Investors who know me on personal level will often shake their heads at the lengths I will go at times to investigate a company from a balanced perspective. Reading financial statements, studying products/services and listening to conference calls is fine for most individuals, but I often seek any opportunity I have to assess a company from a grassroots approach.
Most of the time I attend seminars and information sessions held by a company to evaluate the sales approach of employees or I meet with local management of a regional headquarters to discuss various topics indirectly as owner of my company. My favourite approach, by far, is having the opportunity to tour operations after contacting the investor relations department.
Many investors would be surprised if they took the time to talk with an investors relations representative about receiving information about the company. Many companies will go to great lengths to serve the interests of their current or prospective shareholders. To date I have never had to disclose how significant of a shareholder I was in the company to receive information, but I have implied at times through my personal appearance or attitude that I hold a significant enough individual stake or that I am representing someone who does. Geographically and financially it’s impossible for me to tour all the operations of the companies I own shares in, but I do make an effort to try and gain permission for a tour or to attend a function whenever possible.
If I have the opportunity for a tour I usually request two: one with a salary employee from HR, investor relations or a mid-level manager and another with a blue-collar employee. I don’t intend to see the same thing twice, but what I’m after is a balanced presentation of what’s going on at both the local and corporate level of the business.
A mid-level manager or HR representative will tell me what the corporation wants me to hear: cost cutting initiatives, productivity goals and the overall strategy for operations. A blue-collar employee will tell me what I need to hear: unbiased, no bullshit, first-hand information on the guts of the corporation.
An investor needs to keep an open mind about the conflicts of interest imbedded in the opinions of who is providing you information on the company. Measuring both will often give you a very good perspective of what is going on within the company despite any differences between what one individual is saying versus another.
Remember: when assessing a company one of my vital Value Rules is measuring how well management maintains their finger on the pulse of the business. No CEO or plant manager is above the duties of a blue-collar worker; his or her job security depends on them. If a blue-collar worker isn’t producing a product or providing a service effectively that directly affects the productivity of the company and its profits.
A unionized vs. non-unionized environment during contract talks is something you want to avoid in order to receive the information you want, but for the most part, if you’re a fair and approachable individual blue-collar workers will spill the beans about all sorts of important information.
I won’t name the individual company, for intended legal reasons, but in November I had the opportunity to tour a plant in Toronto for a North American brewing company I was interested in making a potential investment in. I was fortunate enough to schedule a full day tour of the plant with an opportunity for one tour in the morning with a HR representative and the afternoon with a unionized labourer.
During the morning tour I heard pretty much the standard rehearsed story about company and plant statistics, productivity gains and where the Toronto plant fit into the new strategic focus of the merged company. But during the afternoon was when my interest in the investing prospects of the company changed dramatically.
My tour guide during the afternoon was a 51 year old gentleman with almost 30 years of experience with the company and soon approaching retirement. He held no punches about any questions I had about the company and for the sake of this post we’ll call him Jim.
Jim was fair for the most part aside from a slightly biased view of management, but his insights were valuable for a number of reasons. After pointing out a few minor problems with management-employee relations we stopped at one of the main fillers on the production line. Being familiar with the layout of a brewing plant I was impressed with some of the updated equipment on the production line and glanced at the label machine on one of the bottling fillers. At first glance the label looked like any other label for a brand of iconic Canadian beer; but it wasn’t. On the top right of the label I noticed the alcohol content of the beer was 4.7% instead of the standard 5.0%.
I asked if I could keep the label and as we walked along the line I asked Jim about the puzzling discrepancy on the labels. He didn’t respond right away, but smiled instead. The answer was both shocking and troubling for me as a prospective investor.
As a cost cutting measure management had decided that beer exported to the US didn’t need as high of an alcohol content. Management had stated they would save $500,000 per year on reduced alcohol content because they could dilute the beer a little more and sell it for the same price. To any unknowledgeable investor that might have seemed to be a fair response by management to reduce costs, but after working in an experimental brewery for two summers during university for a rival company I had learnt a few important things about beer manufacturing.
My next question to Jim was how many brand changes the company underwent each week. The reason for this was very straight forward and he knew exactly where I was going with the question.
(X is the brand of beer discussed)
“Well, Brad, we bottle X for both the Canadian and US market. That line with the new filler will run about 1,500 bottles per minute. At say $1 per bottle you’re looking at $90,000 worth of sales moving through that line each hour. If we ran only 5% X we’d have 5-7 brand changes per week with a downtime of about 1 hour for each. So in lost productivity we have anywhere from around $450k to $630k, but that’s unavoidable since we can’t run the same brand 24/7. Now we’re running 4.5% X and 5% X in almost equal amounts and we change brands 12 times each week now at a minimum. You do the math and tell me what those extra 5 changes per week amount to and if saving $500k per year in alcohol makes any sense to you.”
I did the math on a notepad I had with me: those extra 5 brand changes per week would result in an additional loss of productivity of roughly $450,000 each week. Doing the math over a 52 week period would bring your additional loss of productivity to around $23.4M. Add in what the company pays employees to stand around for that extra hour, the extra heating and other fixed costs and intending to save $500,000 on paper has now cost the business around $25M each year.
This wasn’t the only cost cutting initiative that someone in the “glass tower” (a reference to young management by Jim) had made over the previous sixteen months.
The majority of the plant had changed to a different set of lights (fluorescents) from the previous high pressure sodium lights because of the savings in wattage and replacement price per bulb. What someone behind the desk had neglected to realize was that the majority of the high pressure lights were on motion detectors and only went on when employees ventured into different parts of the plant. Now the fluorescent lights stayed on 24/7. Jim and others were convinced that no savings in the cost per light would offset the additional electricity used over a twelve month period. As we went along our tour he shared more and more cost cutting initiatives that management had introduced that were actually costing the company more money than the previous method.
When I asked Jim why none of the employees had mentioned this to their managers his response was, “When you were with them this morning, did it look like they gave a shit what we might think? Did you hear any of them saying hello, how’s your day, where can we improve?”
When I went back home and looked over the numbers I had collected on the company there was a very obvious drop in gross margins over the past 24 months and the return on equity was abysmal. There was clearly a direct link between the drop in gross margins with the injection of new management and the comparison to their peer margins was startling; more than 25% lower.
There were other factors that contributed to my decision to not invest in the company, but in retrospect I was very happy that I had taken the time to tour the plant to get a sense of the corporate culture and gain a better sense of management’s role in running the business. This was one situation where management’s inability to engage employees in a meaningful way was costing them millions of dollars per year and the practices are still ongoing today!
“Save a penny to spend a dollar” as Charles once told me are not the types of decisions I look for in management of a company I own no matter the future prospects of growth. I might have found the discrepancies in the margins before I purchased the stock, but $30 in gas and my time potentially saved me a 38% loss based on the company’s current share price and where my intended investment would have been at the time of the tour.
Productivity gains and losses are a very important task for management to focus on in any business. In an industry where competition comes from multiple directions no one can afford to make mistakes attune to $23.4M. If I had been a significant shareholder of that company and found out as I did about that costly blunders ongoing inside one plant I would have wanted the individual, their direct supervisor and anyone else involved in the decisions fired immediately.
Lesson: look to companies who empower and involve their employees in the decisions that affect the business. The CEO doesn’t have the time to walk the floor of his/her plants on a regular basis and no one knows the products, services or customers like the ground level employees. Ground level employees are the ones making productivity gains; not the managers. Leadership is about achieving results through others and when you find a business with that sense of corporate culture you likely have a good prospective investment.