Sunday, December 27, 2009
* Here's something else that makes no sense: California housing prices rose on a YoY basis by 6%, and there is anecdotal info that the flippers are back. California is like Greece, but the Greeks smelled the coffee while the Governator is asking for a bailout from the taxpayer. Who's the "girlie man," Arnold? California has outmigration of taxpayers and businesses, powerful public employee unions, a large underclass, highly business-unfriendly climate and dysfunctional politics. Official unemployment in the state is over 12%, and yet, housing prices- which never went down to proper income-based levels, are going up.
*2008-2009 were the years of the corporate bailouts (when the government decided that failure is not an integral part of capitalism), 2010 will be the year of the state bailout. CA is already asking the other states to fund its deficits, can NY, IL and MI be far behind? Newsflash for the states: if you can't cover your spending with taxes, then increase taxes or reduce spending. Surprisingly for me, NY's Gov. Patterson here has been a breath of fresh air coming from the Albany cesspool. He sounds like he gets it unlike most pols who still think it is politics as usual. The simple truth is that the government costs too much to run.
* I already wrote that one should be aware not only of the news as it comes out, but also the context of the news, such as the date and time the news was released. I pointed out that the House voted on the healthcare legislation on a Saturday at 11 pm, and interpreted it as a bad sign. The Senate voted on their version in the early morning on Christmas Eve. This, along with the partisan nature of the vote and the incremental cost of the last vote (the NE senator), is bad news. The other news that came out in the afternoon is that the Fannie and Freddie bailouts are now unlimited. This is correct: unlimited. And instead of having the past board and management of the companies in jail, and keeping the current management on an $1 salary while they wind down the portfolio, Little Tim is giving them $6 mm of your money.
* One can only speculate as to why the FNM and FRE news was released on a holiday afternoon. My thoughts are that they will be forced to grow again (which means credit losses) as the FHA is about to blow up. Because the bank bailout via housing market inflation sure ain't gonna get done by itself. But this is just me, a cynical guy sipping his coffee at home with the keyboard on my lap.
* In June, I declared that POTUS is a failure. By now BHO completely "owns" Iraq, Afghanistan, the economy, the twin deficits, Bernanke, Geithner and healthcare "reform". He has failed on the first six, and is about to fail on the last one.
* Keeping up with the political streak, if I were running against an incumbent in 2010, I would run on repealing most legislative initiatives (passed or proposed) by Pelosi, Reid and the like. Few incumbents are safe, and I am looking forward to possibly having more reasonable, thinking people in both chambers.
* Is the US going to "emerge stronger" the way "we've always done it"? In a word, no. To qualify, very likely "no." I recommend reviewing Taleb's story of the turkey (figure 1 in the essay). The "growth" has been funded by debt just like the turkey's weight gain has been funded by the farmer. The turkey is happy because, see, every day things move up. The farmer has other things in mind, of course.
So how likely is that the debt gets called one day? I don't know. If I knew, I would not be writing about it. Some of the signs will be rapid currency debasement (vs. hard assets) and rapidly rising interest rates on government bonds.
Speaking of turkeys, here is a nice clip of Idiocracy's poster girl, Sarah Palin, trying to use multisyllable words while some guy is beheading turkeys in the background.
Tuesday, December 22, 2009
I have written about the private label growth in food several times: most recently here (discussing the top growing categories, BrandWeek declaring '09 the year of the private label and CVS consolidating its battery offering to PL and 1 brand), earlier here, (amazing expansion of the PL offerings at a number of retailers; very wide consumer acceptance) and, earliest here (some firm names and initial thoughts).
Nice to see that at least one branded food company does not have its head in the sand. Heinz (NYSE: HNZ) seems to be with the program. Here are some excerpts:
"[HNZ] sees a long-lasting consumer shift to thrift and must carefully balance its business strategy in response, the ketchup maker's chief executive said on Monday...Heinz Chairman and CEO William Johnson told Reuters in an interview the company will have to weigh its approach to promotional trade spending, such as coupons, and other types of marketing as consumers continue to focus on price even as the economy in the United States and Europe improves.
"To say that consumers will return to historic norms is disingenuous," he said...
"What we're seeing right now is an industry that in some cases is grasping for volume and, as a result, has ramped up trade spending," he said.
But Johnson said the maker of Heinz ketchup, Ore-Ida potatoes and Smart Ones frozen meals would not keep resorting to that one strategy to keep sales aloft."So, to translate in English: we have a problem. We have been selling undifferentiated products at higher prices thinking we are protected by the brands we have. We were wrong. We are getting killed by private label. Since we have huge fixed costs, some in the industry have been lowering prices to keep the volumes. We have been doing the same thing but would like to signal to the industry that we think that it is time we stop, and come up with something else. We just don't know what yet but will signal once we figure it out. HNZ is not in the worst shape, in my view, from the food majors. No one else can make ketchup of the same taste, and (as far as I know) with the same margins. They also have a good variety of higher value add products.
Today two of my favorite staples companies were involved in deals today.
One, TreeHouse Foods (NYSE: THS) is acquiring a major player in private label hot cereal and drink mixes called Sturm Foods. I already complimented heavily TreeHouse's management in the articles above, and this deal is supportive of my viewpoint: accretive to EPS in less than a year! The market definitely liked it, and the stock was up 15-16% (mind you, this is a sleepy staple stock) following the deal announcement and increased guidance on top. Not a bad way to start Christmas week.
Two, Chattem (CHTT), a major player in OTC remedies and personal care products with a "drug" twist, is being acquired by Sanofi, a pharma major. CHTT has been a top performer in the staples area (the stock was at $3 in 2000, the deal is at $93.50/share). I already wrote in the last post that I see the possibility of a substantial drop-off in new blockbuster prescription drugs in the future. On the other hand, with healthcare becoming a worse mess by the day, one can see the argument for growth in self-medication (webMD is a pretty high traffic portal: it can't just be hypochondriacs, right?). It seems to me that Sanofi- again, a pharma major- is voting my way by acquiring CHTT and expanding their consumer OTC portfolio. If they were seeing a better future in R&D, they'd be spending that $2 bn someplace else. Though I wonder what the Parisiens think of Chattanooga, TN: "the birthplace of the tow truck, Chattanooga is the home of the International Towing and Recovery Hall of Fame and Museum" (from Wikipedia).
Friday, December 11, 2009
There will be big things that go right, for sure. I just don't know what they are so I can speculate: this blog is free to read which should give you a reasonable estimate of my ideas' real worth.
Things that will go right, almost by definition, are ones that are going to happen without requirements, directives, management or supervision by the government. Think about things like digital music, digital books, e-commerce, social networking, software, "brute" computing power or mobile communications: on average, great advancements that have succeeded in a large part because they are not heavily regulated, or regulated at all. The FTC does not require Intel to make faster chips. The market does. The competition does.
At a different level, Kuwait and Mali happen to be desert countries, and yet one is many times richer than the other (~35x on a GDP/capita PPP basis). Did it have anything to do with either government? Largely, no.
So, with that in mind, what are things that can go right?
(1) Shale gas is more commercially viable than previously thought. Gas replaces gasoline and diesel for fleet needs (similar to "The Pickens Plan"). This lowers petroleum prices for everyone else, resulting in a big tax cut effect. Compare this to government-hatched initiatives, such as ethanol or "clean" coal. Both are absolute malinvestments.
(2) Baby boomers do not retire as planned. The "not exactly greatest"(TM) generation does not exit the work force en masse for various reasons, including insufficient savings and fear of/actual inflation that makes it harder to live on fixed income. Higher middle class taxation also hinders savings. As the biggest chunk of the government obligations are future benefits, this works very well towards reduction as less people are eligible and more people continue to pay taxes.
(3) Baby boomers do downsize en masse, lowering housing costs for everyone (and shooting themselves in the foot, thus delaying the mass retirement even further). This is also a "tax cut" effect. Imagine the average household going from 33% of spending on housing to 27%.
(4) In many ways, "we" have already killed the pharma industry. As they reduce R&D spend, the drug pipeline dries up. This means that in a few years, all these expensive blockbuster drugs will become generics, and there won't be new expensive blockbuster drugs. While this is undesirable at one level, at another level, this should lower healthcare costs as say 90% of the drugs consumed are now priced as generics vs. a substantially lower percentage now.
(5) The population actually loses weight on average and smokes less on average, again lowering health care costs. Smoking rates, save for last year, have been on the decline for most of the decade. This is good news for healthcare costs (yes, I know there are estimates that smokers are "beneficial" in aggregate for tax purposes; I do not buy the argument for a few reasons). The obesity "epidemic" can also take care of itself: I have been reading reports that there has been an uptick in liposuctions as the job market has gotten more competitive. Is this a permanent change in the average views on obesity? I hope so.
Interestingly, the two states with a soda tax (W Va and Arkansas) also happen to have some of the highest obesity rates.
(6) Inflation lowers the real cost of government employees and retirees. Underreported inflation over a decade gradually lowers the real cost of government payrolls, and more importantly, the "guaranteed" pensions. Generally, private businesses can respond faster to inflationary pressures that the government can. Private businesses also have a better view on the "real" inflation as they have incentives to monitor their costs. Government managers have incentives to maximize their budgets and employees under supervision.
