The following post about the auto industry was submitted by a client of FalkerInvestments.
The biggest difference between GM/Ford and Toyota/Honda is their mentality toward suppliers. GM and Ford look to their job regarding suppliers as a purchasing mentality. How can we purchase parts for less? Toyota and Honda have, in contrast, an engineering mentality. How can we together come up with better designs and methods?
Toyota and Honda have reputations for severe pressure on their suppliers to reduce costs, and both customer and supplier then benefit. This has the result of getting more cost out, as well as better designs and stronger suppliers. Compare the amount of warranty claims, recalls, launches on time, and customer loyalty, just to look at what the public sees. Review the kind of help that Toyota and Honda give to their supplier base vs. what GM and Ford do. When I was working for a GM supplier and GM "help" was arriving, it was greeted with dread. GM would pick the best opportunity to save money, do a kaizen class, calculate some (highly questionable) savings, often with a large capital requirement, then extrapolate the findings over the whole plant and demand those "savings" as a price reduction. In contrast, Toyota suppliers generally greet Toyota's help gladly, because both sides benefit.
Why do GM and Ford keep doing this, when the results of the purchasing mentality are so destructive and the results of the engineering mentality so beneficial? The answer is: they want quick fixes, and price reductions are quicker. And the suppliers don't trust them to actually share information (because they've had their suggestions/ideas given to other suppliers who offer lower prices). I believe it will take a total management shakeup. I'm talking an entirely new team, not just Rick Wagoner and Bo Anderson, which will deal with reality as it is and change the incentive and reward systems in place. Plus, I believe they will need the time--and the clout--that the bankruptcy process provides. Yes, that would be disastrous for the public to buy a car unsure about warranty, dealer support and resale value. So much of both companies probably would have to be sold off, allowing the public to buy a car without worrying about the future.
I do not see either Ford or GM being able to change their cultures fast enough to reverse their downward trend. All of the wage cuts and plant closures are to deal with the past problems, and they don’t deal with making the future different. Having a lower-paid (disgruntled) workforce doesn’t sound like a recipe for developing the kind of thinking workforce that Toyota has, with hundreds of thousands of suggestions a year—from Americans. For a different future, they need to have a different present. It won’t happen without a totally different management—and that is more than Kirk Kerkorian can deliver.
-FI Client
Thursday, April 06, 2006
Friday, March 31, 2006
Generous Motors
Growing up in Detroit and working for years at Chrysler, we always referred to GM as “Generous” Motors. That was tongue-in-cheek sarcasm, because in those years GM was anything but generous. In the ‘50s, ‘60s, ‘70s and beyond, they were always the guys to beat. They built a car for less than $500 in variable costs, while Chrysler struggled to get down to $1,000; Ford wasn’t much better, and AMC was the accident waiting to happen. GM management was so tough that they became known around town as the “heart attack machine”. Senior managers beat so hard on middle managers that the heart attack rate among these people, became alarmingly high. I know from personal experience: My wife’s father was chief mechanical engineer of GM’s realty and construction division and he had two heart attacks as a young man, which ultimately cut short his promising career. He was literally one of hundreds affected by the ruthless, cut-throat management environment that was GM in those years. I formed an opinion during my years in Detroit that the managers who shouted the loudest were people who had indeed risen to the level of their own incompetence.
Paradoxically, what happened to GM (as well as the others of the “big three”), primarily in the ‘70s, ‘80s and ‘90s, is that they actually did become “generous”, for all the wrong reasons. The UAW found managements’ weak spot: they just couldn’t bear to take a strike and possibly give up market share to one of their competitors. So, if the union bargained hard enough they virtually always got what they wanted and everybody laughed all the way to the bank. Management didn’t have to bite the bullet of labor strife, thereby risking their own status and inflated compensation packages, UAW officials always got re-elected, and hourly workers got ever-increasing pay checks and benefits, as did all the salaried workers who automatically received the same benefits and pay raises. So everyone was fat, dumb and happy. I can remember shaking my head at the idea that I would have a whole week off (with pay of course) at Christmas, as well as my birthday every year. I was always too busy.
