Sometimes, In Sourcing, It Pays to Marry the Ugly Girl

One of our biggest clichés and often-repeated advice is “don’t judge a book by its

Cover.”

Whether in China or elsewhere, it may be wise, if given the choice, to choose the internal qualities of a woman who is not so beautiful on the outside as opposed to the gorgeous woman who doesn’t have the character, spirit and heart of the plain one.

Sometimes-often- in my experience, the same applies to factory choice:

1.     A small and modest factory, which may be somewhat unkempt and look like someone has been working hard there;

2.     A big factory with an attractive exterior and workshop which is neat and pristine.

So would you choose #2 over #1? If your answer is “absolutely,” you are wrong.

The choice seems clear and obvious to the majority of foreign visitors. They are put off by the physical surroundings, and maybe the humble appearance and demeanor of the owner, leading them to choose the beautiful girl.

I can say without hesitation that, in a great many cases, the smaller, more modest factory with the ugly-girl experience is the better choice. Any factory can be cleaned up and re-organized; what cannot be changed is the character of the people that work there, their desire to make a quality product and a sincere wish to grow relationships with buyers, not just take orders.

In my career, I have chosen the ugly girl several times; never have I been disappointed. Please note that, when you make that decision, you also make a commitment to hold their hand from day one. IF you do that, you will gain another asset: their undying loyalty. This will reflect in price, performance, quality and will count for a lot in a crisis.

My proudest personal story in this area is about when I chose a small, storefront (yes, storefront) factory in Thailand to do some of my underwear business in that country. Why did I make that decision? Because I could see the smarts and the heart of the owner and I believed (this takes some faith in your own intuition), that, given the chance, he would be successful. Years later, the factory had expanded to take over sever adjoining buildings, and what was a dead street became alive with commerce. Economic development 101.

That is not to say that there are not big factories with an owner that has heart, or that there are not small factories which you should avoid at any cost.

So how do you figure this out? It is a judgement and intuition call, but it always has to do with the owner/General Manager and management and your assessment of their commitment to you as a new customer, if not their commitment to the business itself.

Some factories that have grown big find an owner who has made a lot of money, and maybe gone from poor to rich in a short time. More often than not, human nature takes over and the owner things he is all that-which he isn’t- he is just the same guy with more money.

What am I talking about here as an indicator? Humility.

On the other side, there are small and ugly factories that will always be that way and that should be avoided at all costs, despite their price. How to tell? 1. The attitude of the owner and management 2. The quality of the product they are producing 3. The general body language of the factory workers-either “busy, focused” or “I really don’t care.” Again, this is largely intuitive, but after a while you can smell it (that’s another thing- a bad factory has a bad smell).

With all due respect to the great C-Level executives that run our companies, more often than not they do not have the battlefield experience to be able to tell if the ugly girl is worth marrying. If THEY are smart, they leave the decision to those of us who are experts in the field.

Each case is different. But as Malcolm Gladwell has said, after enough experience you are capable of thin splicing the conclusion.- quick and accurate assessments with little information.

A word of caution: I am not telling you to commit your whole production to these little gems (and, for that matter, the big ones). Any new factory should be given a test order first; you only know for sure after they have delivered your order.  Then, if you were wrong in either conclusion, your damage is minimized.

NOTE: For the sake of absolute equality to everyone, I chose the “girl” here because it applies to me. The subject matter is same no matter which gender or preference way you turn it.

Toys ‘Rnt Us- From Category Killer to Comatose

Toys ‘Rnt Us- From Category Killer to Comatose

Of all the sad retail stories I have heard this year,  this has to be the saddest. Not because the firm has gone from Category Killer to near death; the sad part is just how long the illness has been allowed to continue. Not all the sequence of failure is clear to me-but information and statistics from research into the company’s  and the industry’s history since 2004 keeps leading me to one persistent suspicion: The company was killed (it is all but dead now) by greed of executives and financiers who could not see through their own pockets to make changes that would help the company get back on its feet.

