Consumer in the Dell?

Dell has an impressive history as a low-cost, online retailer. Their process and supply chain management tactics are the stuff of business school studies. Despite their success, Dell's stock is down about 30% for 2006 and 60% from 2000. Dell appears to have run into a critical problem: consumer patterns.

Dell has long ignored the consumer as a customer. While H-P has over 30% of sales to consumers and Apple has an even higher number, Dell has averaged around 15%. Dell has repeatedly acknowledged this pattern with CEO Kevin Rollins declaring, "We have never focused on the consumer as a company."

I've found that to be true. My IBM laptop was exhibiting a major problem and I needed a solution quickly. IBM couldn't get me a new model for eight days. So I figured why not try Dell? Since Dell was just down the road in Texas, I thought it might be quicker. Wrong. The computer took the same eight days, but was 25% less expensive. However, I needed to act quickly. I ended up going elsewhere for an immediate solution.

Dell is a high quality company with talented management. The consumer market has expanded rapidly while Dell has been focused on the patterns of the business market. In the meantime, Apple and H-P have been appealing to consumers with their stock prices up handsomely. I continue to believe that Dell has the right idea - direct on-line marketing is the superior low-cost approach. With some sexier features and some higher cost services, Dell could resume growth. The current stock price implies that Dell can't.

Housing Bubble?

More of my recent conversations center on the real estate market. I have three exposures: personal, anecdotes of friends and publications.

Personally, I purchased a lot in March of 2005 and sold it in early 2006 for an increase in price of over 30%. I sold it to a person who had planned to build. Since then, he sold it to a developer who is building a spec house. In addition, I have looked at the partial purchase and potential development of a lot next door to me. I asked a realtor friend to help me evaluate it. She forwarded to me an enormous list of unsold properties in the area. From this list, the market looks overbuilt.

Further, friends tell me that their houses are no longer appraising at higher values. In addition, the sold numbers of builders are dropping.

Finally, publications report that foreclosures are 18% higher than last July. In addition, Toll Brothers has reported horrible financial results.

It appears that Americans have been building bigger and more expensive houses for smaller families. It also appears that more of their net worth is tied up in these houses and more of their discretionary income is dedicated to maintaining and improving these houses. Psychologically, Americans have been comfortable as they viewed the value of their properties going up. This could change dramatically if houses decline in value.

Development is still hot. However, it appears that a saturation level has been reached and that those likely to be more affected are those who attempt to sell older properties while competing with those recently developed. This would be particularly damaging for the "no down payment" properties.

Johnson & Johnson (JNJ)

Some companies possess superior business characteristics and JNJ is one of them. In reviewing JNJ's annual reports since 2000, I discovered that the cash position has moved from roughly $4 billion to roughly$16 billion. This fantastic growth in cash is even more stunning because it has been accompanied by a strong dividend payout and a reasonable share buyback. Look at the numbers since 2000.

JNJ has doubled in sales and earnings and earned roughly $40 billion for the period. JNJ has grown cash by $12 billion. JNJ has repurchased $6 billion of stock. JNJ has paid $15 billion in dividends. The remaining $7 billion or less than 20% of earnings is all that has been needed for a growth rate greater than 10% per year. That's amazing.

Is it all good news? No, it rarely is. Strong results often create excess confidence. JNJ overbid for Guidant. Fortunately, Boston Scientific got frenzied in the bidding and "succeeded" in the purchase of Guidant. Not happy with the "missed opportunity," JNJ has now paid a very high price for the consumer products line of Pfizer.

The other looming problem is JNJ's pension plan. Not only is it underfunded, the plan assumptions also appear aggressive, meaning the plan is even more significantly underfunded. JNJ's management does not appear to have taken steps (such as IBM's freezing of their plans) to address these issues.

International Corporate Tax Rates

In a recent annual report, Warren Buffett complained about the disproportionately high share of corporate income taxes that Berkshire Hathaway (BRK) was paying. And paying close attention to what he says, I spent some time looking at the issues involved.