(7) EU, China and India gradually assume more "world policemen" roles. This lowers US defense spending thus alleviating the deficit. Defense is by far the largest expenditure in the federal budget, and the Ministry of War does a great job at ensuring that cash keeps flowing to it and its top management's future employers, the military industrial complex.
(8) "College education" stops being universally accepted as something of value to everyone, especially with costs going up, which makes the basic cost/benefit analysis more difficult. A reduction in the college-bound population leads to lower educational costs for everyone college-bound, less malinvestment by people who'd be better of not even trying, and less losses borne by the taxpayer on the student loan guarantees by the government.
As you can see, most of these require little to no action on the part of the government and require little to no inventions. These things can "just happen" without any scientific advancements or "public policy decisions", and nearly everyone would be better off.
Monday, December 7, 2009
Quick trade update on the ETF convergence that I described. It would have worked. The long GDX opened at $49.39, or a 2.56% drop. The short GDXJ opened at $26.25, or a 3.28% drop. In other words, as suggested, the long did better than the short. This was still true at 9:45 which was the last time I looked at it. Obviously, one needs to have pretty low transaction costs (this is 2 round-trips) and exceptional execution to win at this. One might also recommend doing it only with other people's money.
Another risk factor that came to mind about this trade is that since I do not know the exact composition of either ETF, the juniors might be more heavily weighted towards Canadian companies, which introduces a cross-currency dynamic.
On to the personality brands discussion.
One, I stated that I think the famous golf brand that has been in the news is safe. I retract this statement as more news of the less-flattering variety have emerged over the weekend. This has become the perfect illustration of one of my favorite theories in finance, the cockroach theory. There is always more than one (problem).
Two, this would make an excellent business school case. There are a lot of multi-disciplinary tracks that our "future business leaders" can discuss smugly. Marketing/branding is one. Then there is PR, media and entertainment angle: what kind of a story can sell more copies? The legal aspect: prenup with earn-outs, contracts with pay-outs, high-powered fixers.
I am just surprised that such prominent ambulance chasers like Jesse Jackson and Al Sharpton are not all over this, like they were around that white-gloved entertainer's funeral. The latter activist would be perfect to "define down deviance": he is quoted as telling the kids of the dead entertainer "wasn't nothing strange about your daddy." May be the brand tried to be post-racial just like the current presidential brand.
There is just too much money bet on this horse to let things be.
Three, let's look at payouts for the women.
The golfer is the productive asset here, and the re-distribution scheme is very logical. Basically, the key to getting a higher payout is a combination of exclusivity and access ("access" overlapping with being a threat by means of that access).
Highest payout: the wife. Legally exclusive relationship, full access to the asset; on top, she had access to the pro-circuit as hired help that got lucky. Payout: she and her kids are set for life
The payouts for the rest of the women in the story are also based on exclusivity and access. The story each one of them can tell is likely the same story, so being first REALLY mattered. It is rumored that the NYC woman got a huge sum, while the 1st cocktail waitress got $100k from the media, and now it sounds like the Perkins waitress gave her story for free. How much value is there to each subsequent story? Not the $1 mm the first one allegedly got, unless there is something even more scandalous.
So, ranking the payouts, Scandinavian model-wife>> NYC party girl >> Vegas cocktail waitress >> local Perkins waitress. It is almost too logical as it follows the likely lifetime earnings potential of each.
Perkins, for the benefit of the non-US readers, is a low-to-mid priced family restaurant chain in the US.
Four, the sponsors in this case were either incompetent, complicit or a combination of both. There should be brand managers fired over this. Where is the due diligence?
This reminds me of lobotomized pensions managers blindly accepting the AAA stamp on whatever they were buying. Everyone is doing it so we're really happy were able to get our hands on some of these nice, safe securities.
Here the sponsors got played a little bit too, in my view. Since the brand can only be linked to one company in most categories (i.e. apparel and equipment, autos, credit card), there is a sense of competition and urgency between the sponsors, who then went on to pour millions of dollars into brand building.
The biggest fallout should be with Nike. They really built their golfing business out of nowhere on the strength of this brand, much like they built the basketball business on Jordan and the soccer business on Brazil. GM, AmEx, TagHeuer and Accenture should not hurt too bad. The golf brand was not essential to them in my view.
Since Nike has the most to lose, chances are they will try to stick with their investment as much as possible. There is also the danger that the sponsors exit en masse. A bit of game theory, if one blinks, all stand to lose. Surely interesting to watch on the side.
Five, there is quite a bit of wisdom passed on from Ben Franklin, some of it R-rated. In this letter, he spells out some battle-tested advice on the choice of a mistress, if one absolutely must have one. Discretion is high on the list of qualities he lists, and for a good reason.
The golf brand should have approached other brands who have a lot to lose if the affair becomes public: top-brand athletes like Maria Sharapova, Gabrielle Reese or Mia Hamm would have been perfect, as it seems that the golf brand was not seeking emotional connections.
Six, and more philosophical. This whole story is one of false idol worship. So, to note that man-made idols are nothing new, I leave you with Percy Shelley's sonnet Ozymandias which describes even the physical fallibility of self-described, alleged and even actual "greatest's."
I met a traveller from an antique land
Who said: Two vast and trunkless legs of stone
Stand in the desert. Near them, on the sand,
Half sunk, a shatter'd visage lies, whose frown
And wrinkled lip, and sneer of cold command
Tell that its sculptor well those passions read
Which yet survive, stamp'd on these lifeless things,
The hand that mocked them and the heart that fed.
And on the pedestal these words appear:
"My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!"
Nothing beside remains. Round the decay
Of that colossal wreck, boundless and bare,
The lone and level sands stretch far away.
Saturday, December 5, 2009
There was a big drop in gold on Friday. May be the yellow metal was taking a breather, may be it is starting to reverse, who knows? Certainly I do not. Knowledge of the future is highly valuable, as the Galleon case illustrates, and I do not have it with any certainty. At any rate, GLD was down 4.17%. The gold miners ETF, GDX, was down 5.31%, while the jr. miners ETF, GDXJ, was down 4.81%.
This might be a good ST conversion bet. Long GDX, short GDXJ in equal dollar amounts. GDXJ should move in any direction by more than GDX does, and GDX should move in any direction more than GLD does. Why is that? GLD is the physical metal, already mined and stored, less expenses. GDX is equity in miners, and miners, even if they are not financially leveraged, are operationally leveraged on the price of gold. Due to their high fixed operational costs, if the price of gold doubles, their earnings should more than double. GDXJ should be even more operationally leveraged: lower yielding mines, lower economies of scale, riskier governance, etc.
This is a risky trade for several reasons. One, precious metals got really volatile on Friday. A friend of mine who trades for a living, and who happens to be a big gold/silver bull, is out over the weekend just to see how it plays out. This means that the planned convergence may not happen. On top, even though the mean and median absolute daily performance of GDXJ is greater than that of GDX (which is consistent with the the operational leverage theory), GDXJ started trading relatively recently, so the number of observations is small.
Finally, of course, you can ask John William Meriwether how well big convergence bets work out.
Speaking of Meriwether, he is obviously a big believer that a third time is a charm, so he is launching a third fund doing, again, "relative value arbitrage" just like LTCM and JWM. A fool and his money are soon parted. But this is a nice lead in for the second thought. It shows that risk is back.
One place where you see this is the high yield market. The Distressed Debt Investing blog, a great blog BTW, reports: "In November of 2008, there was over $230B of corporate debt trading below 50% of par. Today there is less than $10B. As a percent of the market, 31.4% was distressed in November and now only approximately 1%." Emphasis mine.
In other words, someone (or a lot of someones) are throwing money in high yield. There is also anecdotal evidence of things getting too heated. Blockbuster did a deal in October. This is akin to a Trump-branded Dubai yacht harbor getting 3.50% fixed rate 30-year financing. Then last (?) week Pinnacle Foods, a Blackstone portfolio company, bought Birds Eye Foods, a Vestar portfolio company, with a $900 mm covenant-light ("covvie-lite") financing. Now, one, this is a huge deal relative to the recent HY deals, and it is cov light, and it is a sponsors flipping the company to another sponsor. Then there is the JohnsonDiversey deal, which has a PIK provision. These are all dear "relics" from the '05-'07 "boom."
How can one play this? Look at JNK, I think the most liquid high yield ETF. It has had a nice run along with equities since March, but it started leveling off. The run-up, as described in the quote from the debt blog, and the deteriorating quality of lender protections are signs that JNK might be going down. One can even short JNK and long LQD to bet that even if rates continue to go down, high grade will outperform on a relative basis.
Risks in this trade, again, are plenty. I am positive yields will be rising but as Howard Marks, the Oaktree Capital chairman writes, being too early is often indistinguishable from being wrong.
Now on to another recurring theme on this blog: brands. Again, as I have studied more marketing than the average consumer, I do not have "relationships" with any brands. But I do recognize and respect their power.
One of the big news this past week was the adversity that a certain golf brand experienced when it turned out that the person on whom the brand was based had been doing things that can be classified as "inappropriate." The brand protection machine went on full speed and it seems, at least to me, that the brand will be salvaged.
But the companies supporting this brand already have plenty of experience with risks like these and know how to manage publicity crises like that.
Michael Jordan has had well-publicized gambling problems and went through an ugly divorce, and yet the brand is doing fine.
