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It is important to examine Samuel Heath (LSE:HSM) with an income metric better than conventional profits after tax. Normal earnings fail to properly consider the annual cash outflows which end up being spent on more fixed assets and on working capital items (inventory and receivables in particular) just to support the current strategic market position, and therefore turnover and profits. I’ll use Warren Buffett's “owner earnings” approach.
The idea behind owner earnings With owner earnings we are trying to obtain the earnings that, in future, would be left for shareholders after the managers’ use of the cash generated to pay for items of expenditure to maintain the strength of the economic franchise (e.g. additional capital items, additional working capital, marketing spend, R&D and staff training) and to maintain unit volume and to invest in all value-generating projects available. Depending on circumstances, the owner earnings figure may be the same for every future year or on a steadily rising (or falling) trend. Naturally, owner earnings are impossible to obtain with any degree of precision because many of the input numbers are merely educated guesses about the future. Despite this imprecision it remains an important method for thinking through valuations. Using the past to guess the future Owner earnings analysis is about future cash available for shareholders to take out of the business. But the only evidence we have available is past data. We start with that, and then use qualitative analysis to judge whether to simply project forward the past pattern or modify the previous trend for future orientated thinking. In the following we use what the company actually invested in new working capital items and in new fixed capital items, and what they spent on marketing, R&D and staff training etc. already deducted from the P&L. What the analysis really requires is the amount necessary to maintain the quality of the economic franchise, unit volume and invest in value generating projects. To start with we make the bold assumption that what was spent by the managers was also the necessary amount. When we move to forward-looking analysis to value the firm we need to make another bold assumption on the real amount needed to invest in new WC, fixed capital items, etc., in the future. The historical analysis helps us make that judgment. “Owner earnings” in the past £ooos YEAR 2015 2016 2017 2018 2019 2020 Profit after interest and tax deduction 394 769 1,013 980 968 1,069 Add back non-cash items such as depreciation, goodwill and other amortisation 418 369 329 423 375 421 Totals to: Amount available for distribution to shareholders before considering the need to spend on fixed capital items to maintain the company’s economic franchise, unit volume and invest in value generating projects. 812 1,138 1,342 1,403 1,343 1,487 Deduct fixed capital expenditure other than property. And deduct cash invested in working capital. (The figures shown are actual expenditures and are therefore a rough proxy for the ‘needed’ expenditures to maintain franchise, etc.) -604 -282 -804 -313 +111 -585 Owner earnings 208 856 538 1,090 1,454 902Average owner earning over the last six years is £841,000. Will the future be like the past? Now, more than ever, we are uncertain, but we can think in terms of reasonable scenarios. Scenario 1: Recession and recovery Owner earnings fall to zero for two years. All yea………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
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Samuel Heath (LSE:HSM) is a Birmingham metalworker turning lumps of brass into bathroom fittings and door handles - and charging high prices for top quality. For two hundred years has been dominated by the Heath family. Even today 79% of the shares are “not in public hands”, with most of those owned by various family members.
Large shareholders Shares owned, in ooo’s Percentage of equity Samuel B Heath (Chairman) 494 19.5% C A Heath 379 14.9% G S Heath 379 14.9% S A Perkins (nee Heath) 273 10.8%It has to be said, minority shareholders are at the mercy of the Heath family. My experience of holding shares in family-dominated companies is that they generally behave in a fair manner - after all, many of the minority holders are current employees, ex-colleagues or friends. Regarding this firm, I have not come across any indication of prejudice towards minorities. Board pay is very high for £5m market capitalisation company at around £0.9m, but the bulk of that goes to professional managers rather than family. Directors have been reasonable in paying out around one-third of earnings as dividends at 12.375p per share (current share price £2m). I imagine both family and non-family shareholders are keen on a regular dividend flow and so pressure directors to pay up. But, while the current crisis is still with us, shareholders will accept a suspension of payments. A general point about investing in family firms is the tendency to focus on the medium and long term. Thus, there tends to be greater attention paid to reputation and preservation of a brand to be proud of. There is also a propensity toward conservative financing, so the firm can survive downturns. In addition, family companies lean toward making greater effort to hold onto good people at all levels in the organisation – they often form strong bonds and sense of mutual dependence. There are valuable implicit personal contracts in abundance in the form of looking out for each other, being flexible, helping in a common endeavour. This camaraderie and solidarity could be a source of strength in the Covid-19 emergency. 