Monthly Archives: August 2017

more on Whole Foods (WFM) and Amazon (AMZN)

August 31, 2017 By in Retail, Strategy, Uncategorized, Whole Foods Tags: , , , , , , 3 Comments

I was reading an article from Fortune magazine about the AMZN takeover of WFM.  Although it echoed much of what the rest of the press is saying, I was struck by it–mostly because my expectations for Fortune are higher than for financial reporting in general.

Three ideas in the article stuck out in particular:

–that AMZN’s goal with WFM is to compete head-to-head in groceries with Wal-Mart (WMT)

—the implication that because the margins of grocery chains are low they have a poor business model

–that the price cuts made by AMZN on Monday are small, therefore they make no difference.

my take

–ten campers, including yourself, are being chased by a bear.  If the goal is purely personal survival, you don’t need to outrun the bear.  You only need to outrun one of the other nine.

Put a different way, the goal of, say, Zara or Suit Supply is not to compete head-to-head on price with WMT.  that would be suicide.  Instead, those firms intend to provide differentiated clothing to a more focused audience.  Yes, it’s still clothing, but it’s different clothing.  Initially, at least, that’s AMZN’s goal with WFM.  It wants to expand WFM’s appeal to a smaller, younger, more affluent audience, not steal traffic from WMT.

–the key to profitability in a distribution business is to turn inventory over rapidly, taking a small markup on each transaction.  This is surprisingly badly understood by most professional investors, as well as virtually all the financial press–and by WFM, as well.  This is one reason that as an investor I love distribution companies.

Low markups defend against competition and create customer loyalty; continual effort to keep the growth in inventory under the growth in sales creates positive operating leverage.

WFM appears to me to have chosen do pretty much the opposite–to take large markups on each transaction, a “strategy” that has stunted sales growth.  Inventory turns are higher for WFM than for other grocers, although I suspect that this is a function of differences in product mix.  In any event, something else (or, more likely, a bunch of other something elses) in WFM’s organizational structure is all messed up.  The income statement shows that its very fat gross margins are frittered away almost completely by high overhead expenses.

If I were AMZN, I’d figure I’d attack what I think is the abundant low-hanging fruit in operating inefficiency and lower food selling prices as I made gains there

–it’s very easy to lower prices.  It’s extremely hard to raise them again–a key reason that couponing is a favorite supermarket strategy.  So it would be crazy for a merchant to lower prices across the board on day one.  $.49 a pound bananas, displayed prominently by the store entrance, is aimed at setting customer expectations about pricing throughout the store.  It’s a symbol, a promise   …at this point, nothing more.

 

gains for Berkshire Hathaway (BRK) on GE and BofA

August 30, 2017 By in Industry Analysis, Strategy, Uncategorized Tags: , , , , , , , , 1 Comment

Every investment company has to make public filings with the SEC that disclose its quarter-end investment positions.  Comparing the changes between filings allows anyone to see the investment moves of high-level professionals, even though this comes with a lag.

Recently, the press has picked up on the results of two investments made by Warren Buffett/BRK during the financial crisis.  He provided finance to Bank of America (BAC) and to General Electric (GE), two companies whose operations were under great stress because of recession.  As he has done in other instances, Buffett demanded, and received, a long-running option to convert what were essentially commercial loans into the companies’ common stock at 2008 prices, in the case of GE, and 2011 prices, in the case of BAC.

BRK and GE, BAC

BRK has recently cashed out of its position in GE completely and has converted the BAC preferred stock it bought into common.  Back of the envelope, here’s how Mr. Buffett made out:

–BRK lent GE $3 billion and received a total of $4 billion back, including the sale of all the stock bought through warrant exercise;  a gain of 33.3% over nine years, during which time the S&P 500 gained 250%+.

–BRK lent BAC $5 billion.  It has received about $2 billion in dividend payments and has a gain of about $11 billion on the BAC stock it now owns.  That’s a gain of 260% over six years, during which time the S&P 500 gained about 110%.

Together:  BRK lost $6.5 billion by its investment in GE vs. holding an S&P 500 index fund;  it has gained $8 billion vs the index so far on holding BAC.

evaluating results

A more interesting question:  did BRK do well or badly?

On GE, the answer is clear.  The investment did very poorly.

On BAC, the answer is also clear.  The investment gave BRK more downside protection, and higher income, than the common during a time when BAC was in hot water.  And it came just before BAC began its long run of outperformance against the S&P 500.   So this was a home run.

Regular readers will know that my overall view on Mr. Buffett is that he persists in using a manual typewriter in a Word (or Google docs) world.  You have to hand it to him on BAC.  But GE’s salad days were long gone when he put BRK’s money into it.

Whole Foods (WFM) and Amazon (AMZN)

August 29, 2017 By in Industry Analysis, superfmarkets, Uncategorized Tags: , , , , , , , , , 1 Comment

Most of the talk I’ve heard about AMZN’s acquisition of WFM revolves around the idea that AMZN plays a long game.  That is, the company is willing to forgo profits for an extended period in order to achieve market share objectives–which will ultimately lead to an earnings payoff.  After all, it took eight years to get its online business into the black.

