In this podcast, Motley Fool analyst Jason Moser and host Mary Long take a look at Target earnings, the "resilient consumer," and new rules for the buy now, pay later industry.

Then, Motley Fool contributor Matt Frankel joins for some David-versus-Goliath stock matchups.

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.

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Mary Long: Target misses the mark, but you're listening to Motley Fool Money. I'm Mary Long, joined today by Jason Moser. Jason, thanks for being here.

Jason Moser: Hey Mary, thanks for having me.

Mary Long: Of course. Today, Target reported earnings. Here's what I've got. Comparable sales down 3.7%. That's the fourth straight quarter of declines there. Total sales, down 3.2%, traffic, down 1.9%, average transaction, also down 1.9%. Sounds like a lot of bad news. What's behind this?

Jason Moser: It does sound like bad news. It's par for the course, I guess, for most retailers and feels like, with the exception of maybe a few. But I think with Target, they're coming off of some challenges here recently, and when you look through the release, when you look through the call, the management was very quick to focus on the consumer and the normalization. That's a word they used in the call that I think accounted for a lot of what's been going on. It's this normalization and spending patterns that they saw really emerging a couple of years ago as we got back to normal, where consumers are focusing a little bit more on services and entertainment stuff outside of the home, which makes a lot of sense. We were all sequestered for a while, and then, what they say, curtailing those activities during the pandemic. I think what we saw or what we're seeing, at least with Target's results, obviously inflation and higher consumer prices are still playing a role in their results, and they're seeing some soft trends in the discretionary categories. They noted in the call. It was most prevalent in the home and hard lines part of their business, and that makes a lot of sense, but it's something they're going to have to overcome. It also makes me think of restaurants when they're dealing with difficult comps. They go through a stretch where they are really performing well; they keep on chalking up all these great numbers, then they go through a little bit of a low where things hit a little bit of a reset, and then they get back to growth beyond that. That could be where we are with Target right now, but there's no question. They're dealing with what has been a challenging consumer environment.

Mary Long: I think you're right when you say this is par for the course management seems to have the same outlook. They didn't seem too worried. Guidance for the full year, unchanged. Wall Street seems to feel differently. Last I checked, the stock was down 7% this morning.

Jason Moser: Yeah.

Mary Long: But management doesn't seem to be too troubled by that.

Jason Moser: No, and they shouldn't be. I think, again, it's taking the longer view. It could be a little bit of taking some short-term pain for long-term gain there. There are some things to smile about in the call. They've seen improvement in many of the drivers of the business over the last several quarters. They go. We hear this a lot here. This resilient consumer, they talk about the US consumer remains resilient in the face of multiple challenges. It's a little bit confounding at times. We know that consumers are really feeling the pinch of higher prices, and it's becoming a little bit more difficult to access capital in that way, but it does feel like with Target, inventory is down 7% from a year ago, gross margin expanding a little bit. Thanks to cost controls, they're resorting to less discounting. That's always a good thing to see. I don't know if you remember, Mary, several quarters back, the word shrink; that was the word dujour for many of these companies, and they're seeing a lot of improvements in their efforts to control that shrink as well. One of the greatest quarter in the world, but it does feel like they are on the path to recovery here.

Mary Long: I want to zoom in on the consumer for a second because Brian Cornell ain't talking about all this. Put some of the blame on the macro. Basically, sales are down, budgets are tight. We expect that. In response, Target's already slashed prices on already 1,500 everyday items. I think they've said that they're going to slash prices on up to 5,000 items.

Jason Moser: Yeah.

Mary Long: What are these items there? Milk, bread, back-to-school stuff, summer party supplies. What do those discounts actually look like, though? Because of the press release were Target announced this, plain bagels are 30 cents off, frozen pizza, 20 cents off, laundry detergent, 70 cents off. Are those lowered prices enough to get consumers back at Target and spending more again?