Toys R Us declared bankruptcy in September of 2017. But the story of its decay goes back at least as far as 2004.  Weighted under unpaid debts of around $800 million including $400 million in interest payments that it had been laboring under since a leveraged buyout in 2005. Here’s the first greed part:

Judge Keith Phillips approved $21 billion in bonuses for Toys "R" Us executives, garnering public criticism. The U.S. trustee assigned to the case, Judy A. Robbins, said the idea of big bonuses for a bankrupt company “defies logic and wisdom.”

(Seeking Alpha, https://seekingalpha.com/article/4139668-toys-r-us-announces-store-closures-list)

Understatement: Logic and Wisdom. What good use could $21 billion have been put to? And what is the justification for an executive who is ostensibly a person who cares about the company to ask for a bonus in  that situation at all, much less a salary? Where I grew up, “bonus” is for when you do good-and only then.  OMG.

There are definitely MOAT issues that attributed to the slow and painful death of Toys R Us. We will discuss those below. But beyond that, there had to be management and process failures going back to 2004. At that time, Toys R Us and Amazon were embroiled in a lawsuit where Toys R Us claimed that Amazon breached a contract between the two for TRU to be more or less the exclusive retailer and manager of Toys on the Amazon website. In its counterclaim,

Amazon, of Seattle, denies that it breached its agreement with Toys "R" Us, saying the language of their contract allows for exceptions that permit Amazon and other merchants to sell products that compete with offerings from Toys "R" Us. Amazon further alleges that it urgently needs other merchants to list competitive products on Amazon because Toys "R" Us has failed to keep toys and other items in stock. During key holiday-shopping weeks, Amazon alleges, Toys "R" Us has been out of stock on more than 20% of its most popular products. Amazon also alleges that Toys "R" Us has failed to provide Amazon with a comprehensive selection of toys for sale on the Amazon site -- in particular, low-priced toys (Wingfield, Nick. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]29 June 2004: B.7.

Toys R Us won this lawsuit, garnering a $51M settlement from Amazon (http://abcnews.go.com/Technology/story?id=78306080)(Amazon don’t do that (exclusives or let anyone control their website business, or even pricing) nowadays, and this may have been one of the key lessons learned). But Amazon’s claims seem very real, in view of what is happening now, 13 years later.

Inexplicably, the next year, three hotshot VC’s (considering what happened since, remind you that VC once stood for Viet Cong) KKR, Bain and Vornado took Toys R Us private with a buyout of $7.5 billion, from which point the company was saddled with the above mentioned $400 billion in debt payments. On this subject, and not knowing how the debt was structured, I can’t help but get a feeling that someone made money on this deal.

Just two months after the above article, the WSJ reported, “Toys 'Were' Us?; Undercut by Big Discounters, Toys 'R' Us Is Indicating It May Get Out of the Business.”  The article reports that TRU’s MOAT had been breached by Walmart and “In a surprise move, the once-dominant toy retailer said it is exploring a sale of its core 1,200-store toy chain” and reported an analysis that said, “Given the competitive threat of Wal-Mart today, Toys 'R' Us will not be able to continue as a going concern in the long term without drastic structural changes." (Joseph Pereira, Rob Tomsho and Ann Zimmerman. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]12 Aug 2004: B.1.

The sale happened. And then what? Was Toys R Us somehow frozen in time between 2004 and 2017 when they finally declared bankruptcy? How many billions were collected by the VCs and the company’s executives while the company died a slow death?

Let’s look at where the distribution of the toy business is today:

So what is evident here? First, WM and the mass merchants  now dominate the toy business. Why go to a shop to buy toys and only toys? Here is the sad part—the answer, in Toys R Us heyday, was NOT the prices, which is the only weapon WM can use to penetrate their moat. It was the EXPERIENCE. Kids dragged their parents to TRU because it was FUN. I don’t care who you are, Walmart is not FUN.

