RocketLab’s Neutron Update, On Holdings Earnings, and the eVTOL Rivalry Heats Up

0:01Tyler Crowe:Rocket Lab investors are still waiting on the pad. Motley Fool Hidden Gems Investing starts now.

0:10Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors, Travis Hoium and Matt Frankel. A little bit of an end of the summer sort of mix up as everyone gets those last minute vacations in before kids go back to school. So earnings are still coming in. We're starting to wind down in the earnings season, but we still got a couple coming online. We had on holdings report. We're going to talk about the state of the electric vertical takeoff and landing industry because there's been a lot of moves lately. But we're going to start today with Rocket Lab's earnings, which came in yesterday, but obviously didn't get a chance to talk about it yesterday.

0:41Tyler Crowe:Shares of Rocket Lab are down a little, about 2 % as we're taping after earnings. But let's be real, earnings wasn't really the topic du jour. I went through the earnings call transcript and the word neutron appeared in the conference call 61 times. Iridium, which is the acquisition it just made, came up 30 times, and only 17 times for Electron, the rocket they're actually used to generate those earnings. So guys, what did you see in the report and what were some of your reactions? I'm here because my kids started school today. I'll go ahead and say that. We start early in the South. Rocket Lab's numbers, like you said, this real story is not the current revenue and the current profitability, but let's start there.

1:20So Rocket Lab's numbers were strong on the top line. Revenue was a little more than expected. The backlog grew a lot faster than expected, more than doubling year over year. The bottom line missed. It was a little bit of a wider loss than investors had expected. And that matters because the company is not profitable yet. Investors are skeptical about their near-term path to profitability. This is a company that has a roughly$50 billion market cap. So a larger than expected cash burn is justifiably a concern for investors. And that's especially considering that the neutron, which you correctly mentioned, appeared 61 times in the conference call.

1:55It still hasn't gotten off the ground. Investors want to know that they're going to get the profitability without having to raise a ton more capital at this point.

2:02Travis Hoium:Yeah, I think this is a story that we've seen over and over again this earnings season. What is expectations and then what's reality? If you actually just take a step back and look at Rocket Lab, the stock's up 1100 % over the past three years. So it's been a phenomenal run. Let's not take one day as too much of a positive or a negative. But Matt mentioned $50 billion market cap,$2.36 billion in backlog. That is a very small fraction of that market cap. So investors have very high expectations. Any sort of blip in, you know what, we may be a little bit delayed, has been just hammered by the market.

2:38Travis Hoium:So I'm actually a little bit surprised that the market's not reacting a little bit more negatively. Since this is such a long-term growth story, anything that pushes that revenue out is going to be a negative. But they're really trying to convince investors. The reason that they're talking about these next generation products, about their acquisition of Iridium, is because they're trying to solidify that business model and vertically integrate, show that they're going to be able to generate that value long-term. So they're still trying to convince investors. It's a little bit surprising that it's just a little bit of a ho-hum reaction from the market today.

3:09The Iridium deal is like a what we can be

3:12Tyler Crowe:sort of investment that they're making. But at the same time, Iridium is a cash generative business. So you can kind of stem the cash burn that's been having for the rest of the business. You can use that to kind of maybe sharp the balance sheet a little bit. It's not going to solve all those problems, but it's certainly going to be a nice salve for what we've seen so far. Now, let's broaden out the lens a little bit here because there's some key things that have been happening in the space industry. And I'm not even mentioning like, yeah, SpaceX did an IPO and everyone's been talking about space, but there's a lot of like trends to watch in space recently.

3:45Tyler Crowe:And as part of the reason why people are so excited about investing in space, we've got the golden dome, this major defense space investment priority at Pentagon. We've got new international space station, and then just a lot of commercial interests going on. So with all of this in mind, and yes, the space industry is kind of combed over in terms of investment at this point, but where do you see some of the compelling investment opportunities in this particular space?

4:11Travis Hoium:I don't know that anything is necessarily compelling to me right now from a valuation perspective, but I do definitely want to watch what's the reality for these companies. If you look at a company like an AST Space Mobile, a lot of hype behind that business? Are people actually going to sign up for a satellite connection for their phone? Is that going to be included in your plan if you're on Verizon or AT &T? What's the real business model behind it? Because we're currently in this phase of, hey, more rockets going up, more payload, more revenue for these rocket companies. All of this is great.

4:43Travis Hoium:We're not at the they're there yet point, but we're getting really close where these companies are going to have to start showing revenue, margin, whether they have pricing power or not. So that's what I'm keeping an eye on. I don't have many or any investments in this space at this point, but I'm intrigued by the potential for growth. I just think we may be set for kind of a pullback when we get to that reality point. I agree with Travis that the valuations pretty much anywhere in the space economy aren't terribly attractive right now. There are some long-term trends that I think have a lot of potential.

