The Looming Constraint of the Space Industry

0:01Tyler Crowe:Space stocks get thrown a curveball. Motley Fool Hidden Gems Investing starts now.

0:09Tyler Crowe:Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crowe, and today I'm joined by longtime Fool contributors Matt Frankel and Lou Whiteman. Guys, we're going to get into space stocks today. We're going to talk about potential dividend cuts as well as going to the mailbag. But as I said, starting at the top, let's get into space here. Space stocks have been front and center for investors as of late. It's gathered a ton of attention, especially after the SpaceX IPO back in May. But I would say the enthusiasm for space started far before that, just to a lesser degree. Now, Lou, I'm going to steal one of your go-to lines here, but space is hard.

0:45Tyler Crowe:And while there's a lot of promise here, the timeline when those things may materialize can come into question from time to time. And that was really laid bare recently when there was a somewhat, I wouldn't say shocking, but surprising announcement that SpaceX actually plans to retire its Falcon 9 rocket in 2028. This has been the workhorse, you could say, of the space launch industry. Lou, guys, is the industry really ready to lose this vehicle in 2028? Like, I know there's a lot of stuff coming, but we haven't really seen a lot of progress yet.

1:20Lou Whiteman:Well, there's, I think, a big caveat on that decision, because that is assuming that SpaceX's internal successor, the Starship, is ready to take over. If it's not, there's no reason why they can't continue it. But to SpaceX's eyes, the Starship is a much larger vehicle, so it's capable of bringing a lot more into orbit. So your per ton launch price goes down. So it's just like, you know, it's more efficient to have 30 people on a bus versus 30 people driving a car. So I think that that is the plan. And if it happens, it'll mean that Starship is going to script. If Starship, something goes wrong or it's not ready for primetime, I don't think you'll see the Falcon 9 retired as planned.

2:06Lou Whiteman:So I do think there's at least some wiggle there. And it's kind of upside, not downside, at least in their head. but it is a huge thing for people trying to book now looking to 2028 because you're kind of booking into an unknown.

2:19Tyler Crowe:Yeah, Matt, one of the things that's interesting about this too is we're talking about shuttering a vehicle when some of the successors of it, we've talked about like New Glenn, for example, they had their accident where basically the launch plan blew up. Neutron rocket has been slower to develop part of me wonders is like is is saying that it's going to shut down in 2028 just kind of a feigned uh response to the market yeah i mean it just see if there are if there are some caveats like you know elon musk set some targets for that to happen i mean like like lou said that assumes that the starship is going to be up and running and and taking over and it assumes that they don't need it really uh if they need it it's there it could continue, but I mean, customers can't book the space flights.

3:08And it comes at really a terrible time. Like you said, the New Glenn rocket, it's been down since May. Vulcan was grounded in February. And it comes at a time when launch demand is really heating up. From a space development agency, one of their program managers, said recently that thousands of satellites are scheduled to launch by 2030, and there simply aren't enough vehicles to launch them. And that's given what exists in the market now. So it's not a great time to remove one of the main, you know, the main player.

3:40Tyler Crowe:Immediately as an investor, we think like, how does, who benefits, who loses out here? Like I said, we have the obvious candidates are the publicly traded companies because they very much in the forefront of like investors mind, you know, Rocket Lab with It's Neutron Rockets, SpaceX, probably to a lesser degree, Voyager and Firefly, some recent IPOs as well. But those are only solutions here. Like who else could be benefiting that maybe people are thinking about because they're not necessarily public?

4:10Lou Whiteman:Well, I think it's more even complicated than that, because even the Neutron and what Firefly are what they're working on, that's not going to replace the Falcon 9. Those are coming in smaller. So there is a real void there that that there aren't a lot of people trying to fill, to be honest, because it's the expenses, the complexity of it. So there's a bunch of ways this can go. If SpaceX is right and Starship can come online and it can just be this massive distributor of satellites, there's going to be competition all the way up and down the food chain. But if Starship continues to be delayed or if the kind of demands from NASA and other things, one of two things has to happen.