So here’s screwup number 1, TRU. In your sadness about the declining sales and challenges, you let Geoffrey the Giraffe become Bad Santa. You had the experience nailed, and you let it die. Now you are.

Next- If I am a category killer in a category that is dying or declining or flat, what should I do?
Clearly, find something else to sell. Babies stuff is a difficult business with birth rates not growing and economy not healthy. So what? 1. Pet Toys- Pet ownership has skyrocketed in US and globally during the period. 2. Grown up kids toys like Xbox etc. 3. Expand your target audience and maybe change your name to Fun Stuff R Us or something better than that. What not to do? Nothing, and that is what you did.

I know. You think that kids nowadays are not interested in toys. I thought so too.

Suprisingly, the facts state otherwise:

While toy sales have declined, the percentage is really not that much since 2005.  So let’s forget that excuse.

What is true is that, since TRU broke up with Amazon, they forfeited the online business to them. As has most everyone else:

Note to self: see Target lurking there in the grass. Watch who eats the carcass of TRU.

So, like everything else, about 50% of the online commerce is forfeited to Amazon. Now it seems to me like the hierarchy of jungle cats where all must genuflect to the leader. Until, that is, someone has the balls to challenge. Not rocket science.

So what will become of the toy business after Toys R Us is only a story? Anybody with half a brain will see that the toy business now is inextricably connected to the current world of technology, and that children who grow up in the tech world only want to play with stuff that is in synch with the world around them. I think that this is a virgin business; nobody has thought this through. I see a future that is fun and in sync with Alexa.

As far as Toys R Us, they could be part of this future because they still have about 1500 locations. Let’s be clear: there are only two things that Amazon envies: 1. Brick and Mortar and 2. International Business. But that would require a selfless quest on the part of management.

Survival/MOAT/Sustainable value growth is my business. I could make this happen. So I suppose TRU management could do. As it is, it is a big short.

01/11/2018 ANOTHER UPDATE: Target vs. Walmart- Who is YOUR Money On? (I love being right)

ANOTHER UPDATE-DID YOU BUY TARGET STOCK?

1/11/2018

Seeking Alpha:

• Walmart (WMT +0.6%) issues a statement via the Sam's Club twitter account on the multiple reports of store closings in larger U.S. cities (Memphis, Syracuse, Houston, Rochester, Cincinnati).
• Sam's notice: "After a thorough review of our existing portfolio, we’ve decided to close a series of clubs and better align our locations with our strategy. Closing clubs is never easy and we’re committed to working with impacted members and associates through this transition."
• Earlier today, Walmart hiked its minimum starting wage and expanded employee benefits.
• Investors are still bidding up Costco (COST +2%) following the Sam's Club development. Target (TGT +3.9%) is also tracking higher. 

https://seekingalpha.com/news/3322446-portfolio-review-leads-sams-club-closings?app=1&dr=1&uprof=45&utoken=2b889ff8aa710d0cfc9b6f23960fd10d9db11a05#email_link

Me: Target stock is at $73.40 today, up 3.7%.

I am sure many of you who read the original article (December 17th) thought Walmart was the obvious choice. Target's solid management and higher margins make them a better investment. Walmart's moat is definitely not impenetrable.

 Do you agree?

12/29/2017-

I love being right.

All retail stocks minus those whose moats totally collapsed (like BBBY) are experiencing some bounce. Christmas season number looking like around +5% YOY. 

Yet Target is catching the attention of The Street, just for the reasons I stated below. Excitement about the other notable players like Walmart and Macy’s tempered, but I see nobody who recommends caution or waiting when it comes to Target. Today on Seeking Alpha:

Bernstein fires off a price target boost on Target (TGT +0.9%) to $75 from $65 after factoring in tax reform benefits and store labor investments.

The firm's PT is out in front of the Street average of $62 and reps 15% upside potential. Shares of Target currently yield 3.83% vs. 2.05% for Walmart and 1.07% for Costco.