I found that most companies of BRK's size are more internationally diversified. As a result, a wide range of tax planning (or manipulating) is legitimately available. Countries are competing for high quality jobs to be put into their jurisdictions. As a result, the U.S. is now in a group with the highest statutory tax rate at 35%. The others are India, Malta and Spain. The lowest tax rate country is Ireland at 12.5%.

Looking at the likelihood of tax structures is important. A recent study demonstrated that "the effect of a single percentage point reduction in tax rate was the equivalent of the company generating a 15% increase in its sales over a 10 year period." With sales growth generally slow, this shows tax planning has a huge impact. Is there downside to this?

Of course. But after looking around Europe and "the world is flat" thesis, I really think most countries are going to competitively lower corporate tax rates to attract the best working populations and employment opportunities. Technology and pharmaceutical companies should continue to benefit as research employees probably represent highly desirable citizens (high incomes and education levels).

The Foreigness of the Japanese

Recently my family and I were travelling in Europe. While there, it was difficult to ignore the prevalence of natural body odors. Getting back home to reseach, I focused on the geographic differences in the personal care area. But despite the notable difference in smells, the financial differences between the U.S. and Europe personal care segments were only slightly different. The real difference is between Japan and everyone else.

Estee Lauder presented a study comparing the sales of prestige cosmetics to females 15 and older in various markets. It was no surprise that the low end of the scale was held by India with $0.43 per female, next by China at $1.19 per female and up to Russia with $9.03 per female in the developing world. In the developed world, the U.S. and the U.K. were close with $113.22 and $116.96, respectively. The shock was Japan at a whopping $236.82 per female.

Sensing an investable idea, I invested more time in the Japanese cosmetic area and found other facts about the Japanese. 85% of Japanese women between 18 and 65 dye their hair. Only 2.3% of Japanese women between 16 and 64 feel good about their skin. And Japanese women use 50-100% more cosmetic products than other women in the world.

Interestingly, the high expenditures per female seems to have not increased their sense of self worth. Nor have these expenses increased the birth rate or the rate of sexual activity. In a recent survey, the Japanese had, by a huge margin, the lowest rate of sexual activity in the world at 45 times per year against a world average of 103 and a U.S. average of 113.

After this research, I began to sympathize with the management of Colgate-Palmolive (CL). CL views Japan's markets as so foreign that this personal care powerhouse sells only one product in Japan: Hill's pet food.

Will "Alternative" Foods Go Mainstream?

Since Whole Foods built a new store in Highland Park in 2001, I have been a regular at the store. Despite higher prices, I was attracted to a much higher level of cleanliness, a thorough description of food content and the option of no and low fat foods. In the meantime, I watched Tom Thumb close down a recently remodeled store and asked myself, "why don't they sell some of those Whole Food products?"

The recent purchase of 84% of Tom's of Maine by Colgate-Palmolive (stock symbol:CL and founded in 1806) for $100 million points to movement in that direction. Tom's of Maine was started in 1970 by Tom Chappell as a "natural" product category company with deodorants and toothpastes. Last year sales were about $50 million. In light of Tom's high profit margins, it doesn't appear that CL overpaid. Rather, Tom's will get heavyweight distribution and CL will begin to get that product line that Tom Thumb lacked. Winners all around?

Not likely. It looks like Whole Foods may be the ultimate loser through franchise erosion. As production and distribution gets more efficient for Tom's through CL's efforts, other food chains will have the ability to carry such products. While Whole Foods may argue that Tom's should not diminish its brand by selling through inorganic, animal-haters, CL will logically argue that if Tom's is good for the world, why limit its distribution?

Media Patterns

This graph was supplied by Advo in their 2005 Annual Report to describe patterns in advertising. The three categories of high increases are direct mail, cable TV and internet, causing direct mail to surpass newspapers and cable TV to surpass radio. In an age of increasing complexity, the simple act of stuffing our mailboxes continues to grow in value.