Cisco Tumbles After Profit-Margin Squeeze Overshadows AI Gains

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1:02Bloomberg Audio Studios. Podcasts. Radio. News. You're listening to the Bloomberg Intelligence Podcast. Catch us live weekdays at 10 a.m. Eastern on Apple CarPlay and Android Auto with the Bloomberg Business App. Listen on demand wherever you get your podcasts or watch us live on YouTube. We are still knee deep in earnings season. And even though I keep saying that most of big tech has reported, not all of tech has reported. Cisco was the latest to report it's a hardware company. They make the gear for internet networking, and they're benefiting from AI. They're getting more business from AI, like many hardware companies, but they're also seeing a downside to that, and that is higher costs.

1:46Woojin Ho is our senior hardware networking analyst here now to give us some insight into Cisco. So, Woojin, it sounds like the increasing cost of memory chips is kind of dogging Cisco like we've seen with other hardware companies. How do you think about the increase in cost of memory chips? Is this kind of a one-time problem, one-time adjustment, or is this creating a new normal for hardware companies? Yeah, hey, Scarlett. So, you know, when we think about it, it is going to create a new normal. Quite frankly, the magnitude of the DRAM price increases was a bit higher than we had anticipated.

2:22And it's going to be a drag on margins. At least it already hit the current quarter, reported quarter. and then it is going to be another 200 basis points gross margin erosion next quarter. The one thing that we can be assured of is that there's going to be price increases across the board for a lot of Cisco's products and more importantly, a lot of big tech products such as Dell and HPE going forward. So is this more today an industry problem or a Cisco problem here? No, it's an everybody problem, Paul, quite frankly. I mean, look, there's a couple of things here, right? The DRAM pricing isn't going to hurt only Cisco, but I'm scrambling to get new laptops for my kids before the DRAM prices hit the PC market as well.

3:13And what we are going to see is that anything that's DRAM heavy, in particular servers, that's going to be bogged down on the gross margin side. But what I'm trying to balance out is how much of that is going to, how much are the companies going to eat that gross margin and how much is that going to be passed through? Okay, so I guess the other part of it was that Cisco shares were kind of priced to perfection, as a lot of people were putting it. So it didn't take a whole lot for investors to react negatively to Cisco and the latest results. But 10.5%, you know, that's a pretty big adjustment.

3:49Are people re-rating this company completely? Yeah, and you actually make a good point, right? As I was looking into the print, the P.E. was at roughly 21, 22 times. And the last time we saw the P.E.s like that was back in 2023 when people were pre-buying a lot of networking gear during the COVID cycle. And historically, P.E.s are roughly around 17 to 18 times for Cisco. And what we are seeing is that the multiple is coming back to the 17 to 18 times. And I do think that's kind of a bit wrong, Scarlett, primarily because this AI story actually has a lot of sales behind, a lot of wind behind its sails.

4:32And I think a lot of investors are overlooking the AI opportunity, which is going to be multi-year for Cisco. How long will the industry have to deal with, I guess, chip shortage going forward? Is this something that chip makers can just flip a switch and start making more chips? You know, I wish I had a bottle with the Magic Genie that will pop up and create new DRAMs. But the fact of the matter is, is that every time you have, if you want to create capacity for new memory chips, it takes about two to three years. And the memory manufacturers were struggling very badly during the COVID period when there was overcapacity.

5:15And they've been hesitant to build up the capacity. But this AI boom and the memory demand related to the AI boom is a lot stronger than we had anticipated. You know, I think my colleague Jake Silverman has a good piece out on how long it'll last. It might take another two, three years before it gets resolved. So is there, and I realize that this is more Jake's remit, but is there still any kind of excess inventory of those memory chips or have we drawn down on all of that? Well, I also covered the hard disk space. Oh, there we go. Scarlett. So my hard disk drive guys are sold out until 2026 and possibly into 2027.

5:51All the read-throughs from SK Hynix, Samsung, Micron, and SanDisk, they're all sold out through 26 and into 27. They're already taking orders for 27 and 28. So this is a global problem. This isn't a trade spat supply chain screwing everything up, trade war tariff type thing. This is just a global supply issue? Yeah, that's exactly it, right? You know, the BI team has been writing about this for a couple of months now, and it's starting to exasperate into higher levels. To give you some context, we picked up on the higher chip memory prices back in November. When they were rising roughly around 50-60 % on a year-over-year basis.

6:37Over the past quarter, DRAM prices have doubled to almost tripled. so everyone's scrambling to get chips before they rise even further. All right, so inevitably that means laptop prices are going to be higher along with everything else. What about smart appliances? Do they use memory chips or do they use the analog chips that Texas Instrument makes? Well, I mean, get your smart TV, get your smart refrigerator, laundromat, stove, as quickly as possible. I think the bigger issue here, Scarlett, is probably going to be the smartphone market. You know, IDC has cut their smartphone forecast to be in decline, primarily because there aren't enough memory DRAM chips and as well as storage to help supply all the smartphones.

