Showing posts with label industry recession. Show all posts
Showing posts with label industry recession. Show all posts

Tuesday 16 March 2010

History suggests that the winners from a recession tend to win big

History suggests that the winners from a recession tend to win big

The story is possibly apocryphal, but at the height of the Guinness affair in the mid-1980s, Ernest Saunders, the soon to be disgraced Guinness chairman, is said to have been called to a crisis Sunday morning meeting in London.






Saunders insisted there was no way he could make it as he would be in Church. "I didn't know you were a religious man", the adviser remarked. "I'm not", said Saunders, "but at times like these it pays to hedge your bets".
There are still a few optimists out there, a few prepared to accept forecasts from the UK Treasury and other Western policymakers of a strong, V shaped recovery to come, but most chief executives have long since given up hope of reaching these sun lit-uplands again any time soon.
Hopefully, a Japanese-style lost decade of growth can still be avoided, yet the company boss who is not hedging his bets by thinking about how to match his cloth to such permanently reduced growth prospects would be in dereliction of his duties. Most business leaders expect at best an extended period of anaemic growth for advanced economies, and many are preparing for worse.
We already know for sure that this is no ordinary recession; whatever the official data says about growth over the next several years, it is going to feel bad for a long time. And however decisively China and other surplus nations move to stimulate domestic demand, it's not going to compensate fully for the likely fall-off in US consumption.
In recent years, US consumers have accounted for a whacking great 20pc of global GDP. Private consumption in China would need to rise by more than 30pc to offset a decline of just 5pc in US consumer spending.
Most high growth, developing economies are in any case effectively walled gardens not easily accessed by western companies. They'll keep the goodies for themselves.
If low, or even negative growth is the new reality, the implications are profound, both for the public finances (published plans for fiscal consolidation in Europe and America are heavily dependent on a return to robust growth) and the way companies are managed.
In such circumstances, are companies best advised to put themselves into cold storage, sit on their hands, and do nothing until the debt overhang is removed? That's already a quite common approach to the problem, but the evidence of past Depressions is that it is most unlikely to serve its followers well.
Instead, established business models need to be rethought and companies must adapt to survive. Recessions quickly sort businesses into winners and losers. In good times, all companies tend to float along together on a sea of rising consumption, but when the going gets tough, performance will diverge markedly.
Recessions can therefore produce seismic industrial and corporate change, and somewhat counter-intuitively, really serious ones can catalyse great leaps forward in innovation and productivity. Established market leaders get toppled, and upstarts can come from nowhere to take their place. Recessions can be as much a land of opportunity for the fleet of foot as they are the nemesis of the overblown and complacent.
These are some of the observations of a new study by David Rhodes and Daniel Stelter of The Boston Consulting Group. Their book, "Accelerating Out of the Great Recession – How to Win in a Slow-Growth Economy", convincingly demonstrates that well-managed companies can indeed prosper through tough times and what's more, tend to enjoy sustained advantage for decades afterwards.
The fight to maintain company performance during a downturn is not just about short-term survival – it is also about long-term positioning in the industry hierarchy. For examples of this, the authors have gone back to the American automobile industry during the Great Depression.
Like today, the auto-industry was one of the worst affected by the economic contraction of the 1930s. By 1932, US sales of new automobiles had fallen by an astonishing 75pc and combined annual losses had reached nearly $3bn in today's money. At the start of the Depression, General Motors and Ford enjoyed market share of roughly a third each, with the rest accounted for by smaller players.
Over subsequent years, General Motors improved its market share by a remarkable 15pc, largely at the expense of Ford and smaller players, to take nearly half the total market. But the performance of Chrysler, a comparative upstart was even more impressive. During this period it took an extra 20pc of the market to leave Ford standing.
For General Motors, the secret lay with acting decisively to cut costs and mothball plants, allowing the company rapidly to scale back production of its mid-market and high-end brands. GM slashed prices by up to 70pc to clear unwanted inventories, it crunched its sales forces and component sourcing together across brands, and it created new forms of consumer finance to replace non lending banks.
At Chrysler, the approach was even more brutal. Applying the ancient Roman principle of "decimation", it went through the payroll list sacking every third person indiscriminately. But at the same time, it put in place systems to almost double the hourly output of its assembly lines.
Despite the difficulty of the times, it also continued to invest heavily in marketing, research and development. Realising that the highway expansion programme of the New Deal would create demand for faster more powerful cars, it became the first auto-maker to use wind tunnel testing to improve design and engineering.
These are just two of the many industrial success stories of the Great Depression. Others include genuinely new industries in consumer products and business services, including Hoover and IBM, both of which experienced explosive growth in the 1930s.
It all goes to show that even the most structurally damaged of economies will eventually revive on a wave of innovative, needs-must advancement. For the industries of the future we must look to communications, biotechnology, robotics, nanotechnology, renewable energy and healthcare.
And the management qualities needed to achieve high performance in a downturn? Well, these are not so very different to those that underpin outstanding business achievement at all times – strong leadership, decisive, early action, willingness to rethink the business model and ability to take the organisation with you. It's easy enough to define what makes the difference; making it happen is something else entirely.