Lance Armstrong also went through a divorce 2-3 kids later; moving on, he proposed to and then dumped Sheryl Crow; he has been through 2-3 high profile women since then, fathered another kid, etc. And, yet, the brand Livestrong is going on strong.
Kobe Bryant, another unfaithful husband who was also accused of rape, has rebounded quite nicely, even though he did change sponsors and does not have a product brand solely under his own name.
Martha Stewart went to jail, and came back nicely.
This highlights the risk of building a wholesome brand image based on a real person. It is almost easier if the brand is built based on being "real" (or even a "bad boy"). Someone like Charles Barkley is a good example. He does stupid things periodically (such as driving drunk or throwing someone through the window during a bar flight) but he "gets" it once sober, takes ownership of it, and moves on.
Sometimes overreliance on a personality brand can spell trouble for the entire enterprise. A recent example would be Steve and Barry's Chapter 11 and subsequent liquidation, and their reliance on Stephon Marbury//Starbury to drive sales. Turned out $9.99 shoes were not a great idea. Nether was relying on Marbury who showed all the caprices of a douche-star well-before achieving anything. Of course, taxpayer-backed GE Commercial Finance did the DIP loan after the Ch 11. I do not know what the recovery was.
So if there is a caveat related to investing here, look beyond the brands per se. As The Oracle of Omaha says, "I like Disney because the mouse does not have an agent. " Or something to this effect.
Sunday, November 29, 2009
So, to repeat, my thesis, PL has been growing and will grow at the expense of its branded competitors. Further, this is not a temporary phenomenon but rather a "new normal" as shelf space and cold case spots are likely lost forever in many categories, especially in categories where no PL existed prior to the crisis. So do not get lulled to a comfortable haze when company X tells you how many "billion-dollar" brands they've got.
I decided to write a new article, rather than just an update, because Brandweek released the top growth categories for private label over the last year, and the results are very, very interesting.
So, the #1 growth category is Baby Food. Think about this for a moment. Most new parents do not take chances with anything when it comes to the baby. Nothing but the best for junior. Baby food brands are heavily marketed to new parents, with their special ingredients and superior taste. And yet, parents are overwhelmingly going for the PL products! This is not daddy going for Busch instead of Bud or Mommy going for no-name crackers instead of Wheat Thins. This is mommy going for the cheapest baby food options. A "new normal"? Quite possibly.
Also note that PL baby food sales are tiny as an absolute number. You can bet this will be growing. Especially since this is not a traditional PL category, more and more chains will be adding their own PLs as acceptance grows. Call it a "network" effect of sorts. Additionally, baby food is a very high-value add product with complex, regulated manufacturing.
The #2 growth category is frozen pizza and snacks. This comes despite a huge advertising push for DiGiorno ("DiGiorno-mics" or something, with a strong value message). Again, this is not a high PL penetration category normally. This is usually the domain of high-value added, complex branded products, with several pizza restaurant brand extensions thrown in for a good measure. Frozen snacks, like pizza rolls, are even harder to make. And, yet, PL is hitting it hard. Freezer space is even tougher to get than regular shelf space, so think again what are the implications.
The #3 growth category salad dressings, mayo and toppings. I personally see no reason why PL penetration here has not been higher. Dressings are sold based on how close to the "average expectations" their taste is. No reason why a major shopping chain would not have its own, delicious mayo and top 5 (my estimate) dressing flavors: italian, ranch, thousand island, caesar + vinaigrette of some sort.
In summary, what is this "telling" us? One, extraordinarily wide acceptance as consumers are going for PL even for their babies. Two, high-value added, complex products are the next PL target. Three, branded sales in many categories are likely permanently impaired.
Who are the big non-winners here? The top branded baby food guys are: Mead Johnson (NYSE: MJN), Abbott Labs (NYSE: ABT) and Nestle (OTC: NSRGY).
The big branded frozen pizza players are Kraft (NYSE: KFT), Schwan (Private), Nestle, and General Mills (NYSE: GIS).
The branded mayo companies are Kraft and Unilever, dressings again Kraft, Unilever and Clorox.
Obviously, don't go and short these companies just because they have lost share in these categories. They are all very well diversified and operate internationally, while this data is US-only. But the data is something to keep in mind in aggregate.
I already wrote about the publicly traded PL guys before, so no need to repeat it here. Also, you see what I describe strictly in food, bev and some OTC. This does not extend to all brand-centric companies. The data is much harder to come by in areas like clothing (specifically, "compression wear", I was successfully short UnderArmour at one time) or other places.
Update 1 12/01/2009: Here is an interesting story from Reuters. CVS is dropping Energizer alkaline batteries, and will instead have only Duracell and... you guessed... private label. "The move comes as CVS and other retailers work on trimming the variety of products they sell to make it easier for shoppers to make decisions on what to buy." Guess whether the retailers' own brands will stay on the shelves. "Last month, Deutsche Bank analyst Bill Schmitz said he expected retailers to make shelf space decisions over the coming weeks." Who's likely to win here? For my non-NA reader, CVS is a major US-style pharmacy chain with 7,000 stores (they also have a pharmacy benefit manager business, and quick clinics business). I guess I can add batteries to food and OTC medicals as a PL-category. Batteries are overmarketed and I read somewhere that consumers are unable to judge the quality at all.
Update 12/11/2009: Here is something from the McKinsey Quarterly. Even though this is only a part of the full article, the gist is clear:
Companies waiting for a return to normality following the recession may be disappointed. Their customers have tried cheaper products—and actually like them.
Wednesday, November 25, 2009
Today I decided to do some forecasting around the number "2". They are not time-specific but I think they can happen at "roughly" the same time.
They are gold at $2k, S&P500 at 2k, and USD/EUR at 2. EUR up by the least amount due to competitive devaluations. S&P up by the most as the gold grab turns to "any asset" grab; very strong performance by the energy, hard asset and real estate components of the index.
While we're at "2", inflation expectations hit 20%, unemployment hits 20% and Obama approval ratings hit 20%.
There was a lot of noise recently about Obama's deep bow to the official representatives of our creditors. I can assure you that this is nothing: he will be bringing a shoe-shine kit the next time around.
Here's my sampling of future headlines (date range 2015-2050):
"New generation Chinese Navy submarine boat surfaced today by downtown Chicago's Lake Michigan yacht harbor. It was boarded by USDA inspectors concerned whether there was any raw meat or plant seeds on board, and released after a call from Washington"
"CNOOC today signed a 99-year lease to manage responsibly all National Parks west of the Mississippi. Along with drilling, logging and mining, CNOOC has promised to plant various native trees and grasses on the grounds of the parks. They will remain open to American citizens for at least five years, according to Mr. Weng Chei Pen, CEO for the Americas"
"CNOOC spokesperson Jennifer Johnson assured the press that the company will increase its hiring of local Hamptons residents to work on the company's area rigs"
"The USDA has confirmed that American farmers will be able to meet the Chinese wheat and soybean tax this year ahead of schedule, and expressed concern about the 12% tax increase scheduled for next year, as fresh water exports to China have lowered crop yields across the Midwest"
"The US Army has lowered its mandatory draft age to 15 and expanded it to girls, as the US participation in the Coalition of the Willing escalates, after a request from China for additional troops to suppress a natives' uprising in Iran."
"US taxpayers frustrated by Chinese language tax forms, gold payment requirements"
Friday, November 20, 2009
I have been following on a semi-regular basis several stocks of companies that operate as "MLMs" ("multi-level marketing"). They are Avon (AVP), Herbalife (HLF), Usana (USNA) and Prepaid Legal (PPD). There is a thin line between the legitimate and not-so-legitimate operators in the business: the FTC guideline is that if there is an overt focus on "recruitment" rather than selling the actual products/services to non-affiliated end-users, then the organization is most likely a pyramid, rather than a legitimate enterprise. Many operate in a cult-like fashion, preying on the gullible, promising riches, opportunities, success, and so on. They try to convince their recruits that the outside world does not understand them and that they are special, selected group.
A MLM turns into an outright pyramid when the demand for its products is generated mostly within the "system" (through forced sales to each "member") thereby necessitating the constant addition of new members not just for growth but just for maintenance. Once the world runs out of greater fools, the pyramid collapses, much like a Ponzi that runs out of new investors to pay off the old ones. The only people ever making any kind of money in these enterprises are the founders/top layer.
So this brings us to today's news that Pre-Paid Legal (PPD) has received a draft complaint by the Federal Trade Commission (the FTC) for its marketing practices for one of their so-called products. Their CEO and CMO are personally named in the investigation. This comes on top of a SEC investigation from early October. The stock was at over $50 then, now it is at $33ish. It should be lower in my view, and today's drop comes to no surprise to anyone who has followed this company for any lengthier period of time. I recommend Reggie Middleton's analyses (more links at the bottom of this latest piece), Robert FitzPatrick's report (pdf), Tracy Coenen's numerous posts on several schemes and Barry Minkow's "special" site on PPD.
PPD has been a difficult short because of their non-stop buyback efforts as well as the "all clear", until now, from the federal regulators.
PPD, for the uninitiated, sells "legal insurance" and, more recently, "identity theft protection." The sales are done by "agents" recruited by other agents. Agents are required to purchase the product, and then have to either recruit more agents, or sell the "insurance" to outside people. The products themselves are worthless, in my view. You can read about them all over the internet. This leads to an enormous churn, which has to be replaced by new recruits willing to suck it up for a year. The pdf file linked above shows the decline in numbers as it appears that PPD has simply run out of greater fools. I have been approached by PPD representatives twice in my life, once at a gas station in Utah, and once in a supermarket in Maine, and both times they talked to me about what an opportunity it is to have your own "sales" organization. In other words, recruit.
