The Truth is Out There

Ahhh, the stock market. Wherever you go in the world, its always the same. There’s something comforting in the groupthink of many different players all focusing on one thing. It’s even more enjoyable when everyone firmly believes in the conclusions. But the truth is often a lot more complicated than what market players tell you.

Take, for example, the Russian market for fruit juices. 2 major domestic players are battling for market share dominance. Each is a good company, but with different characteristics. WBD is a highly decentralized manufacturer whose stock is traded on the US exchanges. As such, it has a very diverse shareholder structure. The other, L, is predominantly owned by management – to the tune of about 80% of the outstanding shares. In all respects, it’s a much more centralized model.

Conventional wisdom tells us that L is the better company. Its taking share from others, especially WBD, thanks to aggressive marketing. Its also more attractive because of its highly concentrated ownership – strong management means owner/managers are focused on success, have the power to push through their agendas, and generally are better at getting results. Margins are better at L, too, but that aggressive advertising is constraining margin growth while top line is booming.

Sorting through the numbers, however, provides a very different insight into what’s going on at the company. Advertising expense is increasing at L but at a slower pace than revenue. That is, as a percentage of total cost advertising is actually decreasing. So, that’s not the cause of margins getting pinched.

The financial statements show that the most significant growth in expense is actually found in labor costs. Annual labor costs have averaged a 69% increase from 2002 to 2004 while revenue only went up 46% at the same time.

So, it’s a growth story and subject to high expenses, right? Well, look at headcount over that same time. Just dividing labor expense by headcount implies a 35% increase in annual wage per employee over the 2002 to 2004 period. By the way, accounting bodies stopped considering Russia a hyperinflationary economy on January 1, 2001.

In my view, the truth is sort of an amalgam of several elements of the conventional wisdom. Sure, L is a great company that’s taking market share. And yes, concentrated owner/manager stakes seem to be an advantage in this case. But its pretty clear to me that those owner/managers are bringing home the money in buckets.

One more line item: “other expenses”. It only accounts for 4% of total expenses, but that catchall line item has increased at an 82% compound rate from 2002 to 2004. Wonder how many Mercedes’ that much will buy?

So, for now I’ll go along with the wisdom that L is definitely a good investment and a great operator in its local markets. Let’s just not kid ourselves too much – its fat city at L headquarters and management is taking home what it considers its fair share.