4:52Lou Whiteman:Either these medium rockets are going to have to be maxed out or the companies that want lift are going to have to rethink their businesses, rethink their designs for less weight. I think the winners in the near term are companies like Rocket Lab that just have all this capacity and hopefully becoming online and Firefly. But I think, to be honest, I think the real winners are going to be the companies that have the DOD blessing or the Pentagon blessing, because the one thing I'm sure of is, is that nothing will be delayed on the military side. I think for any company that I'm looking at, that part of their plan is to book capacity to launch satellites or launch something into space on the commercial side.

5:40Lou Whiteman:They are a likely loser or at least delayed. It's going to take longer than they hope just based on this bottleneck. Lose right then. I think Rocket Lab is the natural winner here. Now, the stock is priced for that. But the Neutron is arriving at, honestly, the exact right time to take advantage, not just of the Falcon 9 not taking orders past 2028, but just to take advantage of the growing backlog of just demand for launches in general. Other under-discussed winners could be the component suppliers. There's one called Carmen. They're guiding for 57 % revenue growth this year. And companies like this, for the most part, trade at much lower multiples than the pure-play space stocks like Rocket Lab do.

6:21So there are a lot of potential winners. And I totally agree with what Lou said about the companies that are backed by the DOD.

6:28Lou Whiteman:Just one thing on that, though, too. The problem with the component supplier is that while they have opportunities on the launch side, if this causes delays for the commercial customers going up into space, they aren't going to buy and pay for the components going into their satellites. So I think it's a kind of pushback. I think the winner, too, here is the engineers, because even if the neutron works, it doesn't compete with the Falcon 9. It's just it cannot. What SpaceX is retiring is larger than the neutron. There is a company, a private company, Terran, that is trying to build a Falcon 9 replacement.

7:06Lou Whiteman:We need to see it going up. But engineers are going to have to figure out how to get these things smaller or to weigh less or how to they can self-assemble in space. There's going to have to be a workaround. period, because we are just not going to have that heavy capacity unless Falcon Heavy or Starship come through.

7:24Tyler Crowe:I've actually been wondering a little bit, the Terran R that I believe is actually Relativity Space. I think that's Eric Schmidt's private company that is expected to, maybe not this year or the coming 12 months, but I think it likely will go public sometime sooner than another. So it'd definitely be one to watch. And you guys, you really touched on some of the nuances of space here. And I think a lot of people looking at it just say, more stuff goes up, everybody benefits. So there's a lot of like misconceptions and perhaps like misunderstandings of space. So as we're kind of rounding out this conversation here, like what would be your message to investors when it comes to investing in space?

8:02Tyler Crowe:What are some of these misconceptions that are maybe less discussed risk or opportunities that investors should be aware of?

8:09Lou Whiteman:So I'd point to a risk and it's something I've kind of already said, but There is a lot, there are a lot of business plans that are resting on Starship's ability to capably and reliably get things into orbit. And they're not there yet, even when they're ready. There's a lot of internal plans for Starship plus NASA plus DOD plans for Starship. We, I really worry, and this is both on the kind of the side of some companies that are actually building lunar modules and building satellites, but also the component suppliers like Matt mentioned, Carmen, Redwire, the companies that are going to sell to these companies.

8:46Lou Whiteman:There is a real risk that most of the business plans that are driving a lot of these backlogs will be delayed. And that is going to depend on Starship. That doesn't mean the companies are ruined, but it does mean that I think investors should set expectations. I hope everything goes well. And there's a case where it'll all go to plan. But I know a lot of great businesses that are just kind of sitting in neutral right now, waiting for Starship. And what we know about, A, space is hard, as you say, and B, Elon Musk likes to set aggressive deadlines and then not hit them. There is a real risk that a lot of these valuations will be just drained over time by this, by a slowdown that I think is inevitable.

