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In this podcast, Motley Fool senior analyst Jason Moser discusses:
- The strength of a company’s balance sheet becoming more important.
- Increasing data that customers are starting to spend less.
- “Shrinkflation” as a tool that some (but not all) companies can employ.
- Net expansion as a key metric to watch.
Motley Fool analyst Sanmeet Deo joins Jason to talk about potential applications for virtual reality (VR) in the healthcare industry and a mid-cap company that may have advantages over the tech giants in the space.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on June 16, 2022.
Chris Hill: Lately we’ve been asking about pricing power. Today, it looks like we may need to start asking a new question. Motley Fool Money starts now. I’m Chris Hill and joining me today for the second time this week, Motley Fool Senior Analyst Jason Moser. Thanks for being here!
Jason Moser: Hey, thanks for having me!
Chris Hill: Well, yesterday was fun while it lasted [laughs] and today the market continues its grim slide. I wanted to get your thoughts on what appears to be a trend or if it’s not a trend it’s certainly a growing amount of data and it has to do with consumer prices. I think consumer prices may even be on the business side as well, but this morning we got two bits of consumer data. One was that for the first time this year airfare prices have dropped, so for anyone still looking to book some air travel that’s welcome news. More specifically, Kroger came out and said that their customers are starting to drop more expensive name brand products in favor of lower-priced generics, and you and I have talked plenty of times in the past about pricing power; what businesses have it? What are the limits that they can push it? Earlier this year you and I talked specifically with regards to Chipotle and their ability to raise prices, and you had made that point of like, they’re doing a pretty good job right now. I don’t know how much more they can push it. I’m wondering if we’re now moving into a new phase where the question for businesses is not do they have pricing power, but instead the question is how strong is their balance sheet? Can they withstand individual customers or other businesses spending less?
Jason Moser: I think that’s a good question. We’ve hit that phase of this cycle where consumers are starting to trade down. Clearly inflation is hitting us from all sides. You look at some of the data out there in regard to the store brands versus national brands, in the first quarter of this year sales of store-owned brands rose six-and-a-half percent, that compares with 5.2 percent increase in national brands sales. We have seen that move already really from all the way back to the beginning of the year where folks have started to trade down, so to speak a little bit, and that makes sense. Another interesting concept and it’s a funny word that always makes me chuckle when I see it but shrinkflation.
Chris Hill: I’m sorry. What? [laughs] I’ve never heard that.
Jason Moser: Shrinkflation, it’s a word. Companies are very clever. These national brands, they’re very clever in how they exercise pricing power. It doesn’t necessarily always come in the form of higher prices. It can come in the form of shrinking the actual product size in maintaining the same price, so that box of cereal is 14 ounces, maybe now it’s 12. Customers are on the lookout for that stuff, it does matter. Pricing power is a very strong quality to have. We love to see it, but it’s always worth remembering. It doesn’t go to the moon. There is a cap, there is a ceiling where you have to stop, but it’s really sensitive on the food side right now. I think within food products you see the prices up 11.9 percent for food stuff that we’re eating at home versus stuff that we’re eating at restaurants; eating away from home, those prices rising just 7.4 percent. It’s hitting consumers in the house, and so when you see the way these businesses start trying to cope with this, absolutely looking at balance sheets I think is a wonderful way to get a grip on, on a company’s financial stability because if you think about it in this rising interest rate environment, in this inflationary environment, of course we as consumers are getting hit by it. It makes perfect sense that businesses would get hit by it too, but it’s not every business. For businesses that generate free cash flow, for businesses that are profitable, for businesses that have excellent balance sheets, they’re able to more or less self-fund. They’re not going to be necessarily beholden to the same inflationary pressures that consumers might be feeling. It’s a very good reminder though, to always pay attention to a company’s fiscal fitness so to speak because they all are not equal.
Chris Hill: I’ve experienced shrinkflation, I just didn’t know there was a word for it. [laughs] The example I always think of in this case was years ago talking with our colleague Charly Travers, and he made a comment about ice cream in the grocery store packages of ice cream. He was referring to this happening, I said, what are you talking about? He said do you ever buy ice cream at the grocery store? I can, of course I do. [laughs] He said what size do you buy? I said I buy the two quart size. He said no, it’s no longer two quarts. It’s now [laugh] one-and-a-half quarts. They adjusted the packaging, and that’s how they manage it. You can do that with a package of ice cream, but if you’re in the business of say software, that seems like a tough thing to pull off. The two stories I mentioned, those are consumer-facing prices that we’re talking about here. Do you think we’re going to start seeing this on the business side as well?