What’s being lost in the discussion, I think, is the present state of WFM.  It’s not a particularly well-run company.  Analyst comments, which have surfaced publicly only after it became clear that WFM would be acquired, suggest the company has antiquated computer control systems.  It has waffled between emphasis on large stores and small.  We know that it needed a private equity bailout during the recent recession.    It has begun a down-market expansion through “365 by Whole Foods” stores; in every case I can think of, except for Tiffany, this has been a sure-fire recipe for destroying the upmarket main brand.

The easiest way to see management issue, I think, is to compare WFM with Kroger (KR), a well-run supermarket company.  Their accounting conventions aren’t precisely the same, but I don’t think that makes much difference for my point.   (Figures are taken from the most recent 10Qs.).  Here goes:

–gross margin:  KR = 19.7%;  WFM = 33.8%

–pretax margin:  KR = 1.2%;  WFM = 4%

–inventory turns/quarter:  KR = 5.8x; WFM = 7.7x.

What do these figures mean?

–WFM turns its inventories much faster than KR, which should give WFM a profit advantage

–WFM marks up the items it sells by an average of about 50% over its cost of goods;  the markup for KR is half that.

–the combination of faster turns and much higher markup should mean a wildly higher pre-tax margin for WFM

–however, 14 percentage points of margin advantage for WFM at the gross line almost completely evaporates into 2.8 percentage points at the pre-tax line.

–this means that WFM somehow loses 11.2 percentage points in margin between the arrival of goods in the store and their delivery to customers, despite the fact that stuff sells significantly faster at WFM than at KR.

my take

Yes, AMZN can expand the WFM customer base.  Yes, it can cross-sell, that is, deliver non-food goods, like Alexa, through the WFM store network and the 365 brand through the AMZN website.  Yes, using the Amazon store card will likely get customers a 5% rebate on purchases.  Yes, WFM’s physical stores may even serve as depots for processing AMZN returns.  That’s all gravy.

But if AMZN can eliminate what’s eating those 11.2 percentage points of margin (my bet is that it can do so in short order) it can lower food prices at WFM by a huge amount and still grow the chain’s near-term profits.  This is what I think activist investor Jana Partners saw when it took a stake in WFM.

 

auto companies and their financing affiliates

August 28, 2017 By in Inventory Cycle, Uncategorized Tags: , , 1 Comment

Last Friday the Wall Street Journal reported that Ford is going to use new measures of creditworthiness beyond FICO scores that will allow it to approve loans to borrowers now considered too risky to provide financing to.

 

One of the reasons I’ve rarely owned auto company stocks is not just that they’re highly cyclical.  I (hope I) can deal with that.  Rather, it’s it seems to me that, invariably, as the car-buying cycle matures, operating and sales executive put pressure on the captive lending arm of the company to make riskier and riskier loans.

This happens it two ways:  more liberal lending policies; and increasingly optimistic assessments of the resale value of leased cars (called residual value) when they are returned at the end of the lease.

The poster child for this type of behavior is Mitsubishi Motors, which tried years ago to jumpstart US sales through a “triple-zero” sales campaign.  It offered loans with no down payment, 0% interest and no payments for the first year.  The campaign produced an unwanted fourth zero when virtually no one made loan payments when required–and the firm only avoided bankruptcy through a Japanese style rescue by the less-than-pleased other members of the Mitsubishi industrial group.

 

Generally speaking, the PE multiple for companies whose earnings are very cyclical tends to contract as the cycle nears its peak.  For auto firms, and other companies with similar in-house financing operations, this contraction is especially severe because investors fear that too-generous financing may boost sales today but be offset by big writeoffs in a year or two.  Because of this, investors are not willing to pay for what they regard–historically, correctly–as artificially inflated results.

Maybe Ford will be different this time, but my guess is that investors will at least initially regard results with skepticism.

 

 

Jeep as a Chinese brand

August 25, 2017 By in conglomerate breakup, mergers and acquisitions, Uncategorized Tags: , , , , 1 Comment

A mainland Chinese company, Great Wall Motor of China, has recently expressed interest in acquiring either the Jeep brand + manufacturing operations or all of Fiat/Chrysler.

The press has since been filled with commentary whose thrust is that Washington will oppose either sale proposition.

Several things strike me as odd about this:

–brands like Volvo and Jaguar have looked a lot more interesting recently since coming into Asian hands, so that shouldn’t be an issue (although this is likely the crux of the matter)

—Jeep is now part of an Italian company   …which bought it from a German firm that was slowly sinking under the weight of a senescent Chrysler   …which had been foundering despite a government bailout in the 1970s and a huge injection of badly needed engineering talent under Daimler.  So a firmer economic footing for the whole Chrysler enterprise is unlikely to come without outside-the-box thinking.  Also, it’s hard to make a logical argument that foreign ownership for any part of Chrysler is a problem

–if the Great Wall Motor interest is real, it suggests the company has access to foreign exchange at a time when Beijing is cracking down on reckless foreign m&a by domestic corporations.  That likely means that Great Wall has enough influence in China to be able to expand the Jeep brand’s reach quickly

–I haven’t heard a lot of posturing from Washington.  Either I’m really out of touch on this one, or the anti-Great Wall sentiment is mostly in the minds of reporters.