Jason Moser: As prices and inflation persist, it certainly can't hurt. I think all consumers appreciate lower prices, and Target is trying to do what they can to participate in that. It does feel like they're making a lot of progress in regard to their loyalty program. They've relit the fire on that Target Circle loyalty program. They relaunched it back in April. They have over 100 million members now. They added more than one million new members to that Target Circle program in the quarter. I'm glad you focused on key items there. They're grocery items. I think, where Target is concerned, that's a place where they could stand to improve. With Target, grocery still only represents, basically, a fifth to a quarter of the overall business. Whereas when you look to competitors in the space, like Walmart, for example, Walmart, it's a leader in the grocery space, and you're talking about 50% in that neighborhood. It does make a lot of sense for them to really focus on cutting prices, where consumers see it most day in and day out. It remains to be seen whether it ultimately will have a great impact on bringing consumers into the stores on a more regular basis. But again, going back to that Target Circle relaunch, there's a lot to be said for that. I think that's an important thing they did there because, we've seen obviously throughout the last several years and decades. I guess, really, if we could say, there's just a lot of power in that loyalty program and that membership model. If Target can continue to focus on creating reasons for customers to come back, and loyalty programs, membership programs are usually one of the best ways to do that, then they should benefit from that.

Mary Long: Target's got this not-great quarter. Meanwhile, Walmart and Costco have boasted pretty strong results. Target has seen comparable sales slip. Walmart, on the other hand, saw them climb this past quarter. Traffic dipped for Target. It rose for Walmart. You hit on the grocery comparison between Walmart and Target and how Walmart does a better job there, and it's easy, I think, to see these two companies as selling a lot of the same things. But do you think it's fair to make an apples-to-apples comparison between Target and Walmart, or Costco, for that matter?

Jason Moser: I think it's fair. Certainly, it's fair. They all play in the same sandbox. I think one of the things we saw on the call for this most recent quarter for Target. Something they focused in on was being able to fulfill orders, being able to make sure they had what consumers wanted. That's something that a lot of these companies, and Target's certainly fell in this. They ran into shortages, supply chains, really, ran into some headwinds here over the last several years. I think that's where scale comes into play here. You think about Walmart versus Target, and what's the big difference there? Well, Walmart really is just a lot bigger. They have the scale that Target doesn't necessarily have. When consumers know that they can go somewhere and they can get what they want, well, then they're probably likely to go back. Those are good customer experiences. Whereas if you go to a store and you don't find what you're looking for, and if that happens on a repeated basis, that becomes a problem. Customers start to defect, and they go other places, like a Walmart, for example. Being able to see they're able to fulfill these orders more and really give customers everything that they want, I think that can really play a big role in helping bring Target back up to that level where Walmart and Costco is, and I say Costco here. I don't know; Costco to me; they're on a completely different level [laughs]. They've been at this for a long time. They know what they do. They do that one thing, and they do it really well. With Target, they're not quite in that same ballpark, but it seems like they're working to get there. The loyalty program, making sure that they have inventory on hand that consumers want and being able to fulfill those orders, I think makes a big difference and could certainly be a positive driver in the coming quarters.

Mary Long: I want to pivot to one other story because, I am, after all, here with the only Jason War on Cash Moser. The CFPB, the Consumer Financial Protection Bureau, announced this morning that it views buy now, pay later companies. That's Affirm, Klarna, PayPal, as essentially the same as credit card providers under the Truth in Lending Act. What that means in practice is that BNPL companies will now have to refund customers for returned products or canceled services. They'll have to look into merchant disputes and provide bills with fee disclosures. Is this rule really anything new, are BNPL companies already doing this?

Mary Long: Well, I don't know that it's really anything new.

