Over the past several weeks, the tenor of the market has changed, and there has been some significant movement in companies about which I have written in the past.
This post offers my thoughts on GE and the market in general, an update into my research on Microchip MCHP, and a shout out to Tod Schneider, CFA, CPA (Inactive) for a terrific call on L Brands.
General Electric
When I was a youngster, playing for the Houston Youth Symphony, I had the unforgettable honor and pleasure of playing under maestro Seiji Ozawa for a special concert.
Maestro Ozawa had one piece of advice that sticks in my mind 30-odd years later: “Whatever you play, play with confidence. If you make a mistake, make sure you play it loudly so everyone will know!” This phrase sums up how I am framing the work I did on GE.
Over the past weeks and months, the extent to which there are “snakes in GE’s basket” as one of my old hedge fund colleagues would say.
The biggest potentially positive news in my mind has been the ascension of H. Lawrence Culp, Jr. — known to me and his friends as Larry — to the position of GE’s Chairman and CEO.
Larry was promoted to the CEO-ship of industrial conglomerate Danaher DHR in 2001 at the age of only 37 years, and shepherded Danaher to record growth through the aughts and early teens. He retired from Danaher in 2014, just prior to the firm spinning off its industrial business into a firm called Fortive FTV so that it could focus on the medical equipment market.
Culp and Danaher were the subjects of a 2010 case study published by the University of Virginia’s business school, and while my license agreement prevents me from posting that study here, it is available for a nominal cost from the institution.
The market cheered — at least temporarily — the appointment of Culp, and a review of his history at Danaher suggests that such optimism is not irrational.
On the face of it, Culp-era Danaher and GE share some compelling similarities:
- Both are industrial firms with a medical products business as well.
- Both have grown by acquisition and have large and complex business lines.
- Both are true conglomerates operating internationally.
I believe the board members from Nelson Pelz’s activist hedge fund (which purchased shares of GE in the mid-$20 range, roughly the same price as I originally paid) likely “invited” Culp out of retirement and onto GE’s board in April of this year in anticipation of forcing through the change if the prior CEO, Flannery, did not work out.
Their impulse would be understandable looking at Danaher’s stock price change during the Culp years.
Figure 1.
From the perspective of an activist investor, one of the greatest things about Danaher — other than the stock price increase — was its focus on fundamental business improvement in the form of Kaizen– style management techniques and improved cash management. Danaher formalized its focus on these factors by the development of what it terms the Danaher Business System (DBS).
From the Darden case study, I get the impression that Danaher corporate culture — rooted in DBS — is just this side of cult-like.
A focus on efficiency improvement and skillful cash management would certainly help GE’s Power business at this point, so if Culp can inculcate some cult-like movement in that direction, I would welcome it.
That said, I think that investors should be cautious about placing faith in messianic cult-like leaders, because for all the similarities between Danaher and GE, there are a lot of differences as well.
For instance, Culp’s Danaher — while it was known as an industrial conglomerate — produced things like Craftsman hand tools and Delta saws. GE produces enormous gas turbines for power plants and multi-ton Blow-Out-Preventer assemblies for underwater drilling.
While the idea that Culp will be able to pull up inventory turns at GE is comforting, there are only so many clients that need enormous gas turbines or BOP assemblies.
In addition, one overlooked though obvious fact about GE is that it is at least as much of a service company as it is a physical goods manufacturer. As far as I know Culp’s Danaher had much less emphasis on servicing the equipment it made and sold.
The fact that GE produces long-life, large industrial equipment rather than hand tools and that it derives an enormous part of its profits from service agreements related to that equipment suggests that Culp will, at the very least, modify his Kaizen / cash flow strategy at GE.
In addition, the issue that Culp faced at Danaher was essentially opposite of what he faces now at GE. At Danaher, his job was figuring out how to successfully acquire and integrate new industrial businesses in such a way that their businesses would improve. At GE, Culp’s job will necessarily figure out how to successfully spin off businesses while simultaneously figuring out how to improve the businesses that remain.