2020 2019 2018 2017 2016 2015 Number of staff 141 141 145 141 139 130 Employment costs (including directors), £m 6.03 5.72 5.78 5.37 5.07 4.68 Average cost per head £42,766 £40,560 £39,855 £38,063 £36,475 £36,000This is not a company that changes very much from year to year or even decade to decade – just a steady rise of turnover, sending good from the same 150,000 sqft factory producing much the same products it was decades ago. While turnover grew 25% from £11.1m in 2015 to £13.9m in 2020 employee numbers rose 8% and employee costs 21%. The directors Samuel B Heath, 82, Chairman, Fifth generation to oversee the firm. Joined the company in 1956, appointed to the board in 1962. Managing Director from 1963 to 1998. “He was involved in all aspects of the business and especially sales, in both home and international markets giving him a deep knowledge of the company its markets and customers. He brings a depth of financial understanding to the business, he has also led the development of a successful brand awareness campaign through advertising campaigns in the UK and other major markets.” (website). Owns 19.5% of company’s shares. David J Pick, 62, MD until 31 December 2020 Joined the company in 1978 as an assistant production manager. Later moved into sales posts initially in the UK and then overseas. Became Sales Manager then Deputy MD with responsibility in new product development and marketing. Appointed to the board in 1995 and MD since 1998. Owns a mere 5,783 shares. Martyn P Whieldon, 48, Deputy MD, but taking Managing Director role December 2020 Joined the company in 1995 as a sales representative in Europe. Fluent in German and French. Managed sales in both the export and home territories and has travelled widely, promoting the company's products to customers and at numerous trade shows to dealers and specifiers alike. Appointed to the board in 2010 as Sales Director, he was appointed Deputy Managing Director in F ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 While Samuel Heath (LSE:HSM) has an impressive history of profits for a £5m market capitalisation company (see yesterday’s newsletter) it is going into a period when sales may fall by over one-third. Will it survive? I’ll look at its balance sheet where the largest burden is the pension deficit. The pension liability needs analysis to see if that is likely to topple the company.
Piotroski factors are used to obtain an overview of its finances – at least finances up to March 2020. But, given so much has changed since March, we need to also look at potential danger points in a time deep recession. Thus, we’ll consider its cash flow generation. Balance sheet £m March 2020 March 2019 Non-current assets Intangible 0.2 0.1 Property, plant and equipment (of which freehold property is £1.5m) 3.6 3.2 Deferred tax assets 0.9 1.0 Total non-current assets 4.7 4.3 Current assets Inventories 4.2 4.0 Receivables 2.4 2.3 Cash 3.0 3.2 Total current assets 9.6 9.4 TOTAL ASSETS 14.3 13.8 Liabilities Payables -1.9 -1.8 Pension deficit -6.6 -7.4 Other liabilities -0.2 -0.2 NET ASSETS 5.7 4.4For a £5m company the balance sheet is exceptionally strong if we ignore the pension deficit on the defined benefit scheme. It has no bank debt, and payables to suppliers are more than covered by receivables from customers. That leaves £3m in cash plus £1.5m in freehold land and buildings as well as inventories of taps, door handles etc of £4.2m and plant and machinery of £2m. The pension deficit The company’s defined benefit schemes were merged and closed to new members in 2005/6. At March 2020, the scheme had £8.4m of assets (invested 78% equities and 22% cash) and £15m of liabilities, leaving a deficit of £6.6m. But there is a related deferred tax asset of £1.2m meaning that the net liability is £5.3m. This is a substantial deficit for a £5m company. The firm has agreed to step up payments into the scheme to close the gap. Around £0.36m is paid out each year to pensioners but Samuel Heath put in £0.516m in 2019 and £0.783m in the year to March 2020. A new “Pension Recovery Plan” requires that in the current year the company puts in £1m. It also pays around £0.4m pa to the defined contribution plan scheme. Clearly, these sums are quite a burden to the company, especially if it is going into a loss-making year or two. In the absence of bank debt or excessive supplier credit, that le………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 amuel Heath (LSE:HSM) is a very old Birmingham manufacturer of brass bathroom hardware (taps, etc) and door handles. It makes those pricier items you see selling through posh bathroom showrooms, etc. It listed on the stock market way back, in 1890. Since then it has not grown very much, sticking to one factory in the UK, and now having a market capitalisation of only £5m (shares at £2). Its market value rose to £12.5m (shares at £5) in 2005 and again in 2017, but Brexit fear has been disruptive and Covid-19 closed its customers’ showrooms, so turnover is down considerably on its normal rate of around £14m.
