Company Visits and Updates
Inventories have grown enormously in the manufacturing sector of the U. S. economy. This highly reliable leading indicator says slowing lies ahead. Accordingly, earnings disappointments are being announced at a rapid-fire rate. In the past, weakening of employment has followed next, accompanied by declining interest rates. While earnings disappointments are a negative for the stock market in general, interest rate declines are a positive. Hopefully, the two will offset each other.
In the long run, modest economic developments are trivial and difficult to time. The priority of those who invest over a lifetime remains
owning companies that succeed in building proprietary business franchises.
Qualcomm…..The company will spin off its wireless services division as a separate company. Qualcomm estimates a small amount of capital gains, around $4 per share, will be incurred by shareholders due to the spin-off.
The reason for this spin-off lies in the nature of wireless service companies, the largest of which is Airtouch. Building out wireless networks is very capital intensive – it requires purchases of large amounts of equipment. The equipment is depreciated at a rapid rate, virtually eliminating earnings. Wall Street understands this. Instead of focusing purely on reported earnings when valuing wireless service companies, cash flow and customer counts take a role.
Winning the wireless PCS contest over AT&T in Mexico explains the timing of Qualcomm’s spin-off decision. The wireless services company will spend a lot of money building out the CDMA PCS infrastructure in Mexico, and we would prefer these expenses appear on the service company’s P&L, rather than on Qualcomm’s. The net impact on Qualcomm’s stock price should be positive.
The most significant development for Qualcomm this year was the adoption by the European Telecom Standards Institute (ETSI) of W-CDMA as the next generation of Global System Mobile. CDMA won because of its dramatically wider bandwidth. Wider bandwidth exponentially lowers the signal/noise requirement of a wireless signal transmission. This can be explained in terms of something many of us are now very familiar with: Internet access times. Phoning through the current GSM standard is like using a 14.4 kbps modem for Internet access, while phoning through CDMA is like using a cable modem, a difference of "night and day" magnitude. We regard ETSI’s decision as a milestone. Qualcomm’s CDMA appears likely to evolve as a very important standard of the "information superhighway."
Gillette…..The new Mach 3 shaving system is now in stores. I would welcome reports from all who try it. I expect this to be a big source of profits for Gillette in years to come.
Nike…..The balance sheet defined the recent buying opportunity in Nike (and, by the way, the selling opportunity a year or so ago.) More specifically, over the past year and a half, increasing inventories and receivables, as a percentage of sales, indicated revenue growth deterioration. (The analytical method consists of deducting receivable and inventory increases from revenue growth to isolate true end-customer "sell-through".) This trend reversed strongly in the fourth quarter that ended on May 31. "Days sales outstanding" improved by a notable 10 days for both receivables and inventories, indicating that Nike products sell very quickly when on sale. The power of the brand name comes through once again.
Callaway Golf…..Callaway is in the middle of a slow down in revenue growth, not dissimilar to Nike’s. Actually, so many sporting goods companies are reporting slowdowns that it appears to be industry-wide. Accentuating the slowdown at Callaway is the lack of a new metal wood to reinvigorate Bertha family sales. Sales of the Biggest Bertha have slowed, as competitors like Taylor Made have reduced prices. Callaway responded with a $50 price cut aimed at clearing the inventory.
Our visit with the company reinforces our conclusions regarding 1) the great equity of the Callaway brand name, 2) the high quality and depth of management, and 3) the company’s strong motivation to reaccelerate the product introduction cycle. Although timing is difficult, Callaway is expected to return to double-digit growth rates and record earnings-per-share levels. While uncertainty reigns, the stock is cheap.
Boeing…..Over the long-term earnings are primarily dependent upon the spread between the price planes are sold for today and the expense of building them years later. Boeing management says that production problems are mostly behind the company. These problems have dominated the press on Boeing, obliterated last year’s earnings, and ushered the stock down from $65 to $45. Management is now able to focus on expense reduction and productivity improvements, which will enhance the rather slim gross margin. One productivity objective is for salespeople to be able to configure and initiate the production of an airplane at the customer’s office on a portable computer.
The big opportunity for Boeing lies in aircraft pricing, and it is impossible to predict when pricing will improve. In an effort to buy market share, Airbus continues to price and finance planes at levels Boeing will not stoop to. Since there are only two commercial plane manufacturers in the world, one would imagine that at some point Airbus management may realize how much money they could make if predatory pricing were relaxed. I hope to visit Airbus at some point in the future to determine the possibility of Airbus being sold to the public by the European governments that own and subsidize it. Alternatively, I watch for the point that the bureaucrats decide they cannot further subsidize Airbus, even at the political cost of risking jobs. In either case, profitability would then become Airbus’ priority, as opposed to job creation.
The big opportunity at Boeing is a cessation of the vicious price war. That could initiate a period of significant margin improvement at Boeing. When gross margins are at 5%, there is a lot of room for improvement. The investor should not underestimate the growth potential of Boeing if and when that day comes.
Tupperware…..The company generates 85% of its business outside the U.S., much of which is in Asia Pacific. Economic problems and currency exchange have damaged results and the stock price. We have lowered our long-term expectations for Tupperware. The stock is cheap, however, so risk to capital is low. We would sell Tupperware at higher prices.
Church and Dwight…..owns the Arm and Hammer brand name. The top four managers changed in 1995, and have initiated a strong reinvestment campaign. They have invested in new product development while advertising and marketing expenditures have been boosted substantially. New products extend the product line beyond baking soda and deodorizers by adding detergents, dentifrice chewing gum, toothpaste, and pet deodorizers. Management projects earnings growth in the mid to high teens over the next couple of years. Management is focused, deliberate, and impressive. We wish the stock were cheaper.
We attended the Emerging Growth Consumer Brands Conference sponsored by Merrill Lynch, which allowed us to visit with the managements of Sola International, Cole National, Bausch and Lomb, Playtex, K2, Oakley, Scotts, Ray-O-Vac, Avis Rent-a-Car, Sotheby’s Holdings, London International Group, Chattem, Cannondale, and Play by Play Toys. Please contact me if you have interest in any of these.
Steven L. Re¢ , CFA
July 7, 1998