7:25Apple should be OK. But at the end of the day, there is going to be a supply constraint there. Stay with us. More from Bloomberg Intelligence coming up after this.

7:37you're listening to the bloomberg intelligence podcast catch us live weekdays at 10 a.m eastern on apple carplay and android auto with the bloomberg business app listen on demand wherever you get your podcasts or watch us live on youtube we got all the hotels reporting a lot of the leisure companies reporting here hi it just reported and some decent numbers the street likes it. Stocks up 5.6 % today. That's a 52-week high, and it stocks up 11 % year-to-date. Let's check in on Jody Lurie. She's a senior credit analyst for Bloomberg Intelligence. Jody, talk to us about Hyatt. We heard from Hilton.

8:11What are the folks at Hyatt saying about their business? So everything is seeming to be pretty upbeat. I mean, we're seeing a lot of the same narrative that we heard from Marriott, that we heard from Hilton. And it's that we're seeing the strength in the luxury market at the moment. And it's just, it's not so surprising for us, because we've been talking about this. I mean, we did our travel survey, we ran in in November, and we talked about the K-shaped economy. We anticipated that coming into this year, people who have the ability to spend on travel are going to continue. And those who aren't might pull back a little bit.

8:45And so we've started to see that. I think what's probably more interesting, maybe, is that both Brian Egger, my equity counterpart, and I have been talking about this topic. And we've been comparing notes and we're pretty aligned, which usually you don't really see equity and credit analysts aligned, but it's kind of hard not to be in this situation. Right. The fundamentals are the fundamentals. And these companies are able to monetize on that K-shaped economy, certainly by focusing their efforts on the upper end. What about the lower end? Marriott runs Courtyard by Marriott and that's its branding right there.

9:18Does it mean that it just, you know, focuses less on that or devotes less resources to it? Is that a brand that, you know, kind of has a ceiling? So I don't think it necessarily has a ceiling per se, but I think that, you know, I think the companies are taking a longer term outlook of, okay, right now at this moment, those businesses might be a little bit weaker. They also actually cost a little bit less to run because when you think about luxury businesses, you have a lot more additional costs that you have to contribute to give the quality of service that the customer expects. So I don't think they're necessarily going to stop creating those brands and building out that platform.

9:57In fact, I think they're going to continue doing that because eventually this will run its course. What I do think is an interesting point that we've talked about a few times is if you look at a company like Choice, which is much more heavily embedded in that lower income consumer, embedded in that extended stay market that was likely more so affected by, for instance, the government shutdown, which Marriott, which Hilton talked about on most recent quarters. And so I think that's where you're going to really see the differentiation is not so much in these companies that have these global massive brands that they can sort of like shift around resources and also anticipate that some of their brands might be stronger than others at different times of the cycle.

10:37I think it's more in the ones that are a little bit more concentrated that might have some issues. Okay. That makes a lot of sense. And I want to pick up on what you said about how luxury, running those luxury brands costs more. How much of those costs does Hyatt, the company, which has an asset-like business model bear versus whoever's paying the licensing fee to Hyatt? Sure. And I think that's a key question too, because when you think about it, Hyatt is doing the management of it, right? So they have the brand, they have the management, but you do have the company that owns the property. And more so what they sort of reference on the call, and we've heard this a few times from the company, is more the anticipation that some of the owners of the hotels, if they have issues with financing, that these companies have to sort of think about ways that they can leverage their higher quality ratings to help them with financing to grow up the business and to make these sort of modifications on the properties themselves.

11:34Hyatt is an interesting company in and of itself because, you know, it generates great cash flows. It anticipates to generate strong cash flows this year, but it's twice now done the same thing where it made these relatively large-scale acquisitions to expand its footprint and to build out into all-inclusives, into other parts of the market and extend their sort of vertical integration. And in both instances, they levered up to do so, but they've been pretty quick to de-lever. And to your point, Scarlett, they used their pivot into asset light, meaning selling their properties and entering into management agreements to do so.

12:12So they benefit from that fee structure instead. So is there debt for you to look at for these hotel companies? Are there all this asset-like stuff? There is debt because the companies are still borrowing. You know, they're borrowing to sort of build out their platforms. They're borrowing to do tech upgrades. They're borrowing for all sorts of reasons. Marriott has sort of this, I don't want to say it's a flywheel, because it's not, but they're at the point now where they have, you know, they have triple B ratings. They access the commercial paper market and they can access it because of their short-term ratings at the moment.