Jason Moser: If you look at the BNPL space right now, it's not even really clear as to who all of the providers are and ultimately which ones comply with things like refunds and disputes versus the ones that don't. But I do feel like in regard to BNPL, it's such a new space still. We've talked about it for a little while but it's still a very new space. I think this is one of those headlines that ultimately is a positive in that, it's codifying what has been more or less a Wild West and a new offering. We've seen a lot of big incumbents in the space, companies like PayPal and whatnot jumping in there but also a lot of new companies that are founded on this one simple offering of buy-now-pay-later. It's just not been very clear what the rules of the game are. This news, I think, helps ultimately codify what has been a nebulous offering and that I think is good for consumers. I think It's good for investors in that it at least gives us some clarity, some understanding as to how this offering may move forward and how companies can ultimately benefit from it.

Mary Long: Buy now pay later is a $309 billion industry and I hear these rules and they sound positive to me. I wonder, might these protections drive even more consumers to BNPL that were maybe skeptical of it before?

Jason Moser: Yeah. It certainly could and I think that probably would be a good thing for those running it, as long as they're running it well. More purchases means more money flowing through those networks. That's always a good thing. You'd get benefits from take rates. That's ultimately what these companies participating in this space want. They want more money flowing through those networks. But by the same token, there are plenty of risks that come with it. At the end of the day, the BNPL is still essentially like a credit card. Maybe you're just purchasing something with debt, whether it's a credit card or whether it's BNPL, you're still purchasing something with money that you may not necessarily have to spend at that point in time. What BNPL has done so well is, they're able to offer these types of purchases with maybe interest-free or fee-free types of purchases. That's great but that's not something that lasts forever and that's also not something that necessarily applies to everybody that's out there. It creates a little bit more risk for the companies doing this much like lenders. You're going to be writing off loan losses and stuff like that. Ultimately, they will adjust; they will charge more to consumers who don't pay their bills on time. Which then means, that interest-free thing is just thrown out the window. There's going to be some cost to you spending someone else's money, which is totally understandable. I go back to a target data point that I saw in their call, where they call out one in three Americans today has maxed out or is close to maxing out the limit on at least one of their credit cards. Then we also know that based on the data, consumer credit card debt is at all-time highs. While we talk about this consumer that's still resilient, it's clearly a consumer that is under threat. For the BNPL industry to be able to bring these rules into play and make it a little bit more clear so that we as consumers understand at least what we're doing, what we're getting in exchange for the service that we're using. I think that makes a lot of sense. I think it could absolutely result in more folks using BNPL. It absolutely could also result in more consumers trying to figure out more ways to get more credit cards. When you're spending money you don't have, that's not always the greatest option.

Mary Long: Jason Moser, lovely to talk with you today. Thanks so much for the time and for the insight into these two new stories.

Jason Moser: Thank you.

[MUSIC]

Mary Long: It's fun to root for the underdog, but that doesn't mean that the underdog always wins. Up next, Matt Frankel joins me for a look at some David versus Goliath stock matchups. We're playing this conversation in two parts across today and tomorrow. Today we put Upstart against FICO and DraftKings against Churchill Downs. Everybody loves an underdog story. But if you're an investor, is it better to bet on David or Goliath? Today I'm talking to Fool contributor Matt Frankel and we're taking a look at a number of newer, sometimes smaller companies that are going up against more established players in the same space. Matt, thanks for being here today.

Matt Frankel: Always good to be here.

Mary Long: We're going to take a look at four different matchups that each tackle a different angle of this general David versus Goliath theme. Our first fight is going to take place in the arena of credit reporting, where we've got Upstart Holdings going up against a more seasoned player, FICO or the Fair Isaac Corporation. Upstart for those who don't know, is a fintech company that wants to look beyond credit scores when it comes to determining loan risk. FICO is the credit score. Let's start with this, is the world wide enough for both of these companies to exist?

