The Unhappy 13

These are the 13 companies in the Elephant Herd Index that had both (a) negative 12 month returns and (b) 3 month returns below the S&P 500 which makes for unhappy investors.

My interest is in helping founders and leaders of brands maximize their chances of earning the payoffs they deserve from their efforts. Studying the best and worst and those in between can reveal lessons so we can copy the good and avoid the bad. Few of us will be lucky enough to start and exit multiple brands, so we can’t learn everything through experience!

Yesterday I looked at the Elite 5 companies that had more than doubled the S&P 500 over the past 12 months and I concluded that ROC is a critical measure for superior companies and that companies with superior performance must have strong ROC, but ROC by itself does not predict share price performance. Can we learn anything from poor performance?

"Happy families are all alike; every unhappy family is unhappy in its own way.”

Tolstoy wrote that is Anna Karenina. Does the same concept apply to companies? Are all successful companies alike while unsuccessful companies are unhappy in their own special way? Or will be find just multiple flavors of the same mistakes?

I look at the Unhappy 13 by:

1. Revenue
2. Margins
3. Capital Efficiency
4. Net Working Capital
5. Sales and Marketing Efficiency
6. Free Cash Flow
7. Return on Capital

Revenue (1 Year CAGR)

• Two companies, Estee Lauder (-10%) and Sleep Number (-3%) had revenue declines over past 12 months. Growth below expectations is bad enough, but going negative definitely makes investors unhappy.
• Four brands had growth over 20%: Digital Brands (+79%), Solo Brands (+28%), Prada (+25%), FIGS (+21%).
• Average 12 month group for the 11 companies who were not negative was 21%

I think the lesson here for leaders is that growth is not enough.

Margins

• Four companies, Warby Parker, Lulu's Fashion Lounge, Bark, Digital Brands, had negative EBITDA margin %. These same 4 plus Petco had negative Net Income margin %.

Just 36 months ago the markets could have shrugged this off, but today asks ‘where is the capital going to come from to fund losses?’ The lesson for private company leaders is to get profitable!

Capital Efficiency

I am a big advocate of capital efficiency and believe easy wins are to be had from focusing on capital efficiency.

Inventory Turnover Ratio

Some clues to underperformance jump out when looking at Inventory Turnover Ratio.

• FIGS is at 1.1 over the last 12 months. Yikes. That’s 343 days of inventory. That’s terrifyingly bad.
• In the luxury segment, Kering and Prada had Inventory Turnover Ratios of 1.2. Luxury tends to carry higher inventory levels. But when you compare them to Hermes (2.0), the problem comes into contrast. Kering is carrying 315 days of inventory and Prada is carrying 303 compared to Hermes at 184 days. This inefficient capital use is going to show up in their ROC which I discuss below.

Cash Conversion Cycle

• I am picking on FIGS here, but their CCC is a whopping 300 days! People of FIGS: Please, please please get this under control. We need FIGS to shine!
• Solo Brands is at 221. Solo Brands is a little tricky because their diverse product mix of firepits, kayaks, paddleboards and men’s apparel and they are moving omnichannel so they now have to accept terms from their retailers as opposed to collecting DTC. But 221 seems egregious. I know everyone was dunking on them for the Snoop ad, but maybe financial metrics like this was the real culprit.

Net Working Capital as % of Revenue

Which brings us to another metric where DTC (Solo Brands) is a laggard. Generally, the lower your Net Working Capital as a percentage of Revenue, the better. DTC is at 22% and one reason is they are carrying a lot of inventory at 252 days. Similar to FIGS, I want DTC to do well and hope they can get these metrics straightened out.

Sales and Marketing Efficiency

Of the Unlucky 13 who reported Sales & Marketing numbers, three companies stood out:

• Prada at 48%
• Sleep Number at 47%
• FIGS 36%

Prada seemed like a big outlier, so I wanted to compare them to peers. To get apples to apples, I had to use SG&A as a percentage of Total Revenue which is on the leading edge of useless, but nonetheless, Prada looks weak on that front.

• Prada is at 56% v Hermes at 23% (wow)
• LVMH is at 42%, Moncler is at 48%
• and Kering is at an incredible 14%. What is going on there?

FCF/Revenue

Free Cash Flow is where it’s at. This is especially true for private companies in a tough funding market. Looking at Frees Cash Flow (FCF) divided by Revenue gives an indication of how efficiently a company can generate its own cash. The lesson being, the more cash you can generate yourself, the less you need from outside.

• Prada looks impressive at 19%, until you compare them to Hermes at mind boggling 32%
• And Kering looks surprisingly low at 9%
• DTC surprises here at 19%. If they can get their inventory and Net Working Capital figured out, they have a strong cash engine.

ROC

I have written a bunch here and here on why I like ROIC and ROC as metrics, especially for private company leaders and unsurprisingly, ROC is a great guide to underperforming companies.

• Warby Parker, Lulu's, Bark and Digital Brands are negative which makes sense given their lack of margins.
• Petco is at 1% which makes me curious to dive into their financial since they have a negative Net Income
• Solo is at 3% (carrying all that inventory will kill you here)
• FIGS is at 4% (same comment as Solo)
• Estee Lauder (EL) is at 5%, Sleep Number 6% and Yeti is at 7%
• Prada and Kering at 10% and 13% seems respectable until you compare them to Hermes who is at an astounding 25% which is 5th best of 50 in the Elephant Herd Index. I can’t wait to dive deeper into Hermes and write about them.
• Lastly, Starbucks is at 22%. I have not been following Starbucks closely enough to know the story behind the performance.

Takeaways

Your business is a machine that produces returns from various amounts of capital inputs. You can increase returns, you can use capital more efficiently or you can try to do both. Return on Capital is a good (maybe the best) measure of how well your machine runs.

Think about the 13 companies through that lens. Think about what they have done to reduce their ROC. Then think about the Elite 5 through that lens.

Then think about your own company. What can you do to increase returns and increase capital efficiency? If you have any questions or want to chat about your company, please reach out.