Before Danaher would acquire companies, it would carefully review managers and processes at the firm to be acquired and decide which managers it wanted to keep and which it wanted to jettison. For the people it let go, it could slot in its own cultish managers, who had been raised on the gospel of DBS.
At GE, Culp will certainly find managers he wants to jettison, but he doesn’t have any DBS-trained cult members with which to replace them.
Whatever the challenges for Culp, I believe that his experience and success at Danaher suggests his ascension is a positive for GE. However, after reading Leonard Mlodinow’s The Drunkard’s Walk — a book about how humans misattribute random action for “skill” or a “hot hand” — I am wary of seeing Culp as GE’s savior.
The Market
I like to think that because I am so insightful, I am one step ahead in figuring out the direction future events will likely take. However, I also acknowledge that just as often as I am insightful, I am also overly linear in my thinking, meaning that I’m almost always early in matters of timing
The dual disasters of Brexit and the Trump presidency are playing out much as I expected them to, but certainly not as linearly as I imagined. In other words, the world did not fall apart in June of 2017 as it understood how deeply unprepared and uninterested Trump was in carrying out the most powerful job in human history. Nor did the European economy crumble when it became evidence that there were literally no plans — let alone good ones — for Britain to gracefully exit the European Union.
Now, in my opinion, those chickens are coming home to roost. Prime Minister May has trumpeted her Brexit plan — newly agreed with the EU, but yet to be ratified by the English Parliament — and here is what both sides have to say:
Jeremy Corbyn (anti-Brexit lawmaker)
From what we know of the shambolic handling of these negotiations, this is unlikely to be a good deal for the country.
Steve Baker (pro-Brexit lawmaker)
It’s not kind of a grubby compromise that we can put up with and sort later… It’s worse than membership.
Sounds promising. /sigh
Since most of you reading this are American, I won’t even bother to post the most cringeworthy of our Commander-in-Chief’s recent statements…
As financial markets digest the effects of a chaotic Brexit, an unhinged US president for a proclivity for authoritarianism, a structurally weak China, and a system of international comity and trade that seems to be breaking down, oil prices have taken a significant hit since October.
Figure 2. Source: NASDAQ.com
While I do not like to read too much predictive value into asset price changes, it does seem like the financial community is, in general, increasingly worried about the possibility of a global drop in demand for consumer goods.
All this taking place just as I have capitulated on my bearish positions… Perhaps it’s time to rethink those bearish calls now.
L Brands
A big shout out of thanks to Tod Schneider, CFA, CPA (Inactive) for his brilliant call on L Brands!
Those who invested when we first published research on L Brands would have outperformed the market by over 30% in the space of less than three months.
Figure 3.
Tod is a busy guy — teaching investing at a major Midwestern university — and we haven’t done more than exchange brief emails in the last few weeks. The last time I spoke with him, though, he was excited about the potential for a bearish position in electronics retailer Best Buy BBY.
I will follow up with Tod regarding that and other topics in the retail world.
Microchip
While I made it clear in an October 19 article (valuation model attached) that my interest in microcontroller, memory, and analog chipmaker, Microchip had waned after looking through the numbers, I did drop management a line to ask them about the company’s recent strategy of acquiring whole companies (rather than just production facilities).
The investor relations manager told me that the company was in its mandatory “quiet period” before an earnings announcement, so I would have to wait until early November to ask questions.
I took the opportunity to listen in to that earnings call, and again became interested in at least speaking with management.
The result is that I have a conference call scheduled with the company’s CFO for next Tuesday, so will hopefully publish something that you can enjoy reading when your blood:tryptophan level is so high that you should be staying clear of operating heavy machinery.
I also continue to read through IBM Credit LLC’s financial statements, and hope to have a more complete review of IBM out within the next few days.