Building a Fortune

Titleist golf balls, Moen faucets, Master Lock padlocks, Schrock cabinets, Jim Beam Bourbon, Swingline staplers have little in common, except that they are dominant in their respective markets -- and they're all owned by Fortune Brands (NYSE: FO  ) . Fortune sells more than $6 billion a year of home and hardware products, spirits and wine, golf equipment and office products.

Since becoming CEO in December 1999, Norman Wesley has presided over a near doubling of earnings per share (excluding restructuring charges), and a 133% surge in Fortune's stock. In part one of this two-part series, Fool contributor Matt Logan talks with Wesley about Fortune's history, culture, and the importance of innovation.

TMF: Norm, how has Fortune Brands become the company it is today?

Wesley: I guess every company goes through tremendous evolution. And Fortune at one time was a $16 billion business, and we decided that we would get out of any category and/or product area where we weren't a leader. So the common thread of Fortune today is businesses where we are leaders in our category. They're all consumer brands, in attractive consumer markets, with leading market positions.

And 90% of our sales today come from brands that are No. 1 or No. 2 in their category. That includes such things as Moen, our largest brand, and it's a leader in faucets. We're No. 2 in kitchen and bath cabinetry. Titleist -- we're No. 1 in golf balls. Jim Beam is the No. 1 bourbon. And our most recent entry would be Therma-Tru where we're the No. 1 residential entry door.

TMF: Owning companies that make everything from golf balls to staplers, what is Fortune Brands? It could be compared to a conglomerate, like a GE (NYSE: GE  ) , or to more of a Procter & Gamble (NYSE: PG  ) -- a marketer of consumer products.

Wesley: Yeah, I really think of us as a leading consumer-branded business, and one that has really consistently delivered strong results.

TMF: You mentioned that the common denominator of the businesses is that they're all No. 1 or No. 2. Is there a chance that you'd expand into other consumer areas, buying other dominant brands?

Wesley: Our focus is really in the categories that we're in today. We said publicly that we'd like to add to our home category and to spirits as well. So if we have expansion, it would really be in those two categories and not a new category.

TMF: I understand in the past you had tried to sell the office products division and have been restructuring it for the past couple of years. What's your plan for that segment?

Wesley: We made a very conscious decision that we could do more with the business than somebody else was willing to pay for it. So we initiated a three-year turnaround program. We have exceeded the targets that we set to achieve in that business, and we've done it a year ahead of schedule. So we feel very good about the results, which we've been able to deliver in the office products category.

TMF: Going forward, will you hold on to the office products division, or will you once again look for a buyer?

Wesley: We never speculate on anything like that. At this point, we're tickled with what we're doing and have opportunities to further improve the business.

TMF: As the CEO of the parent of these various companies, how do you spend your time?

Wesley: My job is to make sure in each category that we have the right people in place who are really focused on the right issues. It's almost like everything I do today is through someone else. So I think we've got a wonderful, talented group of leaders at Fortune. I'm really proud of the work that they're all doing.

TMF: What's the culture of Fortune Brands?

Wesley: Our culture is very hands-on. I would say that basically, it starts with innovation. Across each of our categories, we're firm believers that the way you drive the business is through innovation. And then you have to fund your growth and your investments in R&D with cost takeout. So I think we have a very balanced culture. The third piece of it is you don't do either one of those two things well if you don't have good people. So I think our approach and our culture is quite balanced with a focus on innovation and growth first, cost second, and people as being the enabler of both of those.

TMF: Innovation is clearly a top priority. How big of a factor are new products on your sales?

Wesley: Twenty-five percent of our sales come from products that were introduced in the last three years. That includes products like Pro V1, Pro V1x in golf, which set a new standard with golf balls. The new 983 Titleist drivers. You're talking about new products, new flavors from Beam, Sour Apple Pucker, Vox Raspberry Vodka. We've really tried to drive our categories with innovation. I think a standard people used to look at was 3M (NYSE: MMM  ) , and they were very proud of the fact that 25% of their sales came from products introduced in just the last five years. For us, if you think about that, we deliver 25% from products introduced in the last three. Pretty impressive statistic.

TMF: And do you see that trend continuing?

Wesley: Yeah, that's something that we certainly are investing in and continuing to invest in and look forward to future new product successes.

TMF: Over the past several years, Fortune has acquired a lot of companies. How has this contributed to your growth?

Wesley: Our long-term objective is double-digit growth in EPS [earnings per share]. Most people think of double digit as 10% or 11%. If you go back to 1996, we've probably compounded EPS at a growth rate of about 16%. And so I think if we're good stewards of capital and we see good opportunities, then we can exceed our long-term goal and have a track record of really doing that. In the first half of this year, if you strip out the benefit of acquisitions and sort of foreign exchange, both of which have been positive, we've had underlying double-digit growth.

TMF: What do you look for in an acquisition?

