO does paint and plumbing excellent business. It’s seen weakness in the last couple of years, but not even close to what we’ve seen in terms of other interest rate sensitive industries. And it’s sort of repair remodel status is going to keep it kind of chugging along and keep growing through some tough times where it’s consumers on the home builder side. We continue to evaluate that side and one of the reasons we like it is because it’s consolidating tremendously. So you can look at the large…

Kyle Helton:

A sense of theme here.

Adam Ballantyne:

Yes, it’s the theme. We continue to look at some of the larger home builders who just 20 years ago had two or 3% market share and today they’re at 12 or 14%. And we think that those scale benefits that they get on lumber and on labor and on purchasing land and on financing, all that land that they’re holding can benefit the consumer a lot and create a disinflationary tailwind to a very expensive good. So it’s a space that we like in terms of housing, especially on the sort of quasi industrial quasi consumer, but when we continue to look at it pretty heavily

Kyle Helton:

And maybe pivoting to an adjacent business line, you’ve done a really good job of identifying some unique businesses within the REIT universe, more quality to defensive characteristics, and I think maybe the broader space hold. Can you walk through what makes some of these businesses attractive to you?

Adam Ballantyne:

Yeah, and I think I would just open up with the REIT space has seen one of its largest underperforming periods over the last few years versus the S&P 500 potentially ever. The REIT space was sort of born in the nineties from very low interest rates, which caused a lot of companies to want to shed very expensive assets, real estate, warehousing, distribution, even sort of very expensive goods like aircraft and vehicles. And so those very low interest rates, those very low financing rates created almost an industry on the REIT side that allowed you to purchase these very, very expensive things at a very low interest rate. Well, we’re starting to see that unravel. So we’re seeing a lot of these REITs struggle to grow because they can no longer continue to consolidate and acquire these assets, whether they’re hotels or offices or cold storage warehouses for this Americold that we own as an example, because the interest rate that they use to finance it and the equity that they want to issue to finance it have both gone the opposite directions of the prior decade.

So it’s just become more expensive to grow. At the same time, these are yield payers, so their attractiveness is in their stability, they collect rent. Who doesn’t want something that is pretty recession proof from a cash collection point of view? That’s why these are such attractive businesses to own over the very long term. Well, a lot of these yields from some of the best larger cap REITs used to be two 3% when the 10 year was around that range. And now we’ve seen the 10 year really skyrocket up to four and a half, almost 5%. And while those yields have tracked up there as well, so we’re starting to see or have seen for a while, just really weak stock price expansion from a lot of even the best in class REITs. And so what we’ve tried to do at Cambiar and on the QPD side is sort of marry a higher yield REIT, so something where we can get value but still get good growth on the organic side so we don’t have to rely as much on M&A or on other sort of acquisitions and benefits from dispositions.

Kyle Helton:

Now to platform businesses. They’ve fundamentally changed the way we think about industries like transportation and hospitality. How do you think these types of companies will continue to evolve over the next few years and where do you see untapped opportunities for growth?

Adam Ballantyne:

Yeah, so these network businesses are newer, certainly in their quantity. We’re most familiar with the post nineties platforms, whether it’s operating systems and search Google or operating systems like Android and Apple or Microsoft Office. And so those were sort of the first platforms, but the business model has been around for many, many decades in terms of the benefits of using one player versus many. So that’s not a new concept. However, the platform businesses mostly due to the expansion of the digital age and computers and the ability, the ease with which you can acquire a customer have fallen so low that we can all sort of communicate in real time millions of us together. Well, that’s sort of spawned Uber and Airbnb because we can kind of see the whole globe of what’s available right now. All of us, whether it’s searching for a ride to the airport or whether it’s searching for a song on the internet that we want to listen to and the benefit of us all doing this on a single platform is very noticeable, very high.