Matt Frankel: Yeah, a couple of points. For anybody who's checked their own FICO score, I'm sure you have at some point, knows that it's not perfect. We have three different FICO scores for one thing. I personally don't have three different credit ratings. My risk profile is what it is. There's a lot of room to consolidate that. It's not just the three different credit bureaus, there's, I think, 28 different versions of the FICO score. There's an auto version, there's a mortgage version so which one is the real number? There's a lot of room for improvement there. Number 2, Upstart actually uses FICO scores in its model. Its goal is to be better than Upstart. But if a consumer has a FICO score, it will use it. FICO overlooks a lot of consumers. For one, if you haven't had a monthly payment reported to credit in the past six months, you don't have a FICO score and not everyone who doesn't have outstanding debt is a bad risk. There needs to be a way to evaluate that. People who maybe have poor credit scores but have more than enough income to justify a certain purchase would be declined by the traditional FICO model but could be approved through Upstart because they look at things like education, employment. Factors that are legally not included in the FICO model. Yes, there is a lot of room for both of them. Upstart is trying to take the FICO model and make it into a better action plan for lenders.

Mary Long: When I align these two companies up against each other, it's pretty clear to me who the Goliath might be. FICO has a market cap of nearly $35 billion. Upstart, on the other hand, is closer to $2 billion today. FICO has been around since 1956. Upstart came onto the scene in 2012. So FICO is the older, more established, larger company here. That said, do you see any weaknesses that stick out to you in FICO's current business that maybe it's mammoth size and longer lifespan might disguise?

Matt Frankel: The weakness is the same as its strength. FICO's strength is that it can describe me with one number or describe any consumer in just one number or not their number saying, don't lend to them, they don't have a credit score. That's also their weakness, is that you are more than your credit score and that's actually Upstart's slogan. You're more than your credit score. There's other things that come into play when it comes to the likelihood you're going to pay back debt. A lot of people don't know statistically, this has been proven, people with college degrees are more likely to pay back debts than those who don't, regardless of credit score. That's something that is included in Upstart's model, that isn't included in the traditional FICO model. Because you are more than just one number. Your credit rating depends on what you're trying to buy and Upstart considers that and FICO doesn't. Like I said, their weakness is the same thing as their strength. If a company has a hard cut-off, we want someone with a 700 FICO score. It's really nice to be able to get it down to one number so they can quickly screen applicants. But you're also excluding a lot of people who should be creditworthy and that represents potential business that you're ignoring.

Mary Long: Even as we're talking about this and laying out the differences between these two companies, I cannot but wonder, like FICO knows everything that you're saying. It's not like this is secretive information about what Upstart's including in their model or what they're trying to do. What is stopping FICO from saying, Upstart is including more people and expanding credit access to more people, we should just do the same?

Matt Frankel: The short answer is because no one's dropping the FICO score. FICO is still used in 90% of lending decisions, including those made using Upstart's model. They don't want to take the risk. It seems like an unnecessary risk when you already dominate your industry. It'd be like Google trying to start a new search engine. Why? You don't really need to, you're already dominant. I think that's why it's really two different businesses and more so than people give it credit for.

Mary Long: Upstart was a pandemic darling that's now down almost 93% from its all-time high. In 2020 and 2021, it was generating income but since then, it's only seen net losses. One of the reasons for that is that interest rates have hit this company pretty hard. That said, is there a secret weapon that's hiding in Upstart's slingshot?

Matt Frankel: [laughs] Well, I think at one point during the pandemic, Upstart was actually the Goliath here by market cap. To be fair, it never should have been a $400 stock at the time, if we're being totally honest. But you're right, it wasn't a profitable business. It was growing rapidly but that's because everybody in the world was borrowing money because it was so cheap to do it. Loan volumes have just fallen off a cliff over the past two years or so. As interest rates have risen, people aren't as convinced that the economy is doing well and is going to continue to do well. People are more hesitant to borrow money. All of that has really dried up the lending business and that's why Upstart are unprofitable. It's not that they necessarily did anything wrong, it's that loan volume is one-quarter or whatever it is of what it was in the pandemic years. They need volume to make money so if we see interest rates start to normalize, which I think everyone hopes that they do, you should see Upstart become profitable because it is a high-margin model. For now, that's why they're unprofitable. That's not the only reason the stock is down 93%. That has a lot to do with it should never have been that high in the first place. I could name you a list of 50 stocks from that era that are in the same bucket. But that's really why.

