Why Buffett Finished Off Burlington: It’s the Inventories, Stupid

Well, what the heck: why not use a great line, slightly altered, to make a point?The point being that what Pink Floyd once called “what the fighting’s all about” (at least as far as capital markets go) is not, strictly speaking, the economy.

Sure, everybody has an opinion on whether we’re going to have a V-shaped, U-shaped, W-shaped or L-shaped recovery (what happens in China: do they have sinographic recoveries?).Even my dog Charles has an opinion: he thinks it’s going to be shaped like his giant plastic red dog bone. But the issue that will determine the near-term course of the economy is simple enough, and has nothing to do with letters or ideographs or even giant red dog bones: it’s the inventories, stupid.

And inventories are probably as low as they are ever going to go.

Here’s how the CFO of 3M put it on their October 22 earnings call:

Heading into 2009, in the face of such a significant economic collapse, we set very aggressive cash flow targets for each of our businesses. Ground leaders and their teams have responded with great results. Third quarter free cash flow is $1.6 billion, up $769 million versus last year’s third quarter. This represents a 97% year-on-year increase. The improvement was driven by many factors, but most notably by lower capital expenditures, improving that working capital, lower cash tax payments and also reduced cash pension contributions. Net working capital declined by $415 million year-on-year, with inventory down $443 million….
Lest anyone think we cherry-picked a particular industrial conglomerate in the form of the famous Post-It notes maker, we did not. Pick any company in the same SIC code as 3M and you ’ll hear pretty much the exact same story.And it is not just old-line conglomerates that have brought inventories down to can’t-go-lower levels.Bob Wachob, the CEO of Rogers Corporation, which makes, to be technical about it, stuff that goes into cellphones, told listeners last week that his company’s hi-tech customers have not much in the way of surplus inventory:

Our customers are continuing to order with a request for extremely short lead times. That is a good indication they don’t have any inventory.

As for Rogers’ own inventories, Wachob said, without mincing words:

I think we are as low as we can go without impacting our customers.

Even a homebuilder as bruised and battered as Beazer has begun running low in inventory at the very moment orders are increasing, as reported earlier today:

As of September 30, we had only 270 unsold finished homes and 417 unsold homes under construction representing declines of 34% and 27% respectively from year-ago levels. With a cautiously optimistic outlook, we do not contemplate further significant reductions in our unsold home inventory levels but rather the resumption of more normal seasonal patterns.

Net new home orders of 1012 for the quarter represented an increase of 2.4% year-over-year.

Most striking of all, however—just as far as being emphatic about it goes—was Jeff Siegel, the CEO of Lifetime Brands, a kitchenware maker that sells to the Bed, Bath and Beyonds of the world, when he was asked by one of Wall Street’s Finest to size up the inventory reduction at that firm’s major customers:

It’s shocking. Honestly, it’s sometimes a shocking number. And I don’t — I can’t get at the numbers by retailer, but we do get it from — like one retailer we’re down about 6% on point of sale at one retailer. Our inventories are down over 30%.

In other words, while sales of Lifetime’s products at this unnamed retailer are running 6% below last year, inventories of those same products at that same retailer are down by one-third.

The response to Siegel’s comment from the member of Wall Street’s Finest who asked the provocative question?“Wow.”

Wow indeed.

So what happens when somebody actually needs to order a pallet of new flexible circuits for a rush order of cell phones, or an extra gross of Post-It notes not available on the loading dock, or a set of kitchen knives not sitting in the warehouse…or, heaven forbid, a whole new house?

Now, we’re well aware that Warren Buffett doesn’t make short-term bets on markets or economies.But given the fact that he stands at the center of an economic supply chain that stretches from a candy maker in South San Francisco to a high-tech machine tooling supplier in Israel, we think it’s no wonder Warren Buffett decided the time was right to buy the rest of Burlington Northern.There’s going to be a lot of—to be technical again—stuff that will need to be getting moved around in the next twelve months.It’s the inventories, and Buffett isn’t stupid.

Jeff Matthews
I Am Not Making This Up

© 2009 NotMakingThisUp, LLC

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