Is AI the Answer to Big-Box Retail’s Woes?

0:03Tyler Crowe:The woes of retail earnings continue. Motley Fool Hidden Gems Investing starts now.

0:13Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Jon Quast and Matt Frankel. So today on the docket, we're going to talk about drone delivery, which is becoming a big topic in the DoorDash and the Ubers of the world. and there's been a lot of deals going on in that market lately. And we're also going to hit some reader questions at the end of our show. But as we're getting started, we're still in earnings season and a lot of the big box retailers have been reporting this week. We've had a sprinkling of them so far. Home Depot was on Tuesday.

0:43Tyler Crowe:We discussed that. And the Wednesday crew talked about Target's earnings yesterday. But we got a little bit more of a story with Walmart, Lowe's, and TJX Companies, the parent company of TJ Maxx. They all reported earlier today or after the close yesterday. Guys, a lot of stuff to cover here, but Matt, what were some of the numbers that you saw and what were some of the reactions that you thought of when you looked at these numbers?

1:09Jon Quast:Well, I mean, the big thing is that the headline numbers are deceiving. Tariff refunds, pretty much every retailer got them. And it made the bottom line numbers look a little better than they should have. And the market knows that. The market's not rewarding it by any means, but we'll get to that. There was a common theme of general strength for the second quarter. um home depot for example reported its strongest comp sales number since you know the third quarter of 2022 uh target which is in the process of a turnaround reported comp sales in the 3.8 ballpark um a nice improvement uh pjx they beat and raised four percent comp growth and it's worth mentioning that you know inflation's running around three percent so this was actual real growth ahead of the inflation rate so that's nice to see uh walmart was the disappointment and kind of an outlier here.

1:56Jon Quast:Comps were 2.6%. They fell a little short of expectations. I'm not even sure they beat inflation, as did their third quarter guidance. That was a disappointment. And this was somewhat of a surprise to me. I mean, I expected Walmart to be a little more resilient in times of uncertain consumer spending. I mean, in 2008, Walmart was the best performing stock in the S &P. And it was because of people needed to cut back and things were expensive. Walmart is the most important of all of these retailers, in my opinion. It gives a read on low to middle income households. And that's really my biggest worry in the economy right now.

2:34Jon Quast:It's not how the people at the top are doing. It's how the people in the middle are doing. And Walmart is really a good indicator there.

2:40Tyler Crowe:John, this is actually kind of brings up an interesting point here, though, because revenue numbers were a little slow at Walmart. But one thing that has been pretty common at Walmart over the past several quarters or even last couple of years is that earnings have been very much outpacing revenue growth. What's been going on here? Because when I think about Walmart, I don't think of a retailer that's like pushing price to increase margins.

3:08Matt Frankel:Yeah, let me start with that revenue number that Matt was talking about, because it was kind of the more disappointing number among the retail players. it is interesting that all these retailers talking about the tariff refund so of course you know all these tariffs that were levied upon them those have been annulled the government had to give them back and companies like Lowe's for example mentioning that its competitors in light of receiving that check kind of leaning into lower prices whereas Lowe's saying hey we're just going to actually maintain those prices. Walmart is kind of on that spectrum of, hey, let's use this tariff to be more competitive on price yet again.

3:53Matt Frankel:And that is really Walmart's MO. We are the low price leader. So not using those tariffs and kind of just dropping it down to cover other expenses, saying, hey, we're actually going to use this to compete on price. So maybe that's contributing to the little bit of a lackluster revenue number if other competitors are kind of saying, hey, we're not going to lower prices. We're going to keep them where they are. Now, to your question about the profitability, this is actually pretty important here and why Walmart has been a good performing stock, in my opinion, over the last few years. Operating income growing faster than revenue.

4:28Matt Frankel:So revenue down in the single digits, operating income growth in the double digits. That is a little bit unusual to see. And it's a big deal when you're talking about a company of this magnitude. When you're talking about a company with hundreds of billions of dollars in revenue, even just a single percentage difference in that profitability, I mean, that makes a big deal on the bottom line. So Walmart has been increasingly offering digital products. It's been selling digital things. It's a digital business. So you look at advertising. I mean, it has a wonderful first-party data set of consumer behavior and data.

5:05Matt Frankel:This is something that it can use in advertising, and that's a high margin business. Of course, it acquired Vizio so that it can have this connected TV platform as well and integrate that into the ecosystem. Also, Walmart Plus. I mean, e-commerce and Walmart Plus, these are digital offerings as well that do help that profitability. And Walmart's been executing this playbook really, really well over the last several years.

5:28Tyler Crowe:It's obviously working because, like you said, the profitability at Walmart's doing incredibly well. But to Matt's point, where Walmart's a little bit slower, one of the things that we could possibly attribute this to, and to Matt's point, is the lower to middle income bracket tends to be the Walmart shopper. We have seen a pretty large increase in fuel prices. Now, we're not going to say that this took up everybody's discretionary spending, but it does tend to be a very large price signal for what people are willing to do. You know, gas prices start to go up. Maybe people, you know, maybe to make a fewer discretionary spend items just simply because like seeing that as like a signal of maybe things are going to get a little bit more challenging.