So, all of this compounded over the years to the point that the American auto industry became so financially cumbersome, poorly managed, and virtually controlled by the UAW, that they literally could not compete with foreign manufacturers building cars with non-union U.S. labor. Can you imagine a labor provision requiring a company to keep thousands of laid-off workers in a “jobs bank”, doing community service for years while collecting full pay and benefits? I can’t, and neither can the Japanese manufacturers down the road.
I am often asked if I believe GM can avoid bankruptcy. My answer is always: “They shouldn’t”. In my view, Chapter 11 is the only way to save GM from themselves and the union. Like the airlines, management in bankruptcy can eliminate ponderous salary and benefit provisions (and the jobs bank!) once and for all. Also, it presents a once in a lifetime opportunity to bring fresh management thinking to an industry that has always been run by people who grew up in the business; usually in the same company. Nepotism has also run rampant, from the shop floor to top management. Note the Fords, who always seem to rise to the top job at Ford in times of strife, whether or not they are competent (usually not). In my view, this inbred management tradition is the primary reason they haven’t made good product decisions. People in Detroit really don’t get it about product, and that isn’t something new. So, if the bankruptcy court is wise, they will cede management of a bankrupt GM to outside professionals, who could care less about “how we have always done it around here”. Also, that ultimate old boys club, the dealer network, needs to be changed drastically, but no one in Detroit has ever been strong enough to tackle it. Jacques Nasser, who was CEO of Ford several years ago, began making noises in that direction, just before he was sacked and succeeded by the ultimate PR man, Bill Ford. In the world of the internet, cars should not be sold from vast inventories held by dealers and floor-planned by captive auto finance companies. This is a huge misuse of capital, but very convenient for keeping assembly lines cranking when cars aren’t selling. Cars should be ordered on-line and delivered “just-in-time”, and dealers should be delivery and servicing agents; obviously very different from today and probably only achievable “in extremis” of bankruptcy. By the way, I’m waiting for the Japanese to figure this one out.
Frankly, I have very little hope that much of this is going to happen. I’m pessimistic about Detroit and I do not believe the U.S. auto industry is too big to fail. However, we have no way of knowing when the band-aids will fall off. In the meantime, we will continue to insulate ourselves as much as possible from financial shocks by owning value-creating companies vs. value-destroyers like Ford and “Generous Motors”. And, yes, there are others out there, but none quite so bad.
Let me know what you think.
Jack Falker
Note: At the time of publication, neither the clients of FalkerInvestments Inc. nor Jack and Peter Falker held long or short positions in GM or F.
Paradoxically, what happened to GM (as well as the others of the “big three”), primarily in the ‘70s, ‘80s and ‘90s, is that they actually did become “generous”, for all the wrong reasons. The UAW found managements’ weak spot: they just couldn’t bear to take a strike and possibly give up market share to one of their competitors. So, if the union bargained hard enough they virtually always got what they wanted and everybody laughed all the way to the bank. Management didn’t have to bite the bullet of labor strife, thereby risking their own status and inflated compensation packages, UAW officials always got re-elected, and hourly workers got ever-increasing pay checks and benefits, as did all the salaried workers who automatically received the same benefits and pay raises. So everyone was fat, dumb and happy. I can remember shaking my head at the idea that I would have a whole week off (with pay of course) at Christmas, as well as my birthday every year. I was always too busy.
So, all of this compounded over the years to the point that the American auto industry became so financially cumbersome, poorly managed, and virtually controlled by the UAW, that they literally could not compete with foreign manufacturers building cars with non-union U.S. labor. Can you imagine a labor provision requiring a company to keep thousands of laid-off workers in a “jobs bank”, doing community service for years while collecting full pay and benefits? I can’t, and neither can the Japanese manufacturers down the road.