It might be the case that this year’s fall in revenue and plunge into losses is a one-off and Samuel Heath will, in a year or two, go back to making around £1m after-tax profit for shareholders and sending them dividend cheques totalling £314,000 per year (around a 6% dividend yield on the current share price). On the other hand, the recession might be so severe for premium-priced shower fitments and faucets that Samuel Heath struggles to survive. Thus, we need to assess both its potential if it does revert to the past average of earnings and dividends and its financial distress likelihood. Earnings and dividends March yearend Revenue, £m Profit after tax £000’s Earnings per share, p Dividends per share, p 2020 13.9 1,069 42.2p 5.5 2019 13.9 968 38.3 12.375 2018 14.4 980 38.7 12.375 2017 13.1 1.013 40.0 12.375 2016 12.6 769 30.3 12.375 2015 11.1 394 15.5 11.75 2014 11.0 443 17.5 11.75 2013 10.1 555 21.9 11.75 2012 9.8 515 20.3 11.75 2011 9.8 232 9.2 11.75(Throughout, the number of shares in issue has been constant at 2.53m). Over the decade turnover has grown at a stately average of 4% per year. And now, in a Covid-19 afflicted year, it’ll be lucky to achieve the revenue number it did in 2011. Average earnings per share over the ten years is 27.4p. The cyclically adjusted price earnings ratio is 200p/27.4p = 7.3, which is half that of the UK market. Prospects In the last few years the directors have been downbeat………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Caffyn’s (LSE:CFYN) has a good history of profits from selling cars and renting property. It has also managed its property assets well over the years. But now is crunch-time – profits from these activities are likely to disappear for some time. The question for this newsletter is whether Caffyns is in a strong position to cope with the crisis.
To start with I’ll use Piotroski’s nine variables to get an overview of financial distress risk at March 2020.
For 2019: £12.63m/£93.1m = 13.6%. Yes, so a third Piotroski point.
2020: £45.8m/£44.7m = 1.02 2019: £47.2m/£44.9m = 1.05 There has been a deterioration, and so no point is scored.
2019: GPM was 12.4% Fifth Piotroski point.
2019: £209.25m/£91.4m = 2.29 There has been a decline, so no Piotroski point scored. Conclusion on Piotroski A score of five out of ten is good and does not signal much financial distress risk from the pre-Covid-19 data. But to consider the financial shock effect on car sales and property prices we need to probe into the downside risk associated with the debt taken on by Caffyns. A closer look at Caffyn’s debt Debt facilities have been agreed with HSBC and VW Bank:
£m 2020 2019 2018 Current 8.9 4.9 1.4 Non-current 8.7 12.6 13.1 Total debt 17.6 17.5 14.5 Less cash -1.5 -3.9 -2.2 Net debt 16.1 13.6 12.3The VW overdraft is asset-backed lending with cars being used a security. But the VW term loan and the HSBC debt, are subject to covenants tested with respect to:
So, if Caffyns fails to make an “underlying profit before interest” in the next few months HSBC may declare default and grab property assets. But the directors seem optimistic they will make a profit – or are they just putting on brave face? “The Company have modelled these periods [12 months to September 2020 and 12 months to March 2021] and………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Last week I sold my shares in the Southeast car showroom company Caffyns (LSE:CFYN) at a significant loss on the £5.01 I paid in August 2017. I have received 52.5p in dividends over the three years but sold the shares for only £2.39 so the loss is 42%.
