Sunday, November 29, 2009

More on Private Label Food Growth

There are two other articles on this blog on private labels vs. brands. Both have several updates at the bottom, so I recommend reading those as well to get a fuller picture of the situation. Brandweek even now has a series called "The Year of the Private Label." Mind you, this is Brandweek, owned by Nielsen, both are highly brand-centric organizations.

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

Random Worthless Forecasts and Future Headlines

Forecasts are nearly always wrong, so if you have to make one publicly, make sure it is overly general, and give yourself plenty of time for it to happen.

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

A Word on Publicly-traded MLMs and Pyramid Schemes

(Disclaimer: I am not a lawyer, and the information here is my understanding of various business models. Pyramid lawyers and representatives: please do not pester me with emails and comments.)

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

Kraft/Cadbury Update

Unlike most bloggers, when I follow a topic, I tend to do updates under the original article, rather than do a new one. This is because (1) I think this is the more logical way to do it and (2) I do not need to "drive traffic" by posting drivel and other "click bait." Please look here to visualize the correlation between posting frequency and traffic. The correlation is .86 in this study. ZeroHedge is blowing everybody out of the water both in traffic and daily posts, though I think that Clusterstock is up there too but it is not in the study. Both Ivandjiiski and Blodget have grown quickly by using multiple contributors over the last year, with Clusterstock becoming a quick-hit, Business Week-type, while ZeroHedge is deeper and substantially more paranoid. I read both on Reader, but I find myself spending more time digesting the ZH stuff. Blodget has journalists writing, while Ivandjiiski is much more plugged in the relevant circles. If I had to guess, one or both will be bought by an "old" news co within 1-2 years.

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.

Random Food Recipe and Beverage Review

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

The "Stuff White People Like" Portfolio

There is this humorous blog (and now a book) called "Stuff White People Like" that was a big hit a few months ago, may be even last year, I do not remember. The author has a running list of over 100 items that he describes as "stuff white people like": things like "sea salt", "unpaid internships", "graduate school" and "co-ed sports." There are many, many more things there. Chances are you know people who are guilty on almost all counts.

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 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

Thoughts on Healthcare

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.

(6) Demographics
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.

(7) Fraud
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.

HCR Passes as Fedor Emelianenko KO's Rogers

Pretty ironic that HCR passed just as Fedor KO'ed Brett Rogers with a wild right in the second round. More on HCR later.

Tuesday, November 3, 2009

Follow-up on Brands vs. Private Label

This might become on of the recurring topics on this blog. I wrote a piece back in August sharing my thoughts about private label (PL), why I see it succeeding and how to invest "thematically" if this is anything you are inclined to do.

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.