6:11Tyler Crowe:Is that showing up in the numbers here?

6:14Matt Frankel:Well, it's at least showing up in management commentary for sure because, you know, the kind of the thing was, are you going to pass through this tariff refund onto the consumer, onto your customers? and several of these companies kind of saying no, not directly, because actually our costs have risen pretty substantially. So we're going to take that tariff refund to offset the higher costs that we're experiencing. And in that way, it's going to benefit our customers. But I kind of thought that that was a little bit of, let's just say, creative language. But I did look it up. According to AAA, gas prices up 31 % in the last year, but diesel prices, and this is, let's say material to these retailers.

6:54Matt Frankel:Diesel prices up 50 % over the last year. So there is a real cost increase here to the retailers. I get why they're saying, hey, we're actually gonna use this tariff to offset some of those higher costs. So it is real. And then the other side of that coin, not only is it costing the retailers more in expenses, but as you point out, that's also costing consumers. And so there is less spend available for discretionary purchases. You gotta kind of just double down on the things that you need.

7:21Tyler Crowe:One last question as we're getting out of here, because I feel like the sexy thing in retail these days or the most popular thing that people are talking about is like agentic AI and using them as agentic commerce, you know, using customers, using them to make discretionary purchases for them or things like that. And I, from a personal, like thinking about it, an investing standpoint, I can certainly see that from like a business to business sort of transaction. That's much more process, you know, purchase what you need. But from a consumer spend standpoint, I'm struggling to see how that works.

7:54Tyler Crowe:Now, obviously, there's a lot of digital companies doing it. Amazon's doing it. Shopify is doing it. are the big box retailers diving into this as much and are they seeing the results of this or is this still very much a i don't want to say early innings we'll call it the picture still

8:10Jon Quast:warming up sort of phase yeah i mean walmart already has an agentic uh shopping app uh i think it's called sparky uh amazon has one too it's not a big box but you know online retail there's two sides of the story here there's discovery and there's actual purchases and and one study i read said about 60 percent of consumers are using agentic ai apps for discovery meaning comparing products researching products seeing what they need but when it comes to actually completing a purchase through an agentic ai uh or an ai agent it's we're in the low teens to you know in in some cases the high single digit percentages of customers are actually using it the real issue is, is trust.

8:52Jon Quast:It's not the tech. The tech is there. Um, you know, how, how do you set spending caps? What happens if your agent buys something you don't want? How easy is it to cancel that? Can you instantly, you know, reverse, uh, reverse the transaction or do you have to do what my least favorite part of online shopping and get the package process or return, bring it to your FedEx store? Uh, you know, so it's a trust issue. Agentic shopping is working mostly for repeat purchases or things you don't really have to consider. Say like, you know, subscription products, groceries, uh, you know, an agent could reorder my laundry detergent once every couple of weeks.

9:29Jon Quast:Uh, that's where it's working. No one's using an agent to say, okay, pick a couch for me and buy it. Uh, so that's really the, the big trust factor in the, you know, do I have like the, an easy process to veto the purchase if I don't want it? Um, but I mean, yeah it's they're definitely using it it's definitely ramping up but you need better data to make these work and you need consumers to trust them to get the better data so it's kind of like a

9:53Matt Frankel:what happens first scenario yeah as matt points out ai actually was a pretty major theme here for the big box retailers in the most recent quarter and walmart highlighting sparky lowe's highlighting milo home depot highlighting my apron and so they're all talking about it i think it's a little cheesy, but the one company that is really leaning into AI here is Target. And Target actually hiring a chief AI officer, I think that that is a really interesting thing. I think maybe even needed to start to coordinate AI visions across the company and make sure that we're all pulling in the same direction.

10:33Matt Frankel:We all kind of have the same goals here when it comes to AI. But Target really leaning into what you're talking about, Tyler, this agentic AI. and this is where not only are you using the AI, as Matt points out for discovery, but you're completing the purchase within an app and Target really leaning into this, both Google and OpenAI are partners here. So with Google, the way that you do it, basically you're able to complete that purchase as you search through the Google AI assistance. With ChatGPT, it's a little bit different. Target builds its own app within OpenAI, but either way you can complete a purchase in that system.

11:14Matt Frankel:Target highlighting that it's agentic AI growing three and a half times the industry average. Obviously off of a small base but still that might be something to watch and might be something that you see increasingly from the other players or it might be something that Target is getting out in front here a little bit and leaning into a new way of shopping and it could be a tailwind.

11:33Tyler Crowe:We could be seeing some early uptake here, but my one takeaway is the names that they're using are really giving off some like clippy vibes from Microsoft Word back in the 1990s. I really hope that they get some better names here. Coming up after the break, we're going to dip into the autonomous delivery market.

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14:25Tyler Crowe:I think the most recent funding rounds has them as like a$7 billion company today. Now, John, you brought this one to the planning meeting this morning so we could dive a little bit more into autonomous delivery. And this may be the first time that people are hearing about the company Zipline. So can you give us the skinny on what Zipline does and what this Uber deal is kind of kind of look like?