The two main attractions for holding are fast disappearing under the weight of Covid-19 and Brexit. These were, (a) steady earnings from selling cars (b) potential profits from gaining planning permission on land owned in prosperous Southeast towns As these two factors deteriorate, the risk of financial distress rises because the company has signed up to onerous clauses when taking loans. These allow HSBC to grab car showrooms in the event of covenant breaches – the one I’m particularly concerned about is the necessity to remain profitable, which is a tough thing to ask as the Covid-19 recession really bites. Previous newsletters on Caffyns: 10th – 16th August 2017, 14th – 16th Dec 2017, 27th – 31st July 2018, 5th – 10th August 2019. A look at earnings Year end (in March) Reported profit after tax (after including the “non-underlying” negatives and positives) £‘000 Earnings per share 2020 -252 -9.4p 2019 -566 -21p 2018 1,030 38.2p 2017 5,123 186.3p 2016 2,487 90.1p 2015 9,255 335.5p 2014 1,411 51p 2013 1,289 46.6p 2012 1,416 51p 2011 218 7.7p 2010 1,107 38.6p 2009 -3,969 -137.8p 2008 2,128 73.9p Average earnings per share 57.7pThe cyclically adjusted price earnings ratio is 239p/57.7p = 4.1. But we need to scrutinise the components of the earnings. For example, the 2015 result deserves a special mention: most of that £9.255m profit was a result of pension rules changing (so that future pensions could rise by only the RPI rather than the CPI) – it is a true one-off. The 2019 earnings number was greatly affected by impairment charges on two properties (£945,000). Also there was a negative £572,000 exceptional charge mostly caused by a one-off expense for equalising pensions (a countrywide imposition on companies). If I correct these distortions, remove true exceptional items and take away the profits made on property I arrive at earnings coming solely from the operating business (including rent collected on properties). Method 2. Stripping out the one-off elements and separating the operating income from the property development income. Year end (in March) Profit from selling cars and rent, £000s Earnings per share from selling cars and rent 2020 -252 -9.4p 2019 952 35.3p 2018 1,030 38.2p 2017 1,284 46.7p 2016 2,525 91.5p 2015 1,600 58p 2014 1,411 51p 2013 626 22.6p 2012 710 25.6p 2011 218 7.7p 2010 846 30p 2009 -4,230 -146.9p 2008 -325 -11.3p Average earnings per share over 13 years 18.4pThus, the average earnings per share is 18.4p from the “operating” business. This puts Caffyns’ shares on a CAPE of 239p/18.4p = 13. Even these numbers have been boosted by what s………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Harvey Golub, CEO of American Express since 1993, announced in 1999 that he did not want to go on working full-time until he was 65 (he was 60). His work was done, “ the company is in terrific shape: robust growth engines have been built; our brand and our reputation are stellar; our people and intellectual capital are outstanding; and our customer base is large and loyal.” (reported in AP News, “American Express CEO Resigns Early”, November 17, 2000)
He allowed plenty of time for the transition to a new CEO. Golub chose, and the Board and shareholder approved, the highly respected Ken Chenault, who had been his trusted No 2 since 1993. He became only the third black CEOs of an S&P500 company in 2001. Buffett said, in his 2006 letter, that he greatly admired Chenault. He went on to note the different skill set required to run a company compared with being an investor: “I don’t think I could do the management job they do. And I know I wouldn’t enjoy many of the duties that come with their positions – meetings, speeches, foreign travel, the charity circuit and governmental relations. For me, Ronald Reagan had it right: ‘It’s probably true that hard work never killed anyone – but why take the chance?’ So I’ve taken the easy route, just sitting back and working through great managers who run their own shows. My only tasks are to cheer them on, sculpt and harden our corporate culture, and make major capital-allocation decisions. Our managers have returned this trust by working hard and effectively.” Chenault retired in 2018 to be succeeded by another American Express lifer, Stephen Squeri. In May 2020 Buffett offered the same advice to Squeri concerning American Express when Covid-19 was raging that he had 56 years previously at the height of the Salad Oil Crisis, “The most important thing about American Express is the brand and the customers that aspire to be associated with the brand” (“’The brand is special”’ Warren Buffett called on American Express’ CEO to protect its reputation during the coronavirus pandemic” Theron Mohamed, Business Insider, May 30, 2020.) Squeri doubled down on maintaining customer relationships when many faced financial difficulties. Amex waived late fees, lowered interest rates and cut monthly payments. It also helped customers obtain refunds. Moats and castles This emphasis on building the brand has always been to deepen the moat around the economic franchise castle: “A truly great business must have an enduring “moat” that protects excellent returns on invested capital. The dynamics of capitalism guarantee that competitors will repeatedly assault any business “castle” that is earning high returns. Therefore, a formidable barrier such as a company’s being the low-cost producer (GEICO, Costco) or possessing a powerful world-wide brand (Coca-Cola, Gillette, American Express) is essential for sustained success.” (Buffett's 2007 letter) Buffett warns us to beware of illusionary economic franchises. You will come across many “Roman Candles,” those companies where the moat loses its effectiveness and thus the economic franchise fizzles out as determined rivals succeed. An economic franchise, by definition, has to be enduring, which is unlikely to occur in industries prone to rapid and continuous change. A lot of “creative destruction” is going on out there. While this is great for society, it precludes investment certainty. As Buffett says, “A moat that must be continuously rebuilt will eventually be no moat at all” (2007 letter). An illusion arises where the outstanding success of the business depends on a great manager leading the enterprise. “Of course, a terrific CEO is a huge asset for any enterprise, and at Berkshire we have an abundance of these managers. Their abilities have created billions of dollars of value that would never have materialized if typical CEOs had been run ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 On August 1, 1994, when Berkshire bought its first common stock in American Express, the company’s market capitalisation was $12bn. Was Mr Market too optimistic, too pessimistic or about right? To try to answer I’ll estimate annual owner earnings and, from those derive possible intrinsic values.