12:48And they use it as cash gaps, right? And they'll fill those cash gaps and then they refinance the debt that's coming due. So I don't think we're in a situation where these higher grade companies like Marriott is going to necessarily decrease their debt load. They're just going to sort of lean on the EBITDA growth. They're going to lean on the fact that they have these cash flows to support that. You know, they are going to give back to shareholders. They're continuing to do so. We're seeing Hyatt talk about that as well. And I expect that that's going to be the case. Now, in Hyatt's situation, they are still talking a little bit more about deleveraging just to get back to the category that they need to be in.

13:22But I think that over time, it's the type of thing that we see these companies issue debt for an acquisition, and then they deliver, and then they do it again. Stay with us. More from Bloomberg Intelligence coming up after this.

13:38You're listening to the Bloomberg Intelligence Podcast. Catch us live weekdays at 10 a.m. Eastern on Apple CarPlay and Android Auto with the Bloomberg Business app. Listen on demand wherever you get your podcasts or watch us live on YouTube. I get a busy day in the earnings front, particularly for some of the restaurant companies. McDonald's reported numbers that beat estimates. restaurant brands think Burger King, I think is kind of it raised its dividend. So let's talk to Michael Halen. He is the analyst at Bloomberg Intelligence, follows all the restaurant companies out there. Mike, thanks so much for joining us here.

14:13Let's talk about McDonald's. Their value menu was kind of a hit with consumers. Yeah, they reestablished themselves as the value leader in QSR, which makes sense, right? They have 14 ,000 stores in the U.S., more scale than anybody. And they've done a phenomenal job with the marketing. I mean, I think they sold 55 million pairs of Grinch socks, right? The Grinch Happy Meal. There you go. One of their most successful promotions ever, right? So, yeah, they're firing on all cylinders. They also benefited from lapping E. coli a year ago. And that's that's how they ended up with such a strong comp in which was a pretty tough quarter for most of the industry because of the cold weather and the flu that we saw in December.

15:00Right. And we also are hearing that McDonald's is not going to rest on its laurels. It's looking to innovate. It's going to introduce some new beverages under the McCafe. McCafe. McCafe. McCafe. McCafe. McCafe. That's hard to say. McCafe. It's not French. Anyway, indulging coffees. That sounds kind of fancy. Is that to appeal to the consumer who might be trading down to McDonald's? no you know what it's it's beverages are hot i mean cosmics you know although that that chain isn't isn't you know has been kind of um dissolved they they've learned a lot about the beverage uh beverage industry through that um through that test right um dirty sodas you know there's a chain out west called swig that that absolutely crushes it with dirty sodas think you know Coca-Cola with added syrups and whipped cream on top and things of that nature, right?

16:01That's a lot of energy drinks. These are like really a really hot segment of the QSR industry. It has been for years, right? As some of these bigger, slower moving chains like McDonald's are starting to kind of jump on this bandwagon a little bit later. But, you know, we think this is this could be meaningful for them in the second half. um you know and it's no longer public but you know this could take a chunk out of sonic's uh business you know because they've they've long been a beneficiary of the the beverage market you know and and what's nice about that business is a lot of those drinks are sold and during that snack period you know during when these restaurants have a low around you know two three four o 'clock in the afternoon um restaurant brands uh they also reported some numbers here mike remind us who restaurant brands is and what they're doing these days?

16:54How are their results? Yeah. So, you know, it was kind of mixed results versus what the street was looking for. You know, I look at the underlying trends and I think they're still strong. So the reason why it's down right now is, you know, Burger King showed an acceleration in the U.S., which is pretty promising. You know, they showed strong results at an international and international is a pretty well-oiled machine for this company. But there was some deceleration in the Tim Hortons numbers, which makes up 60 % of adjusted EBITDA. And, you know, Popeye's remains kind of weak, right? So I'd say the biggest concern in this report is really about the slowdown in Tim Hortons, but it's lapping tougher comps.

17:39And when we look at, you know, same store sales trends going back, you know, a handful of years, the trends are actually accelerating, even though it deceled on the one-year and a two-year basis. And so, you know, Tim Hortons is a monster in Canada. I wouldn't be too concerned about it. Like I said, a big part of this story is the international unit growth that they're putting up. And we think they can get back up to mid-single digits here in another year or so. You know, Popeyes and Burger King are absolutely crushing it around the globe. And, you know, we expect pretty solid growth here. And we think they can outperform a lot of their quick service peers here in 2026.

18:23Michael, how are the McDonald's and the restaurant brands of the world using AI? We've seen them embrace automation with, you know, you have to go order yourself at the kiosk and then someone calls your number. So they've removed, they've made things more automated in that regard. But how will AI change the whole experience? Yeah, well, you know, AI is going to change the experience, the restaurant experience in different ways. Like different chains are going to look to different solutions. Something that works for one type of chain, like a Chipotle, isn't going to work for McDonald's and vice versa.