9:32Yeah, you make a good point about Elon Musk's aggressive deadlines. The Tesla Roadster reveal is happening next week, and it was supposed to happen in 2017. So yeah, that's just one example. But I would say, in addition to that, one of the biggest risks is that with more things that need to get into space than there are rockets, which is kind of the simple way of saying what we've been saying, the companies that have the rockets will have the pricing power. So companies whose business model it is to get things transported into space could be the losers here. They could see margins kind of compressed, at least in the near term, until the bottleneck goes away.

10:11Tyler Crowe:It's going to be a fascinating one because the degree of difficulty here is certainly a lot harder than the topic we're going to discuss next. And that's kind of the boring and stodgy dividend stocks coming up after the break.

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11:56Tyler Crowe:A few weeks ago, Campbell's, the maker of the most, I would say, the most famous soup label ever made, announced a dividend cut alongside with layoffs and to cost cuts, you know, try to shore up the balance sheet. Basically the reason anyone actually cuts a dividend these days. It was basically 25 years to the quarter that the Campbell's company cut its dividend. You know, one of those markers everyone tries to hit with dividend payments. And now I did a, there was a research note that came out. And so far this quarter, 19 % of dividend payout announcements have actually been cuts. And it's been the highest in six years.

12:29Tyler Crowe:So basically since COVID times is what we're seeing here, higher interest rates, lots of reasons as to why this may be the case. I wanted to use Campbell's specifically because it's an iconic company and use it as a jumping off point here because I think it highlights some signals investors use for determining dividend safety, like dividend streaks that go on for a really long time and iconic brands that aren't necessarily great indicators over the long term. I think this story here is going to be the big takeaway is no dividend streak is safe. And while we're, you as investors, guys, and we do this all the time, when you're looking at companies, because we all have dividend stocks in our portfolios, what are some of those false flags or those data points that you see that really aren't great signals to finding a quality company that pays a dividend?

13:19There are a few flags that I look for. One is I use free cash flow to analyze dividend stability, not necessarily earnings per share. There's a lot of different accounting things that happen with the bottom line earnings number that don't necessarily reflect the company's ability to keep paying dividends. I was just kind of doing some research for this segment and I found one company who's on an earnings per share basis, their dividend payout ratio is about 70%. And as a percentage of free cash flow, it was about 130%. So that's one thing to look for. And there are some kind of warning signs. One is growing debt load.

13:54One is upcoming debt maturity. We can talk about that more if you want to, but that's one of the biggest reasons that the dividend streaks are coming to an end. And you can see like boards that have streaks, like you mentioned Campbell's. A lot of companies that I follow that have 30, 40 year dividend raise streaks are now just making like penny a share dividend increases just to say that they increase them. And when you see boards start to do that, like kind of just giving nominal dividend increases, it's not necessarily a sign that a cut's coming, but it's a sign that the streak might be cracking.

14:26Lou Whiteman:I have to say that Matt's right. Yeah, you want to look for just their ability to fund it without taking on debt, because all two common companies, if they risk that they don't have enough cash to pay their dividends, they will take on debt, which is kind of very, you know, that's short-term thinking. I want to say, though, one of the issues, I think, with all of this, and one of the things that causes companies to make weird decisions is, I almost wish that dividends weren't as automatic as they were. I wish a company could just say, all right, this is our excess cash. We're going to distribute quarter to quarter as we see it.

15:02Lou Whiteman:The market punishes that. And we do see dividend cuts is almost always a sign of stress. Management teams would have a lot more flexibility and probably run the business better if they could just not have to kind of do what they do with buybacks, where, you know, as the cash is coming in, if we have excess, we will distribute it versus just having, like Matt says, play the game where, all right, well, we don't want to blow our streaks, we'll just raise it by a penny.

15:28Tyler Crowe:Matt, as you were saying, like debt maturities, we have rising interest rates. I'm sure that that is playing a part here with why it's happening right now with as long as other points of pain, we've seen retail companies struggling a little bit. I mentioned Campbell's at the top here. As you guys have been scouring the world of potential investments and maybe looking for things that are red flags, what are some of the companies you're looking at right now where you're like, hey, I know they pay dividends and they've been pretty reliable for a while, but this is not looking as hot as, you know, the market may be suggesting that it is.