5:16I mean, it sounded kind of ridiculous when I first started. I have to admit, but the data centers and space thing sounds pretty cool. And like it could really be a solution to a lot of the problems that we're going to face. But of the things you mentioned, I'd say the Golden Dome is really the most investable on a near-term basis, at least in my mind. Now, call it a defense play, call it a space play, call it what you will. Depending on the scope and the timeline, I mean, estimates have ranged from anywhere from$175 billion to$1.2 trillion in total spending. And unlike a lot of the other things we're talking about, there are already real contracts being awarded, real money changing hands.

5:50It's a theme that has money moving now, and there are some real legitimate cash flowing businesses that have a big piece of it.

5:56Tyler Crowe:I can't help but whenever I hear data centers in space, this is not for anything investment related, but every single time I hear it, I just hear like that Muppet show pigs in space sort of thing. And it's like that big cry at the end. Hopefully, I know it dates me incredibly as like an old person talking about the 1970s Muppet Show, but I don't know why. Just kind of etched in my brain. Coming up after the break, we're going to kind of come back down to earth a little bit. We're going to take a look at on holdings earnings.

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7:39Tyler Crowe:jumps 20 % or down 15%. And then three days later, we're just right back where we were. We'll see if that happens here. But Travis, I know you follow this company a lot. So give me the rundown. What did you see? Maybe the 18 % is just another blip? Or was there actually something that might justify why the market's thinking this?

7:57Travis Hoium:Well, the justification in the short term is that their guidance was relatively weak. So if we look at the results, and now on always reports in Swiss francs, which makes their results really confusing for investors, because you look at revenue was up 13.5 % in the quarter. That doesn't sound all that impressive. But on a constant currency basis, it was actually 21.6%. So it's always important to look at those constant currency numbers because most of their sales are in the US. So a weak dollar is going to make those sales look smaller when you look through the lens of a Swiss franc. But what investors are really focused on right now is that their guidance for the rest of the year was down a little bit.

8:36Travis Hoium:So they're expecting growth in the low 20 % range instead of I believe it was 23 % plus that they said last quarter. That's telling you that maybe the consumer is a little bit weaker. Maybe they're losing a little bit of market share if we're having some sort of recovery with Nike. I don't think we're seeing that yet. The interesting thing for Ana is that they have made a explicit decision to keep their pricing power. I mean, their margins are phenomenal. They're expecting a gross profit margin to be at least 65%. That is just crazy in an apparel business. So they're saying, you know what, we're going to focus on this profitability.

9:09Travis Hoium:We're going to give up growth as a result. The markets are actually negatively to that today, but you could look back at the last five years or so with Nike, the last five years at Lululemon and see that, you know what, it's a slippery slope going down the, I'm going to start discounting my products, give people a little bit better price to move sales, to move volume, to increase that sales number. On says that they don't want to do that strategically. I think that's probably a good move long-term, but it also means if your growth is a little bit slower, those growth investors are going to be disappointed, even if the profitability is going to be a little bit better than maybe we thought it was when the company was growing faster.

9:45Travis Hoium:So a lot of trade-offs that they're making, what we don't know, like I said, based on some of those competitors, is how many of those are macro trade-offs and how many of those are on-specific. As Travis said, to sum that up, beat on earnings, they missed on revenue. Sales were somewhat disappointing, especially on the wholesale side, which they framed as they did that on purpose, and maybe they did. But margins expanded more than expected. Their gross margin, their adjusted EBITDA margin were both pretty impressive compared to a year ago. The big geographical disparity in the results, the Asia-Pacific sales grew 55%.

10:16All of this is in constant currency, by the way, to not confuse anybody. And in the Americas, it was 13 % in constant currency. So big sales disparity. It's still their core market, but you're really seeing kind of a slowdown in the strange consumer in America and things like that. The real reason for the decline, as he mentioned, was the guidance, a guidance reduction. At the same time a company reports a big revenue miss, it kind of causes investors to take a step back and consider whether this growth story, which admittedly has been stellar for years, could be slowing down a little quicker than expected.

10:50Tyler Crowe:So one of the things that stood out to me, Travis, you were talking about gross margins, and being so strong. I think part of the reason they do that is that on one of their strengths is direct to consumer channel sales, their own website, not necessarily doing things wholesales at like a Dick's Sporting Good, nearly as much relative to a lot of the other companies. I had mentioned DTC sales were up more than its overall growth numbers, which does tend to explain a little bit on that higher margins because that tends to be a higher margin sale. What I find interesting about this point is kind of comparing it to like Nike and Adidas and companies like that, where the other larger companies, which haven't been as successful with DTC channels relative to them, they're still trying to work really hard with the Dick Sporting's goods, the Foot Lockers, the companies that you end up doing a wholesale.

11:38Tyler Crowe:It's larger volume, but much lower margin. So my question is whether like DTC sales, is this just how new companies that grow up in the age of the internet and the age of DTC? Is this just how it's going to be? Or can On actually get to the scale of a Nike or Adidas relying heavily on this DTC model? Or is there going to be some point where that channel starts to limit growth and it will have to push into those other channels more?

