Author Topic: What are the danger signs for cannibal strategies  (Read 4751 times)

black-dog

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What are the danger signs for cannibal strategies
« on: April 19, 2018, 10:26:47 AM »
Seeing as the last thread on cannibals is ~5y old:
http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/cannibals/20/

And Mohnish Pabrai & an analyst at Dhando Holdings have been publishing Uber Cannibals (first here: https://www.forbes.com/sites/janetnovack/2016/12/22/move-over-small-dogs-of-the-dow-here-come-the-uber-cannibals/#7f4910bd7f92, the new 2018-9 list of five here: http://www.chaiwithpabrai.com/blog/the-new-2018-2019-uber-cannibals4839631 )

I've always been Buffet-skeptical of companies buying their own stock back, but also, Munger says watch the cannibals, so I've been watching this Uber Cannibals strategy because it's easy enough to follow I'd be able to recommend it to people who want minimal effort strategies. (And also, because of that, doubling my skepticism, see: early Motley Fool)

Today seems to highlight one of the pitfalls of the approach: SNBR's been on a share buyback tear while hitting turbulence -- sales are flat, profit's falling, they're doing a supply chain transition -- and after missing earnings, the stock's down 15% as I type this. During the same period, they spent $75 million on share repurchases in the quarter... so not to be reductive, but they essentially set fire to >$10m.

So: what characteristics do you want to look for in a company that's buying back its stock to ensure the cannibal has good taste, beyond the obvious fundamentals like "are they borrowing like crazy to fund the buyback?"

(SNBR on their quarter: http://newsroom.sleepnumber.com/phoenix.zhtml?c=254487&p=irol-newsArticle&ID=2343283 )


rb

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Re: What are the danger signs for cannibal strategies
« Reply #1 on: April 19, 2018, 10:35:31 AM »
You don't want them to buy the stock at elevated valuations. But most importantly they need to have a strong business. I remember a few years back Weight Watchers bought back about 1/3 of their stock (with cash) right before earnings and stock price took a massive dive. You don't want your cannibal to do that.

Jurgis

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Re: What are the danger signs for cannibal strategies
« Reply #2 on: April 19, 2018, 10:54:22 AM »
You don't want them to buy the stock at elevated valuations. But most importantly they need to have a strong business. I remember a few years back Weight Watchers bought back about 1/3 of their stock (with cash) right before earnings and stock price took a massive dive. You don't want your cannibal to do that.

I agree with you. However, is it easy to predict that the business will take a dive? It's easy looking backwards by Monday Morning Quarterbacking, but is it possible going forward?
I guess you could argue BBBY was predictable. I am not so sure about Weight Watchers (disclaimer: bought low, sold low, have not followed afterwards, Oprah saved them from BK?). Haven't followed SNBR, so no comment.

Looking at:

    Sleep Number Corp. (SNBR) - I've looked at Tempurpedic when the stock dived. I don't particularly like the business segment. IMO the products are sleazy and overpriced. But then I'm cheap (got IKEA bed/mattress, totally happy with it). Other than that no comment.

    Corning Inc. (GLW) - I had a large position when the stock price was low, then sold out, then they went on tear... I'd guess they are at least somewhat cyclical, so they might be overpaying. I haven't looked at their recent numbers though. I think it's a good company although it might hit cycle when/if 4K TV adoption flatlines or drops. I'm speaking of the cuff though.

    PulteGroup (PHM) - home builder. If you expect something like 2008 crisis, then not a good company to invest. OTOH AFAIK housing starts have been low, so homebuilders may still have a lot of runway and it might not be overpaying... Have not looked deeper.

    Discover Financial Services (DFS) - somewhat strong number 3 (or whatever) CC business. Probably fair bet.

    Lear Corp. (LEA) - car parts? Cyclical. But I don't really know if they are heading for cyclical low and overpaying. Perhaps. Have not looked deeper.

And you know what? I can pretty much guarantee that it's not the "good/great" companies that will have best return in April 2019, when the cannibal strategy reallocates to new five...  8)
« Last Edit: April 19, 2018, 10:57:21 AM by Jurgis »
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no_free_lunch

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Re: What are the danger signs for cannibal strategies
« Reply #3 on: April 19, 2018, 11:12:24 AM »
I don't know if there are any hard and fast rules.  I do try to look at the history of buybacks vs valuations.  If they only buy back stock when valuations are lower then that is interesting.  Some companies will flip between buying back stock and issuing stock depending on price, so it is not so simple as high buybacks.   It is critical that they use their brain and only buy when it makes sense.