I am often asked if I believe GM can avoid bankruptcy. My answer is always: “They shouldn’t”. In my view, Chapter 11 is the only way to save GM from themselves and the union. Like the airlines, management in bankruptcy can eliminate ponderous salary and benefit provisions (and the jobs bank!) once and for all. Also, it presents a once in a lifetime opportunity to bring fresh management thinking to an industry that has always been run by people who grew up in the business; usually in the same company. Nepotism has also run rampant, from the shop floor to top management. Note the Fords, who always seem to rise to the top job at Ford in times of strife, whether or not they are competent (usually not). In my view, this inbred management tradition is the primary reason they haven’t made good product decisions. People in Detroit really don’t get it about product, and that isn’t something new. So, if the bankruptcy court is wise, they will cede management of a bankrupt GM to outside professionals, who could care less about “how we have always done it around here”. Also, that ultimate old boys club, the dealer network, needs to be changed drastically, but no one in Detroit has ever been strong enough to tackle it. Jacques Nasser, who was CEO of Ford several years ago, began making noises in that direction, just before he was sacked and succeeded by the ultimate PR man, Bill Ford. In the world of the internet, cars should not be sold from vast inventories held by dealers and floor-planned by captive auto finance companies. This is a huge misuse of capital, but very convenient for keeping assembly lines cranking when cars aren’t selling. Cars should be ordered on-line and delivered “just-in-time”, and dealers should be delivery and servicing agents; obviously very different from today and probably only achievable “in extremis” of bankruptcy. By the way, I’m waiting for the Japanese to figure this one out.
Frankly, I have very little hope that much of this is going to happen. I’m pessimistic about Detroit and I do not believe the U.S. auto industry is too big to fail. However, we have no way of knowing when the band-aids will fall off. In the meantime, we will continue to insulate ourselves as much as possible from financial shocks by owning value-creating companies vs. value-destroyers like Ford and “Generous Motors”. And, yes, there are others out there, but none quite so bad.
Let me know what you think.
Jack Falker
Note: At the time of publication, neither the clients of FalkerInvestments Inc. nor Jack and Peter Falker held long or short positions in GM or F.
Thursday, March 30, 2006
Safe Harbor
The following post about the inverted yield curve was submitted by a client of FalkerInvestments.
“The Fed Chairman said recently that the Fed is studying the concept that a growing excess of global investment liquidity (which may continue to grow indefinitely) has found its way into the long term U.S. Treasury market. This excess global investment liquidity may be the principal source/cause of the current U.S. inverted yield curve. If this supply of liquidity continues to exceed alternative business investment opportunities on a global basis, an inverted yield curve could become the rule, not the exception.
“Apparently an excess of global investment liquidity was the principal cause of an inverted yield curve situation, which existed for a number years during the late 50's and early 60's, until Federal deficit spending associated with the Vietnam War and a fear of long term price inflation came to dominate the thinking of global investors, who abandoned long-dated Treasuries, thereby causing long-term interest rates to escalate relative to short term interest rates.
“Let's face it, the USA, even with all of its many problems, is still the safest harbor in the world for investors to "park" long term idle investment capital.”
-FI Client
“The Fed Chairman said recently that the Fed is studying the concept that a growing excess of global investment liquidity (which may continue to grow indefinitely) has found its way into the long term U.S. Treasury market. This excess global investment liquidity may be the principal source/cause of the current U.S. inverted yield curve. If this supply of liquidity continues to exceed alternative business investment opportunities on a global basis, an inverted yield curve could become the rule, not the exception.
“Apparently an excess of global investment liquidity was the principal cause of an inverted yield curve situation, which existed for a number years during the late 50's and early 60's, until Federal deficit spending associated with the Vietnam War and a fear of long term price inflation came to dominate the thinking of global investors, who abandoned long-dated Treasuries, thereby causing long-term interest rates to escalate relative to short term interest rates.
“Let's face it, the USA, even with all of its many problems, is still the safest harbor in the world for investors to "park" long term idle investment capital.”
-FI Client
Saturday, March 11, 2006
FI Update - 3/11/06
To Our Investors and Friends:
The equity markets ended the week on a positive note, with short-term good news on U.S. Payrolls. That seemed to counteract long-term macro-economic news earlier in the week on the ever-worsening U.S. trade deficit. If the order of the announcements had been reversed, market results would likely have been significantly worse, since the trade-deficit implications greatly outweigh employment data in the longer term. But that’s how the markets work in the short term, irrational though that may seem.
