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The world can change. Fast. Or at least perception can.
At hand is a confession. Or rather, a reflection.
The game of investing is hard. Very hard. A mere 18 months ago I was fairly convinced LaCroix was a true brand. The kind that could stand the test of time. The kind that a young Buffett and Munger would dream of. At the time I saw (and to some extent still see) a low wallet share, frequently purchased, habit forming product that didn’t suffer from taste attrition. The taste attrition attribute was absolutely key to my thesis because it’s the quality that makes Coke so desirable. And, more importantly, keeps customers returning. See the clip below (starting at ~44:28 for why I thought that was so key).
Below are screenshots of when I made my meaningful purchase and sell decisions on National Beverage Corporation (“National Beverage” or “FIZZ”), the owner of LaCroix. I am sharing because I think it’s important to be transparent. In that same spirit I have to admit I bet too little at the time. I wasn’t fully comfortable running a portfolio back then so my strategy was to bet small and ensure survival.
Below is a chart of what happened during my “investment.” I put investment in quotes because it is never my intention to hold a position for under a year. In my view, holding a security under a year is closer to speculation than investing.
Ultimately, I got nervous about how quickly the position increased. I just couldn’t get myself to hold on to an entity priced at ~2.5% current cash flow yield (~$100mm of trailing 12 month free cash flow and a $4.0Bn enterprise value at time of sale). So I sold. The hardest part of selling is I was certain the business would continue to grow. So, I felt pretty horrible as I watched the stock increase another 20% within 10 weeks.
Fast forward to today…I tweeted at @alderlaneeggs (hereafter “Mr. Cohodes”) asking why he was short the company. I was poking around because the stock has fallen substantially since I exited.
Mr. Cohodes is known for shorting frauds. It was odd to see him short this company because, while I agree there are substantial corporate governance issues, I don’t believe fraud is a major risk. While he didn’t give me a direct answer, he did mention competition and his Twitter feed has pictures showing Costco discounting LaCroix Curate (an extension of the LaCroix brand). Therefore, I believe Mr. Cohodes is short because of capital cycle theory (more assets/competition chasing the market) resulting in LaCroix discounting to drive sales. Discounting is not only a sign of organic demand declining, but also results in lower margins.
In layman’s terms the 10-Q said “We’re selling less LaCroix because of a lawsuit ( https://www.usatoday.com/story/money/nation-now/2018/10/05/lacroix-lawsuit-claims-sparkling-water-ingredients-cockroach-insecticide/1532241002/ ). Consequently, our manufacturing margins declined because we processed fewer units and costs stayed fairly constant.” I’m skeptical the lawsuit is the real driver of the volume decline. Therefore, as of today, it looks like Mr. Cohodes is right.
Alternatively, it is possible the lawsuit against LaCroix really has hurt volumes and customers are waiting for the outcome. I suspect the headline of the lawsuit reads worse than the facts ultimately prove. If that is truly the case, I’d bet LaCroix will recover (see Chipotle for an example of a food company rebounding from negative health publicity).
Beware that facts can change pretty quickly- Just last quarter FIZZ disclosed 16% growth in the Power+ (mostly LaCroix) brands. What a difference a quarter makes.
Don’t be afraid to sell when you think you are getting above fair value- I exited when the cash flow yield felt egregious. The short term pain of exiting and watching the stock run up is worth not being in the stock today.
Be mindful that things you know may not be so- I was certain LaCroix would grow and grow. This is now two consecutive quarters of free cash flow erosion. Pay attention to facts as they develop and don’t get anchored to an opinion/conclusion.
Seek out smart people with divergent opinions- I wasn’t prepared to purchase the stock today. I didn’t have enough data. But, tweeting at Mr. Cohodes (and his response) reframed how I view the situation.
The only thing worse than a value trap is a busted growth story.
Never anchor to a narrative.
The spirit of Henry Singleton cried a little this earnings season. If you don’t know who he is see https://25iq.com/2014/11/08/a-dozen-things-ive-learned-from-henry-singleton-about-value-investing-venture-capital/. In short, he was one of the best capital allocators of all time. He issued shares when Mr. Market loved his company and bought them back when Mr. Market didn’t like his company. Dr. Singleton didn’t care about Mr. Market’s opinion. He used Mr. Market to his advantage.
Why? Because in December there was carnage in the market. Everyone was selling everything indiscriminately. The selling offered up some very interesting opportunities in certain companies. That’s when management teams should pounce.
So what did Facebook, Apple, and Google all do with their cash hoards at that time? Nothing. At least nothing meaningful. And that is a disgraceful outcome given the amount of talent that is at these companies. In retrospect, it’s pretty clear that December was not a fundamentally driven sell off. It was fear based (though Apple actually had a meaningful slowdown in China).
Moreover, these companies had internal data that showed they were healthy. The CFOs knew the businesses were not deteriorating like the stock price. That is the exact time a corporate finance department should increase their buying activity. Especially in a cash generative company! Instead, they sat on their hands.
And that lack of action demonstrates why corporations, in aggregate, are not very good at share repurchases. On average, corporate buybacks do decrease share count and shares historically tend to increase in price. So, for the long term investor buybacks are better than nothing. But, buybacks have immense potential power and even today’s best companies don’t understand how (or are too scared) to use them properly.
In the interest of disclosure, SCG reduced its cash position from 33% in October to just under 20% by the end of December. This isn’t a promotional statement. In fact, it’s way too early to determine whether that was the right long term decision. But, why in the world were the best companies not meaningfully deploying capital when SCG was? The answer lies in the institutional imperative. And that is a sad realization considering who those companies supposedly employ.