new CEO for Tiffany (TIF)

TIF has languished for a number of years, for several reasons:

–the waning of the important Japanese market

–the shift of Chinese jewelry buyers away from foreign firms and toward local creations

–the recession, which lowered spending on jewelry worldwide

–perhaps most important, a lack of success in providing new designs for regular customers.

The company’s greatest strength is its brand name.  It’s unique in being able simultaneously to appeal to ultra-wealthy customers spending $10,000+ a pop and to ordinary people looking for a $200 trinket to have wrapped in the iconic blue box.

Oddly, in the discussion of TIF’s merchandising as being “tired” that I’ve been reading, analysts and (especially) reporters have been referring to this ability to serve low-end customers while still retaining the aura of exclusiveness that attracts the wealthy as a weakness.  Hard to understand.

At the same time, what’s being missed is the hole that has long existed in the TIF merchandise lineup–items that appeal to customers wanting to spend $2,000-$10,000. This middle ground is dominated by firms like Bulgari, which coincidentally have little presence among TIF’s customers in either of its market segments.

That’s wha’s so intriguing about the appointment of Allessendro Bogliolo, a former Bulgari executive, as TIF’s new CEO–something no one’s mentioning.

my $260 price target for Tesla (TSLA)

A regular reader recently asked how I arrived at $260 as a price target for selling TSLA, which many of you will know I have been trading alongside my younger son for a while.

 

To some degree, I’ve regarded TSLA in the way I would look at any growth stock.  That is to say, I look for signs that the company can grow faster than the market expects and/or would sustain an above-average expansion pace for longer than the market believes.

I then try to use the company’s financial information, plus government, trade association and individual competitors’ data to project an income statement and flow of funds statement for several years into the future.

In TSLA’s case, reliable data are scanty.  In addition, the company’s own projections of its production capacity and sales have not been anything to hang your hat on.

 

Typically, and for a stock I would consider as a core part of my portfolio, I would try to make a projection that I believe to be reasonable, or perhaps mildly aggressive, and would reassess as/when the stock reaches the future target price that projection would lead me to.

In the case of TSLA, however, I did something different.  I decided to make an extremely optimistic projection, one I thought would leave the shares at least temporarily overvalued–and which would serve as a sell signal.

 

This is what I did:

–I decided to make my projection based on 2018 earnings, since I don’t think anyone has the faintest idea of what earnings for years farther in the future will be

–I took the TSLA production forecast, which has proved consistently too optimistic, of 500,000 cars during 2018 as a given

–I decided that most of these cars would be Model 3s, where the average selling price indicated in preorders is about $42,000, as another given.  To account for a small portion of more expensive models, I rounded the average selling price up to $50,000

–I examined other publicly traded auto companies worldwide.  The highest pre-tax margin I found (yes, although this is a dangerous shortcut, I did use margins) was Porsche, at 15%.  I assumed that TSLA would achieve that margin in 2018, even though I think the figure is substantially too high

–I assigned a financial reporting tax rate of 25%, which is probably too low.  That gave me net financial reporting profits of $2.8 billion, and earnings per share of $17.10

–I decided to apply a price earnings multiple of 15x to the earnings number, even though auto companies typically trade at single digit valuations.  I don’t think TSLA should trade at the 20x+ multiple that an IT stock would merit, so 15x seemed about right.  That gave me a valuation, based on 2018 earnings of $257–which I rounded up to $260.

 

As we can clearly see from a TSLA chart, the stock blew through my $260 target in March-April as if it weren’t there.  It peaked, for now, at least, at $386–leaving an embarrassingly large gap between me and it.

 

Where did I go wrong?

The obvious place is in the PE multiple.  The prevailing market view would seem to be that 2019 earnings will be, say, $25/share, and that it’s safe to be factoring anticipated earnings for two years from now into today’s stock price.  Another way of saying the same thing, one which I think must be TSLA bulls’ belief, is that TSLA is this decade’s Amazon (AMZN)

That may well be correct.  Personally, I’m uncomfortable making the bet, though.  One thing experience does tell me, however, is that, barring a total corporate collapse, the stock is highly unlikely to get back to the $180 – $200 range that has marked the lows over the past couple of years.

a bad day for Tesla (TSLA) shares

First, let’s put yesterday’s negative price action for TSLA–down by 7%+–in context.  Prior to yesterday, the stock had risen by 75%+ since the opening bell in January.  So a down day–or even a down few weeks–shouldn’t come as a shock.

