Thought I'd take this opportunity to make some updates on companies either owned by the Rule Maker Portfolio or written about glowingly in this space in the last year. It's a pretty quiet week out there, if you ignore that bankruptcy of United Airlines (NYSE: UAL), the second-largest airline in the U.S., and the appointments of a new treasury secretary and a new SEC chairman.
Nope, not much going on.
I would take a moment to mention that a corporate watchdog called new WorldCom CEO Michael Capellas' proposed compensation package of as much as $23 million "excessive." We've made it known that we were decidedly unimpressed with Capellas' actions leading to his departure from Hewlett-Packard (NYSE: HPQ) and arrival at WorldCom.
This level of compensation for someone who has thus far done absolutely nothing is despicable. It reminds me of another corporate savior's compensation package -- Gary Wendt at Conseco. Make that "might-as-well-be-bankrupt, no-longer-listed, three-cent-share" Conseco. I will, of course, reserve judgment of the job Capellas does for later, but such a pay package makes it clear that, regardless of WorldCom's outcome, his personal success is assured. Grrrr.
Costco (Nasdaq: COST)
Costco has dropped more than 28% in stock price this year, and currently sits below $30 for the first time since 1998. The culprit, it seems, is the general weakness of the economy and the fact that Costco's same-store sales are now climbing at a tepid 2%, rather than the company's normal 5% to 7%. As a result, a few analysts dropped their earnings and even ratings on the company.
I'm not sure why people are surprised by the lower same-store numbers. It also bears noting that as recently as August the same-store sales growth surpassed 6%. I guess one must ask a few questions to determine if the Costco decrease of late is due to some trends. Is the company's advertising campaign faltering? No, it has no advertising. Have memberships dropped? No, they continue to increase faster than store growth. Is the store's product mix somehow less desirable? It's possible, but, remember, Costco and the other wholesale clubs work awfully hard to keep a consistent churn on the types of products available. If people don't like what Costco has, they should just wait a minute, because it'll change.
If we see several months of lowered growth, there might be reason to be concerned. One month ain't it.
The only issues I had with Costco was the fact that its receivables grew by 46% over last year's level, on top-line growth of only 11%. That is not positive in any way, shape, or form. I was also concerned that Costco, which generally turns in operating cash flows that are substantially higher than reported earnings, suddenly showed the reverse. Generally speaking, earnings that are not substantiated with commensurate operating cash flow are lower quality. The biggest culprit was (again) a $157 million rise in accounts receivable. Same problem manifesting itself in different places.
This bears watching in future quarters. Frankly, it bears much more vigilance from shareowners than the same-store sales numbers. Costco operates at a level of extremely low SG&A. Though its profitability depends upon inventory turns, it does not have an expensive installed base that crushes it should sales remain soft for the near future.
Schering-Plough (NYSE: SGP)
I read an extremely interesting conversation on the Rule Maker Companies discussion board the other day regarding whether or not Schering-Plough even was a Rule Maker anymore. I'll have to say I'm inclined to agree. I did agree in an article not that long ago. Schering-Plough's claim to Rule Maker status has always been slightly tenuous, and may now be even more so. That doesn't mean, however, that the company's stock is anything but undervalued.
At issue are a few elements in consideration of Schering-Plough. First and foremost is the fact that its blockbuster drug Claritin has been moved from prescription-only to over-the-counter status. Even though it is the exact same drug, such a move by the Food and Drug Administration does a few very specific things to the economics of Claritin, very few of them good from a gross-margin perspective or average sale price. For Claritin, revenues are estimated to drop from $1.2 billion to about $200 million. That's big coin. Further, the company has just blatantly violated Regulation Fair Disclosure and received a massive fine from the FDA for its inability to display appropriate safety standards.
None of these things gives me a warm fuzzy feeling. However, I think that the stock market has overreacted to these weaknesses.
Claritin has been at severe risk for months, and this risk should have been built into the stock. The last management, which it seems could not get out of their own way, is gone. I don't want to imply that I still believe that Schering-Plough is a double-thumbs company by its inclusion in the port. Perhaps the best thing to do from an appearance standpoint is to sell and move on. I'm not exactly ecstatic about the idea of selling a company directly at its darkest point, particularly one that still has a substantial pipeline of drugs. More to come in the upcoming weeks.
Church & Dwight (NYSE: CHD)
This boring-as-all-get-out maker of all things baking soda has gotten a bit more exciting as of late. Some of this, of course, is good, some not so much. The company recently has launched its first big branding campaigns in years, including having Jason Giambi of New York Yankees fame serve as pitch man for the company's Arm & Hammer deodorant products.
But Church & Dwight has gotten acquisitive in the past few years, and one of the things that has come out as a result is a substantially increased debt profile. Its takeover of Carter Wallace's product portfolio, including Trojan condoms, Arrid antiperspirant, and EPT pregnancy tests, was a fairly shrewd move for the company. But, at the same time, I can't help but think that Church & Dwight took a pretty substantial hit to its balance sheet as a result. Its long-term debt increased from less than 2% total capital to more than 35%, up to $400 million. At the same time, Church & Dwight's free cash flow over the last 12 months is coming in substantially lower than it was in 2000, before it made these acquisitions.
There may be no company that I like better than Church & Dwight, but these items are a bit concerning for one that is in such a low-profile business. Furthermore, its stock has continued to remain buoyant with price-to-free cash flow multiples exceeding 21 times. Given the higher level of debt, that's a much lower level of safety than I would prefer, even for Church & Dwight.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
Bill recently read the following product warning on a kitchen knife: "Warning! Keep out of children." At time of publishing, he owned shares of Costco. He is managing editor of The Motley Fool Select, where you can find his best Foolish stock ideas you won't find anywhere else. The Motley Fool has a disclosure policy.
The Rule Maker Portfolio has had a cumulative investment of $44,000. As of December 10, 2002, its current value of all cash and equities is $31,172.74. This equals an internal rate of return of -11.0% since the launch of the portfolio in February 1998.
[Have you checked out the charities in this year's Foolanthropy? Last year, our charitable giving cured cancer. This year, we're aiming for figuring out world peace. No, not really, but our contributions have brought happiness and hope to people in short supply of both.]