As an investor, here are my questions when analyzing a company of this sort:
(1) Is there an explicit limit to the "layers" in the MLM? Avon has those, I think. If there is no limit, then I'd be concerned.
(2) Product sales to agents vs. product sales to outsiders: are those disclosed? what is the ratio?
(3) Agent churn rates: do they seem excessive? Are they disclosed at all?
(4) Products/services: are those products that offer legitimate benefits combined with reasonable prices? Most products are not unique, really.
(5) How cultish is the enterprise? Do the agents get defensive and/or aggressive if you question the products or the organization during your research?
(6) How understandable is the accounting in the company's public filings? Is it difficult to track different classes of agents, actual unit sales, net agent growth and other operating metrics? If it is hard to understand, it is made hard to understand for a reason.
(7) Is management also on a "top" level in the scheme, and getting a cut from every new recruit 15-20 levels down the pipeline?
(8) Are agents required, without exceptions, to purchase "inventory" on a regular basis without regard to the agent's actual sales levels?
(9) How is the MLM marketed? Do they target certain isolated and semi-isolated groups, religiously, linguistically or ethnically, and why? I have been seeing a lot of central Americans recently with bags and buttons from a certain health food/beverage company.
(10) Actual sales figures per agent per Q or per year: are those disclosed? Are they fitting with the recruiting promises?
(11) What is the chatter on the company? Are there lots of upset former agents?
Remember, there is nothing inherently wrong with owner-operates small businesses as a part of a larger corporate enterprise. But most are single-level, with a territory manager and legitimate products: things like Snap-On tool trucks, independent bakery routes, Mr. Softee, Zee Medical cabinets, single-person franchisees and so on. The "agents" do not "recruit." They are focused on developing their own business with outside customers. There is no cannibalization, forced out-of-pocket inventory and the like. Franchising is highly regulated and is less likely to attract bad actors (there are some really bad business models, and some incredibly high fees, but that is a different risk). "Buyer beware."
P.S. I should also point out that I have studied PPD in grad school as an example of deceptive accounting (yes, they are a case study) from the late 90's-early '00s, and, more recently, I looked at their accounting again.
Thursday, November 19, 2009
Back on track, KFT/CBY is something that I followed via updates here. A few things have happened since the last update, so it will be nice to have a recap in a new post.
(1) Kraft has gone hostile without raising the offer.
The original offer is now lower as KFT's stock dropped immediately post-announcement and has stayed in the $26-$27 range.
CBY calls the offer "derisory": gotta love the English sense of humor. Where was CBY's stock before the offer, pals?
I have to admit that I am pleasantly surprised by Kraft's stance in this case. Good for them, as this is proper negotiations techniques on display. I, as well as the market, was expecting an increase prior to going hostile, instead KFT is holding firm, like a Milka Zartherb chocolate after a night in the freezer.
(2) Yesterday, CBY had a huge spike, and fell, but stopped at a higher level, when the word got out that HSY and Ferrero might do a joint bid. HSY confirmed talks but no imminent offer. Exactly how that would work out, I do not know, possibly some sort of a split across the ocean.
In any event, it is a dangerous situation to be in. The only bid right now is KFT. A new bid may come above KFT but below the current price. KFT signaled during the last call that they would be disciplined (telegraphs "no bidding wars" to potential entrants). And, yet, CBY traded even higher. The potential for getting creamed in this situation is dangerously high. Do not attempt to do this at home. An arb would be short KFT and long CBY, and if KFT drops out, their shares will likely move up, CBY will move down, which is the exact opposite of what the arbitrageurs want.
(3) There is a good writeup on Kraft's credit woes over at Research Recap. Moody's does not like that KFT is once again looking to borrow before paying down the debt they took on for the Danone biscuit acquisition (yes, my friends, Le Petit Ecolier has now joined Miracle Whip at Kraft). There is also an interesting wrinkle with the COC provisions in CBY's current bonds. So, I think when it is all said and done, the case study would be interesting.
Research Recap today has good links from several sources with analyst opinions. Basically, KFT is still the front runner, Nestle does not seem to care, HSY's weird structure is once again coming in the way of a deal if equity is required.
Update 1 11/21/2009: Bloomberg is reporting that the Hershey trust is pushing for a HSY-only bid. Note that they do not have the cash for it: they are looking at $10 bn in cash, $2 bn in new shares and $X bn (sounds like $5 bn) from a partner. They mention PE, looking at their advisers, Buffett might also chip in, as he did in the Mars-Wrigley deal. What's becoming clear is that there will likely be a second bid, probably not much higher than KFT's, and it will come from a coalition of some sorts: HSY-Ferrero-PE-Buffett.
One of the nicest things about having an anonymous personal blog with a financial slant is that I can write whenever I want to about whatever I want to. So I like interspersing the serious, near-macabre posts with some lighter ones, such as "The SWPL Portfolio."
I have not done a food review here, and I have done only one beverage write-up earlier this year (Wild Turkey Rare Breed Barrel Proof bourbon). I recommend this fine spirit to all, even to my regular readers in places like Vilnus or Liverpool, NSW (hi, guys!).
The food review/recipe is for cheese pie aka tyro-pita aka banitsa aka burek. There are two kinds of basic kinds of burek, rolled or layered, based on how the filo dough is folded. This one is layered, with eggs and feta cheese. I use about a pound of cheese, six eggs and a package of filo (roughly 20 14x18 sheets, or 1 pound- 454 g), oil and seltzer water. Soak the feta overnight in regular water to remove all the excess salt that they put in for some reason. It should not be saltier than ricotta or cottage cheese.
The recipe is harder than usual. So, start with a pan but do not oil it. Crumble the feta and set aside. Layer one filo sheet, brush lightly with oil, and sprinkle some of the feta. Go all the way with the filo sheets, not putting feta on top. Then cut the layers all the way through with a knife making squares about 1.5x1.5 inches in size. Beat the eggs with one glass of seltzer with a mixer and carefully pour the mix over the cuts you just made. Let it sit and soak for a few minutes, then bake until golden-brown. Once out, take two bowls, put them on the counter upside down, and flip the pan with the burek upside down on them so that the edges of the pan rest on the bowls. This way the burek will "hang" and become even fluffier after a few hours. It should be sticking to the pan which is why you should not have oiled it. Old school and delish.
Also, recently I came across a real "independent" brand French cognac. Most major brands of spirits are owned by a handful of multinationals and some people feel cheated when they find out that their "special" brand was owned by company X. I personally view "brand relationships" with a fair level of sarcasm, may be because I studied quite a bit of marketing as an undergrad, but most people to one level or another have an attachment to their favorite brands. This is why marketers describe brands as something people "love", "trust", "know", "rely on", etc. These are all "relationship" words. They even do studies to assess what % of the population remembers them in "unaided recall" and "aided recall", are we the top brand? Do we define the category? People wed to brands even more strongly when brands use personal brands as tie-ins: Lance Armstrong/Nike, Woods/Tag Heuer, and so on. Sadly, my pair of airmax shoes have failed to make me fly. Anyway, back on the topic.
So here a brand of cognac that you can have an honest relationship with: Jules Gautret. ("Maison Foundee en 1847"). Between cognac and wines, these guys have annual turnover of 18 mm euros. Definitely a nice small business. The cognac product range is here. "Jules Gautret's passion and attention to detail have been perpetuated to this day. The firm's cellar master is like an orchestra conductor, balancing sublime, subtle nuances to create a perfect harmony that reflects the heart and soul of the Cognac region." I am not a connoisseur but I liked what I tried. So stock up before some giant gobbles them up.
Monday, November 9, 2009
So, why not a "Stuff White People Like" portfolio? I browsed through the list and came up with several stocks that are "on trend." Obviously, this is blog is not financial advice, so we are doing this just for fun. Some "stuff" has a direct corresponding stock (i.e. Apple) while other "stuff" does not (like "Scarves"). I am also laboriously giving the YTD return on each stock.
#1 Coffee: GMCR (YTD +174%), can't go wrong with Vermont, "green", "mountain", coffee and "social responsibility" in one
#4 Assists: Cablevision, CVC (+51%) Owners of the NY Knicks (soon to be spun-off with the MSG business)
#6 Organic Food, #32 Vegan/Vegetarian: WFMI (+202%) Despite their CEO writing an editorial in the WSJ (Murdoch and Wall Street in one!!), still the gold standard
#8 Barack Obama: a double-header here, F (+257%) autos-Michigan-unions, can't be beat under this administration, and, from the First Lady, J.Crew, JCG (+254%); of course, they also have one of the best CEOs in the industry
#11 Asian Girls: another double-header here, IAC (+26%), owners of match.com among others, and, for a real immersion, JALSY, the Japan Airlines ADR (-58%)
#13 Tea: HAIN (+1%); makers of the Celestial lines of tea
#15 Yoga: LULU (+244%); Lululemon Athletica has the yoga thing locked up
#19 Traveling: double-header again, PCLN (+136%) and OWW (+40%). Obviously, this is real travel, not going to the NASCAR races at Talladega for 3 days with the camper in the back of the truck.