What happened yesterday:

–TSLA reported 2Q17 results.  Profits were hurt by another production foulup–a shortage of batteries this time–that prevented the company from churning out cars at a higher rate.  The good news is that the problem was solved intra-quarter and shouldn’t affect results for the second half

–TSLA also said it intends to be churning out 20,000 Model 3s a month by the end of the year and 500,000 in total during 2018

–two negative analyst reports were released, arguing that TSLA is substantially overvalued.  Reasons:  plateauing demand for older models, increasing competition from other auto companies and TSLA’s less-than-perfect production experience.  Goldman Sachs says it now thinks the stock is worth $180 a share (down from $190 previously)

–Volvo announced it intends to become a exclusively a hybrid/electric car company in 2019; Baidu announced it will give its autonomous-driving car technology away for free in return for usage data.  Takers include a bunch of other Chinese carmakers + Ford and Daimler

my take

–I sold my last shares of TSLA at $260, based on the idea that this is the highest price I can reasonably conceive of TSLA trading at during 2018, assuming the company does indeed make and sell 500,000 cars.  I guess that’s my bottom line

–the negative reports are good news in the limited sense that they imply the authors’ firms see no possibility of future investment banking business from TSLA.  Maybe their negative analyst stance in the past has already ruled them out.  But emphatically underlining the fact suggests to me they think TSLA needs no further funding to carry out its production plans

–the possible turn to significant profits being earned in 2018 is a mixed blessing.  On the one hand, say, $5 a share in earnings for the company, with the promise of more to come in 2019 is better than the current situation.  On the other, the emergence of earnings–and of a more easily predictable future–means an end to the “dream” of unparalleled riches that many early-stage-company investors routinely harbor with any of their stocks.  For a certain percentage of “dream” stocks, the minute the earnings begin to arrive marks the peak in the stock price.  A minerals exploration company that owns a single orebody peaking the day the mine opens is the stock example.  Euro Disneyland is another.

UK investigation of the investment management industry

The UK Financial Conduct Authority is wrapping up a two year investigation of the money management industry in this important global financial center.

Despite heavy industry lobbying which has squelched similar inquiries in the US, the FCA’s just-released preliminary report is an indictment of many traditional industry practices.  Excessive fees, lack of disclosure and conflicts of interest among asset managers and pension consultants are recurring themes.  The Financial Times, which seems to me to be in the best position to know, thinks that the “good” news for the industry is that the FCA has not recommended a government investigation of its practices for potential breach of UK law.

Although the investigation began before Brexit became a reality, it occurs to me that the FCA’s conclusions are being shaped by the idea that UK investment services no longer need simply meet the (very) low bar of being better than what’s available in the rest of the EU.  Without a built-in clientele, services must also be good in an absolute sense.  A regulatory regime that gives investors a fair shake is a sine qua non–as well as miles better than what is generally the case elsewhere, including in the US, the current market leader.

The FCA investigation has two implications I can see for US-based money management:

–increased disclosure of fees/performance in the UK will increase pressure for similar disclosure in the US.  One particular bone of contention is the use of “soft dollars” or “research commissions,” meaning a management company pays a broker, say, 2x the going rate for a portion of its trading.   In return it receives goods/services that the manager would otherwise have to pay for from management fees.  The kinds of stuff a manager can receive is already regulated in the US, but disclosure of the amount of money in extra commissions ultimately being paid by clients is not.  The FCA will require such disclosure in the UK.  My sense is that the amounts will be surprisingly large.

–during the years prior to the financial meltdown, US banks opened London branches to process transactions–often involving US buyers and US sellers of US products–that were allowed in the UK but illegal domestically (think:  sub-prime mortgage derivatives).  This was a result of the UK’s decision to build up its financial services industry using a “regulation lite” approach to governance.

In the absence of any changes to US laws, why wouldn’t large US institutional investors demand that their investment managers similarly conduct business out of London.  In this case, however, it would be to obtain lower fees, greater transparency and better legal recourse in the case of disputes.

Yes, this sounds a little crazy, but the legacy investment management industry–both managers and consultants–are so powerful that I think favorable change for investors is unlikely to happen otherwise.

 

 

Sprint and the cable companies

The Wall Street Journal reports this morning that Sprint, Comcast and Charter Communications are discussing an agreement for mutual support in providing a discount mobile telephone service.

Sprint is controlled by the Japanese conglomerate Softbank, whose chairman, Masayoshi Son, made his first mark in that country by launching a successful deep-discount mobile phone service that resulted in much lower prices for consumers there.  Mr. Son has already tried once to repeat this move in the US.  To gain the requisite size to offer a similar disruptive service in the US, he agreed to combine with T-Mobile.  This would have formed a third big mobile telecom group, after Verizon and ATT.  But the federal government ruled against his plan, on the grounds that joining Sprint and T-Mobile would reduce the number of big telecom companies in the US from four to three (violating an anti-trust rule of thumb that frowns on market shares above 25%).  The fact that Mr. Son wanted to provide more competition, not less, made no apparent difference to the regulators.

Hence, I think, Mr. Son’s very visible support for Mr. Trump, as a businessman who might see through regulatory clutter.

I’m not sure what will develop from talks among the three parties.  I don’t think this is simply a way for Son to extract himself from an investment gone wrong in Sprint, however.  My guess (as someone with too-high cellphone bills, my hope?) is that a viable mobile service with adequate national coverage will emerge from the talks.

If so, while this may/may not be good news for the companies involved, it is definitely bad news for both Verizon and ATT.

Whole Foods Market (WFM)–final round

As I pointed out last week, WFM has gross margins that are much higher than the average supermarket’s.  WFM also turns its inventory in a little less than two weeks, which is two or three times the rate of a typical grocery store.  Over the past several years, it has been generating over a billion dollars in annual cash flow.