12:05Travis Hoium:They're definitely not going to reach the scale of Nike. I mean, I think we're all similar ages, growing up in the late 80s and into the 90s. Nike was just completely shifted because you're going from a supply driven environment where the supply is the power, the having, you know, Jordan as a sponsorship, having TV commercials, all that kind of stuff. Everybody was wearing Nike. Now you're in much more of a case where there can be individualized ads with those direct to consumer sales on Instagram or on Google, where Matt's going to see a different ad from me and we're going to maybe buy different products as a result.

12:40Travis Hoium:So I think there is going to be more of kind of a disparate market. And the question for these companies is going to be, where do you fit in that market? And what is your scale going to be? You're right that on maybe reaching a point where this isn't going to be a 30 % compounding company anymore. But if they can compound their revenue growth at 15 to 20 % and do so at a really, really high margin, that can still be a really phenomenal business. I think when you're looking at on holding, when you're looking at Nike or Lululemon, the question you have to ask yourself is what are they going to be and what are they showing themselves to be?

13:14Travis Hoium:On showed you this quarter, hey, all that talk that we had about pricing power, about keeping margins high, that's exactly what we're doing. And what we're doing is we're giving up sales as a result. But that means that in five years, this is still going to be a premium brand. They're not going to go down that slippery slope of Under Armour, for example, which has been disastrous for investors. So when you get to that DTC world, you've got to look at, yes, the pie is smaller for an on-holding to reach, but as long as you're reaching the customers at a very profitable level, that can still be a really phenomenal business.

13:48Travis Hoium:So it's a little bit of both. And I don't necessarily think that that means that they're going to give up sales or give up margin long-term. It's just a very different business than you had in the 80s and 90s when a lot of these other companies were growing up. Speaking of these companies growing up, like the three of us, Nike came up in a different era. The tools to grow direct-to-consumer relationships didn't exist yet. I don't remember anyone being on the internet back in the late 80s. It was a thing, but it wasn't commercialized yet. Yeah, there weren't Nike ads on Prodigy back then. Right.

14:19The TV didn't show you a targeted ad. It didn't exist yet. Direct-to-consumer was the JCPenney catalog at the time. That was the closest thing we had to direct-to-consumer tools. Its identity was formed completely on its wholesale relationships. Companies these days have more control. Direct-to-consumer gives a company more control over pricing, over margins. That's why we kind of mentioned that on-holding is somewhat engineering its margins right now deliberately by pumping the brakes on wholesale. It can control its brand image better. That's how you maintain that premium brand that On's doing.

14:49But I will say that a little more than Travis, I feel like the direct-to-consumer model is going to have more limits at scale when it comes to building out your own stores, building out your fulfillment logistics, especially things like that. And it's going to come to a point where onholding is going to have to make a choice, become a value stock that's growing at 10 to 15 % annually, which it's approaching value stock territory right now, if I'm being totally honest, or maintain a 30 % plus growth rate, but really lean into wholesale and give up a lot of your margins. They're going to have to kind of compromise a little bit within at some point.

15:22and I'm not sure what direction they're going to go. So far, I can't argue with anything they've done strategically. So I have no doubt that they're going to make the right call, but it's going to be more of a balancing act, I think, over the next five years.

15:34Tyler Crowe:The holding the price thing always works out until all of a sudden there's a lot of inventory building up on the balance sheet. And then you start to see a little bit more of that wholesale moving stuff, maybe in channels that they don't expect. So it seems as long as ON can kind of keep that inventory supply chain working efficiently and not having a lot of stuff build up on the balance sheet should work. So before we go, Travis, I know you're a fan of the company, also a fan of the shoes. What's the most recent on purchase you've had?

16:03Travis Hoium:I've got these new slip-on shoes where the back folds down a little bit like, I don't know if you would like a Kizik's be kind of an example. So it's like a crock if you want it to be, or a shoe if you want it to be. They're a little goofy, but I don't know. I'm liking them so far. Did you buy them wholesale or direct to consumer? Direct to consumer. Absolutely.

16:20Tyler Crowe:There you go. Coming up after the break, we're going to look at the moving and shaking in the eVTOL industry.

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18:36Tyler Crowe:It's been a minute since the last time we had two companies persistently engaged in a game of anything you can do, I can do better than electric vertical takeoff and landing companies like Archer Aviation and Joby Aviation. That's not even counting the numerous times both have dragged each other into the court for various reasons, one suing the other for patent, whatever, stealing stuff. It's been quite a dramatic past couple of year or two. Now, it's only Tuesday, but we've already seen both companies announce significant acquisitions. So again, one does one thing, the other's got to react. Archer announced a deal with Boeing to take over its eVTOL and several of its other non-core Boeing properties.