#23 Micro-breweries: well, SAM does not qualify any more, now that they are the largest US brewer (what, you did not know that BUD and TAP ain't American no more??) so we have to go with HOOK, formerly known as Red Hook Breweries, that has bubbled up to +195% YTD.
#24 Wine: STZ (+4%), Constellation has a large wine brand portfolio (yes, the wine you're drinking might have come from a multinational; not some independent vineyard started by people who had the dream and the tenacity to create the perfect wine, or whatever else it says on the label)
#25 Manhattan, now Brooklyn, too!: another double-header here, SLG (+58%) and ALX (+8%) are both REITs with a heavy NYC focus.
#26 Marathons: double-header, ING (+35%) sponsor the NYC event, and ADDYY, the ADR for adidas, returning 36%. Of course, you investing in NKE would have meant FAIL in the entire SWPL concept.
#31 Snowboarding, #128 Camping: JAH (+142%) Jarden owns both the K2 and Coleman brands.
#33 Marijuana: CBIS (-51%) Cannabis Science Inc. Yes, there is such thing.
#39 Netflix: Easy. NFLX (+91%)
#40 Apple Products: Also easy, AAPL (+136%)
#45 Asian Fusion Food: PFCB (+52%) has ~360 restaurants under the PF Chang and Mei-Wei banners
#46 The Sunday NYC: of course, NYT (+18%), not bad at all for a paper
#48 Whole Foods and Grocery Coops: I mention WFMI above, so you might as well add UNFI (+42%), a distributor focused on natural foods to get the exposure to the grocery coop business
#51 Living by the water: try St Joe's, they've got plenty of land in Florida to develop, JOE (+10%)
#53 Dogs: PetSmart is doing well, PETM (+33%)
#54 Kitchen Gadgets: lots to choose from, so why not go with Williams-Sonoma, WSMI (+155%); they have all those wonderful cookbooks, too, and classes, and cutting boards made from exotic wood, and chrome toasters
#58 Japan: the first ETF in the SWPL portfolio, EWJ (+1.6%). Still better than a savings account. Just imagine saying at a party "I own Japanese equities". Cooler than cool.
#59 Natural medicine: Nutraceutical International Corp (+52%). Never heard of this small cap, but they are certainly with the program
#60 Toyota Prius: TM (+21%)
#61 Bicycles: Try Dorel (ADR is DIIB, +37%), a $1 bn cap Canadian company that makes Cannondale, Schwinn and others.
#63 Expensive Sandwiches: PNRA (+20%) certainly fits the bill in my book, they have managed to do very well at the $6.99-7.99 price point, while the giants have been hammering the $0.99 price point for 2 years now.
#64 Recycling: RSG (+11%), like it or not, the two titans there (WM and RSG) are likely to benefit the most from any recycling mandates (as is often the case with incumbent heavyweights)
#67 Standing still at concerts: LYV (+28%) gives them the opportunity to do just that as the largest concert promoter one can buy in the public markets.
#71 Being the only white person around: here's an interesting pick, try Anglogold Ashanti AU (+53%). They have gold mines in South Africa. That would be a good place, judging by the photos in National Geographic.
#75 Threatening to move to Canada: now you can do that from the comfort of your living room with the second country ETF in the portfolio, EWC, with a cool, crisp +49% YTD return.
#76 Bottles of water: this is tough, but I will have to go with the owners of all #1 water brands in the US, Nestle SA, and their ADR, NSRGY, at 20% YTD.
#78 Multilingual children: start them early with RST, "Rosetta Stone Inc", at -28%.
#82 Hating corporations: for the passionate, I recommend shorting them all, indiscriminately, at double strength with SDS. This year hating has not worked though, with SDS at -48%.
#84 T-shirts: I have already written why APP is a bad idea, but APP is just the SWPL thing, at +31% YTD (and still solidly at $2.61/share, can't even buy half a t-shirt from them).
#87 Outdoor performance clothes: check out Columbia, COLM, up a cozy +12% YTD.
#88 Having gay friends: Planet Out, ticker LGBT was public but was taken off NASDAQ earlier this year.
#89 St. Patrick's Day: IRL (+70%) is a tiny closed-end fund investing in Irish companies; also try Diageo (makers of Guiness and Bailey's) ADR is DEO (+22%), and, if you can trade the ISE, see PWL, aka Paddy Power, a solid bookmaking business. Even try K (Kellogg), makers of Lucky Charms, +20% YTD.
#92 Book deals: McGraw-Hill, MHP, is up 31% if you do not mind owning a rating agency on top.
#94 Free health care: don't we all like free? Since it can't be free, who is making money from it? Pharmaceuticals are evil, insurance companies are evil, so may be medical devices? IHI, the ETF, is up 30%ish.
#102 Childern's games as adults: bet on Hasbro, HAS, -1.4%: Cranium, Trivial Pursuit and other games WPL.
#103, #111, #118 Sweaters, Peacoats, Ugly Sweater Parties: the #1 sponsored ads for both "sweaters" and "pea coats" on Google is Macy's, so M it is, +88% YTD.
#112: Hummus. PEP has it, +14% YTD; they bought the Sabra brand a few years ago.
#115 Promising to learn a new language: see RST, from above.
#117 Political prisoners: Do you think there are too many Leonard Peltiers locked up in some dungeon? Then buy Corrections Corp. of America, CXW, +60% YTD, owner/operators of private prisons.
Obviously, with the S&P being at +20% YTD, a SWPL portfolio would have handily outperformed the index if all stocks were equally weighted.
Who needs to read footnotes about changed pension actuarial assumptions and estimate their effect on EBIT next year when you can think big, be cool and invest in the products and services you and your friends know and love???
Sunday, November 8, 2009
In one of the earlier posts on jobs and why "they ain't coming back", I mentioned that I may share some thoughts on healthcare (or "HC" for short). Now with the passage of Pelosi's masterpiece in Congress last night, I figured I might as well post some of my thoughts.
As a pre-amble, part of the problem is that our politicians view HC first as a right (vs. a good) and, second, view "coverage" in an abstract sense (just like "jobs") and equate it with "access." Also, as a part of the introduction, I should point out that I have a very good, near-insider, view of the actual workings of two large city hospitals. With that:
HC is a very complex problem that cannot be reduced to soundbites, slogans and the like as much as the booboisie would like to have it that way. There is absolutely no silver bullet and any attempted solution with create an upset constituency. Usually in these cases, as it happened last night, the taxpayers get hosed. In addition, the current changes are so wide, that the unintended consequences will be incredibly large. Just the fact that the demented congress leaders are proudly comparing it to Social Security and Medicare should be a huge warning sign.
I will take a stab at a few aspects that need to be addressed in any HC reform (and they are not in the current 1,900+ page fake math monstrosity).
The problem with US health care is cost. It costs too much relative to what it costs in other OECD countries and it costs too much relative to income. A cost problem is in essence a price problem. Prices serve as signals. Since HC is a marketplace- quite distorted, but a marketplace- the price is telling us that there is a supply-demand imbalance. There is either too much demand, too little supply, or both.
Like good market fundamentalists, let's look at both sides:
(1) Doctors: the medical mafia has made it very difficult and expensive to become a doctor in the US, all in the name of patient safety, of course. I am not saying that it should be easy, BTW, but compared to other OECD countries, where doctors are more or less a middle class-level occupation, here, in most locations, doctors are not. Part of the supply constraint is the number of years of schooling required (upwards of 10 years post high school; often 15 with fellowships for certain specialties) and another part is the cost of education. When software engineers make too much in the US, somehow the H-1B quotas get adjusted and the supply of engineers in increased. Doctors, obviously, are luckier and smarter in restricting entry into their fields.
Does the Pelosi bill address doctor shortage? No. In part, they "promise" to cut reimbursements. Like that's going to happen.
(2) Coverage availability: A huge problem now is the incredibly high cost of individual policies. There are a number of reasons for this, such as negative selection, state-level insurance market regulation, monopoly law exemptions, absolute lack of transparency in pricing and others. There really isn't a functioning market for individual policies, as far as I can judge. We recently changed car insurance policies. It took minutes. While the parallel is far from perfect, there is something to learn there.
Does the Pelosi bill address the dysfunctions of the individual policy market? Only partially, and will create more problems than it solves. At least, they recognize that it is a problem and they are attempting to take steps towards a more transparent marketplace.
(3) Employer-link: I mentioned "unintended consequences" above. A big part of the problem is that most employed get coverage via employers, and this started as an unintended consequence back in the 1940's when the government started limiting compensation to control war-time inflation. This is a very, very perverse aspect of the existing HC system. It forces employers to get in the business of buying healthcare, medicines, flexible spending accounts, dental, fitness programs and other what I would call "non-essential" business activities. In addition, employers pay for a part or all of the insurance, on top of payroll taxes. This makes American businesses waste resources on non-business activities, and makes hiring in the US expensive.
Does the Pelosi bill try to move away from employer mandates? No, it makes them worse by taxing businesses that do not offer it. I am going to make the prediction that within 3-5 years employers will be choosing to pay the 8% payroll tax penalty and not bother with the whole thing. If an employer can fire 60% of their benefits department, save on insurance costs and get away with an 8% payroll tax, I think the decision will be a no-brainer. Either that, or a wholesale move to hiring "contractors" in lieu of "employees": why even bother with payroll taxes at all? Or some other "who could have known" side effect.