We have seen nothing to contradict our opinion that we are in the midst of an economic dichotomy, i.e. in a micro-economic, short-term context, things are going pretty well, but in a macro-economic, long-term context, they’re not going well at all. The bond market continues to reflect this dichotomy, with a virtually flat yield curve. For example, at the end of the week, the 30-year Treasury bond yielded 4.74% vs. the 10-year at 4.72%, the three-year at 4.76% and the 90-day T-bill at 4.46%. Anyone want a 30 or 10-year bond when you can get virtually the same yield at 90 days? Hardly! There is clearly something wrong with this picture, and the economists we read (who don’t have a political agenda) are rending their garments waiting for the next shoe to drop, and long-term interest rates to start rising.
So far, it hasn’t happened, and it may be some time before it does, because there are so many dollars in the hands of foreign governments who need to keep those dollars invested. In other words, it’s a matter of supply and demand, until some better investment comes along for those foreign dollar-owners. The Dubai ports deal, which we have heard so much about recently, is a good case in point of a vast excess of foreign dollars trying to find a permanent equity ownership home in the U.S.A., their country of origin. Look for many more such efforts by foreign governments, particularly China and the Arab oil producers.
We saw some movement this week toward higher international interest rates when the Bank of Japan abandoned its long-standing zero interest rate policy (ZIRP), signaling an end to five years of deflationary economic trends. Long-term U.S. rates immediately moved up several basis points; in other words, long-term U.S. government rates were actually lower (and more inverted) a week ago than those quoted above.
For the moment, we feel comfortable with a close to fully invested position in properly valued, dividend-paying stocks. This week we deployed some of the profits we took earlier in the year (see our 2/09/06 blog note) by taking a core position in TCF Financial (TCB). We have done very well with this high-quality holding in the past and have re-entered at a level lower than our last very profitable sale of this stock. Incidentally, when we last sold TCB we redeployed that capital in Moody’s (MCO), which has since doubled in value. TCB is an excellent Minneapolis-based national bank, with a growing retail base, which keeps its cost of funds (which it calls “Power Liabilities”) among the lowest in the business. TCB ranks first among the 50 largest banks in Return on Equity (ROE), one of the most important statistics in the banking business. It also pays a very bond-competitive 3.5% dividend. Right down our EVA alley!
We welcome your comments and observations.
Jack and Peter
The equity markets ended the week on a positive note, with short-term good news on U.S. Payrolls. That seemed to counteract long-term macro-economic news earlier in the week on the ever-worsening U.S. trade deficit. If the order of the announcements had been reversed, market results would likely have been significantly worse, since the trade-deficit implications greatly outweigh employment data in the longer term. But that’s how the markets work in the short term, irrational though that may seem.
We have seen nothing to contradict our opinion that we are in the midst of an economic dichotomy, i.e. in a micro-economic, short-term context, things are going pretty well, but in a macro-economic, long-term context, they’re not going well at all. The bond market continues to reflect this dichotomy, with a virtually flat yield curve. For example, at the end of the week, the 30-year Treasury bond yielded 4.74% vs. the 10-year at 4.72%, the three-year at 4.76% and the 90-day T-bill at 4.46%. Anyone want a 30 or 10-year bond when you can get virtually the same yield at 90 days? Hardly! There is clearly something wrong with this picture, and the economists we read (who don’t have a political agenda) are rending their garments waiting for the next shoe to drop, and long-term interest rates to start rising.
So far, it hasn’t happened, and it may be some time before it does, because there are so many dollars in the hands of foreign governments who need to keep those dollars invested. In other words, it’s a matter of supply and demand, until some better investment comes along for those foreign dollar-owners. The Dubai ports deal, which we have heard so much about recently, is a good case in point of a vast excess of foreign dollars trying to find a permanent equity ownership home in the U.S.A., their country of origin. Look for many more such efforts by foreign governments, particularly China and the Arab oil producers.
We saw some movement this week toward higher international interest rates when the Bank of Japan abandoned its long-standing zero interest rate policy (ZIRP), signaling an end to five years of deflationary economic trends. Long-term U.S. rates immediately moved up several basis points; in other words, long-term U.S. government rates were actually lower (and more inverted) a week ago than those quoted above.