Jason Moser: I think we will to an extent, I think the message is clear. We’re seeing businesses, more and more headlines coming out of related businesses are focused on maintaining a strong hold on the expense line, the hiring. I think Uber said for example that they will treat hiring as a privilege. I think now more than ever businesses are looking at the costs of doing business and looking at ways that they can simplify, become more efficient. Software like you, you think about the way that the workforce has changed over the last few years, and there are certain things that companies now are more dependent on than before. You look at your Zooms and your Slacks of the world and how pivotal they are to just our every day work. Most people are using some form of those platforms in order to be able to get work done. It all speaks to well, if a company really is reliant on it then they don’t necessarily have that freedom to be able to say, you know what? We’re going to cut this cost, we’re going to cut that like that. They’re not going to say what we’re just going to get rid of Slack for example because then what’s the alternative? Now, interestingly, there is an alternative. Microsoft, I think, stands out as a shining example here, but you look at Zoom and Slack both provide services that a lot of businesses are using. Well, Microsoft obviously provides services that most businesses use. Furthermore, now having developed the Teams platform, which could certainly be seen as a substitute for Zoom and Slack, and Microsoft having that fortress balance sheet, having that size, having the financial resources, they can package that differently, they could price that more effectively, and so it does seem like this would be a stretch where Microsoft could get out there and say, “Hey, we’re going to help businesses save a little bit on those expenses by offering something like Microsoft Teams as a competitor to what you’re doing on Slack and Zoom today.” Some companies maybe will make the shift and some won’t, it just really, I think, ultimately depends on what leadership of the company’s want and reenrolling what the employees prefer to use. But I do think it does speak to the value and having something where substitutes are rare. I think when you’re looking at the software that companies are using, there are probably a million payment providers, there are a million payroll software providers, and I feel like that might be a little bit different than something like a communication tool. It does matter exactly the purpose that the software serves.
Chris Hill: It’s one more question we can ask ourselves as investors when we’re looking at any business. It’s, of course, related to the pricing power question. It’s basically, how big are the switching costs for this business? It’s pretty easy for anyone going into a grocery store to just switch to a lower-priced product when faced with that choice, and as more people are tightening their fiscal belts, I think we’re going to see more of that. It’s a little bit harder when the switching costs for what is the communications platform that our company uses, and the bigger the company, arguably the higher the switching cost because it’s as you indicated, you’ve got to get your employees on board with it.
Jason Moser: I think that’s really the key is, ultimately employees need to be on board with it. It’s never just that cut and dry. The longer that you use these particular platforms, the more that you get used to using them and the more functionality they build in. There’s things that you do probably without even thinking twice with these platforms now, and then to switch over, you really do have to weigh that. It is going to be a short-term versus a long-term perspective there. Is it worth the financial savings for something that could potentially be an inferior product or maybe it’s a superior one? I look at Microsoft Teams as an interesting example because having used Microsoft Teams before, I found it really good. Zoom and Slack are helpful too. For me, I don’t know, I really guess I would be more or less indifferent. But others would probably feel very strongly one way or the other. Yeah, you have to figure that out, it’s a balancing act for sure, the bigger the company, the more employees. There’s just more opinions that you have to take into consideration. [laughs]
Chris Hill: It’s really going to be interesting, the next six months, what we see out of these types of businesses because, again, the switching costs are higher. But if some businesses, and you spoke to this, that it’s not really an option to not have them. So many more businesses look at things like Zoom and Slack and whether they are a hybrid setup or fully remote, like whatever it is, you got to have some version of Zoom or Slack to exist as a business. Then the question becomes, all right, well, do we want to switch? It’s going to be really interesting to see over the next couple of earnings seasons if we start seeing some of these businesses lose customers as a result, or if they are less in the driver’s seat and they have to basically make some concessions so that they can keep their customers. This is something you and other analysts bring up when we’re talking about software companies, a business like Okta, that sort of thing where it’s, hey, they’ve got their customer base and then they’ve got their, essentially the customers who spend over $1,000, or over $100,000, or over a million dollars per year. It’s going to be interesting to see what those numbers continue to look like.
