Drip Portfolio Report

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Campbell and Intel
No difference between right and wrong?

by Jeff Fischer ([email protected])

ALEXANDRIA, VA (March 4, 1999) -- I must have made a mistake buying Campbell Soup for the Drip Port. The stock is now more than 30% below its high and 22% below the average price that we paid. It took us three months to analyze the industry and decide on Campbell, and yet look how incorrect we've been in the last year.

Where did we go wrong?

Our analysis showed Campbell Soup (NYSE: CPB) as most likely to improve margins by divestiture and smart acquisition, most likely to grow retail dominance due to new marketing initiatives and new distribution channels, certain to lower sharecount through aggressive annual 2% share buybacks, and a shoe-in to increase cash flow by effective cost cutting. All of that was in the cards.

And all of that has been happening.

So, we weren't wrong in our analysis? Apparently not. However, correct analysis doesn't always result in the desired outcome. You can be "right" and still be very "wrong" in the near term, and even in the long term, too.

Despite the fact that Campbell's management has been successfully accomplishing every point mentioned above, it hasn't resulted in what logic-imbibed analysis calls for: increased sales volume and increased earnings per share. Essentially, one thing has kept Campbell from growing the past year. That one thing is an external factor: the public.

The public hasn't been buying condensed soup in any increased volume. Campbell can advertise it extensively, make new kinds, put it in convenience stores and discount chains across the country, but if people aren't willing to buy more than they did previously, Campbell's strategy comes up Snake Eyes until they do.

We may have been right by focusing on Campbell Soup's internal improvements, but we were wrong in assuming that the market for canned soup could grow some 4% to 6% annually through price and volume increases, and that Campbell could turn that into 11% to 14% annual earnings per share (EPS) growth.

Campbell did grow earnings that much initially, but it won't this year. This year EPS is expected to decline 4% before rising 11% again in the year 2000. That 11% rise represents a guess. The five-year expected growth rate is still 12%, too (another guess), but analysts are expecting the same thing that we have been: volume growth in condensed soup, which accounts for a majority of Campbell's earnings. Management can do everything right -- everything that we saw and foresaw -- but if the public doesn't respond with their wallets, management can only do so much. Analysts are betting on the public to respond more than they are on Campbell at this point. We've already seen what Campbell management can do.

It can do everything we wanted: divest itself of poor businesses, acquire international leaders, increase advertising to 6% of sales, increase distribution by leaps and bounds, cut costs by hundreds of millions of dollars, buyback 2% of shares annually, increase cash flow and the dividend each year... all of that, it can do. All of this is what we bet on it to do.

However, so far we were wrong to buy the stock. We've lost money.

The lesson is that an investor can and almost always will be both right and wrong. You can analyze a company correctly, but then the market it operates in can change. Or, you might analyze an industry very well, but then your company might take on new initiatives and change its own landscape. You are never 100% correct. Instead, you're correct by degrees. The Drip Port is correct by degrees and incorrect by others. As time moves, our "degrees of correctness" move like the sun passing over the earth; right now, we're about 60 degrees wrong on Campbell. Give us another year, we might be 80 degrees right.

The other lesson (one that might be less obvious) is that we weren't really any more wrong with our Campbell Soup analysis as we were right (you would argue by the returns) with our Intel (Nasdaq: INTC) analysis. The fact that Campbell is 30% below its high -- just as Coca-Cola (NYSE: KO) is right now -- reminds us that Intel declined nearly 40% below our initial purchase price before it moved higher. We first appeared to be very wrong about Intel, yet we stuck behind our original thesis throughout last year's slide. And we still stand by it. Part of it is right, part of it is wrong. Just as we've been on Campbell.

Let's consider Intel.

The past weeks have been brutally volatile for Intel's stock. The news that Advanced Micro Devices (NYSE: AMD) captured 44% of the total PC desktop market (by unit sales) in January, compared to Intel at 40%, made Intel's stock stumble 7% in one day. However, this news isn't surprising. AMD has always led the low-end PC market and that's what it continues to lead while the market is growing leaps and bounds. In the sub-$1000 PC market, AMD has over 50% market share compared to Intel at 25% (and growing).

The important point for us to remember is that Intel didn't sell in the low-end market eighteen months ago -- it wasn't even interested in it. Then management changed its mind. Now Intel's market share in the low-end is growing. However, the low-end market is growing fast enough (sub-$1000 PCs accounted for 66% of total PC sales in January, up from 51% in December) that the niche leader, AMD, is able to sell more chips than Intel for the first time. In sale dollars, however, Intel is still crushing the competition and bringing in barrels of cash because it controls the middle and high-end market and also because, overall, 80% of all computers still run on Intel chips.

The news about the low-end market, when presented with headlines such as "AMD Chips Knock Intel From Top Spot" (that is an actual headline), sent analysts scurrying to downgrade Intel, even though the company just completed its strongest quarter and even though 1999 should be its strongest year in history. EPS estimates for Intel haven't changed a whit. The company is still expected to grow earnings about 20% annually in the long term, and 32% this year. At $113 per share, it trades at 24 times this year's estimate and 20.5 times next year's estimate -- significant discounts to the S&P 500. This year Intel will spend $300 million on marketing to draw buyers to its brand while trying to capture more low-end market share, too.

To conclude for today:

No matter how well you analyze a company, you can only be correct to varying degrees. With Campbell, we were correct about most of the predictable factors that one analyzes by running spreadsheets filled with numbers: increased efficiency, cash flow, etc. But we didn't guess that the public wouldn't buy more soup given all of Campbell's work to sell it. Meanwhile, with Intel, we didn't guess that lower-priced PCs would challenge the company for this long (we didn't even think about the segment in mid-1997).

However, regardless of our faults, our Intel investment is still very profitable, and given enough time, I think Campbell Soup will be, too. (Will Campbell ever beat the market? We'll see.)

Overall, Dividend Reinvestment Plans allow you more room for error -- more room to be right and wrong -- because you can smooth out your degrees of victory and error over time by using dollar-cost-averaging. (Buy less when the shares are higher, more when they're lower.)

As long as we're mainly right over time we should reach our goals. We'll make several mistakes along the way, however. Some of them might even merit a complete change of opinion: a sale. Ideally, though, we'd only like to sell something if -- similar to the Rule Breaker Port -- we see a different and much better place in which to invest. To discuss Campbell, Intel or anything, please visit the Drip message boards linked in the top right of this page, or the specific company boards on the Web.

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