19:02So, you know, I think when you're looking at AI, first and foremost, it's going to be continued progress on that one-to-one marketing. Getting people into your loyalty program and eventually getting those very directed offers to them at the right times, right? This has been kind of a long time coming. AI should really kind of help with that piece. And I think for these quick service chains, the thing that's going to be probably most useful is like an AI assistant. You know, Taco Bell is rolling this out, testing it, and then eventually going to roll out to all its stores where they have basically an AI assistant for their GM.

19:40Tells them how much food they need to prep, if they need more labor on the line, helps them have more accurate sales projections so they know how much labor they're going to need on any given day, how much food prep they need to do, whatever it might be. Right. So I think those are going to be the two most ubiquitous use cases and probably the ones that we'll see most of the progress on in the near term. Stay with us. More from Bloomberg Intelligence coming up after this. You're listening to the Bloomberg Intelligence Podcast. Catch us live weekdays at 10 a.m. Eastern on Apple CarPlay and Android Auto with the Bloomberg Business app.

20:22Listen on demand wherever you get your podcasts or watch us live on YouTube. One of the stocks on the move to the downside is tech company AppLovin. I'm just looking at the stock here, really taking it on the chin here today. They had some earnings and some guidance, a little bit of a challenge here. The stock's down 19 % today and 45 % year to date. This is a big company that a lot of people, including myself, don't know a lot about. We're going to change that right now. It's got a market cap of$125 billion. Nathan Nadeau joins us, Bloomberg Intelligence Technology Research Analyst. Nathan, do me a solid here and just tell me what AppLovin does, number one.

21:02And number two, why is this stock getting hammered today? So thanks for the questions. First question, AppLovin essentially controls an auction, which is a marketplace where ad space inside of mobile apps are bought and sold. It has a commanding influence on this sort of real-time auctions for in-app ad space. And that is helping, you know, the reason it runs an auction house is because it essentially connects advertisers which want to advertise inside of mobile gaming apps. And also mobile gaming app publishers that want to sell ad space to make dollars, you know, because a lot of these days, a lot of mobile apps, games or otherwise, are actually offered for free.

21:46So how else are they going to make money if not selling the ad space inside of the apps? And AppLevin is essentially the mediator connecting brands which want to advertise and apps which want to sell the ad space. And on the share price reaction we saw today, I think, you know, I think to some extent that's due to this sort of AI disruption risk or so-called AI fears. And obviously AppLevin is not alone in facing disruption for any sort of AI companies. and there's been a lot of headlines with a Google Genie in the last week that can create an interactive video with simple text prompts. It means people like you and I can create games sometime soon.

22:26And also more closer to home for AppLevin, there's a startup called CloudX, which is in the space that AppLevin is in. It's AppLevin's brand-new business, which is mobile ad monetization. And there's still uncertainty around how much disruption, the extent of disruption to Apple Vins, because Apple Vins' moat, which is a word that gets thrown around a lot, but it's essentially its competitive advantages are relatively stronger than other rivals in the space. Yeah, I think I would leave it there to see if there's any follow up. OK, thank you for that introduction. So it sounds like to a large extent, because it's tied to the advertising industry, that it is cyclical, that it's going to move in line with how people feel about the economy.

23:12So where does that leave this company when it comes to disruption or resilience to the AI narrative? I mean, even if it doesn't happen right away, there's that idea that it could down the road. Yeah, you're certainly right that it could happen down the road. But I guess going back to the extent of disruption and this so-called mode, which is competitive advantage. And I think Ablovin has some tricks up its sleeve. For example, it has this AI or machine learning models that took more than five years to build. And it's trained with data from in-app transactions back when it was still publishing games.

23:52And obviously, how sharp a model is at targeting ads depends on the quality of the data and the length and the amount of data. And I believe because AppLevin's model, at least in helping advertisers target ads instead of mobile gaming apps, that model is mature in a sense. It would take some time before any sort of upstarts can catch up to that level of sophistication in the modeling. So I believe AppleAvin still has some one way. And for context, when an ad is shown to a mobile gamer, seven or eight out of 10 times that ad is mediated by AppleAvin. That is how much of a commanding influence AppleAvin has in the auction of digital ad space.

24:38So I believe that dominance, it would take a lot to displace that. But obviously, for smaller arrivals in the space, whether it's Unity's vector or for smaller arrivals, I think the concerns for AI fears might be even more pronounced. This is the Bloomberg Intelligence Podcast, available on Apple, Spotify, and anywhere else you get your podcasts. Listen live each weekday, 10 a.m. to noon Eastern on Bloomberg.com, the iHeartRadio app, TuneIn, and the Bloomberg Business app. You can also watch us live every weekday on YouTube and always on the Bloomberg Terminal.