Retail stocks to watch or buy in 2018….?

Happy Holidays!

Godzilla vs. King Kong- Amazon playing Godzilla and Walmart playing King Kong. We are all watching the ongoing battle with rapt interest. Walmart has Amazon direct in its sights, trying to be all that in the ecommerce world and even spending advertising money to point out that they have free two-day delivery with no membership fee. And Amazon just keeps on keeping on, evolving into a bigger and perhaps invulnerable force.

With all this attention, you might think that these are the only two retailers in America. Left behind in the news lately is Target. Who? The Minneapolis-based retailer is 5^th largest in the US and 10^th in the world.

So which retailer is your money on for the future-if you can only buy stock in one of them? I know what you said-Walmart-right? That’s OK. Let’s take a brief and focused look at the two of them and then let me know if your thinking has changed at all. Spoiler alert: My definitive conclusion at the end.

As an investor, I want to look clearly at past history as it may predict future trends-sales, marging, PE, dividends, etc. In this regard, taking the last 5 years as a timeline, Walmart has the edge:

1.     Share Price- Both company’s stock price declined in 2015. Since then Walmart (WMT) has recovered, increasing from $56.42 to $97.11 (12/15/2017). Target reached a high of $84.69 in mid-2015 and closed at $62.61 on 12/15/2017. Advantage: Walmart

2.     Revenue Growth Rate- Neither one has been breaking any records, but Walmart had a modest increase in 2016, while Target declined, due to its decision to close its pharmacy business. Advantage: Walmart. See below chart:

3.     Gross Margin %- Neither company has been growing in this area, mainly due to price panic in retail land. BUT Target’s gross margin % is significantly higher than Walmart. Advantage: Target. See below chart:

4.     Asset Turnover Ratio (how fast goods turn)-  The chart below shows us that Walmart’s is higher than Target’s. But Target’s is growing while Walmart’s is not. Numbers Advantage: Walmart. Trend Advantage: Target.

5.     Earnings Per Share: EPS- You can see from the chart below that this is a wash (Target’s dip from the closing of their Canadian stores): Advantage-None.

6.     Dividend- Despite its tribulations, Target has managed to have a better dividend ratio than Walmart. Advantage: Target:

(Source for all above: “Walmart vs. Target: Survival of the Fittest?,” Ploutos Investing on Seeking Alpha, 9/25/2017, https://seekingalpha.com/article/4109072-wal-mart-vs-target-survival-fittest)

You still awake? This is by no means a throrough financial analysis. If interested, do some more work at the above article and many other statistics available at Seeking Alpha and other web sites.

A couple more statistics before we move on to what is behind them and makes the real difference.

7.     The above report also compares Sales/Square Foot (as of 7/2017). Walmart  $436, Target $290. Since the dawn of time, this has been the bellwether statistic for retailers. The more each square foot pays for itself with sales turnover, the better the health of your store.  This is combined with revenue/employee to give a total health report on your store.

The report and most others say that Target has done a poor job compared to Walmart in advancing its ecommerce business. Granted and this is advantage: Walmart- in the short term.  Longer term, consider this: With the massive size of most Walmart stores, the more business is transferred to online, the less profitable each square foot of store space will be. Conclusion: Walmart has a lot more to lose, and will be a victim of its own success if its online business expands dramatically. No free lunch, it has to come from somewhere.

Target is on point and will have a future advantage in this area due to its move to create SMALLER (wow) stores with its CityTarget program. Where would you even put Walmart in a city. Like King Kong trying to find a seat in Manhattan. And what would a concise Walmart look like?

Both stores have recognized that brick and mortar not only is not dying, it is and always will be a critical part of the mix. People will never stop shopping, just will be more picky about where and how long.

To that end, both stores realize that facilitating customers to shop in store and not have to schlep their goods home is an invaluable service in future. Target has gotten a lot of press for their acquisition of Shipt to offer customers same day delivery of their purchases (don’t get too excited just yet- Shipt has a membership fee and, at least for now, will continue to deliver for other retailers). This acquisition of $550 million acknowledges the critical ongoing role of brick and mortar.

