Turn-Arounds And Retail

Turn-Arounds And Retail
Image source: Investment Master Class

If, you, like me have been observing many of the great investors over time, no doubt you will have noticed that most prefer to invest in businesses that have been operating with long track records of success.  Consistent profitability, excellent brands and market share and products and processes that require little in the way of constant management intervention. These types of businesses are likely to be doing the same thing in ten years that they are doing now.

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While its inevitable that many businesses will hit bumps in the road along the way - product launches may not go quite as expected, management unexpectedly changes, competitors gain a short-term edge, etc. - most of the Investment Masters stay well away from those businesses that need to be 'turned around'. These are organisations that need significant management input and skillful execution to return them to profitability.

“Both our operating and investment experience cause us to conclude that 'turn-arounds' seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than a poor business at a bargain price”  Warren Buffett

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“There’s more safety and optionality in businesses that don’t need to be rescuedVinson Walden

“We generally don’t invest in broken businesses that need to be straightened out .. It’s just not what we do” Chuck Akre

"We actually don’t do turnarounds. What attracts us to the whole concept of value investing is the idea of having a margin of safety, in terms of value over price. That margin of safety only exists if values are stable and it only improves if value increases.  With turnarounds, you’re making a bet – maybe a very intelligent one, but still a bet – that something broken can be fixed. Even in the best case, you may be looking at years when value declines or stagnates. Our experience is that we’re better off investing in a good business that is constantly compounding value from the beginning of our ownership, without what to us is the unacceptable risk that the turnaround doesn’t work. We just don’t think we need to take that kind of risk to earn strong returns” CT Fitzpatrick

Some management teams are well-known for their capabilities in rescuing businesses. Inevitably though, the return to successful operations is a painstaking and often frustratingly long exercise with no guarantee of success. Whilst they initially may look like a very attractive bargain at the beginning, the road to rescue can often cost a lot more than was anticipated.

“Managements of weak companies often announce plans to improve earnings and other fundamentals, but my experience is that turning around entire companies usually is a difficulty process that rarely meets with satisfactory success”  Ed Wachenheim

Turnarounds are exceedingly rare and bargain stocks often wind up costing a good deal”  Scott Fearon

Many Investment Masters cut their teeth on turn around companies. Very few can show the benefits from what they initially saw as a wise investment. Most have learnt their lesson.

“I was tempted in my youth by turnaround stories or betting on new product or service offers, where you could hit the ball out of the park if things got fixed or the new product took off. But I’ve had enough failures pursuing those types of ideas that I’ve for the most part lost the stomach for them. From a performance standpoint, I’m more focused on what something is than what it can be” Thomas Gayner

“After 25 years of buying and supervising a great variety of businesses, Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them” Warren Buffett

Businesses that require significant capital expenditure to get back to profitability require a leap of faith that is often too far. Unless the business has a strong competitive advantage, the benefits of additional capital ordinarily end up with the customers and not the shareholders.

"We react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures.  The projections will be dazzling, and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.” Warren Buffett

One area the Investment Masters are particularly cautious about is poor performing retailers that need turning around.  Even at the best of times retailing is a tough business .. consumer tastes can be fickle, competition is usually intense, barriers to entry are low, margins are thin and fixed costs are high. The industry has a history of significant disruption and is a wasteland of corporate bankruptcies.

"Retailing is a tough, tough business, partly because your competitors are always attempting and very frequently successfully attempting to copy anything you do that's working. And so the world keeps moving. It's hard to establish a permanent moat that your competitor can't cross. And you've seen the giants of retail, the Sears, the Montgomery Wards, the Woolworth's, the Grants, the Kresges. I mean, over the years, a lot of giants have been toppled." Warren Buffett

“Warren [Buffett] is super smart and highly disciplined, but he has made lots of mistakes in other industries. Berkshire has bought many loser retail operations over the years. Other than Nebraska Furniture Mart and Borsheim’s, most of the rest of them have not worked out so well.” Mohnish Pabrai

“I don’t do retail because you have to recreate the demand every day.” Jeffrey Ubben

Retail is a tougher place to make money than most people realise.” Guy Spier

"I think Warren and I can match anybody's failures in retail." Charlie Munger

Retailing is a difficult business.  It involves large investments for a thin margin.” Marathon Asset Management

Retailing is a tough business.  During my investment career, I have watched a large number of retailers enjoy terrific growth and superb returns on equity for a period, and then suddenly nosedive, often all the way into bankruptcy.  This shooting-star phenomenon is far more common in retailing than it is in manufacturing or service businesses.  In part, this is because a retailer must stay smart, day after day.  Your competitor is always copying and then topping whatever you do.  Shoppers are meanwhile beckoned in every conceivable way to try a stream of new merchants.  In retailing, to coast is to fail.” Warren Buffett

In retailing good management is essential  ...

“Buying a retailer without good management is like buying the Eiffel Tower without an elevator.” Warren Buffett

But sometimes even that isn't enough ..

"Every day retailers are constantly thinking about ways to get ahead of what they were doing the previous day. Retailing is like shooting at a moving target. In the past, people didn't like to go excessive distances from the street cars to buy things. People would flock to those retailers that were near by. In 1996 we bought the Hochschild Kohn department store in Baltimore. We learned quickly that it wasn't going to be a winner, long-term, in a very short period of time. We had an antiquated distribution system. We did everything else right. We put in escalators. We gave people more credit. We had a great guy running it, and we still couldn't win. So we sold it around 1970. That store isn't there anymore. It isn't good enough that there were smart people running it" Warren Buffett

And turning around a poor performing retailer rarely works...

“Turning around a retailer that has been slipping for a long time would be very difficult. Can you think of an example of a retailer that was successfully turned around? Broadcasting is easy; retailing is the other extreme." Warren Buffett

“In general I don’t like retailers, and I have a bias against turnaround of struggling retailers.  Those are very hard things to pull off”  Mohnish Pabrai

"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." Warren Buffett

It's easier, less risky and likely more profitable to find other things to do...

"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." Warren Buffett

Particularly with the arrival of Amazon...

"[Amazon is] one of the most powerful models that I've seen in a lifetime, and it's being run by a fellow that has had a very clear view of what he wants to do, and does it every day when he goes to work, and is not hampered by external factors like people telling him what he should earn quarterly or something of the sort. And ungodly smart, focused. He's really got a powerful business, and he's got satisfied customers. That's hugely important." Warren Buffett

In 2016, Buffett sold his position in Walmart .. he decided to look for an easier game.. 

".. Amazon in particular is an entity that’s gonna have everybody in their sights. And they’ve got delighted customers. And it’s extraordinary what they’ve accomplished. And a lot of people, the delivery, you know, and that is a tough, tough, tough, competitive force. Now, Walmart’s pushing forward online themselves and they’ve got all kinds of strengths. But I just decided that I’d look for a little easier game.”

Turn around business situations, particularly those in retail are hard going. Lots of capital, lots of hard work and almost constant management intervention are required. Is it really worth it, though? The Investment Masters have determined there are far easier fish to fry out there....

Article by Master Investment Class

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