For the moment, we feel comfortable with a close to fully invested position in properly valued, dividend-paying stocks. This week we deployed some of the profits we took earlier in the year (see our 2/09/06 blog note) by taking a core position in TCF Financial (TCB). We have done very well with this high-quality holding in the past and have re-entered at a level lower than our last very profitable sale of this stock. Incidentally, when we last sold TCB we redeployed that capital in Moody’s (MCO), which has since doubled in value. TCB is an excellent Minneapolis-based national bank, with a growing retail base, which keeps its cost of funds (which it calls “Power Liabilities”) among the lowest in the business. TCB ranks first among the 50 largest banks in Return on Equity (ROE), one of the most important statistics in the banking business. It also pays a very bond-competitive 3.5% dividend. Right down our EVA alley!
We welcome your comments and observations.
Jack and Peter
Thursday, February 09, 2006
FI Update - 2/9/06
To: FI Clients
From: Peter and Jack Falker.
Subj: FI Update
Here is a summary of our investment activities over the last several months, along with some of our thoughts:
In early February 2006, we sold ATK Systems (ATK) for a profit of 51 %. The stock had reached an all-time high and was somewhat overvalued based on our modeling assumptions. Also, a question had been raised in the January 9th edition of Forbes Magazine about the size of ATK’s unfunded pension liabilities. After talking with the company, we concluded that, as so often happens in the popular press, the pension issue was probably overblown. However, perception often becomes reality in this world, so we decided to book our profit the day before the company’s quarterly conference call. The street was disappointed by their results (which had little or nothing to do with their pension issues) and the stock dropped nearly $5.00 (6.2 %) that day.
Also in early February, we sold J.P. Morgan Chase (JPM) for a small profit. During the two years we held JPM we collected an annual dividend of 3.5% which was better than we could have earned on cash and approximately equal to the yield of a high-grade bond of similar duration. Now, with cash yields up, we will look for the opportunity to re-deploy this capital in another bank with an equivalent or better dividend and a better potential for a capital gain going forward.
In late January 2006, we sold PNC Bank Corporation for a profit of 18.5%. We also collected a 3.6 % dividend in the 13 months we owned PNC, giving us a 22% overall yield on our investment. We originally bought relatively small positions in PNC and U.S. Bank Corporation (USB) as weak dollar hedges, since they were both undervalued, compared with most other large banks in the U.S. Based on our reading, the thought was that they would make attractive acquisition targets for European banks with a surplus of strong Euros. With the U.S. dollar strengthening in 2005, our hedge strategy became irrelevant, but PNC had good results and the stock responded, making it somewhat overvalued, so we took our profit. We still own USB, which is slightly above our basis and continues to pay us a 4.5% dividend (as good as a 10 year government bond). We may decide to sell USB, as well, when we see a better investment opportunity for the funds.
In mid-December 2005, we sold Briggs & Stratton Corporation (BGG) for a small (.6%) profit. The stock had performed poorly since we bought it last February, and at one point had lost about 20 % of its value. In late October, we talked with the company’s CFO, with a thought toward exercising our long-standing stop-loss policy. After that conversation, we suspected that the company might report a good quarter, based on generator sales after the hurricanes, plus a pricing initiative they had undertaken for 2006 lawn and garden sales. Apparently a few other folks in the market thought so too, because the stock literally rocketed up in December. On the old theory of not looking a gift horse in the mouth, we sold BGG and reclaimed our capital investment. In January, BGG reported a disappointing quarter and the stock has subsequently gone back down.
In late October 2005, we sold Techne Corporation (TECH) for a profit of 54 %. While we still really like this little-known Minneapolis biotech raw-materials supplier (and know them very well), our analysis indicated that it had reached a valuation we felt was unsustainable. We believe we will have a chance to own it again when its valuation is more in line.
In late September, we sold Conagra Inc. (CAG) at a small (3%) loss. Unfortunately, we had seen a nice profit in the stock erode on the basis of disappointing results, and decided that things might get worse before they got better (we were right). Fortunately, we had collected an annual 4.6 % dividend on the stock over the two years we owned it resulting in an overall 2 year total return just over 6%.