None of us want to have to search 5, 10, 15 websites or locations to find the movie. We want to watch the song. We want to listen to the way we want to transport ourselves from point A to point B. We just want to go to the same place every day or every time we need to do these things. And so that sort of recurring customer, the low acquisition cost of getting these customers and the benefit of us all using the same brand has spun very powerful network effect businesses that really used to just exist on the industrial side. I’m thinking like water and electricity many years ago. So when we look at the platforms we own such as Airbnb, we see tremendous two-sided benefits to if you own a second home, a vacation home of which there’s probably 10 million or so of those in the United States, you can now make money off of that home just sitting there.

We can use this asset much more frequently and have supply meet demand where demand is existing, and this can actually create another disinflationary benefit to hotel prices, to vacation home rentals. And so this market was sort of just created and Airbnb was first, they became the largest and they run their product very, very well. In terms of Uber, it’s a very similar thesis. It’s using these vehicles, these very expensive vehicles, significantly more than if they were just sitting in a driveway and because of the sort of archaic, old expensive, hard to reach taxi system, it worked but didn’t work for so long. It was very easy for Uber to take this market share, accelerate their growth for the last decade. They haven’t even been around that long as a business and they’re already doing close to a hundred billion in booking. So it’s been incredible to see these platform businesses take off, grow, consolidate and sort of in a zero sum way, utilize the assets that make up their industry, utilize them more efficiently and create benefit for their consumers.

Kyle Helton:

Convenience seems to be the commodity of our generation and the ability to seamlessly and efficiently, to your point, leverage these assets that we already have seems super important to these businesses. What other characteristics of specifically Uber and Airbnb, as we’re talking about them as their own names in our portfolio, what sort of characteristics do these companies possess that align with our investment philosophy? I think it would be easy for a more Graham and Dodd style investor to look at these companies from the outside and question whether they should fall in the value bucket. But as we think about valuation a little differently than some of our more traditional peers, I wonder how you kind of reconcile those things.

Adam Ballantyne:

So in both situations, their multiples are actually quite low and not reflective of where traditional monopolistic or oligopolistic networks trade. There’s unique niche reasons for that for each of those companies, but if we think about what an ultra high quality monopolistic or oligopolistic network typically trades at on its earnings, you’re quite a bit higher than the average S&P 500 multiple, like 25, 30 times its earnings next year. And we caught Airbnb recently at sort of a mid-teens multiple, so substantially below where credit ought to be due. I think the presence of Expedia and Booking and their investments into this space have limited Airbnb’s acceleration to become the only provider of what they’re doing, but we think we don’t Airbnb to be a monopoly to be an excellent business, continue to get tremendous returns on invested capital, continue to have very high margins. They announced a couple weeks ago that they’re reinvesting heavily into their product, expanding into new geographies, and that the runway for the industry is still so long that they can still have a lot of really high growth ahead and that the industry is going to be sort of a rise in tide for everybody.

In terms of Uber, they’ve shown such dominance. I think they have now close to 70%, maybe more than that market share versus Lyft. And they’re sort of at that point, that tipping point where you start to look like a monopoly. They have Uber Eats as well, which has a very tough competitor in DoorDash, also very well run, but they’re able to combine those two together to a single offering, and we think that’s a very powerful product. Versus DoorDash, that’s their Uber One subscription and subscription model has grown to 30 million users globally. It’s growing significantly faster than the overall company and other esoteric risks that you can come up with to these networks as can occur from time to time. The most notable one being ai, taking over ride share or autonomous vehicles we calculated currently has 0.1% market share. It’s growing quite a bit and it’ll be in fits and starts.

We think it’ll be the future. But we agree with the CEO Dara that it’s going to take many years for the geographies, municipalities, the states on the federal level insurance, the additional costs that aren’t factored into housing, all of these vehicles, the costs of the LIDAR systems that they have to operate to feed into the price to the consumer. And so these things are going to take very long, and that’s sort of our arbitrage here is a tremendous high ROIC, 20% growing high margin business, very well run with lots of adjacency growth outside of its core Uber Eats and rides products, excellent net cash balance balance sheet that produces a tremendous amount of free casual well, we see that going on for many, many years, even with AI growing and being successful as well in the autonomous vehicle angle. So in both situations we kind of caught you can get the negative headlines and sort a disruption in the near term story and the thesis, but the fundamentals are perfectly intact and very good and we think they’re going to be very good for many years. And so that’s why we think we were able to get these businesses, what we would call sort of half off. And so I would argue that’s very Graham, that’s very Dodd getting excellent businesses, substantially cheaper at market prices.