I should also point out that the worst side effect of the employer-linked coverage is that it makes it difficult for start-ups to attract people. We all lose in aggregate when this happens but too few people care about what "might" have been. If Sergey Brin needed kidney dialysis, do you think he could have dedicated all his time to starting Google?
(1) Users of free HC goods and services: "poor", illegals, elderly
Most of our representatives are both innumerate and economically illiterate. Some even have troubles filing tax returns. They fail to understand that the demand for free goods is near unlimited.
As a result, here in the city hospitals, you have a huge population that pays nothing for their hospital stays, and as a result, they treat it like a full-service hotel: non-stop demands, frequent visits, you name it. Homeless people simulating sickness to stay in for a couple of days, eat and take a shower. Nursing homes refusing to pick up patients if they have another test in two days. Families collecting the social security check from grandma refusing to let her die. Caribbean tourists visiting family trying to get in for a kidney transplant. Illegal aliens giving birth to their "anchor" babies. Drug addicts faking illness to get morphine and a good night's sleep. "Poor" trying to get themselves checked in so that they get 2 week supply of meds without a copay. These are all actual cases. ALL PAID FOR BY THE TAXPAYERS/FUTURE TAXPAYERS AT $5,000/DAY.
Does the Pelosi bill address these huge generators of losses for the system? Absolutely not. Even the simplest thing, such as mandatory minimum copays, are not in. Never mind some other solutions, like, gasp, rationing. The bill even bans illegals from buying insurance, even if they want to, thus guaranteeing that the taxpayers get the tab.
(2) Heavy users of HC goods and services: the obese, the smokers, the drug users, people with genetic conditions
Another way to reduce demand would be to discourage behaviors that are likely to result in increased health care demand. The way I would approach it, the government will not pay for anyone's care if they are obese (based on BMI or body fat %), smokers or drug users. And, on top, the system should assume that one does not qualify, unless proven otherwise, with annual eligibility checks.
Does the Pelosi bill do anything to reduce future demand by discriminating against the obese, the smokers and the drug users? No.
One exception to this group are people born unlucky with genetic disorders. I would have no problem with a portion of my healthcare dollar going to those truly, genetically unlucky people. However, smoking, obesity and drug use are a matter of choice by and large (with the exception of metabolic disorders affecting obesity), and have to be actively discouraged, something the bill does not do at all.
(3) Federal programs matching state spending
Another large factor in the "demand" side of the equation is that for many of the state-level run programs, the Federal government provides matching funding. Obviously, this creates huge incentives for states to maximize spending on everything, and, as a result, costs skyrocket.
Does the Pelosi bill change these incentives to reduce demand? No.
Again, unlike most HC problems, the solution here is relatively simple. Move away from matching, and go to zero-based budgeting: every year the budget resets at 0, and every dollar has to be rejustified.
(4) Tort reform
Talk to any doctor, particularly anyone doing invasive procedures of any kind, and you are likely to hear horror stories about malpractice lawsuits. The lottery-ticket tort system (the cesspool home of slime like John Edwards, and a major donor to the DNC and the President) encourages frivolous lawsuits and outsized jury awards. Since most jury verdicts are unpredictable, doctors and their insurance companies often choose to settle, thus feeding the scum.
The current system has two perverse consequences, one is an increase in insurance costs (which can run tens of thousands of dollars or more per year). The second, and much more costly but difficult to quantify, is that doctors overorder medical tests for unlikely conditions both in in-patient and out-patient setting, and have patients overstay in hospitals while waiting for all of those to come through. This is a huge money drain in the entire system.
Does the Pelosi bill address tort reform as means to reduce demand? No.
The solution is relatively simple: limit the maximum award in any malpractice suit to $50-100k, and refer all alleged cases to the State medical boards for review. As a result, in a true malpractice case (which is something a jury in my view absolutely cannot decide as most Americans in my view lack basic science skills), the doctor would lose his license.
(5) Prescription drugs
There are a few problems here. On one side, drugs are incredibly expensive to develop, and the people who develop them must earn a proper risk-adjusted return on capital for doing so.
Then there is the other side. The US taxpayer and paying HC consumers have been paying for the development of drugs that the rest of the world gets at much lower prices. This is not a system that can last for too long as the free riders have to be cut off. Second, the US is the only OECD country, to my knowledge, that allows direct-to-consumer (DTC) drug ads. This generates demand for certain brands even when generics are available. "Ask your doctor if the purple pill is right for you" has a cost and it is coming out of your pocket.
Does the Pelosi bill address the problems with prescription drug costs? No.
There are a few things that can be done: ban consumer advertising, ensure flat or reasonable pricing across regions, and so on. Obviously, it would take too much thinking on Congress's side.
There isn't anything the bill can do per se, but it would have been the perfect occasion to start with future cost reductions via various mechanisms as it is clear that the problems we have now are only going to get worse in the future. To paraphrase a famous management thinker, demographics is the future that has already happened. And it is not pretty, in my view. Ideally, this would be a wider national discussion on aging, and how what was promised simply will not be there. There will be substantial reductions in benefits in the future, whether you like it or not, and these reductions will be in healthcare, pensions and social security, again whether you like it or not.
Does the Pelosi bill address the coming demographic upheavals in the healthcare system? No.
Finally, it is not a secret that there are substantial fraud operations going on with the various programs. Every major bust there is simply staggering in scope, but what is also staggering are the incentives for people not to work and to hide assets to qualify for the "free" programs, a small-time "beat the system" operators.
Does the Pelosi bill address fraud at the large and individual levels? No.
This is my market-based look on the bill. I am sure there are a lot more aspects of it, but I have given up thinking any more about it as there is no way I can change anything. I rate this bill at FAIL as it fails to address the underlying problems with the current system. It simply raises taxes while doing nothing for a "true" reform even though the bill is marketed to the clueless populace as "reform." It is not.
Mind you, the bill is completely unconstitutional as it mandates purchases of services from private parties that you do not want. There is plenty written about the tax increases it will bring about, going to jail if you do not have insurance (what sort of a Orwellian country is this becoming?) and so on. In aggregate, Congress took upon to reform the status quo, and made a bad situation into a complete disaster last night.
The unintended consequences of this monstrosity will surely surprise everyone. Here are a few suggestions. Remember that black swans are black swans for a reason. My view as clear as anyone's on what will happen. I am only sure it will be something that will "surprise" the consensus.
(1) Disappearance of employer-based insurance as employers accept the "fine" as a cost of doing business
(2) Republican majority in Congress in 2010 based on the HCR-economy combo
(3) Controversial aspects of the bill get voted down in the next 2-4 years
(4) Since the bill does nothing to address supply and demand, HC costs continue to outpace inflation to the politicians' surprise
(5) Attempts at cost-fixing in healthcare lead to rationing
(6) Rationing leads to a two-class health care system: one for the "rich" and one for the "masses". The "rich" pay cash to providers who do not want to deal with insurance companies or the government.
(7) The cash-only providers are banned because it is not egalitarian. End result: Royal Caribbean retrofits a few cruise ships into healthcare centers/hospitals, parks them in international waters near the big coastal cities and operates heli/ferry services lifting cash customers for treatment.
(8) Proliferation of self-medication and outsourcing of medical services
(9) The whole B/S reduces the supply of doctors, dropping the physician to population ratios to near third-world levels within 30 years
(10) Canada and Indian reservations become medical tourism hotspots for regulatory arbitrage purposes
(11) Introduction of end-of-life care vouchers to control costs. Since most costs are incurred in the last 3 months of a patient's life, when faced with a serious condition, a patient can choose to use "the" voucher. If the patient survives, she no longer has a voucher the next time around. Black market develops for identities and vouchers.
(12) No one goes to jail for failing to purchase insurance, despite what the bill says
(13) The bill thrown out as unconstitutional within four years, starting with a state judge decision in "flyover land" where there is still some common sense and respect for the constitution left
(14) New pharmaceuticals nearly disappear as producers cannot afford R&D; most pharmaceutical production moves abroad
(15) Major national politician runs on a platform consisting entirely of rounding up the illegal aliens and shipping "them" South in box cars
(16) NYT- if not liquidated by then- runs stories of young people who died while waiting for treatment while some "old, rich" white guy got it quickly
(17) Legalization of a market for organ and tissue donors for cash payers; everyone else dies while waiting for a transplant (this already exists in some niches, like eggs, embryos and gestational carriers)
(18) Patients are asked to pay for linens, food and medicine out of pocket during hospital stays (not a rare practice in many places around the world)
(19) ER doctors demand cash pay to see patients (again, not rare in many places)
(20) Increased rates in hospital-caused deaths as cost-cuts endanger basic safety
I think that my short last post, having the USSR rep knocking out the US guy just as the bill was passed is an apt analogy. I admit that I was rooting for the USSR guy, just a better all-around fighter, while keeping an eye on twitter for the vote results. What is really depressing is that there has not been a real attempt for reform since Hillary-care. Here's a classic from a few years ago, Fedor vs. Randelman, with Fedor winning shortly after being on the receiving end of this move.
Update 1 11/13/2009: Here are a couple of things that worry me a bit in retrospect. One, HC is about 15% of the economy. Congress just passed major legislation regarding HC. It was off the headlines within 24 hours: by Monday there was practically nothing. This is disturbing. Part of it might be that the Senate battles lie ahead.
