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Jim Jubak: Adjusting to New Markets
02/28/2003 12:00 am EST
Jim Jubak is the senior markets editor for CNBC on MSN Money. His column "Jubak's Journal " appears on MSN Money every Tuesday and Friday. Previously, he was senior financial editor at Worth magazine and editor of Venture magazine. He believes we are facing a "new" market environment in the decade ahead, which will require a "new" focus by investors. Here he outlines his long-term views and suggests some favorite stocks that are well-positioned for the changing world ahead.
"What comes after the bear? If you go back to when the bear started to show its claws, in the spring of 2000, we asked what comes after the bear next September? And then we got to next September, and we asked what will we do when the economy recovers in 2001? And then we pushed it out to say what happens when the economy recovers in the second half of 2002. Now we’re in the early part of 2003, and the scenario is the same, with everyone talking about a second half recovery later this year. But there is no evidence of that one way or another right now. The data is deeply, deeply ambiguous. You can find data points to support a second half recovery and you can find data points that say it will never happen.
"When we talk about leaders for the new markets, we have to ask what the new market will look like. Everyone seems to say that we’re going to get a rally when bonds start to fall and the Iraq army disintegrates, and our geopolitical problems end quickly. If that is indeed the scenario, it will produce a massive short-term market rally. But I doubt that’s the likely scenario. Granted, our military victory will lead to a rally. But I think any such rally will peter out very shortly, because it doesn’t really solve any of the problems of the economy, terrorism, North Korea, and it might not even solve the problem of Iraq.
"We could see maybe 15% to 20% upside from current levels. Certainly that’s nothing to sneeze at, but I don’t see that being followed by additional gains. We are still going to be facing a world where two trends have been gathering steam for the last ten years. One is a massive expansion of global manufacturing and service capacity. We have a global expansion with the Chinese economy, the Indian economy, and other Asian countries such as Vietnam. A decade ago, American businesses were doing business in Singapore or China. Some now view China as too expensive, and are outsourcing to Vietnam to drive down labor costs. This is an explosion. China has added capacity, capacity, capacity. We are seeing a squeeze on costs and margins and companies have to respond to this. This is an old story. This is the same process we went through in the 1970s, when everyone said that American companies are never going to be efficient and that the Japanese were going to own everything. Well, American companies did find ways to compete with Japanese companies, by getting efficient and cutting manufacturing costs. We’re going to go through a process that is very similar to that one, only this time, the target is not Japanese efficiency, it’s now the efficiency of all these brand new factories being built in places that used to be rice patties five years ago.
"There’s good evidence that this trend that it is not going to impact only manufacturing this time, but that it is going to also include parts of the service economy. Look at ‘call centers’ which over the years moved their operations from suburban New Jersey, to rural Iowa. After that, they moved them to Ireland. Now, the Indian subcontinent has trained its students to speak English, and companies are moving their call centers to India, Bangladesh, etc. – all places where you have a technically-trained, English-speaking workforce. This is resulting in additional cost and margin pressure.
"This is also happening in a rapidly aging world. That’s most apparent in the first world, but the newest figures show that everywhere outside of Africa, the birthrate is falling to below levels of replacement and populations are aging fairly rapidly. You have to look at this not as a demographic issue, but a cost problem for businesses. For example, the average age of a GM worker is 47. What’s bad about that? Not their productivity. Not their intelligence and not their work skills. All those are good things. But the problem with an older worker is that they have accumulated lots and lots of pension liabilities, they have lots of healthcare liabilities and these companies must support this growing retiree population. If you look at GM’s variable costs, costs of labor, parts, etc., they are highly competitive with the Toyota and Honda operations in the US. But if you put in the retirement costs, GM winds up with an additional cost problem of about $1,300 per car.
"You can see the same problem in the airlines industry. The problem is not just that people don’t want to fly in a post 9-11 world. The real problem is that they have these massive, massive pension liabilities, and bankruptcy courts will be the only way for the airlines to ‘bust’ these pension plans. If you look at this as a social problem, it’s not a good thing. If you look at it from the standpoint of taxpayers, it’s not good, as many of these bankruptcy costs are passed on to taxpayers. It’s not a good thing, but it is happening. Comparing American Airlines to Jet Blue is the equivalent of comparing an American manufacturer to a manufacturer in China. Jet Blue’s employees have perhaps two years seniority. They have very little built up in pensions, and there are very few retirees for which they have to pay healthcare costs. The company faces a massive cost advantage just because it wasn’t around years earlier.
