Tuesday, February 24, 1998

Cash-King Portfolio Report
by Rob Landley (landley@flash.net)

Austin, TX (Feb. 24, 1998) -- A question came up on our Fool web Cash-King board a while back about why Ford and GM are not being looked at as Cash-Kings. The argument was basically, "The companies have been around a long time, GM practically invented the "Just in time" manufacturing methods that have made Dell so successful, and Ford's profits have been skyrocketing. Since both are sitting on huge piles of cash, why aren't these Cash-Kings?"

First, there's the business model. Automobile manufacturing is more or less exactly the kind of business we don't want to be involved with in the Cash-King portfolio. To start with, the underlying cost of manufacturing a car is very, very high. While there are a few brand names out there capable of bumping up the profit margin to respectable levels (think Porsche, Lamborghini, Rolls Royce), these companies sell to a very, very limited market. For normal buyers, a five-figure purchase isn't something most people do without careful thought or bargain hunting. Add in the middleman profit that the dealer pockets, and the average car manufacturer's bottom line is lucky to be in the black at all.

A Cash-King doesn't have to choose between margins and volume. It has lots of both. (For an explanation of "margins," click here.)

Second, contrast the enormous "used car" market with the market for "used software," "used Coke," "used heart medicine," or "used mutual funds." Manufacturers don't profit from sales of "used" items, and every sale of a used item is the loss of a potential sale of a new item. Worse, the fact that the used version was desirable enough for someone to buy again means the original owner could simply have kept it, and many of them probably do. Increasing sales, year over year, is one of the keys to being a Cash-King. When your strongest competitor is your own history you have to constantly top yourself just to keep sales flat. Actually growing sales requires a herculean effort. A Cash-King can sell to the same customers, over and over, on a consistent, predictable, and regular basis. It has a repeat purchase business model, selling products that get used up and/or services paid for each time they're performed.

Next, car manufacturing is an inventory nightmare. Cars are huge. You need a lot of space to store them, and they're tempting targets for vandalism or theft. They take months to sell, and at the end of the year many have to be marked down to clear room for the next year's cars. Transportation costs to get the vehicles from the manufacturer to the dealers aren't cheap either, UPS isn't going send a car through the mail.

Cash-Kings tend to make small items, of high value but easy to store and transport. Microchips. Pill bottles. Drink concentrates. The ultimate inventory is stuff that, technically, doesn't exist: electronic information like software.

All of these things combine to determine growth potential. Yahoo! says GM's net profit margin is currently 3.6%. For every additional dollar in profits, the company has to create $28.78 in new sales. To do that it has to build more factories, hire and train more workers, and somehow make arrangements to transport and store twice as many cars each year. That's also assuming the company could somehow stimulate demand for twice as many cars without further eroding profit margins. In a recession, the first thing people give up is new cars. If Ford lays off workers or closes factories to ride out slow demand, it risks a strike. When demand picks back up, it has start-up costs all over again. It can't build a stockpile of cars, they'd be last year's model and would have to compete with all the (much cheaper) used cars from the same year. This isn't even taking into account foreign competition, which may have different environment laws, cheaper labor, and a favorable currency translation ratio.

Automobile manufacturers build up cash stockpiles because they must. It's not to protect them from disaster, but from the cyclical nature of their business. The companies can't spend the money on research and development because it needs that stockpile to stay afloat when nobody is buying cars. Despite the booming economy, on Feb. 6 GM announced it was cutting its output because of slow sales. Even in the current market, Ford and GM are both trading at a P/E below 10. This does not necessarily make either one a bargain.

A Cash-King's job is to turn cash into more cash, by as direct a method as possible. It wants margins high and inventory low, with strong steady demand and some advantage over any competition. A Cash-King must be good at what it does, but if it can't do very much of it, can't do it very quickly, and can't make much of a profit doing it, why is it bothering to do it in the first place?


Stock  Change    Bid 
 INTC  -1 3/4   92.38 
 MSFT  +  1/2   82.06 
 PFE   -1 7/8   87.50 
 TROW  -1 1/4   66.75 
                 Day   Month    Year  History 
         C-K      -0.50%   1.79%   1.79%   1.79% 
         S&P:     -0.73%   2.92%   2.92%   2.92% 
         NASDAQ:  -0.74%   5.19%   5.19%   5.19% 
     Rec'd    #  Security     In At       Now    Change 
    2/13/98   22 Intel         84.67     92.38     9.09% 
    2/3/98    22 Pfizer        82.30     87.50     6.32% 
    2/3/98    24 Microsoft     78.27     82.06     4.85% 
    2/6/98    28 T. Rowe Pr    67.35     66.75    -0.89% 
     Rec'd    #  Security     In At     Value    Change 
    2/13/98   22 Intel       1862.83   2032.25   $169.42 
    2/3/98    22 Pfizer      1810.58   1925.00   $114.42 
    2/3/98    24 Microsoft   1878.45   1969.50    $91.05 
    2/6/98    28 T. Rowe Pr  1885.70   1869.00   -$16.70 
                               CASH  $12562.83 
                              TOTAL  $20358.58 
 *The year for the S&P and Nasdaq will be as of 02/03/98