End Game for Beer

This graph illustrates the tremendous challenge faced by major U.S. breweries. Today's announcement that SABMiller and MolsonCoors (TAP) are consolidating their U.S. operations into a joint venture follows naturally.

At this point, major U.S. breweries are forced into finding ways to efficiently produce "sub-premium beer" (the character of the name says it all). The decline is this category is stunning. Yet, the consumers in this category are the most loyal of any category. So the U.S. breweries are looking for a way "to have your beer and drink it too."

One topic to study is how the proposed joint venture is structured. If the arrangement is feasible, we might see other joint ventures. Anheuser-Busch and Heinekein are both family-controlled and operated concerns. A workable joint venture would allow them to retain independent identity and cut costs.

Is BUD a dud?

I came across this graph while doing research on Anheuser-Busch (BUD). It depicts clearly the dramatic reversal of fortunes for investors in BUD. Five years ago, BUD's total value (as measured by market cap) was generally four times the size of its three largest competitors. Now, BUD may finish the year as the next to the smallest of the group. How did that happen and what does it say about our investing environment?

The most significant impact to BUD's relative shrinkage was caused by the dramatic decline in the dollar. During the last five years, measuring from the height of BUD's market value, the euro has risen in strength against the dollar by 43.77%. The following graph depict the dollar's five year journey downward:

Had the dollar not dropped during the last five years, the values of the other beer companies would be almost one-third lower than they are. Essentially, that would mean BUD would still be almost twice the size of Heinekein, InBev and SABMiller. So almost all of Heinekein's relative growth came as a result of the dollar's decline. However, InBev and SABMiller made significant growth relative to BUD, even accounting for the decline in the dollar.

The engine for this significant growth is evident by reviewing each company's history of stock issuance or stock repurchase from 2002 to 2006. BUD started 2002 with 879 million shares and ended 2006 with 762 million shares, for a shrinkage of 117 million shares or almost 15% of the stock outstanding. Heinekein split shares 5 for 4 in 2004, but maintained 490 million shares throughout. InBev issued shares aggressively, moving from 430 million shares to 613 million shares, for an increase of almost 50%. SABMiller issued shares even more rapidly, moving from 841 million shares to 1,575 million shares for an almost 100% increase.

When adjustments are made for these changes in share counts, these companies fall back into their pre-2002 alignments. This mean that changes were not the result of major changes in operating results and organic growth patterns. But the differences in stock price movements resulting from the dollar effect and the growth strategy are dramatic.

BUD's stock price is roughly where it was in 2002; Heinekein's has moved up roughly 75%; Inbev's has moved up over 100% and SABMiller's is up over 200%! The dollar decline significantly affected investment performance, but the share issuance further correlated with favorable investment results, while share repurchases have done the opposite.

Inbev and SABMiller both went on shopping sprees around the world by issuing shares, while Heinekein utilized their own resources for a more methodical growth strategy. At the same time, BUD returned profits generously back to its shareholders, while pursuing non-capital intensive growth strategies.

As was evident in the "tech bubble," today's "go-go global" bubble puts a premium on aggressive share issuance and new market penetration. The markets are treating companies as if they are international venture funds which get penalized for not spending all their funds.

More About Wal-Mart

I probably have more posts about Wal-Mart (WMT) than any other topic on this blog. I have written about the deceptive tactics used by unions, the dominance of WMT in grocery business, the benefits to the lower classes in terms of increased purchasing power and the stock performance itself. Why so much focus? I have a long-term affinity for the "underdog" and a contrarian streak.

WMT has an opportunity to become a powerhouse in financial services. Currently, WMT conducts over two million money services transactions per week. This is a large number until one recalls that over 100 million people go to a Wal-Mart store every week. WMT is rolling out MoneyCenters to provide its client base access to financial services with over 1,000 stores expected by the end of 2008. These MoneyCenters do not operate on "bankers hours." By operating from 7 a.m. to 9 p.m., these centers give the working individuals the opportunity to work, enjoy their family and get some of their financial affairs in order.

Lower income individuals have limited access to financial services. Financial services work on a fixed cost principle because just as much work is required to deal with a $10 transaction as a $10,000 transaction. For that reason, smaller transactions are priced at higher levels. The result is that as many as 25% of the U.S. population do not have a checking account. Without such a basic financial tool, this "unbanked" population pays a series of fees that probably averages about $200 per person annually ($13 billion in revenue on a population of 73 million).

Is there profit here? Assuming that the 1,000 stores can increase the transactions to at least 10 million transactions per week and that each transaction averages $1 (money orders are $0.46, money transfers are $9.46, check cashing is $3.00 and bill payment is $0.66), then WMT would add $5oo million of profitable business. While this is not a major number in light of company-wide revenues in excess of $350 billion, this business will solidify the "one-stop shop" principle WMT is built on and strengthen its ties with its customer base.