Wesley: I think every deal is a little bit different. Fundamentally, we look to buy things that round out our portfolio and where we really believe we can add value, either through cost takeout (where we may have technology to run a business, to add efficiency through some technology that we might have, where we might overlay a brand over our existing cost structures as an example) or the other area where we can add value is through our customer relationships in helping a business grow.

The most recent example of that would be Therma-Tru. After we acquired the company, we've been able to secure the Lowe's (NYSE: LOW  ) fiberglass door business. And we're in the process of rolling out Therma-Tru to about a thousand Lowe's stores over the next six to nine months.

Similarly, we've got a track record in the cabinets area. For instance, when we acquired Schrock, that was one where we overlaid that business on our existing cost structure. We kept their manufacturing facilities, but we basically integrated the front end of the business. And then we added some new technology to their existing facilities and manufacturing. And, as well as with Omega, where we've really brought great technology to their production sight and we've been able to expand their customer relationships. What we try to do with acquisitions is buy smart and then execute well.

TMF: In these next few of questions, I'm going to play the armchair skeptic. Home and hardware is your biggest segment. Low interest rates and cash-out refinancing have certainly contributed to the boom in construction of new homes and remodeling. With interest rates on the rise, how do you see this affecting your business?

Wesley: If you look back over the last several years, we have had an underlying growth rate (that's stripping out the benefits of acquisitions) of double digits. And what we have said is we think over time, this business will return to our long-term growth target of mid-to-high single digits. Two-thirds of the industry relates to repair and remodel, and one-third relates to new construction. Repair/remodel tends to lag existing home sales by up to 12 to 18 months, and we have had record existing home sales even last month. If you look at our product categories, we tend to be skewed more toward the repair/remodel element. We're very focused in kitchen and bath. And that tends to be your best repair/remodel sector. So we really think that we will outperform the industry and that we're well positioned to continue to perform well.

We also think that the long-term demographics in this category are better than most people think, that homes are still seen as your best investment. They're getting better, and there's being more space allocated to kitchen and bath. There's growth in household formations. We have an aging housing stock and a growth in people's investment in their homes. So we think that the underlying demographics are better than most people think. And given our bias to repair/remodel, we'll do better than most in this sector.

TMF: So if I'm understanding that correctly, even with a slowdown, you still don't see that really being a negative, but rather bringing you back down to a more reasonable long-term growth rate?

Wesley: Basically, we will not sustain the underlying double digits, but we will seek good growth. I always like to say that I think that Wall Street is obsessed with interest rates, but Main Street isn't. And that even with rates going up, by any historical measure, they're still very inexpensive.

TMF: OK, moving on to your next product category, there was an interesting article in The Wall Street Journal a couple months ago. It talked about how 10% or more of existing golfers are quitting each year because they say it's too difficult, too time-consuming, and too expensive. What do you see as the long-term trend for the golfing industry?

Wesley: We think that the industry itself is going to grow, and it's really driven by baby boomers. And as they age, the rounds of play go up. We think, as an industry, it's an industry where we'll see low single-digit growth with a focus on innovation. We have the best R&D in, I think, all areas of golf. We're the leader in balls, we're No. 2 or No. 3 in clubs, No. 1 in shoes with Foot Joy, and No. 1 in gloves. We've invested aggressively behind the development of those brands. We've invested aggressively in R&D. And we think we'll be in a market that will support low- to mid-single-digit growth.

So I see all the skeptics, but in any industry, there are people who quit. But there's new people coming into the game. So it's not one of these where we look for phenomenal growth. But we do see good growth.

One of the biggest challenges for a consumer business is growth. If you've got a business that can grow low- to mid-single digits and you're the market leader, that's pretty good consumer business.

TMF: There have been a lot of restructuring programs and changes made in the past several years, which has led to increased profit margins and higher returns on invested capital. Can you explain what you've done and what the outlook is going forward?

Wesley: The largest part of the restructuring program was office [products division]. We've had a couple of other areas -- we downsized a corporate office and moved it from a high-cost location in Connecticut into an existing facility in Chicago. We've always said that we look at cost and culture as a little bit of a revolution in our company. So I think we've aggressively looked to take cost out of our business and to reinvest in the growth side of our business. I think we've done a good job of that.

We've also managed our working capital extremely well. As a result, we've delivered very significant free cash flow. We've used that to deliver value for shareholders. We've bought back some shares. We've paid down a little bit of debt. And we've made some significant additions on the acquisition front to our portfolios. And not just acquiring, but once we've gotten those businesses, we think we've run them pretty well, and as a result, have delivered real value. As you mentioned, our return on invested capital has moved up, from about 11% to over 16%. Our return on equity has moved up into the mid-20s. And I think it's been a very balanced, disciplined approach, and we've been stewards of capital.

Don't miss part two on Friday: Wesley thinks Fortune's stock is cheap -- and he's buying back stock to prove it.

If you want to learn more about dividend payers like Fortune Brands and their place in your portfolio, sign up for a free 30-day trial ofMotley Fool Income Investorright now.

Fool contributor Matt Logan does not own shares in any of the companies mentioned. The Motley Fool is investors writing for investors.


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