An Inexpensive Fortune?

Titleist golf balls, Moen faucets, Master Lock padlocks, Schrock cabinets, Jim Beam bourbon, and 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 charges) and a 133% surge in Fortune's stock.

In the final part of this two-part series, Wesley tells Fool contributor Matt Logan Fortune's stock is cheap -- and the company is buying back shares.

TMF: Bill Nygren, who runs the Oakmark Fund (FUND: OAKMX  ) -- and coincidentally is a big shareholder of Fortune -- said, "The typical or ideal investment is one where the market reaction is out of character to the value of the business that's involved." Your stock certainly hasn't performed poorly, but do you think investors have recognized fully the value of Fortune's businesses? Are they under- or overreacting at all?

Wesley: First of all, we do think our stock is cheap, and we've been buying back our shares as a result of that. We think we've delivered very consistent results, and that we merit a premium to the broader market. We trade at about a 10% discount to the S&P and I think about a 25% discount to other large consumer products companies. If you look at our track record, we really have largely outperformed both the S&P and other consumer companies.

Now that said, we've had a nice run-up on our shares, and we've delivered significant appreciation in our share value to shareholders over the last several years. I think a lot of that's been driven by the performance of the business.

TMF: Are you aware of how investors are perceiving the company? Is there too much of a focus, like you said, on interest rates and viewing your company as being interest rate sensitive?

Wesley: It's hard to now what's in the mind of each investor. But I do think that oftentimes money moves on sort of big, broad brush -- and they oversimplify things. And I think that when they think anything related to housing is going to go down, they don't always differentiate those who are better positioned than others. In addition to the favorable demographics in home, we have a number of [market] share gain initiatives that are in the process of rolling out right now. I talked about the new door business at Therma-Tru. We're rolling out new cabinet offerings at both Lowe's (NYSE: LOW  ) and at Home Depot (NYSE: HD  ) . I think people sometimes under-appreciate the things which you are doing, the momentum you have in a business, and paint everybody with the same brush. We raised our outlook for home in our last conference call, to be up, sort of in the mid-20s this year, and so that shows a great deal of confidence.

TMF: Your company generates a tremendous amount of free cash flow in relation to earnings. Is that sustainable, or will there be more reinvestment needs going forward?

Wesley: No, I think we have reached a new level in free cash. And in our last conference call we said we'll raise it from around $400 million to around $450 million. We just increased our dividend by 10%. I think that reflects our confidence in our future cash flows.

TMF: How do you make your decision between buying back shares and paying it out in dividends?

Wesley: As you know, those are dynamic situations. You're always looking at how do you return money to shareholders. Depending upon where your stock is valued, it's sort of a balanced approach. Sometimes you favor one more than others. Certainly, the tax changes have influenced that.

TMF: And the buybacks, I'm assuming, are fairly opportunistic.

Wesley: Yeah, although we've been very, very consistent in our belief that our stock's undervalued and have bought back shares consistently over the last several years.

TMF: Can you help investors out there get a better sense of your growth rates? How do you project your growth rates for your business as a whole?

Wesley: What we set as our underlying growth and EPS [earnings per share], our target, is double digits. And that's what we look to achieve. Most people think of that as 10% or 11%; we think there are opportunities to do better than that. And if you look back, we certainly have done better if we're able to invest our cash flow wisely. And that's just EPS growth; that doesn't include the return to shareholders with buybacks and dividends.

TMF: For the earnings growth that you're looking for -- plus 10% or 11% growth -- can you dissect that figure a bit? For instance, x% coming from increasing sales, x% coming from cost cutting, etc.

Wesley: What we do is we have a model that says if we can grow our top-line mid-single digits -- we have a history of being able to do -- then with all the cost initiatives we have, we want to grow out operating profit a point or two faster than that, then if you add in the benefits of our free cash flow, whether we use them to acquire or to buy back shares or pay down debt, that gets you to double digits. We have targets in each of our businesses for what they need to contribute, that they've done consistently. We look to golf to grow sort of low to mid-single digits. We look to home to grow mid- to high single digits. We look to spirits to grow low to mid-single digits. And then we look to office to grow sort of low to mid-single digits as well. So that really gets us to our mid-single-digit growth. Now this is all before the benefits of acquisitions.

TMF: That seems logical enough. How about market share positions -- are you still taking share in a lot of your bigger segments?

Wesley: Yeah, we are. We've got significant share gain initiatives in faucets with new products, in cabinets with the rollouts which we talked about earlier. We gained significant share in golf, in balls. We gained some share in clubs. So we have a number of initiatives. It starts with internal growth, and then it's really a focused development.

We have become increasingly the partner of choice, we think. Starbucks (Nasdaq: SBUX  ) is a good example of that, with the alliance which we announce or the partnership. We're going to market a premium coffee liqueur that's branded Starbucks. With a joint venture with Absolut a couple years ago. We've got expanding relationships with large customers, whether they be Home Depot, Lowe's, or the top ten builders. And we think all of those things have really helped us gain share.

TMF: Let's say it's five years from now -- the summer of 2009. What will Fortune Brands look like?

Wesley: I think we'll be a diversified consumer business. And I think you'll see significant growth from where we are today. It's hard to predict where that's going to come from. Some of that will come internally. That's really our principal focus. But we will find some good additions to our categories as well.

TMF: Will the sales mix be fairly similar -- home products being the largest?

Wesley: Yeah, I would think that we have our biggest opportunities to add to home and spirits, so you'll see those being a larger piece of our total business.

TMF: What keeps you up at night, business related?

Wesley: I'm not one of those who lays awake at night. We've got good momentum. We don't take anything for granted. We feel very good about our past success, but we recognize that in business, you have to earn it every day. I think we've got a very good group of folks that have been with us a long time who work very hard to make sure that our products are fresh, we're bringing innovation to the category, and that we have a relentless focus on cost and our business. So I feel good about our prospects as a result.

TMF: Are there any companies or executives out there that you really admire?

Wesley: Not really. I think you learn from everywhere. Learning is something that if you don't have a big ego, you can learn from so many different areas. I respect what others do with their businesses. I learn from folks in our own business who work for me. So I think there's learning that can come from everywhere.

TMF: This one is tough. It's probably like choosing your favorite child. Do you have a favorite product of Fortune Brands?

Wesley: You know, I really don't. I love all of our products.

TMF: How much longer do you plan on staying with the company?

Wesley: I'm 55 and very happy with what I'm doing, and I really don't have a plan right now. We've had a good run. We have a good business. And it's a lot of fun to be a part of it.

TMF: Is there anything else you'd like to add?

Wesley: Look at our results; sort of the proof of the pudding is always in the results that you're able to deliver. And I'm very proud of our track record. If you look back to '97 when Fortune Brands came into existence, we've delivered 15% compound growth. That's compared to the S&P at about 6%. And we've done it in an environment, as you pointed out earlier, where we have improved returns substantially. And I'm very proud of that.

Read Part 1 of this interview.

Fool contributor Matt Logan does not own shares in any of the companies mentioned. The Motley Fool has a disclosure policy.


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