16:04For one thing, I'm not sure Campbell's made a wrong move cutting the dividend. Their stated goal is to cut dividends to pay down debt, which at a time when you're seeing so many companies having to refinance debt that they took out during the 2020-2021 zero interest era and having to refinance it today, it's not necessarily a bad move to shore up your balance sheet right now. So I'm not saying they made a bad decision. But yeah, there are some others that, I mean, Amcor is one, ticker symbol AMCR. They've raised their dividend for 28 consecutive years. This is the one that I was saying, 133 % of free cash flow.

16:41It's a 5.4 % yield. Several analysts have come out and said that they're at risk of cutting. Genuine parts is one that's really interesting, GPC. They've increased the dividend for 70 consecutive years, but their dividends really exceed free cash flow right now. It's 134 % free cash flow payout ratio compared to 57 % two years ago. And a lot of that is debt. So there are others like that, but for the sake of saving time, I'll pass it over to Lou.

17:11Lou Whiteman:Yeah, so a couple I'd look at. Keymore's, the chemical company, they cut their dividend last year. I think they could have to do it again. You've seen it throughout the industry, a lot of dividend cuts. This is just a bad environment for them. Other ones I'd look at with higher rates, kind of higher rates and just the business conditions, commercial REITs, like the ones that do offices and office mortgages, names like Granite Point, Orion Office. They look vulnerable right now on my screen.

17:38Tyler Crowe:I might catch some flack for this one, but I've mentioned it a couple of times before. Actually, one on my radar is actually UPS. I brought it up and sometimes I get waved off, but everything we've mentioned, you know, payout ratios, they're north of 100 percent cash from operations doesn't cover its dividends. And, you know, interest coverage metrics are all deteriorating. I know that a lot of there's a lot of people said, oh, it's it's UPS. They'll figure it out because they're in the middle of the turnaround plan. But I all the companies over the 12 months, that's one that's always been on my radar as a potential dividend cut candidate that perhaps is a little more controversial than others.

18:15Tyler Crowe:Coming up after the break, we're going to hit the mailbag.

18:45Lou Whiteman:slash market update podcast or wherever you get your podcasts. That's schwab.com slash market update podcast. You just found out that your sales team is at risk of missing quota. Don't panic, just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region. In seconds, you'll see exactly what's behind your quota risk and fix it before it's missed. Question answered, action taken, crisis averted. When you have critical business questions that need answers, don't just file a ticket and wait weeks for an outdated report.

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19:57Tyler Crowe:Hey everyone, quick reminder, if you want to get a question into us, you can email us at podcasts at fool.com. That's podcasts with an s. We also left the email in the show description so you can get it there. Always keep it foolish, keep it short enough I can read on air, and we can't give personalized advice. I apologize, I'm going to say this name wrong. Today's comes from Carolus Shimkus. And the question is, hey guys, love your podcast. We're talking a lot about chips, supply chains, and a lot of AI-related stuff. As a hidden gem podcast, have you found anything interesting in the AI build-out space, specifically in Europe?

20:30Tyler Crowe:So I think we might be a little unsatisfying here, but guys, as far as when I look at this, most of the European companies also happen to be like global leaders. And so they're benefiting, not just from, you know, European Europe's build out, but the U.S. as well.

20:46Lou Whiteman:Right, exactly. I mean, the first names come to my list and it's not very satisfying, but ASML, Snyder Electric, Siemens, all of these companies, great European companies that are doing a ton of business in the U.S. and all over the world related. Yesterday, I built out and other things. But I mean, I think whether I was in Europe or in the U.S., I think going with the established companies versus trying to play the fringe of a trend when things are overvalued, it makes sense to me to use the boring companies. There's other little companies in the weeds. Was it Prismian Group in Italy does a lot of high voltage cables?