Jason Moser: It does seem like an opportunity for some of those providers to really earn a little goodwill from their customers. In a trying time such as this, you can either be the provider that is going to try to capitalize on that and raise prices, or you could be a provider that say, “Hey, listen, we’re all in the same boat here dealing with the difficult economic environment.” I think you’re probably looking these Q2 numbers coming out and they will indicate that we’re in a recession now, it certainly feels like one, it feels like the longer-term opportunity is for a company to hold back on pushing that pricing up. Listen, we’re not going to try to put the screws to you right now because we know everybody is dealing with it from all angles, that goodwill certainly can breathe longer-lasting relationships where you ultimately grow the relationship with that provider, you go back to those net expansion numbers, you’re looking for those how are they growing the relationship? That’s always a good metric to pay attention to. It’ll be interesting to see how companies approach this because there are a couple of different perspectives there.
Chris Hill: I appreciate the time, Jason. Thanks.
Jason Moser: Thank you.
Chris Hill: When we think about the applications for virtual reality, we often go to gaming as an example. But one of the more promising used cases for VR is in healthcare. Among other things, virtual worlds can make something like physical therapy a lot more engaging. Sanmeet Deo joins Jason Moser to talk about the possibilities for VR in healthcare, and one midcap company that has an important leg up over the tech giants in this space.
Jason Moser: Hey, Sanmeet. It’s great to catch up with you again. This week we’re talking about immersive technology, and immersive technology, it’s all around us. But you and I are actually both really excited about one particular market where it has significant potential, and that is in the health and wellness space. This week we’re going to talk a little bit about some of the companies in this space, what they are doing. When we talk about immersive technology, it’s the broad term, it includes things like augmented reality and virtual reality, and now you hear a lot of talk about mixed reality. Real quickly just for our listeners, let’s remind our listeners the differences between the two in augmented reality and virtual reality. What is augmented reality and how is that different from virtual reality?
Sanmeet Deo: Jason, and thanks for having me, I’m excited to talk about this. Just to lay the groundwork here, augmented realities enhances your surroundings by adding digital elements to a live view or a real-world setting, and it’s usually done through your camera on your smartphone or augmented reality device. Think Iron Man’s glasses, how he put those glasses on and then he sees the real world, but then he sees digital, either images or information laid on top of the real-world setting, gets information that he needs. Virtual reality is a completely immersive experience, so basically replaces the real-life environment with a simulated or virtual one. Think of the Holodeck on Star Trek when they walk onto the Holodeck, and you can simulate a whole different environment from what you’re in already. That’s how I think of the difference between augmented and virtual reality.
Jason Moser: I think that’s spot on there. I think for our discussion today, we’re really talking a bit more about virtual reality and the impact that it’s having in the health and wellness space. There are some obvious suspects that are doing a lot of work in this space, and then there are some smaller companies that may be folks might not be as familiar with. Let’s just start from the top here and talk about some of those companies that are making waves in this market, the companies that people are probably more familiar with, and there are, I think, four in particular that you’ve kept your eye on.
Sanmeet Deo: Yeah. One of the biggest ones that you think of is Meta. Meta has their Oculus Quest, where now I believe it’s called the Meta Quest 2. It’s the big goggles that you put on, and then they have a whole bunch of apps related to gaming and health and fitness, and all those things. The Meta Quest 2 is like your virtual reality platform where you put on the glasses and some of the apps that they have that are great, especially for fitness are things like the FitXR, which is entitled the most intense workout among VR apps. There’s an app called Supernatural, which won the best VR workout app overall, so you have workouts like boxing, meditation, hit, stretching. It can gamify fitness with leaderboards and creating goals for yourself and interacting with coaches. It’s a great device, I’ve never used it myself, I have definitely been wanting to use that. Meta has that, which is their main device, which is a big consumer device that we think of primarily. Microsoft has the HoloLens, which is what they call a mixed reality headset, which can work augmented and virtual reality to like what we talked about earlier. Allows the person to put on these glasses, work hands-free, collaborate with remote colleagues in real-time.
Some of the use cases for those are of course, healthcare, seeing a patient, like as you’re working with the patient, you could see their patient records, they’re charged their data, like in an image right next to you as you’re working with the patients, so it makes it a lot easier than fumbling around with a chart or data or pulling up any information you need as you’re working with the patients. That’s an exciting device. Even Intuitive Surgical is a company that has a sim now simulation system where it guides surgeons through realistic exercises and master complex procedures. Think of medical training and education for doctors and nurses and medical professionals being able to perform procedures and surgeries and all the work that they do on a virtual body versus a physical body so that way they don’t mess it up on someone [laughs] in real life which I for one would be totally for. They also received an FDA approval for their IRIS augmented reality system which displays 3D renderings of patient’s anatomy for physicians on their iPads and iPhones, they can view, manipulate the 3D model as part of their pre-op surgical planning and referencing and doing operations. In the healthcare space, a lot of the use cases are digital pointing, which is simulating the patient for the doctor to observe and practice on or work on, telemedicine where you’re remotely treating patients through an ARV or your headset or your smartphone and medical training education like we talked about a little bit with training the doctors and nurses on a virtual patient versus actual patients so when they get to the actual patient, they can actually perform very well.