Mary Long: Given a choice between these two companies and understanding as you said, that both but Upstart especially, are operating on cycles here that are dependent on a lot of other factors. Looking ahead long-term, taking that Foolish view between the two of these, Upstart and FICO, Matt, which would you say is the better buy?

Matt Frankel: Well, I own Upstart so that's the easy answer but it really depends on risk tolerance because these are at totally opposite ends of the spectrum.

Mary Long: Our next battle pits online sports betting platform DraftKings against an older, more traditional company, Churchill Downs. Matt, when I first started looking into these companies, my inclination would have been to have labeled Churchill Downs as the Goliath and I think I would have attributed that largely to the fact that the company has been around. I think of online sports betting and the phenomenon that it's become as something that's newer and more modern and I know that Churchill Downs has been around far longer than that phenomenon has existed. They opened their first race track in 1875 for instance. That said, when you look at the market caps of these two companies today, it appears that DraftKings is actually or may actually be the Goliath here. They're valued at over $21 billion to Churchill Downs's 9.8 billion so they're both sizable companies but lined up next to each other DraftKings seemingly takes the cake. What do you say, when it comes to sports betting in particular, who is the real underdog here and why?

Matt Frankel: Oh, that's a tough question. They're both good companies, they're both really impressive. DraftKings was probably the most successful SPAC IPO of the entire SPAC era. A lot of people don't realize that that was one of the blank check companies and it's one of the few that actually did well. They've really been a big beneficiary of the widespread legalization of sports betting and it's a west capital-intensive business so that's why they get more credit from the market for the revenue they generate because they're growing rapidly. As they grow, profitability should come and they should be able to get, eventually, right now they're in growth mode. But when they're more of a mature business, should theoretically have higher margins than Churchill Downs just because they are an online presence. Same reason online banks tend to be more profitable than brick-and-mortar banks. But for the time being, Churchill Downs is an impressive business by itself. The gambling business if you're a brick-and-mortar operator, it's not easy to make money. It sounds like a real easy business, you're literally in a business where people give you their money. But it's a lot tougher than that if realized just how much capital is involved in building and maintaining facilities. Churchill Downs is a big place, it's not cheap to maintain. They also own a bunch of brick-and-mortar casinos, they own off-track betting facilities, they own a lot of physical assets that need to be maintained and for them to generate a 14% net margin from those assets, that's not easily done in the casino business. Great casino operators, Caesars Entertainment has been bankrupt in the past but it's not a terribly easy business. But having said that, DraftKings has an advantage they are actually the number 2 online sports betting company next to FanDuel, Flutter Entertainment is there's. But they're the domestic player, they're exclusively US-focused. There are in 26 states, they expect 30% revenue growth this year. Very impressive company, and they're going to be cash-flow positive this year.

Mary Long: I think one way to think about the difference between these two companies while they largely dabble in the same space is exactly what you hit on. That DraftKings is a digital offering and Churchill Downs has far more of a physical brick-and-mortar presence. That said, are we seeing Churchill Downs start to dabble in that digital gambling space as well?

Matt Frankel: They are. I wouldn't necessarily say it's been a focus, they've been making like bolt-on acquisitions in the digital space. They have the brand recognition, they're probably not surprising. A lot of their focus on digital gaming has been in the horse racing and that space, where I think they do have an advantage over DraftKings. Churchill Downs, I don't know if you can name a bigger brand. I'm not a horse racing guy, but if you can name a bigger brand in horseracing, that's got to be it. They are dabbling in that. I don't see FanDuel, DraftKings and Churchill Downs becoming the big three in online betting but they have a pretty big moat in terms of their physical presence and that's really their niche.