In the following calculations I make a simplifying assumption, but one that is not too far from the truth: The amount American Express needed to spend annually on capital items and increases in working capital to maintain its economic franchise, volume and invest in value-adding projects amounted to roughly the same as the non-cash charges in the accounts (e.g. depreciation and amortisation). (see older Newsletters for owner earnings and intrinsic value calculations without this assumption) With this assumption in place owner earnings equals net income (This assumption works with some companies, but for many others capital expenditure and working capital investment can absorb far more than the allowance made for depreciation, amortisation, etc., leaving little cash for shareholders to take away from the business without damaging its franchise.) This allows us to estimate intrinsic value by using published net income figures rather than making the adjustments to published earnings which might otherwise be necessary to obtain owner earnings estimates. To calculate intrinsic value the investor needs to look at the financial record of the company, and its qualities in terms of strategic position and management to gauge likely earnings power in the future. This is a process Buffett went through in the 1994 as he grasped for estimates of future owner earnings. His starting point might have been observing 1993’s owner earnings/net income of approximately $1.5bn and the expectation for 1994 of $1.4bn. It is likely he would also examine a number of years before that. And he separated income from the core economic franchise businesses from that of non-core activity which often produced write-offs and losses. If he then took a conservative approach and assumed no change in future years, i.e. a perpetuity of say $1.4bn, and used a discount rate of 10% (The US ten-year Treasury yielded between 5.6% – 8.0% in 1994, so using a 10% pa required return allows for additional equity risk) he would calculate an intrinsic value of $1.4bn/0.10 = $14bn, slightly higher than the $12bn market capitalisation. But that estimate does not allow for the elimination of drag from the investment bank and brokerage businesses. If he could allow himself some optimism, imagining that the new managers would effectively re-focus the business on the core and would raise capital by selling under-performing units, then perhaps owner earnings would rise from one year to the next. Let us estimate that average annual growth at 5% Then estimated intrinsic value would be $1.4bn/(0.1 – 0.05) = $28bn, providing a very large margin of safety on the market price. We have the benefit of hindsight – we know the net earnings after 1994 – see Table. Our perfectly foresighted selves can use actual future owner earnings/net income to calculate intrinsic value in 1994. The final column of shows the present value of net income if discounted to 1994. Table 3.1 American Express, net income, discounted net income Year Net income, $bn Discount factor (10% per year) Discounted net income, $bn – to present value in 1994 1995 1.56 0.9091 1.42 1996 1.90 0.8264 1.57 1997 2.00 0.7513 1.50 1998 2.14 0.6830 1.46 1999 2.48 0.6209 1.54 2000 2.81 0.5645 1.59 2001 1.31 0.5132 0.67 2002 2.67 0.4665 1.25 2003 2.99 0.4241 1.27 2004 3.45 0.3855 1.33 2005 3.73 0.3505 1.31 2006 3.71 0.3186 1.18 2007 4.01 0.2897 1.16 2008 2.70 0.2633 0.71 2009 2.13 0.2394 0.51 2010 4.06 0.2176 0.88 2011 4.94 0.1978 0.98 2012 4.48 0.1799 0.81 2013 5.36 0.1635 0.88 2014 5.89 0.1486 0.88 2015 5.16 0.1351 0.70 2016 5.41 0.1228 0.66 2017 2.75 0.1117 0.31 2018 6.92 0.1015 0.70 2019 6.76 0.0923 0.62 Assume perpetuity thereafter 6.76 (6.76/0.1) = 67.6 0.0923 6.24 Intrinsic value estimate in 1994 (total of discounted earnings) £32bnClearly, the conservative………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 Warren Buffett's decision to hold on to his American Express shares in 1994 (see the last newsletter) turned out to be a great one. Within five years they multiplied by five. To date the investment is a twenty-bagger and Berkshire Hathaway now owns $19bn of American Express shares - that is 18.7% of the company.