Jason Moser: Yeah, it feels to me like one of the things that technology is doing in the healthcare space. In a particular immersive technology, virtual reality, things like that, it’s helping scale healthcare. It’s giving us the ability to get more healthcare out there to the folks that need it most. It feels we’re in this environment where we have a growing number of patients, the population continues to grow, and yet if you look at the actual data, we have a shrinking number of physicians. The actual professionals, the providers in the healthcare space, the barriers to entry there are high. It’s a lot of money, a lot of education, and you really need to be committed and passionate about doing that. It is a limited supply of providers and a growing base of real demand there. In virtual reality immersive technology in general, is helping us scale healthcare, which I think is one of the bigger challenges that we’ve been trying to solve for, so it’s really encouraging to see this happening. It is slowly but surely, but you really see a lot of these companies making a lot of investments, they’re making great strides in doing this. Now, we talk about the big companies like your Googles, and Metas, and Microsofts of the world that are doing all neat things when it comes to immersive technology, but they’re not limited to healthcare space. They’re doing all things, gaming, healthcare, entertainment, all of that needs stuff. There are some smaller companies out there, perhaps a little bit lesser known to some investors, but they’re making great strides and focus specifically on healthcare. Penumbra is a company that stands out to me and you and I have talked about Penumbra a little bit. I know that you recently had an interview with Penumbra leadership. Let’s talk a little bit about Penumbra, what the company does and how Penumbra is using virtual reality to advance the healthcare space.
Sanmeet Deo: Penumbra actually bought a company that they were able to incorporate and create what they’re calling the real Immersive System, which is an advanced rehab technology that uses virtual reality for therapeutic activities, developed with input from rehab experts. It’s basically they have a device similar to Meta, where is big goggles and it’s actually received initial FDA clearance in 2019 so using the device along with a physical therapist or physical therapist professionals or doctors, they can help patients recover from things such as chronic back-and-neck pain or stroke rehab or Parkinson’s. They can support the rehab of the upper body with focus on strengthening range of motion and postural control. It can even do things like addressing cognitive functions like visual spatial awareness and command response. Basically, I find this interesting my wife is a physical medicine rehab doctor and she works with physical therapist and patients who are experiencing a lot of these things, mostly like we can worry, so fitness-related stuff, but being able to use a virtual reality device and to enhance the rehab process, especially for things like stroke rehab or patients that really can’t feel or use their arms or legs or whatever they’re facing their challenges in, using a virtual reality device, actually, it’s almost like tricking the mind to be able to do what they thought they couldn’t do. It actually enhances the process of rehab, and so it’s a very exciting field. The interview I did with the CEO was great, I definitely recommend listeners to check that out. But it’s very young, it’s very new, but it’s a lot of practical, great use case that I feel could really help these patients get to another level on the rehab quicker because of virtual reality so that’s definitely an exciting company doing some exciting things.
Jason Moser: Penumbra’s small-cap by I think virtually every definition. How important do you feel like it is for a company like Penumbra going up against the behemoths in tech, like Apple, Google, Microsoft. Those are formidable companies with vast virtual limitless resources. How important do you think FDA clearance is for something like that? Having that FDA clearance, is that something that really separates them from the comp?
Sanmeet Deo: Oh, absolutely. Because while the device may look like a regular consumer device, there’s becoming a divide between the consumer devices and the more medical oriented devices where you need a medical professional to help you use that device to achieve the goals that you’re trying to achieve when it comes to your rehab or your health or medical goals. While somebody looking to help themselves with crank back-and-neck pain can pick up the device and just start doing stuff, you may not necessarily know how to use it in the proper way to get the gains and the goals that you have. I think it’s a real competitive advantage and something they can use to their benefit.
Jason Moser: All right. We’ll leave it there. Sanmeet, it’s been great catching up with you. Thanks so much for taking the time to come on the show today.
Sanmeet Deo: Thank you, Jason.
Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don’t buy or sell stocks based solely on what you hear. I’m Chris Hill, thanks for listening. We’ll see you tomorrow.
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