Kyle Helton:

Yeah, absolutely. You mentioned having a shot on goal with business trading in the mid-teens relative to other network businesses that trade in the upper twenties, low thirties range. You talked about growth a little bit and finally touched on free cashflow generation. Can you walk through the importance of free cashflow growth when you consider your valuation methodology with some of these platform companies?

Adam Ballantyne:

Absolutely. It’s cash is king, not just on the balance sheet, but also through the income statement. It’s real, it’s tangible. There’s a lot of good reasons to have nuanced accounting behind on the income statement to not confuse investors and the public about how a business is operating. We understand why these were created over the last couple of decades. They’ve been amended multiple times after each sort of financial crisis we work through. And maybe we haven’t seen the last there, but they’ve improved a lot over time. And I would say the core reason we look at free cashflow, we look at it as sort of a function of the others. So you have to have revenue to generate cash, so that’s obviously very important. We like other metrics, whether it’s operating earnings, your EBIT, or whether it’s your EBITDA as well to sort of smooth out what’s going on with the business.

But at the end of the day, we hold management teams accountable for collecting cash. That is what comes to the door. It is what allows reinvestment of capital. It allows dividends to be paid shareholder returns to accelerate. And that’s why we have at Cambiar, we have a very strong focus on cash, on the balance sheet, sort of a lack of debt is what we like, and also access free cashflow. And that’s really the pinnacle of a lot of the valuation metrics that we go through. It always sort of ends with what’s the actual cashflow that we’re forecasting for this business, and where is that relative to the multiple and how should we alter the multiple in a way that is accepting of the amount of cashflow that this company generates?

Kyle Helton:

Well, I appreciate it. Any final thoughts you’d like to share with our listeners?

Adam Ballantyne:

I think we’re in extremely interesting times in the stock market in the economy. I’ll point out that I think our number one concern, and we’re starting to see this concern rear its head throughout the market and throughout the public is related to the amount of money that the federal government is spending beyond what it collects. When you reverse that back to where it has been those levels as a percentage of GDP or is a percentage of what we collect in tax revenue, you start to get materially different GDP figures. So how that impacts employment, whether it’s through the DOGE led, Musk led cuts to federal employment and how that impacts, again, things like housing that we’ve touched on or how that impacts goods that travel on intermodal and on logistics and transportation. There’s a lot that we don’t know there’s, that is going to be determined in the next six to 12 months that will dictate how our views will change on certain industries and perhaps on certain companies and how we evaluate their earnings and cashflow and their futures and ultimately what we think they’re worth.

And I think that’s why we have these jobs is because great businesses can be great businesses and great industries, great industries, but bad industries become great ones and great ones become bad ones over very long periods of time. And you can say the same of any business for sure. And so some things change very slowly. Some things change very quickly, and we’re assessing and sort of thinking we could see some very quick changes to our economy and to how we view the industrial space broadly. Perhaps even some of these platform names as we sort of reduce deficits and perhaps have a weak period of employment. But I would just point out that that’s probably our number one watch item when it comes to not even just the industrials, but just the broader market in general and how we’re allocating capital and trying to find Alpha.

Kyle Helton:

Well, that’s a wrap for today’s episode of the QPD podcast. A special thanks to Adam Ballantyne for sharing his insights into the opportunities he’s uncovering within industrials real estate and platform companies. If you enjoyed today’s discussion, be sure to subscribe, rate and leave us a review. Your feedback helps us continue to bring you valuable content. For more information, visit Cambiar.com. Thanks for listening, and we’ll see you next time on the QPD podcast. Take care.

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