Long before the fateful golf game in which Buffett was persuaded to hold on to the shares by his golfing partner, Frank Olson, CEO of Hertz, Buffett had observed the return to rationality at American Express. First there was a change at the top in February 1993 after Robinson was pressed by investors and the board to resign. He was replaced by Harvey Golub, who had been in charge of the very successful IDS Financial Services Division since 1984 and of the card and travelers cheques businesses since November 1991. Golub had a three-part strategy: (1) to build the core franchises, with a particular focus on the “brand value” - music to Buffett’s ears (2) to raise money by selling underperforming divisions, and (3) to cut costs. Second, a bunch of non-core businesses were sold, raising billions. In April 1992 a 46% stake in First Data, the information service subsidiary (card processing operations for many card companies including Visa and Mastercard), was sold in a public offering, raising almost $1.1bn. The next March saw the First Data stake reduce to approximately 22%, raising another $1.1bn. Also in 1993, Shearson Lehman’s retail brokerage and asset management business was sold for $1bn plus a portion of future profits from that business. And, The Boston Company, a private banking, trust and mutual fund administration businesses, was sold together with Shearson Lehman Hutton Mortgage Corporation, which engaged in mortgage banking, for $1.45bn. In May 1994 the Lehman Brothers division was spun off to American Express’s shareholders in a tax-free distribution (a special dividend: 1 share of Lehman for five of American Express). Prior to that the company’s stated its “investment” in Lehman at $2.4bn. These actions were designed to achieve the targets Golub set of, (a) achieving an annual return on equity of 18–20%, and (b) increasing earnings per share by 12-15% per year In 1995 the revitalised card business expanded to 27 countries. And the company started the drive to beef up its credit card offering (branded the “Optima” card to distinguish it from the charge card) to compete with Visa and others, entering a foreign country for the first time, Britain, that year. Sending money to shareholders The third stage must have been the clincher for Buffett because it gave insight into the degree to which the directors were of shareholder oriented. Between 1992 and 1994 the directors did so well in improving the core business, raising capital through non-core sales and in cutting costs that American Express was clearly generating cash flow greater than that needed to maintain the economic franchise, and it looked as though it would continue to do so for as far as the eye could see. Instead of hoarding the money or going on a wild spending spree of acquisitions – as far too many managers do - they quietly returned it to shareholders via the repurchase of common stock. They understood their circle of competence and they understood that any additional dollar invested must generate a good rate of return. The directors expressed their intent in the 1994 Annual Report thus, “To the extent retained earnings exceed investment opportunities, the Company will return excess capital to shareholders in the form of share repurchases. During 1994 the Company has moved from the point several years ago when it needed to strengthen its capital position to where the Company has the capital to support its credit ratings, fund growth opportunities in its core businesses and return capital to shareholders through a share buyback program.” The stream of cash to shareholders started in September 1994 with a buy back of 14.6m shares at an average of $30.37. Large repurchases have taken place in most years since, reaching as much as $1.89bn in 1998 and $4.6bn in 2019. Berkshire becomes the largest shareholder All these encouraging signs led to Buffett becoming increasingly convinced that American Express was on track to be a superb investment. In 1994 Berkshire not only held on to the 14m shares coming from the conversion of the PERCs, but bought a further 13.8m (average price $30.81). This raised Berkshire’s stake to 5.5% of the company. Already Amex was Berkshire largest spend on a non-controlled company at $724m except for the amounted devoted to Coca-Cola, $1,298m. Then, in March 1 ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 There are lessons for modern day investors in the way that American Express with its extremely strong franchises can take some duff "strategic" decisions and end up lowering the value of the firm to shareholders. I must remember that I musn't assume that those companies I'm looking at today which have historically thrived because they built a powerful competitive position will always be strong. So much depends on the current leadership.