Home Depot's Capital Allocation

As I wrote in a post (1/3/2007), Home Depot (HD) has been attempting to make two wrongs equal a right for sometime. The first wrong, a poorly structured (at least from a shareholder perspective) employment contract, facilitated bad relations all around. The second wrong, a reactive removal of Nardelli as the CEO left HD with difficulty executing the complex business model Nardelli had constructed.

Now, HD has struggled with refashioning itself. The basic business platform generates a likely return on capital of 12%, creating adequate cash flows to build new stores, refurbish old ones and pursue business initiatives. Left to its own devices, this would indicate a growth rate of 7% plus inflation on an unlevered basis. Not bad.

But HD is trying to refocus on this business model. It is disposing of HD Supply for about what it paid, given that HD is getting cash back of $8.5 billion, keeping a 12.5% equity stake and guaranteeing $1 billion of debt. Overall, this is not a bad outcome. The purchasers will ultimately take the stock public and HD will cash out at that time without the business having been a management distraction. Thank you, Jamie Dimon.

The aggressive area seems to be the increase of debt in order to repurchase $22.5 billion of stock. HD has been extremely fortunate to have a market downturn, reducing by at least $1.2 billion the cost of its repurchase. The total is almost 290 million shares at $37 per share for a total cost of $10.73 billion. This is roughly 14% of the shares outstanding. Most of this cost will be covered by the $8 billion of sales proceeds from HD Supply. In addition, HD will be borrowing about another $12 billion to repurchase more shares. A downturn in the stock would be welcome as it would allow HD to dramatically shrink share count.

Another Saga of "Synergy"

A great business story is starting to unravel. In 1969, George Valassis opened a small home sales business that sold printing around Detroit. He had enough growth to purchase a printing press in 1971. However, he didn't have enough work for the press. So what did he do? To the dismay of paperboys since, he invented the coupon-insert-in-newspaper business, or in industry terms FSI (free-standing insert). Valassis grew rapidly and dominated the FSI business, until recently.

Over the time, Valassis has continued to search for other ways to get advertising dollars. This has accelerated over the years and recently culminated in the purchase of Advo - another great business story. Started in Hartford, Connecticut in 1929 by Paul Siegel, Advo specialized in delivering fliers door-to-door from retailers. Moving by fits and starts, Advo continued its growth into mailers for the large insurance companies. The growth reached a milestone when the United States Census Bureau purchased its mailing list for American households.

Both companies, Valassis and Advo have struggled with newspaper competition, changing technology and the search for better, more measureable results for their advertisers. Valassis made an acquisition of Advo in 2006, commenting on the multiple "synergies" that would be generated. As I have commented before in this blog, synergies seem to fail either because of illegal monopolies or an overpayment for an acquisition. This case seems to be the latter. But here is some truly destructive potential because of a huge (to me) amount of debt loading up the entire purchase price of $1.1 billion with an annual free cash of only about $100 million.

The stock (VCI) could be a real bargain, but the debtload looks too heavy. Here is a telling graph depicting the core weakness of the business which is servicing that debt:



It looks like Mama ain't using coupons as much these days!

I've Been Workin' on the Railroad

As the song title indicates, I too have been working on the railroad. My motivation has been understanding the interest of investors with good history: Warren Buffett and Carl Icahn.

The railroad industry is the most capital intensive of all industries. Capital intensivity is so unattractive that I refer to the characteristic as being a "capital pig." Railroads are capital hogs, consuming over 20% of their revenues with track maintenance. Trucking companies, in contrast, pay a much lower percentage of revenues in taxes for support of road maintenance.

So what's to like? Warren Buffett commented "As oil prices go up, higher diesel fuel raises costs for rails, but it raises costs for its competitors — truckers — roughly by a factor of four." This is a powerful metric in a rising fuel cost environment. In addition, there has been consolidation to the point that the industry has more pricing power than in the past with very few new tracks being built. This is important, because a typical cylical stock (as in commodity cycles) generates more capacity just as profits get strong. In the railroad business, such a cycle is unlikely.

John Amos, Founder of AFLAC

AFLAC is an amazing company. When I first studied the company over ten years ago, I was certain that the information was wrong. It was inconceivable that a company from south Georgia dominated the insurance market in Japan. But I learned it was true. So much for the fabled inability of U.S. companies to do well in the Japanese market.

I searched for the story and found it in a book titled "The Man From Enterprise: The Story of John Amos, Founder Of AFLAC." After reading about his entrepreneurial childhood, wonderful marriage, early law career, I found what I wanted. In Chapter 16, the author describes that John was on a round-the-world trip with an eighty-one year old friend of his.

On a cold, rainy April day in 1970, John saw something. "Many of the Japanese wore surgical masks to prevent other people from catching their colds. Most people would think...how quaint. John...thought of something else..these were a health conscious people, people who might buy cancer insurance if it could be made available."

Over the next four years, AFLAC worked to get approved. They were not only approved, but granted a monopoly on the writing of supplemental cancer insurance for a period of three years that was extended for eight. The first year was portentous. They expected to write about $3.5 million of premium and ended up writing $25 million. The rest, as they say, is history.