Now let’s get to my favorite topic to compare these two- the Economic Moat. Morningstar rates Walmart a Wide Moat (due to price) and Target as NO Moat.  This means that the barriers to entry for a competitor to take business from Target is much easier than Walmart.

I totally disagree.

Why?

The first and most important reason is Private Label. Target has made an excellent and ongoing effort to develop private brands that would be unique and meaningful to the customer-not just the mass market customer, but the crossover customer as well. They have a serious and credible organization, headed by the talented Michael Alexin, to develop and carry on private label business.  (Read: https://corporate.target.com/article/2012/08/video-michael-alexin-target-as-design-house) Brands such as Cat and Jack (Kids), Merona, Goodfellow (Mens) will earn their validity with product. As I have continued to say, any brand that earns its stripes can win in this market.

Further to this, Target has secured the cooperation of real designer brands such as Marimekko and Mossimo to enhance their product assortment as well as their credibility as an everyone department store, not a mass market destination.

Remember the gross margin chart above? Remember that success as defined by investors is sustainable value creation? Private label is the reason and the best vehicle for this difference; if you have your own design and your own product, you can set your own price (within reason). Result: gross margin.

So what about Walmart? Their entire portfolio of brands is positioned that they can copy name brands at better prices. Not that there’s anything wrong with that. But it sets their image into more stone as a discounter trying to get your money with price deals-not design.

So, back to the Moat- Price is an open battlefield. Costco does and will continue to kill Walmart on price. Now you don’t even have to leave home to get Costco-type deals, courtesy of Boxed.

In the grocery business, private label has become a major battlefield.  First grocers Trader Joe’s/Aldi, as well as Lidl are killing everyone (maybe RIP Kroger) on credible private label goods at an incredible price. Now Costco, ever the smart one, who has always had great credibility for their Kirkland brand, now has gone into the wine and liquor business. Come on folks- a Kirkland Chianti Classico Riserva with the Gallo Nero (DOC) on the label for 6 bucks? 1.75L of Vodka made in the Grey Goose factory for $20? I don’t care who you are- you are trying this one.

IN the food area, Target currently trails Walmart, averaging 15% higher prices on grocery items. BUT if they follow the same trail of establishing credibility as they are doing with their apparel and home brands, that 15% may not matter. Or if they decide to be a category killer like Lidl and Aldi..

Now- please tell me- whose Moat is wider for the future-Target or Walmart?

And please don’t tell me about ecommerce, Jet.com, etc. Sure it matters, but about 90% of business is still brick and mortar.  Walmart is more vulnerable as they have played their chips on price-which, as I have always said, is the easiest area to defeat. Again-unbridled growth of ecommerce at the expense of brick and mortar has a downside, which shows up in two critical retail metrics- $/square foot and $/employee. Who is more vulnerable here?

Finally, I have said and I believe everyone has agreed that brick and mortar shopping today is about the experience. That agree, let’s talk about the shopping experience of walking into a Walmart Superstore-OMG- I don’t care who you are, you are absolutely not considering taking more time to absorb the experience at Walmart. Even Sam’s Club vs. Costco is a totally different experience. I can’t wait to get out of Sam’s and I can’t get myself out of Costco. Key metric of Experience-what tempts you once you are in a store, even if it is something you didn’t come for.

Those who have been tempted by other than price at Walmart, please share your experience.

IF brick and mortar shopping is about experience and value, and Moats are about barriers to entry, Walmart is not in an commanding position and has a lot more to lose. What is more, there is a long road ahead until Walmart becomes and exciting-and simple-shopping experience.

My general observation about Target is that management manages carefully and thoughtfully, and makes the tough decisions when needed. For now, Target passes my bubble test.

As you might have guessed by now-my advantage: Target.