Thursday 9 October 2008

The Bad News that creates a Buying Situation - Industry Recession

The second kind of situation that presents a buying opportunity is an industry-wide recession. In this case an entire industry suffers a financial setback. These situations vary in their intensity and depth. An industry recession can lead to serious losses or it can mean nothing more than mild reduction in per share earnings. Recovery time from this type of situation can be considerable, one to four years, but it does present excellent buying opportunities. In severe examples, a business may even end up in bankruptcy. Don't be fooled by too cheap a selling price. Stay with a well-capitalized leader, one that was very profitable before the recession.

Capital Cities/ABC Inc. fell victim to this weird manic-depressive stock market behaviour in 1990. Because of a business recession, avertising revenues started to drop, and Capital Cities reported that its net profit for 1990 would be approximately the same as in 1989. The stock market, used to Capital Cities growing its per share earnings at approximately 27% a year, reacted violently to this news and in the space of six months drove the price of its stock down from $63.30 a share to $38 a share. Thus, Capital Cities lost 40% of its per share price, all because it projected that things were going to be the same as they were last year. (In 1995, Capital Cities and the Walt Disney Company agreed to merge. This caused the market-revalued Capital Cities to upward of $125 a share. If you bought it in 1990 for $38 a share and sold it in 1995 for $125 a share, your pretax annual compounding rate of return would be approximately 26%, with a per share profit of $87.)

Warren Buffett used the banking industry recession in 1990 as the impetus for investing in Wells Fargo, an investment that brought him enormous rewards. Remember, in an industry-wide recession, everyone gets hurt. But the strong survive and the weak are removed from the economic landscape. Wells Fargo is one of the most conservative, well run, and financially strong of the key money center banks on the West Coast, and the seventh-largest bank in the nation.

Wells Fargo, in 1990 and 1991, responding to a nationwide recession in the real estate market, set aside for potential loan losses a little over $1.3 billion, or approximately $25 a share of its $55 a share in net worth. When a bank sets aside funds for potential losses it is merely designating part of its net worth as a reserve for potential future losses. It doesn't mean that losses have happened, nor does it mean they will happen. What it means is that there is potential for the losses to occur and that the bank is prepared to meet them.

This means that if Well Fargo lost every penny it had set aside for potential losses, $25 a share, it would still have $28 a share left in net worth. Losses did eventually occur, but they weren't as bad as Well Fargo prepared for. In 1991, they wiped out most of Wells Fargo's earnings. But the bank was still very solvent and still reported in 1991 a small net profit of $21 million, or $0.04 a share.

Wall Street reacted as if Wells Fargo was a regional savings and loan on the brink of insolvency, and in the space of four months hammered Wells Fargo's stock price from $86 a share to $41.30 a share. Wells Fargo lost 52% of its per share market price because it essentially was not going to make any money in 1991. Warren Buffett responded by buying 10% of the company - or 5 million shares - for an average price of $57.80 a share.

What Warren Buffett saw in Wells Fargo was one of the best managed and profitable money-center banks in the country, selling in the stock market for a price that was considerably less than what comparable banks were selling for in the private market. Although all banks compete with each other, as we said, money-center banks like Wells Fargo have a kind of toll brideg monopoly on financial transactions. If you are going to function in society, be it as an individual, a mom and pop business, or a billion-dollar corporation, you need a bank account, a business loan, a car loan, or a mortgage. And with every bank account, business loan, car loan, or mortgage comes the banker charging you fees for the myriad services he provides. California, by the way, has a lot of people, thousands of businesses, and a lot of small and medium size banks, and Wells Fargo is there to serve them all - for a fee.

The loan losses that Well Fargo anticipated never reached the magnitude expected, and nine years later, in 2000, if you wanted to buy a share of Wells Fargo you would have to have paid approximately $270 a share. Warren Buffett ended up with a pretax annual compounding rate of return of approximately 18.6% on his 1991 invetment. For Warren Buffett there is no business like the banking business.

In the cases of both Capital Cities and Wells Fargo, there was a dramatic drop in their share prices because of an industry-wide recession, which created the opportunity for Warren Buffett to make serious investments at bargain prices.