Most of our remaining portfolio is doing quite well, with a few exceptions such as Dell, Wal-Mart and Gap, which all should recover in time. We are holding a little more cash than normal, because of our recent profit-taking, but we are also looking at a few companies we would like to own at the right prices. In the meantime, money market yields have improved considerably and we can afford to wait. In that regard, it still seems likely to us that bond yields should move higher over the next year or so. If and when those yields become as attractive as overall market expectations, we may want to hold a few bonds.
Best regards,
Peter and Jack
From: Peter and Jack Falker.
Subj: FI Update
Here is a summary of our investment activities over the last several months, along with some of our thoughts:
In early February 2006, we sold ATK Systems (ATK) for a profit of 51 %. The stock had reached an all-time high and was somewhat overvalued based on our modeling assumptions. Also, a question had been raised in the January 9th edition of Forbes Magazine about the size of ATK’s unfunded pension liabilities. After talking with the company, we concluded that, as so often happens in the popular press, the pension issue was probably overblown. However, perception often becomes reality in this world, so we decided to book our profit the day before the company’s quarterly conference call. The street was disappointed by their results (which had little or nothing to do with their pension issues) and the stock dropped nearly $5.00 (6.2 %) that day.
Also in early February, we sold J.P. Morgan Chase (JPM) for a small profit. During the two years we held JPM we collected an annual dividend of 3.5% which was better than we could have earned on cash and approximately equal to the yield of a high-grade bond of similar duration. Now, with cash yields up, we will look for the opportunity to re-deploy this capital in another bank with an equivalent or better dividend and a better potential for a capital gain going forward.
In late January 2006, we sold PNC Bank Corporation for a profit of 18.5%. We also collected a 3.6 % dividend in the 13 months we owned PNC, giving us a 22% overall yield on our investment. We originally bought relatively small positions in PNC and U.S. Bank Corporation (USB) as weak dollar hedges, since they were both undervalued, compared with most other large banks in the U.S. Based on our reading, the thought was that they would make attractive acquisition targets for European banks with a surplus of strong Euros. With the U.S. dollar strengthening in 2005, our hedge strategy became irrelevant, but PNC had good results and the stock responded, making it somewhat overvalued, so we took our profit. We still own USB, which is slightly above our basis and continues to pay us a 4.5% dividend (as good as a 10 year government bond). We may decide to sell USB, as well, when we see a better investment opportunity for the funds.
In mid-December 2005, we sold Briggs & Stratton Corporation (BGG) for a small (.6%) profit. The stock had performed poorly since we bought it last February, and at one point had lost about 20 % of its value. In late October, we talked with the company’s CFO, with a thought toward exercising our long-standing stop-loss policy. After that conversation, we suspected that the company might report a good quarter, based on generator sales after the hurricanes, plus a pricing initiative they had undertaken for 2006 lawn and garden sales. Apparently a few other folks in the market thought so too, because the stock literally rocketed up in December. On the old theory of not looking a gift horse in the mouth, we sold BGG and reclaimed our capital investment. In January, BGG reported a disappointing quarter and the stock has subsequently gone back down.
In late October 2005, we sold Techne Corporation (TECH) for a profit of 54 %. While we still really like this little-known Minneapolis biotech raw-materials supplier (and know them very well), our analysis indicated that it had reached a valuation we felt was unsustainable. We believe we will have a chance to own it again when its valuation is more in line.
In late September, we sold Conagra Inc. (CAG) at a small (3%) loss. Unfortunately, we had seen a nice profit in the stock erode on the basis of disappointing results, and decided that things might get worse before they got better (we were right). Fortunately, we had collected an annual 4.6 % dividend on the stock over the two years we owned it resulting in an overall 2 year total return just over 6%.
Most of our remaining portfolio is doing quite well, with a few exceptions such as Dell, Wal-Mart and Gap, which all should recover in time. We are holding a little more cash than normal, because of our recent profit-taking, but we are also looking at a few companies we would like to own at the right prices. In the meantime, money market yields have improved considerably and we can afford to wait. In that regard, it still seems likely to us that bond yields should move higher over the next year or so. If and when those yields become as attractive as overall market expectations, we may want to hold a few bonds.
Best regards,
Peter and Jack
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