"What does this have to do with picking stocks? It means that we’re looking at an economy with intense pressure on margins. In this environment, you want to look at companies that are taking market share. This is going to be a time of turmoil and companies are going to die. Companies that can’t make the cost cuts needed are going to go out of business. You have to worry about companies with falling margins, or those facing margin pressure. An example is American Express. It’s not an efficient credit card company. It never has been and never will be. Nokia is no longer worried about Ericcson and Motorola. They are now concerned about the Koreans and other Asian countries that will come after them, who have much lower costs. The problem at Cisco is that the new markets it faces carry lower margins than its older markets. AOL sells a product at $23 a month, and increasingly people are choosing to either go broadband, or buy it for $9.95 a month from other companies.
"Microsoft has been a great stock, because its return on invested capital has been tremendous. It’s one of the advantages of being – well, we won’t say a monopolist, we’ll say the leader in a highly concentrated industry. Other great leaders are Intel, Gillette, EMC – companies that have garnered massive market shares. Microsoft is sitting on $40 billion. Why? It’s very hard for these companies to find another business with the same kind of return on capital as its monopolist business. And as they reinvest their money in less attractive areas, it’s likely that the company’s overall p/e will be reduced. Lastly - and this should be a no-brainer - beware of companies that don’t have any obvious growth plan, such as any full cost airline. Long distance is a commodity; I can’t see anyway for them to grow volume and prices. Domestic automakers have the same problem. I can see domestic auto volume at 16 million units, as long as their willing to pump massive incentives. But I don’t see a growth path.
"So what you want are companies gaining market share that have highly visible growth paths and that have shown the ability to cut costs, again and again and again. It has to be imbedded in their structure. Sysco (SYY NYSE) is a great example of a company that can bring its efficiencies to acquisitions. They are the dominant player in the institutional food supply business. They are the largest company in this business by far. There are still some 3,000 companies out there that Sysco can acquire to gain more market share. And with each acquisition, they bring in their management, their software, they help lower the cost basis, they bring in their efficiencies of scale and actually improve profits. Comcast (CMCSA NASDAQ) has got the same dynamic going on. They recently bought AT&T Broadband, which had been the world’s worst run cable company. We could pick random people in this room to run AT&T Broadband and do a better job than its management. Well, Comcast turns out to be pretty good at taking badly run cable firms and getting profits out of them. They just bought the world’s greatest opportunity to be better managers.
"We also look for those companies we call gorillas, that have locked in increasing returns. One such firm is PepsiCo (PEP NYSE). I don’t care if Pepsi is going to beat Coke. Pepsi is a great cash cow. The world loves salt and fat. And given that its Frito Lay division already has retail shelf space, they can just roll out endless new products. American International Group (AIG NYSE) and Dell (DELL NYSE) are companies that have locked in cost savings. And while it’s harder to find, we look for ‘gorillas in the making’. These are smaller companies that have a highly efficient management and increasing efficiencies of scale, a cost cutting culture, and massive opportunities. Zebra Technologies (ZBRA NASDAQ) makes printers and software systems for bar coding. As the rest of the world focuses on bar coding, the company will have a big, big future ahead of them. Stryker (SYK NYSE), which makes artificial joints, is a great play on an aging world. It is an incredibly well run and efficient company. Univision (UVN NYSE) is in the TV market for Spanish speaking people around the world.
"Basically, I think the markets after the current short-term problems are over is going to be one where growth is hard to come by, margins are falling, and competition is really fierce. In that case, these are the best stocks to own. If I am wrong and the economy turns out to be better than I expect, these stocks will still do well. They may not do as well as more leveraged companies, but they will still do well. If the world is much worse than I’m expecting, in that we see no growth, and inflation and interest rates spike up, then these companies will also do relatively better. Overall, these companies should represent the core of a long-term portfolio. They are well worth owning from a decades-long perspective."
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