Second, again a gut feeling, the bill was passed at 11 pm on a Saturday. However, our congress people love their holidays. They even take Yom Kippur off because they can. Now somehow they did a vote on a Saturday night. Hm. Makes you wonder.
Tuesday, November 3, 2009
A couple of things popped up today that caught my eye. One, Retailer Daily, is reporting that 7-11 is dramatically expanding its private label product portfolio. It will roll out 265 SKUs by the end of this year, and 300 more next year. The site also reports that Wal-Mart's private label is now on 750 goods, and that Target has a new label, aiming to expand it to 800 items.
Towards the bottom of the article, we see some good numbers for PL from various reports: "among all outlets in the last 12 months, private label unit share has grown 1.2 percentage points to 22.8% and dollar share has grown 0.7 percentage points to 17.6%. . .the U.S. Private Label Food Market - Forecasts to 2013,” the U.S. private label food market has expanded by almost 60% since 2003, as opposed to 23% growth for the U.S. retail food and drinks industry as a whole. As a result, private label now accounts for more than 19% of market value, up from less than 15% in 2003. In volume terms, private label has increased its share of the overall market to 24%, up from around 20% in 2003. And a study . . . indicates that in 2008, 24% of all food and beverages served in U.S. homes were store brands, up from 18% in 1999. Furthermore, 97% of all U.S. households consumed private label foods and beverages on a regular basis last year."
These are some impressive stats. 3x the growth, 20-25% share, very wide consumer acceptance.
As in my previous article, I should be clear that the discussion is on food/beverage private label, and does not extend to all branded products. Probably most similar to f/b are OTC medical products. I am a big believer in private label and its future, bigger role in a poorer America.
The second article comes from Brand Week. It underscores the combination of fear and contempt that brand people have for private label.
The problem for them, in part, is that the channel has become the leading force in the chain. WMT often accounts for 20% of revenues, and if you add the top 5 supermarket chains, you probably have 50% of the market cornered by some of the smartest merchandisers.
On to the article. Emphasis and commentary are mine.
"With private label brands currently accounting for more than one-third of all shopping cart purchases in the U.S., it’s safe to say that our depressed economy has done wonders for the private label sector.
But at what cost to name brands? A national or retail brand imbued with its own positioning, a unique selling proposition and a one-of-a-kind look and feel is a gold mine. However, the fact that retailers have access to the newest products and latest positioning by leading national brands enables them to steal valuable colors, shapes, symbols and keywords for the design of their own private label brands—a phenomenon that can and should be described as “brand malpractice.”
Adding insult to injury is the fact that many of these same retailers play God with consumer product manufacturers by selecting their own shelf placement. [How dare they do what they want in their own stores! We, the brand people, know better what the retailers need to be doing!]
Retailers would do well to acknowledge that they can’t be good at everything. With studies showing that an average of five parking lots are visited during a typical shopping day, it’s clear that consumers will cross-shop if iconic brands—and increasingly their line extensions—are muscled out of retail. [Laughable, non-sequitur argument. People don't stop at different stores to chase their favorite brands and their extensions.]
The playing field should be leveled with the understanding that it’s the customer, not the retailer, who will always be king. [Right! But reading the paragraphs above, I thought that the king is the Brand, and it is being dethroned by those private labelteers]"
There's more in the article. What you are seeing is reality interfering with the self-congratulatory world of the brand leaders. The crisis has forced people to go for value, and the retailers are responding properly. However, once the shelf space goes to the PL offerings, there is no coming back, in my opinion. These are gains that are here to stay.
Also, Kraft reported today. KFT makes many wonderful products, like Milka chocolates (we buy Austrian and Turkish Milkas locally in NY but they are not available anywhere else). KFT has a number of "billion dollar brands." And yet, they reported declining sales, largely due to currency effects. Flat "real" sales is not what the investors want to see, and the shares are off 3%.
Finally, tangentially related to brands, I wrote about Smart Balance (SMBL) last month. They were up 6% today upon announcing that they are going nationwide with their enhanced milk. This is branding done right: a truly unique product, favorable "big" trend, patent protection, too niche for PL entry and yet, probably 99% PL equivalent from a cost perspective, ex of marketing.
Update 1 11/3/2009: One of the publicly traded PL players reported after hours today. I already mentioned that I like TreeHouse Foods (THS) in my first article on the topic. They continue to deliver financially and operationally. Here is some color from the company's CEO: “Our strong third quarter results show that private label continues to be a strategic focus of our grocery customers and that consumers have not strayed from the value proposition afforded by quality products at value prices."
Update 2 11/5/2009: From today's CVS conference call: "Front store comps increased just under 1%, with more customers seeking out promotional prices and private label products in the quarter. Consumers I think continue to be conservative with their spending and they opt for higher value, certainly and are looking for lower price points and as I said, more value. In fact, growth in private label sales during the quarter more than doubled the rate of other sales in the front store. Obviously this is good for us from a margin standpoint." Clearly the gatekeepers like PL.
Update 3 11/11/2009: The Retailer Daily is reporting that "Private Label Edge in CPG Lessens" for the last 4 weeks. PL grew 4.3%, branded grew...0.1% Of course, it would be too much for the publication to discuss whether this is unit share or dollar share. The data is from Nielsen and may or may not include discounters, again not clear from the article.
Saturday, October 31, 2009
If you are a newbie to the inflation discussion on this blog, please take time to read this, this and this. I have a PhD in Macroeconomics focusing on inflation from Garage Logic University, and, consequently, some of my ideas are not from the US mainstream books written by the macro-cabal. They come from reading real accounts and from bruised knuckles, not from lofty, enriching beret-tweed-pipe discussions in the faculty club.
Some of my examples present real dark case scenarios. Do not dismiss them as "this will never happen here." We've been very lucky in this country, and luck runs out eventually, especially if unappreciated, like the talent of a gifted basketball player who hangs out in the wrong crowd.
Black Swans do happen, and they are called Black Swans, not fluffy puppies, for a reason.
Inflation is asymmetric
This is an FYI point that I think I should clarify upfront. Most textbooks define inflation as the overall increase in price levels, including the price of labor. This is an overly simplistic view.
The prices do not go up in unison. Essentials go up drastically and first, and keep rising (water, food, energy, medicine, security items); non-essentials sometimes take years to catch up (salaries, many services). In E Europe it took years for salaries to catch up to the pre-hyperinflation real levels. Any credit-based products (think housing) will also lag in real terms because credit will disappear, and other "normal" drivers, such as incomes, employment, mobility and household formation stall. Try selling a house if the price is 200 American Eagles, the only accepted form of payment.
Inflation will not solve the entitlement crisis
The problem larger than the $12 trillion in debt is the $50-60 trillion in promises the government has handed out to the American people. Here and there you hear that inflation will help with the "national debt." However, the $60 trillion in Medicare, Medicaid and Social Security are present value amounts. They will not disappear unless there is entitlement reform (read, massive reductions). No elected politician will stand for it, and the majority of the electorate do not understand neither the cost nor the complexity of the problem, nor its implications. But, my point here as it relates to the rest of the article, is that inflation will not help with the unfunded promises.
Inflation in a service-based economy
The sad truth is that most services are non-essential. As essentials take up more and more of the consumer budget (in Weimar Germany, food went up for 30% to over 90% of the average family budget), many service businesses will collapse. As in, $0 in revenues. Think about it, when the choice is bread or a haircut. Or keep contributing to the $1 mm life policy when a gallon of gasoline is $2 mm? All 401(k)'s cashed out in a mad rush for food hoarding? What would be the demand for real estate appraisers then? Drycleaners? Florists? Car detailers? Professional baseball? Most retail? Hotels? Management consultants? Roofers?
Inflation is very hard to control
Inflation cannot be "controlled" once the genie is out of the bottle. It becomes as much of psychological phenomenon as it is a monetary phenomenon (as described in your favorite macro texts). What does it mean that inflation becomes psychological, and what are the implications?
Inflation becomes a front and center event. If it is on top of everyone's mind, then society as a whole will overreact to it, thus exacerbating the problem: pre-emptive price increases daily, workers demanding weekly raises, any money earned is spent right away (which really speeds up the velocity of money, making the problem deeper), and so on. The implications are that things that have historically worked to slow down inflation, such as raising interest rates, will not work as intended: businesses will still raise prices all the time anticipating inflation, no matter what the discredited (by now) government says. People will still be rushing to spend, keeping the velocity of money high. In short, the participants' actions to protect themselves individually will be hurting the collective outcomes. In addition, there will be supply-driven inflation, as inflation brings about business shutdowns, thus reducing capacity/supply of goods. Imagine the following headline: "Fed Raises Short-term Interest Rates to 400%; Bernanke Says Inflation Now Under Control" If we get to 400%, do you really think the Fed's decision will matter to anyone?
Only credible actions from credible people will solve the psychological problem, such as a new government instituting a credible currency board.
Inflation: dispelling the serious misconceptions about how it happens and how it affects people and businesses
Many people here in the US that actually have a clue about inflation think of it in textbook terms. In other words, both incomes and prices rising more or less at the same pace; no inflation if there is high unemployment and low capacity utilization; inflation helps companies as they can raise prices while debt service gets "easier", and so on. All in all, inflation is business as usual, may be with some more aggressive pricing action.
