Beating the Street (28 page)

Sun TV is central Ohio's lone high-volume discount outlet for small appliances as well as refrigerators, washers, and dryers. Oyster said there were seven Sun TV stores in Columbus alone. The company's most profitable outlet is located in Chillicothe, Ohio, a name that my fellow
Barron's
panelists later congratulated me for being able to pronounce. It also has a dominant position in the Pittsburgh area.

Trivia buffs and shareholders of Sun Television & Appliances will be happy to know that 50 percent of the U.S. population lives within 500 miles of Columbus. In fact, Columbus is the only major city east of the Mississippi and north of the Mason-Dixon line that increased its population from 1950 to 1990.

The population growth in this part of Ohio, the news of which has yet to reach the East Coast, augurs well for the future of Sun TV. The company was engaged in a vigorous expansion program
(7 new stores in 1991, 5 more in 1992), which would bring the total to 22. It had less than $10 million in debt. With the stock selling for $18, its p/e ratio was 15. Here was a 25–30 percent grower with a 15 p/e. Several of its competitors were struggling to stay in business.

Sun TV made money in the 1990–91 recession when the economy was terrible, home sales were sluggish, and people weren't buying new appliances. The company's earnings actually increased in 1991. I had no reason to doubt it would do even better in 1992.

Nevertheless, Sun TV has a lot to prove before it makes my all-star team of great companies in lousy industries. A what-if portfolio of this Magnificent Seven (plus Green Tree, which is a provisional member) would have given you the results shown in
Table 11-1
. Most of these stocks had recent run-ups, which caused me to omit them from my 1992 list of recommendations. But every one is worth tuning in later.

In the 1980s, what business was worse than the airline business? Eastern, Pan Am, Braniff, Continental, and Midway went bankrupt, and several others were on the verge of doing so, yet in this disastrous 10-year stretch the stock in Southwest Airlines rose from $2.40 to $24. Why? Mostly because of all the things Southwest Airlines didn't do.

It didn't fly to Paris, it didn't serve fancy meals, it didn't borrow too much money to buy too many airplanes, it didn't overpay its executives, and it didn't give its workers a good reason to resent the company.

Table 11-1. Magnificent Seven Portfolio (+ One)

Southwest Airlines (symbol LUV) was the lowest-cost operator in the industry. How do we know this? The telling statistic is “operating cost per seat mile.” Southwest's ranged from 5 to 7 cents during a period when the industry average was 7 to 9 cents.

One way to judge a company's commitment to frugality is by visiting the headquarters. “The fact that a company you put your money in has a big building doesn't mean that the people in it are smart, but it does mean that you've helped pay for the building,” says investment adviser William Donoghue. In my experience, he's right. At Golden West Financial in California, a champion of productive penny-pinching and the lowest-cost operator in the S&L business, the role of the receptionist was taken over by an old-fashioned black telephone and a sign that said, “Pick up.” Southwest Airlines operated for 18 years out of a home office at Love Field in Dallas that resembled a barracks. The nicest thing you could say about it was that it was “antiquated.” In 1990, the company splurged and built a new three-story high rise. A decorator was hired to beautify the interior, but he made the mistake of trying to replace the employee award plaques and photographs of company picnics with expensive art. When CEO Herb Kelleher got wind of this, he fired the decorator and spent the weekend rehanging the plaques and the photographs.

Kelleher set the tone for Southwest's wacky esprit. His office was decorated with turkeys. The annual get-together was a chili cookout. Pay raises for the higher-ups were limited to the same percentage increase the work force got. One day a month, all the big shots from Kelleher on down served as counter agents or baggage handlers.

Southwest's stewardesses were outfitted in blue jeans, T-shirts, and sneakers. Meals were limited to peanuts and cocktails. Prizes were awarded to the passengers with the biggest holes in their socks, and the safety information was delivered as a rap song.

While other airlines were flying their widebodies over the same routes to Los Angeles, New York, and Europe, Southwest found a niche: the short hop. It called itself “the only high-frequency, short-distance, low-fare airline.” As the others killed themselves off, Southwest grew from a four-plane operation in 1978 to the eighth-largest carrier in the country. It was the only U.S. airline to have made money every year since 1973. For return on capital, Southwest has yet to be outdone.

As its competitors falter, Southwest is fully prepared to take advantage, which is what usually happens to a great company in a lousy industry. It recently expanded into routes abandoned by USAir and America West, both of which were forced to cut back on service because of financial problems.

Shareholders who saw their Southwest holdings increase 10-fold from 1980 to 1985 had their patience tested from 1985 to 1990, when the stock price went sideways. It could have been worse—they could have been invested in Pan Am or Eastern. After 1990, patience was rewarded, as Southwest doubled again.

What could be less exciting than a company that makes retread tires in Muscatine, Iowa? I've never been to Muscatine, but I've looked it up on a map. It's a small node on the Mississippi River southwest of Davenport and southeast of Moscow, Atalissa, and West Liberty.

Whatever is up to date in Kansas City probably hasn't gotten to Muscatine, which may be to Muscatine's advantage. Wall Street hasn't spent much time in Muscatine either. Only three analysts have followed Bandag on its rise from $2 to $60 in 15 years.

Bandag's CEO, Martin Carver, returns the favor by staying away from New York. He holds the world speed record for a diesel truck. You won't see him sipping champagne in the courtyard at the Trump Plaza Hotel, but on the other hand, Carver is solvent.

This is the Southwest Airlines of retreads: earthy management (in the 1988 annual report, Carver thanked his family), devoted penny-pinching, and an unusual niche in what otherwise is a cutthroat business. Every year in the U.S., 12 million worn-out truck and bus tires are replaced with retreads. About five million of these replacements are Bandag's.