Mary Long: Yes. Let's talk about that physical presence a little bit because you mentioned that Churchill Downs, in addition to owning the race track that host the Kentucky Derby, that's what comes to mind when we hear Churchill Downs. They also have many other real estate properties. I believe it's 14, what they call live and historical racing properties plus a number of gaming and casino properties. DraftKings, again, we said that they're mostly digital companies. They do partner with some physical sportsbooks but again, it's digital at its core. When we line these two companies up and we think about Churchill Downs's real estate footprint, is that footprint an asset, a liability, how do you think about that?

Matt Frankel: The short answer is it depends what the economy is doing, what the market is doing. Right now, live entertainment has never been a better business. If you've gone to a concert anytime in the past year, you know you're paying so much more for your concert tickets than you were just four or five years ago. Live entertainment is great right now. It depends on what consumer preferences are with live entertainment. A lot of people thought that the live entertainment boom was just a post-COVID, pent-up demand thing like that but no, concert tickets are still going for $500. How much would it cost you to see Taylor Swift right now and how much would it cost you in 2019? It seems like it has some staying power that live entertainment is a much better business than it was a few years ago. But at the same time, it is a capital-intensive business. If we hit a real recession or real economic trouble, you can see attendance at those places start to decline. Casinos have historically been surprisingly recession-resistant, but that's not a guarantee. Vegas revenues do dry up during really tough periods but it can be a benefit or a burden depending on what the economy is doing.

Mary Long: Let's pivot to DraftKings because they're losing money and burning cash. What needs to happen for this company to turn a profit in? I'll say a reasonable timeline that maybe let you define what reasonable is.

Matt Frankel: Well, first off, management said that they're going to be cash-flow positive this year, that's why the stock is doing so well right now. It's very close to its 52-week high, and that's why. Cash-flow positive 2024, they said 30% revenue growth. Profitability, they're going to need really two things to happen. They need to engage the current users they have more which they're doing. Their average revenue per user increased by 6% last year. They're building better relationships with their customers and they really need the legalized gaming to continue to roll out. It takes a little while before their presence is really known in a market. For example, my state neighboring [inaudible] North Carolina is just recently legalized sports gaming. A lot of people don't really know it yet, a lot of people don't know how to bet on sports if they wanted to. It does take a little bit of ramp-up time to educate the consumer and really let them know the options out there. I mentioned earlier that they are in 26 states right now. They're not fully maximized in 26 states in other words. They really need to build out that engagement, that's really what's going to lead them to profitability and as they get mature their customer acquisition cost comes down a lot and the amount of money they need to spend on growth, which is a lot right now will start to come down. Long term, they have the potential to have better profitability than Churchill Downs. Right now they have a 39% gross margin, Churchill Downs is 33%. When you look at just the gross margins of the business, even though they're a younger company, their gross margin is already way above where Churchill Downs is. As they grow, they have a lot of room to expand their margin.

Mary Long: It sounds like you just answered this question, but I'm going to set it up for you just in case there was any questions. As we've addressed, these companies operate in overlapping sectors or there's a lot of overlap between the business that these two companies do. But it doesn't sound like there has to be a winner necessarily. If we take a foolish long-term time horizon of 5-10 years. Which stock are you betting on in this match-up?

Matt Frankel: I could make a solid case for both of them, I would have to go with DraftKings as far as long-term. If my time horizon is 20 years, I'm a DraftKings fan.

Mary Long: 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 buy or sell stocks based solely on what you hear. I'm Mary Long, thanks for listening. We'll see you tomorrow.

Jason Moser has positions in PayPal. Mary Long has no position in any of the stocks mentioned. Matt Frankel has positions in PayPal and Upstart. The Motley Fool has positions in and recommends Costco Wholesale, PayPal, Target, Upstart, and Walmart. The Motley Fool recommends Churchill Downs and Fair Isaac and recommends the following options: short June 2024 $67.50 calls on PayPal. The Motley Fool has a disclosure policy.

Tight Budgets Come for Target was originally published by The Motley Fool