Buffett on the imperfect turnaround
Can you think of an example of a retailer that was successfully turned around?
Broadcasting is easy; retailing is the other extreme. If you had a network television station 50 years ago, you didn’t really have to invent or being a good salesman. The network paid you; car dealers paid you, and you made money.
But in retail you have to be smarter than Wal-Mart. Every day retailers are constantly thinking about ways to get ahead of what they were doing the previous day.
We would rather look for easier things to do. The Buffett grocery stores started in Omaha in 1869 and lasted for 100 years. There were two competitors. In 1950, one competitor went out of business. In 1960 the other closed. We had the whole town to ourselves and still didn’t make any money.
How many retailers have really sunk, and then come back? Not many. I can’t think of any. Don’t bet against the best. Costco is working on a 10-11% gross margin that is better than the Wal-Mart’s and Sams’. In comparison, department stores have 35% gross margins.
It’s tough to compete against the best deal for customers. Department stores will keep their old customers that have a habit of shopping there, but they won’t pick up new ones. Wal-Mart is also a tough competitor because others can’t compete at their margins. It’s very efficient.
Another addition to the turnaround toolbox so that I don’t forget the obvious and known even in tempting circumstances.
And these are tempting circumstances. There are two retailers that I like their owner operators and I like their prices. Is there a need to mention their names?
Running the risk of being repetitive, my opinion is that in comeback stories the balance sheet is better used to estimate the runway of a business rather than its value. Both of these retailers have decent runways but the problem is that neither is turning.
These were some thoughts from an old previous post on players facing external threats.
The prospects do not look so bright when you consider that for most of these companies, failure means their core business declines into oblivion. Also many of them may not have clients, hidden capabilities, or platforms to leverage.
A good financial position, like Dell’s or Yahoo’s, can give them time to experiment and look for alternatives. But from the point of view of an investor even if the plan is successful the company will probably be a follower in the new industry, product, segment, business model: a shadow of its former self.
So the downside is not that well protected, the probabilities of success are not that good, and the upside will probably be limited: does not look like the recipe for successful investing. This is an area where I think value investors have to be careful.
I’m still curious about Dell and Yahoo. I’m still curious about these two retailers. Actually, at the moment there are dozens of interesting situations. However, my preferred style is to jump on businesses that are turning or have already turned at the risk of missing some… and there are some good ones out there.
Now, if they decide to liquidate abruptly or in willful steps … well, that’s not a turnaround.
A friend suggests me to read Mauboussin’s More Than You Know, Chapter 21 and I do. Retail and technology are not the best sectors to look for comebacks.
Exhibit 21.2 shows what happens to companies that realize a downturn. The sample includes almost 1,200 companies from the technology and retail sectors.
The data for the two industries are strikingly similar, and not particularly encouraging: Only about 30 percent of the sample companies were able to engineer a sustained recovery. (Credit Suisse defined a sustained recovery as three years of above-average returns following two years of below-cost-of- capital results.) Roughly one-quarter of the companies produced a nonsustained recovery. The balance—just under half the population—either saw no turnaround or disappeared. Companies can disappear gracefully (get acquired) or disgracefully (go bankrupt).
This analysis also shows how long companies experienced downturns. For both retailers and technology companies, roughly 27 percent of downturns lasted only two years, and for both sectors over 60 percent of downturns lasted for less than five years. In other words, the destiny of most firms that live through a downturn is determined rather quickly.
These mean-reversion and turnaround data underscore how strong and consistent competitive forces are. Most stocks that are cheap are cheap for a reason, and the likelihood that a business earning poor returns resumes a long-term, above-cost-of-capital profile is slim.