Bandag has increased its dividend every year since 1975. Its earnings have grown at a 17 percent clip since 1977. Its balance sheet is a bit weak, primarily because Bandag has invested in overseas expansion (it now has 10 percent of the foreign retread market) and has bought back 2.5 million of its own shares.

While the earnings continued to grow, Bandag's stock price dropped sharply in the Great Correction and again in the Saddam
Sell-off. This overreaction on Wall Street's part was a perfect opportunity to buy more shares. Both times, the stock recovered all its lost ground and then some.

Cooper Tire is another version of Bandag. It has found its own niche in the replacement tire market. As the industry giants carry on a money-losing battle to equip new cars with new tires, Cooper stays out of their way and equips old cars with new tires. It's a low-cost producer, which is why independent tire dealers like to buy from Cooper.

In the late 1980s, when the big three (Michelin, Goodyear, and Bridgestone) were ruining one another's business, Cooper was making money. Its earnings increased every year from 1985 and hit another record in 1991. The stock price tripled from the 1987 low to $10 a share before the Saddam Sell-off, when it lost much of those gains and fell to $6. Investors ignored the fundamentals to focus on the sad future for tires after the world came to an end. When that didn't happen, the stock rose fivefold to $30.

This company belongs in the Enchanted Forest Portfolio along with Cedar Fair, Oak Industries, EQK Green Acres, Maple Leaf Foods, and Pinelands, Inc. Green Tree has tremendous debt and a CEO who is higher paid, even, than some second basemen, so it doesn't qualify as one of our great companies in a lousy industry. I include it here to show that even an OK company in a lousy industry can do well.

The lousy industry I'm talking about is mortgage loans for mobile homes. Green Tree specializes in such loans, and the business has been getting lousier. Every year since 1985, mobile-home sales have declined. In 1990, buyers were so scarce that only 200,000 new units were sold.

To make matters worse, record numbers of mobile-home owners were defaulting on their loans and abandoning their property, leaving notes for the lenders: our trailer is your trailer. There's not a lot of resale value in a 10-year-old double-wide.

The industry's disaster was a boon for Green Tree, because its major competitors gave up. Valley Federal, a hapless California S&L, made $1 billion in mobile-home loans, lost money, and fled the business. So did Financial Services Corporation, a subsidiary of an insurance company in Michigan. So did Citicorp, the biggest mobile-home lender of all. Green Tree was left to take advantage of all the action—if and when the action resumed.

There were enough doubters that it ever would resume that the stock fell to a low of $8 at the end of 1990.
Forbes
magazine had published a negative article in May of that year. The headline itself, “Are the Tree's Roots Withering?,” was enough to make you want to sell your Green Tree shares. The reporter did a thorough job of recounting every woe: the slump in mobile-home buying, the loan troubles, a nasty lawsuit overhanging Green Tree's assets. “Even at just seven times earnings, Green Tree doesn't look like much of a bargain,”
Forbes
concluded.

Investors shrugged off this bad review and the stock rose to $36 in nine months. How could something so terrible have turned out so well? With no competitors, Green Tree had the mobile-home loan business to itself. This resulted in a sharp increase in loan volume. The company had also begun to package its loans and sell them in the secondary market, the way Fannie Mae does with mortgages on houses. It was also making lucrative home improvement loans and used-mobile-home loans, and was moving into the motorcycle financing market.

If you had bought Green Tree as soon as you read the
Forbes
article, you would have tripled your money in less than nine months. I'm not out to chide a good magazine—I've missed plenty of Green Trees in my career. The point is that a survivor in a lousy industry can reverse its fortunes very quickly once the competitors have disappeared. (This company recently changed its name from Green Tree Acceptance.)

Here's another folksy bunch of managers with a tight grip on corporate purse strings. The Dillard family (principally 77-year-old William and his son William II) own 8 percent of this department-store
company and almost all of the voting stock. They run it out of Little Rock.

With Scroogian intensity, they search the books looking for new ways to cut costs, but not at the expense of employees. Dillard employees are relatively well paid. One place where Dillard does scrimp is on debt. There's little of that on the balance sheet.

The Dillards caught on to computers very early, not only to keep track of the money, but also to manage the merchandise. If a shirt is selling well in any Dillard store in the country, the store's computer notices it and automatically sends a reorder message to the warehouse computer. The warehouse computer then passes the order along to the vendor. Store managers and front-office types always know what is selling where, and the company doesn't have to support an army of wandering experts to tell it what to buy.

Dillard has stayed away from the glamour markets where the larger retail chains stumble over one another. Dillard stores are found in small towns and cities like Wichita and Memphis. As the glamour chains (Federated, Allied, Macy) restructure or go bankrupt, Dillard expands by buying some of their discarded divisions and hooking them up to the Dillard computers. Among others, it bought Joske's out of Allied and J.B. Ivey out of B.A.T. Industries.

A $10,000 investment in Dillard stock in 1980 has turned into $600,000 today.

Crown Cork & Seal reminds me of New England Wire & Cable, the company Danny DeVito tried to acquire in
Other People's Money.
The executive suite at New England Wire was a messy room over the factory, decorated with muffler-shop calendars. The executive suite at Crown Cork & Seal amounts to an open loft above the assembly lines. New England Wire made wire, Crown Cork & Seal makes soda cans, beer cans, paint cans, pet food containers, jugs for antifreeze, bottle caps, bottle washers, bottle rinsers, bottle crowners, and can warmers.

In both cases, the CEO was a businessman with old-fashioned ideas. The difference is that New England Wire & Cable was about to go bankrupt, whereas Crown Cork & Seal is the world's most successful can maker.