On the other hand, sales are falling.  The largest use WFM has been making of the money it generates is to buy back stock ($2 billion worth over the past three years).  Its working capital management seems to produce much less cash for it than rivals–although this may be the result of an unusual product mix and/or worry that the current poor sales trend will continue.

In addition, it appears WFM is attempting to extend its brand downmarket with the opening of 365 stores–a tacit acknowledgement that its core high-end market is saturated.  In my experience, though, this strategy rarely works.  Its main effect is typically to degrade the upscale image of the main brand.  Tiffany is the only exception I can think of.

what interests Amazon (AMZN)

–WFM has a well-known brand name, that stands for healthy, high-quality, and ethical behavior.  But it also stands for “whole paycheck,” an attribute that AMZN can most likely eliminate without damaging the rest of the image

–an ironic plus, WFM doesn’t appear to have kept up with the times in pricing, computerization or inventory control.  So there’s arguably low-hanging fruit to be picked

–WFM has a physical distribution network that culminates in 430+ physical stores covering most major markets in the US

–the NPD Group, a leader in consumer marketing research, points out that:

—-WSM stores are located in areas that are younger and more affluent than average

—-52% of online grocery buyers are members of Amazon Prime, and therefore arguably disposed to by groceries through AMZN if the company had an adequate delivery mechanism

—-60% of Millennials bought at least one item from AMZN last year vs. 24% who bought something from WSM.  So AMZN has, at least on paper, the potential to deliver a large new audience to WFM

–according to a Morgan Stanley survey, which I read about in the Wall Street Journal, 62% of WSM’s current customers are already members of Amazon Prime.  Arguably, there’s a big opportunity for AMZN to increase the frequency/amount of WSM purchases through the Prime network.

my take

From its high in early 2015, the WFM had almost been cut in half–in a market that was rising by 15%–before Wall Street began to anticipate a couple of months ago that the company would be either restructured or sold.  Although I’m by no means an expert on WFM, that negative price action is hard to ignore.  So, too, the declining sales trend.

The picture that emerges to me is of an high-end retailer that has saturated its niche and whose chief product–healthy, but expensive, food–is being commoditized by rivals.  To date, management has marshaled no adequate response to this competitive threat.

AMZN provides a face-saving way for WSM to retain its counterculture self-image while turning over its market problem to more competent hands.

 

 

 

 

high margins vs. low

Many traditional growth investors characterize the ideal investment as being a company with substantial intellectual property–pharmaceutical research or computer chip designs or proprietary software–protected by patents.  This allows them to charge very high prices, relative to the cost of manufacturing, for their products.

Some go as far as to say that the high margins that this model generates are not just the proof of the pudding but also the ultimate test of any company’s value.

As I mentioned yesterday, the two issues with this approach are that: the high margins attract competition and that the price of maintaining this favorable position is continual innovation.  Often, successful companies begin to live the legend instead, hiding behind “moats” that increasingly come to resemble the Maginot Line.

In addition, high margins themselves are not an infallible sign of success.  Roadside furniture retailers, for example, invariably have high gross margins, even though their windows seem to be perpetually decorated with going-out-of-business signs.  That’s because furniture is not an everyday purchase.  Inventories turn maybe once or twice a year.  Margins have to be high to cover store costs–and, in normal times, to finance their inventories.

Although I am a growth investor, I’ve always had a fondness for distribution companies–middlemen like auto parts stores, or pharma wholesalers, or electrical component suppliers, or Amazon, or, yes, supermarkets (although supermarkets have been an investment sinkhole that I’ve avoided for most of my career).  My experience is that the good ones are badly misunderstood by Wall Street, mostly, I think, because of a fixation on margins.   In the case of the best distribution companies, margins are invariably low.  So that’s the wrong place to look.

Where to look, then?

the three keys to a distribution company:

–growing sales, which will leverage the fixed costs of the distribution infrastructure,

–rapid inventory turns, measured by annual sales/average inventory.  What a “good” number is will vary by industry.  Generally speaking, 10x is impressive, 30x is extraordinary,

–negative working capital, meaning that (receivables – payables) should be a negative number   …and getting more negative as time passes.  Payables are the money a company owes to suppliers, receivables the money customers owe to the company.  For a healthy firm, its products are in high enough demand that customers are willing to pay cash and suppliers are eager enough to do business that they offer the company generous payment terms.

A simple example:  all a company’s customers pay for everything (cash, debit or credit) on the day they buy.  Suppliers get paid 90 days after delivery of merchandise.  So receivables are zero; payables will end up averaging about 90 days of sales.  This means the company will have a large amount of cash, which will expand as long as sales increase, available to it for three months for free.

not just cash generation

The best distribution companies will also have a strategically-placed physical distribution network of stores and warehouses.

They’ll have sophisticated inventory management software that ensures they have enough on hand to meet customers’ needs + a small safety margin, but no more.  It will also weed out product clunkers.

They’ll have stores curated/configured to maximize purchases.

Monday

…the curious case of Whole Foods.