Blunders at American Express in the 1980s The core American Express businesses threw off so much cash in the early 1980s that James D. Robinson III eyed an opportunity to create a “financial supermarket”, offering customers an increasing range of services. Surely, there would be synergies, not least from being able to market additional products to card holders and travelers cheque clients? It stands to reason that customers would welcome access to half dozen different services without needing to step outside the Amex family of companies. And surely, there would be economies of scale in back office work? Thus it was, in 1981, that investment bank and retail brokerage firm Shearson Loeb Rhoades, the second largest securities firm in the US, was acquired for $932m. In 1983, the Swiss private bank, Trade Development Bank was added for $550m. And, in 1984, Investor Diversified Services was bought for $790m to create a diverse financial service group that could bundle services. To beef up even more, investment bank Lehman Brothers was purchased in 1984 for $360m, followed by E.F. Hutton, a retail brokerage house for $962m in 1987. That is a lot of spending for $10bn - $14bn market capitalisation company. Maybe not such a great strategy Many of the once-fashionable financial services conglomerates of the 1980s turned out to be failures. The American Express experiment was partially successful - for example, IDS was a good fit - but mostly there was disappointment. The various parts did not mesh into a coherent whole. Executives at the card division did not want to tie their valuable brand to Shearson’s investment banking adventures, suspicious that their buccaneering style and regular slipups would tarnish their image. They were also reluctant to hand over their precious customer list, created through patient relationship building, to Shearson’s or Lehman’s hard-selling transaction-focused guys. Besides which, most cardholders quite liked shopping around for value in financial services, rather than buying all from one organisation. The conglomerate became unwieldly to manage. In the sprawl, division chiefs were allowed to grow their domains unimpeded and power seeped from the centre. Some bosses, freed of constraint and with an over-abundance of self-confidence, made errors that had large impacts on the Group. Losses sprung up at the insurance subsidiary, the Fireman’s Fund, and at the Trade Development Bank, when risks were not carefully controlled. Shearson exposed the Group to enormous risks and losses, from underwriting gaffes and commercial real estate asset errors to poorly priced bridging loans and Latin American loan debacles. So much was lost that Robinson was in no position to refuse to pump in more money into Shearson to keep it afloat. And so much senior management attention was devoted to fire-fighting problems at various loss-making arms that the core card and travelers cheque businesses were neglected. Other ways of losing money As if these problems were not enough, Group “strategy” included escapades into businesses that did not even offer financial services, such as the over-priced Beaver Creek Conference Centre, and an art gallery. And there was unethical behaviour, the Safra affair being an outstanding example. Edmond Safra was head of The Trade Development Bank when it was sold to Amex. He was given to believe he could run the bank under the Amex umbrella in his way. However, two years later, in 1985, dissatisfied with the restrictions under which he had to operate, he resigned. When Safra tried to establish a new bank he became the subject of a smear campaign. To discredit him Amex people planted false rumours in newspapers. This unprofessional and unprincipled conduct received considerable press attention, to the detriment of American Express’s public image. An embarrassed and humbled American Express paid $8m to charities agreed with Safra in 1989, together with an apology. Then there was more intense competition from credit cards issued by a wide variety of organisations, led by Visa, Mastercard, but including powerful groups such as Sears (Discover card), General Electric, Ford and AT&T, which made headway difficult for the Amex charge card or their credit card. There was widespread protests about the merchant fees charged by Amex. These was led by the “Boston Fee Party” group of restaurants. In one particularly memorable episode a chef stuck a knife through an Amex card on national TV. Amex had been able to get away with high merchant fees because its cardholders spent so much more than holders of other cards, and so retailers etc., were particularly keen on their custom. But, in the late 1980s Amex arguably went too far and suffered “suppression” as a result: merchants would ask customers to use another card or cash. Amex lost market share. Shareholders were not happy John J. Byrne - the same “Jack” Byrne who saved GEICO for Warren Buffett in 1976 - sadly summarised the story of the 1980s when he spoke as a director of American Express in a Board meeting, in September 1992, “$3 billion to $4 billion of the shareholders' money had been lost during Robinson's tenure” So, despite the profits and high returns on capital flowing from the core businesses the share price went nowhere over the eight years to the summer of 1991. Two deals The Shearson-Lehman losses and the worsening position in ………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1 |
Prof. Glen Arnold
I'm a full-time investor running my portfolio from peaceful Leicestershire countryside. I also happen to be UK´s best selling investment book author and a Financial Times Best selling author. Originally, I wrote all my ideas out in full on this website. Now that ADVFN publish them they are entitled to display the full version for six months – you can see them here. Thus can I only post the first few paragraphs here for anything younger than six months.
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