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Getting Intimate with Stocks:

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.

Example:

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.

Disclosure: I do not own shares of any global brewing company at the time of this post.

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{ 12 comments… add one }
  • widemoatinvesting March 23, 2009, 11:27 am

    Wow, great post and an excellent example. I don’t have a lot of time to travel right now, but it looks like I need to start making the time.

    Just to be clear–you ask for two tours, and one with a blue-collar worker, and you’ve never gotten any push-back? On one occasion when I tried to do something similar, I got the response that “we don’t have anyone prepared for that kind of thing.”

  • Nurseb911 March 23, 2009, 11:50 am

    Thanks WMV,

    Yes, I always ask for two tours: one with a salary employee (Investor Relations, HR, etc) and another with a union/blue collar worker for the reasons I’ve stated.

    I have had difficulty only once when I asked for two tours and kindly explained that I wanted a more “technical” tour of the everyday operations that no manager could give me. When he asked how significant a shareholder I was or who I represented I asked if he needed me to ask his boss for the tour 🙂 I would advise going dressed casual and carefree. If they give you a hassle show them your backbone and get serious about what you want. Usually implying that you have a prospective $100,000 to invest in the company will get you what you want. They won’t stick you with the 19 yr old intern and you’ll get all your questions answered.

    This summer I have it planned to tour a major Saputo factory in Quebec, the Russel Metals distribution centre in Hamilton and another company for a client of mine.

    Anyone interested in tagging along can feel free to let me know.

  • Chris March 24, 2009, 1:56 am

    Terrific post! Good job

  • mjw2005 March 24, 2009, 11:07 am

    Again…yuou should be doing this full-time….how many MF managers do this….

    Great Post…

  • Mark March 24, 2009, 9:49 pm

    Great stuff. Just goes to show you how a qualitative approach can help just as much at times as a quantitative analysis. Going the extra mile saved you a pile of $$. In ‘Snowball’ there are plenty of references of Buffett using the ‘scuttlebutt’ approach to dig up info on a company.

    Question – How much impact does your qualitative data have on your overall perception of a company? Is this a sliding scale depending on the size and scope of the company? I.e. If it is a large multi-national corp. a site visit may not be as reliable as a visit to a small company with a handful of plants.

    Cheers,
    Mark

  • Jae Jun March 24, 2009, 10:52 pm

    Great post Brad.

    If you’re ever in Seattle we should hook up and hit it up with some of the big boys at MSFT, AMZN and SBUX 🙂

  • Nurseb911 March 25, 2009, 8:32 am

    mjw2005: Thanks for the vote of confidence, but I still like nursing fulltime and running my business part-time for now. I am available for a fee if your MF manager wants me to improve his alpha 😉

    Mark: I’ll answer your question in a follow up post this week sometime.

    Jae: You’re on man. They might not let us in once we become world famous bloggers, but we can go undercover as Dividend Addicts!

  • Richard March 25, 2009, 1:22 pm

    Hi Brad,
    With regard to brand changes, correct me if I’m wrong (I’m sure you will) – in the example you gave is the constraint not on how much beer this company sells. What I mean is, say they sell a million bottles of beer a month. As long as the company can produce this much what difference does it make if they do this in 4 line changes or 12? Their cost to produce this much is fixed. They can’t send the workers home if they can do this in 3 days vs 5. Sure, the workers could spend the extra time doing other tasks, but realistically how much of that would be productive – making MORE beer? On the other hand decreasing the alcohol content is a real saving, like putting less Corn Flakes in the box.

  • Nurseb911 March 25, 2009, 1:53 pm

    In the example I gave I assumed that in an environment where sales are flat (0% increase in revenue) that the additional cost of the brand changes was a poor decision by management. The additional downtime is equivalent to closing the door to your shop every two hours for a 15 min break. The customers who want to come in, but are locked out are loss revenue and a loss of productivity.

    The company would have to post an increase in sales of $25M to just cover the additional expenses these additional brand changes required.

    If they had continued on their previous number of brand changes there would have been no additional potential increase in costs or lost productivity, but by adding an additional 5-7 changes per week increased their costs dramatically. The company now has to increase revenues by the same scale just to break even.

    The company might still be selling a million bottles of beer per month, but by adding all those brand changes their costs just went up by $25M per year.

  • Richard March 26, 2009, 1:04 pm

    I still think we are on different wavelengths. Line changes in a brewery as I understand don’t involve any additional cost, only the lost productivity. Having done some work for a brewery on their control systems, I recall that a line change involves reconfiguring the equipment, loading different labels, perhaps different bottles. It’s not the same as a store closing the doors because you assume that during that time additional sales can be made. I’m not understanding how/where the $25M a year comes from. Sure, it’s lost productivity but that matters only if the company can sell the additional beer. Sorry if this seems repetative. Cheers.

  • Nurseb911 March 26, 2009, 7:23 pm

    Here was my initial thought on the situation:

    The management of the company I was investigating were touting at the time their commitment to achieve higher profits through increases in sales and decreases in costs.

    In this situation we’re talking about the exact same brand but with two different alcohol contents that calls for additional brand changes. Instead of continuously running one brand the company was shutting down to change over for an unnecessary length of time in order to save a fixed cost. If the company can sell 90% of the product produced and they aren’t making that product because of downtime I equate that to a loss opportunity to sell (loss of revenue). The additional brand change doesn’t change productivity to the upside and doesn’t result in any additional product for sale. To the consumer they would never notice the difference.

    No worries about the repetitiveness of the argument. Maybe it’s just a difference of perspectives in that you see it as only a loss of productivity where I see it as beer that could be sold and instead if not because of an attempt to change fixed costs. In the end the erosion to margins was evident and I decided the investment wasn’t in my best interest.

  • Richard March 26, 2009, 11:46 pm

    Thanks Brad. I enjoy your posts and find them very useful and informative. My last comment on this brand change issue – in the example you site, if all they are changing is the alcohol content then in my experience this is even more of a non issue. All they would have to do is change the labels (load the labeller with different labels) and swing over to a different vat (basically closing one valve and opening another) for the other beer. On a can line it would be a little more involved. Anyhow all good discussion which reminds me of what the guys in the brewery were fond of saying, “We make one beer and five different labels.” Cheers.

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