I don't really understand the business so can't recommend it but ADS is a good example of opportunistic buybacks.  They did a lot during the GFC and when it went back up they stopped buybacks.  That is what I would look for.
« Last Edit: April 19, 2018, 12:06:18 PM by no_free_lunch »

Cigarbutt

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Re: What are the danger signs for cannibal strategies
« Reply #4 on: April 19, 2018, 11:57:38 AM »
As a simple investing rule, I would say that the "strategy" is likely to work until it doesn't as the concept of buybacks is quite institutional and pro-cyclical: IMO, in the main, firms tend to buy back a lot of shares when valuations are high and tend to scramble for capital (and shun buybacks) when valuations are low.

The basic rule seems to be that if:
1-the firm has excess capital
2-the shares trade at a discount to intrinsic value

then, you should buy shares alongside management. :)

IMO, lately, 1- has been the norm and 2- has been misunderstood.

Following is a link that is somewhat out-dated but still relevant about a company, which may not be relevant to the general universe of investments (good, because that is a reason that allowed such a high return from buybacks and maybe I should delete this paragraph), that continues to selectively and opportunistically use buybacks in order to maximize intrinsic value per share. It sells furniture and is relatively "unknown" relative to other competitors like Wayfair.

https://www.burgundyasset.com/wp-content/uploads/GrowthThatMatters-July2010.pdf

ScottHall

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Re: What are the danger signs for cannibal strategies
« Reply #5 on: April 19, 2018, 12:30:22 PM »
I like asset lite, high margin businesses like MAR. It has basically been a long term cost of capital arbitrage, gradually replacing equity with debt. It is very hard for MAR to lose money on an operating basis, though lodging itself is cyclical.

What is the cost structure of the business? Will operating leverage kill you if things turn sour (SHLD)?
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LC

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Re: What are the danger signs for cannibal strategies
« Reply #6 on: April 19, 2018, 12:51:22 PM »
Lowe's (LOW) - homebuilding/renovation
NVR (NVR) - homebuilding/mortgages
The Hackett Group (HCKT)-business analytics
Select Comfort (SCSS)-mattresses
Willis Lease Finance (WLFC)-airplane engine leasing

Seems to me 3/5 are related to housing. Of the 5, Hackett group looks most interesting from a business perspective.
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Jurgis

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Re: What are the danger signs for cannibal strategies
« Reply #7 on: April 19, 2018, 02:38:28 PM »
Lowe's (LOW) - homebuilding/renovation
NVR (NVR) - homebuilding/mortgages
The Hackett Group (HCKT)-business analytics
Select Comfort (SCSS)-mattresses
Willis Lease Finance (WLFC)-airplane engine leasing

Seems to me 3/5 are related to housing. Of the 5, Hackett group looks most interesting from a business perspective.

You're looking at the 2017 list that is no longer current one...  8)
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ScottHall

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Re: What are the danger signs for cannibal strategies
« Reply #8 on: April 19, 2018, 03:11:30 PM »
Lowe's (LOW) - homebuilding/renovation
NVR (NVR) - homebuilding/mortgages
The Hackett Group (HCKT)-business analytics
Select Comfort (SCSS)-mattresses
Willis Lease Finance (WLFC)-airplane engine leasing

Seems to me 3/5 are related to housing. Of the 5, Hackett group looks most interesting from a business perspective.

Do you know much about NVR’s strategy? Tied to housing and cyclical but it is not a land bank, takes little capital to run the business.
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Contra123

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Re: What are the danger signs for cannibal strategies
« Reply #9 on: April 19, 2018, 06:13:32 PM »
IMO the question posed by the OP might as well be rephrased into “how do you determine if mgt team are good capital allocators” or “how do you know mgt’s capital allocation skill won’t get worse”. That’s a super hard, broad question IMO that’s hard to get right even if you have decent access to mgt. IME what gets people comfortable is a sophisticated (often buyside) background of mgt team and nice IR slidedecks that have the right buzzwords and explain the allocation framework in the right way + good track record of timing the buybacks. For me personally, favorite warning signs include buybacks when leverage is creeping up and buybacks accompanied by high stock compensation / issuance to mgt.
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