14:46Matt Frankel:Yeah. Some people maybe have heard of Zipline because it did have a limited partnership with Chipotle Mexican Grill. But I became enamored with this company because of the work that it's been doing in the country of Rwanda. It has literally been able to save thousands of lives because of what it's doing. And that's not exaggeration. When you look at some of these remote places in Rwanda, some lives could be saved with a simple blood transfusion. But those clinics, those remote clinics, maybe even don't even have electricity. And so they don't have the infrastructure they need to keep enough blood on hand to perform this simple medical procedure.

15:25Matt Frankel:Now, there is infrastructure in a bigger city such as the capital. And really, that's what Zipline's been able to do. It's been able to, as soon as there's a need in a remote clinic, it's able to get the blood that it needs onto a drone, send that way out, and it can do over 100 miles round trip and get it delivered. Now, last I checked, it was using parachutes to kind of just drop it off. But it's a real, real benefit to a society like this where delivering infrastructure or even just storing blood on site is just not possible. And so really cool company doing some great things in the world, in my opinion.

16:01Matt Frankel:But now really trying to, I mean, it was trying to basically find customers, find a use case to kind of build out proof of concept. But Zipline's goal has been what it's partnering with Uber here to do. And so Uber is going to allow customers in many cities to be able to choose drone delivery for a Uber Eats order. Now, what's interesting here is that basically a restaurant is going to be able to receive an order, kind of put out a little pad out in their parking lot. They can put the food there and the zipline drone will fly from a hub to the restaurant, lower a basket on a tether, and that's where it gets its name, Zipline.

16:42Matt Frankel:It's going to lower that down, scoop it up, take it to the home that ordered it, then lower that basket down again with the Zipline and open it up, leave it there, and fly back to the hub, get recharged, and wait for its next order. So kind of an interesting way to do this, and I could see it taking off.

16:59Jon Quast:Yeah, I mean, Zipline already has some major partners. It's still in the very early stages of actually monetizing the business, but it has partnerships with Walmart, with restaurant companies like Pinero, like Chipotle. The company's targeting one million drone deliveries daily by the end of 2029. That sounds pretty ambitious, but with those partners, the order flow is definitely there. I'm curious about the economics, and maybe John knows more about this than I do, but drone delivery so far has been a money loser for companies who have actually used it in the real world, including Amazon. You know, I read that the average Amazon drone delivery costs the company like$30 to$40.

17:39Jon Quast:But at scale, could it improve to the point where it makes economic sense to do those, do 1 million drone deliveries per day and be profitable without passing on$30 a delivery or whatever the cost is to customers?

17:51Tyler Crowe:Yeah, that seems to be the recurring theme with just about anything autonomous these days is where these early testing versions of it are, in most cases, uneconomical for reasons one reason or another you know maybe the manufacturing isn't up to snuff so that it can build at scale maybe the ai or the autonomous software that it's using isn't quite there yet and so you know more data points to make it more accurate and and things like that so lots of like similar to what we're talking about with agentic ai is like that chicken and egg sort of situation like how does how does one scale fortunately companies like uber and amazon can throw lots of money at this stuff.

18:30Tyler Crowe:And sometimes it works out, sometimes it doesn't. And that's actually what I wanted to get at here, because this isn't the first deal that Uber has made with autonomous delivery companies. I think around this time last year, it partnered with an Israeli drone delivery company called Flytrex. That hasn't been quite working out as planned. And it was a partner with ground-based autonomous delivery robot company, Serve Robotics. But unsurprisingly, Uber and Serv didn't renew their agreement and that actually ended last week. I don't think it's a coincidence here that these two stories, the, hey, we ended our agreement with Serv Robotics and we signed this big deal with Zip Robotics or Zip Line, excuse me, right or happening around the same time.

19:13Tyler Crowe:It can't be a coincidence. So like drone delivery, autonomy, these are challenging markets. You know, who's winning, who's doing well. And it seems like, you know, these partnerships and agreements can come and go at any given time. So guys, as investors, clearly this is an exciting industry that likely to do incredible things in terms of growth. But what are you looking for in this industry as a like, what makes it a good company in this industry?

19:39Jon Quast:Well, I mean, as I mentioned a minute ago, I want to see that the economics work. If you remember when Amazon first launched two-day free shipping, that was a money loser for the company for years. It did not make economic sense. Companies like Amazon and others have all invested a lot of money and a lot of time and research efforts in building out the logistic networks. So things like free overnight shipping don't kill their profits and actually make sense economically. So I'm wondering if it's going to be that big of a curve when it comes to, you know, drone delivery and robotics and things like that.

20:11Jon Quast:But beyond that, there are a few other questions I have. There's going to be a big regulatory runway. Right now, companies like Amazon, like Zipline, have regulatory permits to fly drones. There's going to be more regulatory hurdles when there's a million of these going through the air at any given time. So there's going to be big regulatory hurdles that will need to be addressed. And I'd like to see them build out their partnership relationships. The big lesson you can get from Serve is that being too reliant on any one platform like Uber Eats for your demand is not a long-term sustainable model.