No, no, and no.
The above statements are true at when inflation is at low single digits. If unemployment is at 7%, inflation will be 2%, vs. 3% if u/e is 5.5%. Companies target price increases of 3-4% every year, and costs rise at about the same rate. So far, so good. This is roughly the US experience over the last 30 years.
What happens if inflation is higher?
High inflation leads to both high unemployment and low capacity utilization. How's that possible? Most businesses actually cannot pass on the cost increases simply because most businesses do not offer essential products or services. As a result, they simply shut down: you have both high unemployment and low capacity utilization. This also leads to product scarcity in many areas, further increasing prices.
Just think what would happen if diesel prices go up 3x tomorrow (not out of the normal for an essential good in a hyperinflationary environment). What would happen to UPS and FedEx? Will they be able to pass it on? No. They will shut down. What happens to shipping costs? They go up. What happens to unemployment? Up. Capacity utilization? Down.
What worries me even more is that the vast majority of US management teams are simply too young to have been in management in 1979-1980. They would have had to be born in 1940 at the latest, or they'd be 69 now. More than likely, these people are golfing somewhere in Florida.
US businesses are not run with an eye towards inflation: long term fixed price contracts, vendor credit, reliance on short-term and variable-rate borrowing, even mundane things, like gas station pumps having only single-digit per gallon prices, vending machines accepting only $1 bills, or average employee commuting distance becoming prohibitively expensive. Sure, they can adapt in the long run but only few will.
Inflation: how it happens even without "printing" and without changes in the wider money supply, and without changes in the velocity of money
Here is something I do not think you can read about anywhere else. First, inflation rates are personal as personal consumption patterns differ, housing choices differ (i.e. own outright vs. rent), etc. How is it possible that you can experience inflation even if you do not purchase products or services with rising prices?
Here in the US the last 40 years have been marked by increasing governmental involvement in healthcare and education. As a result, the healthcare and educational costs have risen far faster than the overall CPI. Even if you are not a user of either (unlikely) your personal inflation rate reflects it because there is no free lunch. The new money the government spends comes from taxes (sooner or later), and this means lower disposable income for you. All of a sudden, for a unit of your labor, you can buy less. De facto, your own personal inflation.
A similar mechanism works when there is a government decision to limit say, oil drilling. Prices go up across the board because of the higher oil costs. No change in money supply or anything, but what is in effect a tax, creates inflation as your money is now worth less.
Inflation: the signs you will see when it is already here
This section is for the benefit of my US/Canadian/Western European readers. People from Latin America, Africa and Eastern Europe will likely find nothing new in it.
- Inflation is headline news
- New dollar denominations: $500 bill, $1,000 bill, $5,000 bill, $10,000 bill
- Disappearance of coins (both because the prices now have zeros and the value of the metal)
- Lack of essential products: everything you take for granted now is gone
- Explosion of petty theft: gasoline siphoning, food, light bulbs from common living areas and offices, hospital thefts
- Disappearance of credit
- Currency controls: limits on foreign currency transactions, gold and silver ownership, limits on bank withdrawals, etc.
- Blame game: incessant attacks on a gray subset of the population called "speculators" and "hoarders". If you think the Exxon hearings in Congress two years ago were a farce, this will be much worse. Read up on Venezuela's confiscation of food producers. Think it can't happen here? Think again. "Chevron's new management committee compromised of ACORN activists will work to ensure fair distribution and prices for gasoline." Or "Kraft Foods pledges to produce 100 tons of cheese in 2015 in order to reduce prices." The theft, of course, has happened at the printing press.
- Social unrest: If you think that the LA Lakers championship celebratory events were riots, wait until the monthly food stamp benefit can't buy a loaf of bread
- Non-stop "initiatives" to control price increases at the federal, state and local levels: price and wage controls, rationing, new laws and regulations about "black markets", "hoarding" and "speculation"
- Breakdown in services such as hospitals, ambulances, public transport and police; even electrical and phone services become unreliable (imagine the local utility company with regulated rates not being able to cover half of their nat gas purchases at market)
- Rise in bartering
- Rise in reference rates for pricing (i.e. products priced in today's dollar equivalent of euros, gold or some other rate)
- Rise in foreign currency circulation
- Rise in local currency circulation (how does a Dixie Dollar sound?) and other methods of payment aimed at avoiding dealing in the depreciating currency
- Widespread disbelief in the "official" inflation rates and money supply stats (I strongly recommend that you start keeping track of several products that you purchase often now)
- Widespread drop in the standard of living (wages take forever to catch up)
- Change in societal values, usually for the worse (things like civility, respect, etc.)
Reading first-person accounts from Weimar, Argentina, Yugoslavia and Zimbabwe can give you a pretty good idea of how things change.
Deflation: is it all that bad?
Is deflation bad? Some say so, I disagree. Here is why.
Deflation, widely defined, is a lot more controllable than inflation. Deflation helps with "creative destruction": a business should be built and run in a way to survive the lean times (in other words, with less debt than what the bankers told you at the presentation.) Deflation is natural in many businesses as a part of the cycle (think iron ore pricing for example). Deflation is inherent in businesses such as computing power, and yet, you do not see Intel complaining that the price for a certain computing chip drops all the time. This deflation in computing costs has been a boon both for the players there as it has expanded demand for their products, and to society as a whole. Deflation in housing is great because the prices had gotten ahead of themselves. Deflation in the overall CPI is good because the US worker is squeezed by both global wage arbitrage and by the bubble policies of the government. Deflation in living costs can help soften the blow. There should be deflation in education and healthcare costs, if you ask me. Of course, it won't happen so long as the taxpayer is on the hook for the massive programs in both areas.
At the end, I'd like to present you with a paper currency story, that of the not-so-mighty Bulgarian lev (pl. leva).
The story starts in 1944. Bulgaria started WWII on the side of Germany but switched over to USSR once the Germans left, and the Russians showed up on the border in 1944. Fortunately, save for some Allied bombing, there were no battles on its territory, unlike most places in Europe. The USSR installed its own muppet government, and the said government went on to execute, chase into exile or put in forced labor camps most of its political opponents, including most of the "bourgeois." Post-war inflation picked up (see Hungary), in part because there was no one to produce any goods after the factory and land confiscations (see Chrysler LLC). By 1952 inflation forced a replacement of the "old lev" with new ones at 100-to-1 (these numbers are a proxy for the actual inflation) but prices were changed at 25-to-1 (the government can do whatever it wants to prices in a planned economy). In other words, the purchasing power of the lev went down about 400 times in the post-war period.
Think of it this way, if in 1944 you had 100 leva that could buy you 100 boxes of nails at 1 lev each. By 1952, those nails were worth 100 devalued "old" leva each, and 4 leva each in "new" post-reform leva. Those 100 leva you had in 1944? They could then buy you 1/4 of a box of nails post reform (you had 1 "new" lev but nails were at 4 leva each.)
But wait, there's more. Scratching zeros does not work that well. Continued inflation forced a 10-to-1 conversion ten years later in 1962. Again, this is a proxy for the devaluation that happened. Those 1944 100 leva you had turned to 1 lev in 1952 are now 0.1 "new new" leva. The box of nails at 4 leva in 1952, probably went up to 40 in 1962, back to 4 after the 10-to-1 exchange. Your 1944 100 leva that could buy you 100 boxes of nails can now buy you 1/40th of a box.
But wait, there's even more! Several years of price stability followed largely due to below-market oil from the Soviet union. However, inflation accelerated again in the late 1980's leading to a currency board, pegging the lev to the Deutsche Mark, and a subsequent exchange into the "new new new" leva at 1,000-to-1. Again, using the exchange ratio as a proxy, those 1944 100 leva could buy you a 1/40,000th of a box of nails, when they could have bought you 100 boxes of the same product in 1944.
How does your purchasing power go from 100 boxes to 0.000025 of a box? The same way you go from 1 box to 0.00000025 of a box. Inflation.
Of course, the example is highly theoretical, as the old paper money itself is no longer a legal tender after each exchange, and the money exchanges are a proxy for the actual inflation rates. They could be over or under those but not by much.
Wikipedia has a nice list of examples of what inflation does to paper money. For example, 1x 1992 Argentina peso is 100,000,000,000 (100 billion) pre-1983 pesos.
Greece, the 1953 1x drachma was 50,000,000,000,000 (50 trillion) pre-1944 drachmas.
Of course, the winner and the runner-up are Hungary (1946) and Zimbabwe (to Jan 2009).
My ($0.02) advice is: do not take inflation lightly. Do not think it cannot happen here. Do not think that it can be "controlled" once the ball really starts rolling. "You can't predict but you can prepare."
Update 1 11/2/2009: Mish, one of the top econ/business bloggers, has a good post on deflation. I strongly recommend clicking through on the links to read up on the deflation argument. He makes the best argument for deflation that I have seen. There is one to be made, and some would argue we are in a real deflation (if Case-Shiller is subbed for owner-equivalent rent in the official CPI). There is a particularly interesting link about debt deflation: no doubt we have seen some, but I think the paper overall is too academic (1), and (2) does not look at all mechanisms through which we can have inflation spiraling out of control: currency shocks leading to supply problems, new legislation that will undoubtedly raise both taxes and prices (health care and cap and trade are the two big ones): remember your own "personal" rate of inflation goes up if you can buy less with your labor as I described above.