Friday, 28 February 2014

Shrink to survive or shrink to grow . . .

This blog doesn't follow the retail sector, nor for that matter does it follow pharmaceuticals. The rational for this is because of the deafening noise that extraneous factors bring to the process. In retail I spent many years trying to come to grips with a moribund retail environment while trading Japanese equities. During those years there always seemed to be a reason for failure to deliver. Perhaps the most frustrating reason was weather.Leaving that aside I do occasionally get an interest in the space when things get to extremes. Let's take J C Penny for example.

I remember walking into a J C Penny store in Chicago in 1993 and coming away with the feeling that they had what I wanted, but I just couldn't find it. It never occurred to me to ask anyone for help as staff seemed fairly conspicuous by their absence. Anyhow flash forward to yesterday when Penny's released their results. Now the only thing I knew about them was the Hedge Fund Pershing Square owned about 18% of the shares and had spent the last few years agitating for a turnaround of some king. Bill Ackman, the boss at Pershing Square has been on the board of JCP since 2011. The results yesterday must have brought a smile to his face after a seemingly fruitless campaign. In the new world of stock analysis it must have been somewhat galling to those betting on a total collapse of this retailing stalwart that the company actually produced a profit for 4Q13 by increasing margins and a decline in sales. This is the crux of things. JCP had become an undisciplined giant giving away margin for the sake of sales, always trying to out-discount competitors. The realisation that this game is a fruitless race to the bottom seemed to allude many, especially today when internet companies spend most of their time on conference calls talking only about the top line and avoiding questions about how they'll actually make money. This blog only 2 weeks ago pointed out the problems with this business plan in respect of Amazon (Margins 0.6%). JCP has provided an example today why in order to stabilise a business you have to shrink to grow returns. They are not out of the woods yet, but investors interested in the end game for companies trumpeting top line growth would do well to follow this one and its' board over the next 4 quarters.

Of course if the JCP board is showing retailers a new face you might expect that here in Australia someone at Qantas might be watching what can be done when you realise your limitations. QAN yesterday produced another big loss (AUD 250m) and decided they needed to sack 5,000 staff. The problem is that the way the airlines current management set things up very few observers believe that they can deliver. This blog also is in that camp. The current CEO Alan Joyce drew a line in the sand and was determined to defend a 60% market share of the domestic market in the face of a better financed, newer operation (Virgin Australia). This effectively meant that every time Virgin added a 100 seats to a route QAN added 200. And because QAN has a higher cost base due to old union agreements they either had to swallow the margin or introduce a new low cost entity Jetstar to a route. This of course also had the knock-on effect of educating the public away from premium price levels and played into the hands of Virgin. I mean the travelling public once it had been weened off QAN saw no reason not to at least try Virgin or move to Jetstar. In other words the confusion became similar to what I'd experienced at that JCP store in Chicago and just like me people walked away and looked for something more simply presented and therefore easier to deal with. The end game with QAN will be a severe shrinkage and this blog is of the view that QAN will end up as a domestic player with 50% of the market. Investors should heed Warren Buffetts words from an interview in London's Daily Telegraph in 2002:

“If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say: ‘My name is Warren and I’m an aeroholic.’ And then they talk me down.”

Its not so different being on a bicycle. After all the growth rate in cycling is starting to imply very different metrics when it comes to valuations of bicycling related stocks. The trouble of course comes when growth starts too plateau. Look at Shimano . . . it's very similar to something like Apple because theres a cap at which the market can expand. At that level you start to see valuation dew back and RoE pick-up. Clearly there's only so many times you can release a new group set. The next high earnings will be when disk brakes are legalised by the UCI  . . . . until then you better hope for natural growth through population up-take . . .

I switched back to tubulars this week on the Cannondale because I'm sensing a problem with my Mavic Cosmic Carbones SLRs. I felt a shuddering through the front fork of my bike late last week which at first seemed likely to be a loose headset. When I checked I found no discernible movement in the headset so tried switching front wheels. Immediately the sound was gone. I checked the skewer and cleaned and greased it which helped a bit, but I checked with Mavic and they suggested it was probably that the bearings were starting to go. Interesting? I'm not sure, but will take the wheels down to Cheeky Monkey next week as they are a Mavic authorised dealer. Im off to Orange; north west of Sydney (3 - 4hrs) and need clinchers to ride on. The team I'm going wit are from Tattersalls Club in Sydney and there's no way I want to hold up fellow 40+ year old men on a weekend away from wives and loved ones. Patching and pasting with super glue and tubulars is boring. Imagine if you will taking a pre-glued tubular and carrying it on a ride. Then a puncture . . . stripping off the old one, adding rim tape and stretching the new one on , , , if you're a 50 year old man you're not going to want to wait around . . . you get the idea . . . .


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