Tuesday, January 4, 2011
How dope smokers with the munchies at 2AM almost destroyed the number three wholesale grocery distributor in Australia
Anyway you need a bit of background.
There are two dominant grocery market chains in Australia - Woolworths and Coles. The latter is now owned by Wesfarmers. These chains have enormous market power - far more than say Wal-Mart in the US because the concentration here is so high.
These chains own their own distribution businesses.
When I first started investing seriously there was a third-player distributor in most states of Australia. The third player in the biggest state (New South Wales) was David’s Holdings - owned by John David. I met John David once - he was a very nice man. He was also ambitious. He wanted to consolidate all the number three players - something that was probably necessary if the third player was to survive.
So David raised some of the necessary capital by listing his company. He then one-by-one purchased the wholesalers in the other states.
But he did not raise enough money by simply listing. He started to raise money by playing around with payment terms. After all a wholesaler turns over an enormous amount of merchandise on margins that are below 2 percent. If a wholesaler is vehement about collecting from their customers rapidly (30 days or less) and starts paying its suppliers slowly (60 days or more) it can generate a lot of cash - a free loan if you will from the suppliers.
And that is what John David did. Payments to suppliers became increasingly tardy - and DPO edged towards 80 days. (By contrast well Wal-Mart DPO is 35.7, Tesco is at 34.3, Wesfarmers is at 35.7 and Woolworths is at 30.8). Suppliers might not like it - but it generated Davids a large cheap float - and kept the third-force in wholesaling alive.
Woolworths however kept growing and kept destroying mom-and-pop corner grocery stores. It was awfully difficult staying open as an independent against the large chains. And every time one of those stores closed Davids lost volume. And when it lost volume it lost the float associated with that volume. Negative working capital employed in a business is wonderful until your business shrinks.
David’s - which had levered itself up for its acquisition spree - dealt with this cash drain the only way it could - which was to allow payment terms to blow out even further. Now Davids was operating above 100 DPO.
Woolworths however smelt blood. It started using its wholesale operations to supply third parties - mom and pop stores, shops at gas stations and the like. These shops were reluctant to go to Woolworths because - well frankly - Woolworths was the enemy. But some left and David’s had to increase its DPO even further.
Now enter Arnotts. Arnotts is the dominant biscuit maker in Australia. It is now owned by Campbell’s soup and is one of their best assets. Arnotts however have a biscuit which figures above all others in the Australian psyche - the Tim Tam. The Tim Tam is a desperately rich biscuit - beloved by teenagers and twenty-somethings and an iconic part of getting fat in Australia.
They are sold by gas stations (open all night) at ridiculous markups - a couple of dollars a pack being a common mark-up. And the only person that buys them at 2am is someone who has the munchies. (Irrational hunger - known colloquially as the munchies - is a side-effect of smoking marijuana.) And Tim-Tam’s at 2am are the mainstay of the (overpriced) grocery shop attached to an all-night gas station. They are an important product.
And Arnotts, sick of David’s tardy payments, supplied David’s with their entire product range except Tim-Tams.
This annoyed the gas stations who would put signs up on the vacant area where the Tim-Tams should be - saying “supplier out of stock”. This convinced some gas stations to shift their supplier to the enemy - the dreaded Woolworths. At least they could get Tim-Tams.
This drove David’s almost bankrupt. The stock plummeted (it traded as low as 40c). Eventually it sold itself in distress to a South African group (Metcash) who injected enough capital to fix the DPO problem.
And so in my memory we almost lost the third biggest grocery wholesaler in Australia because dope-addled kids with the munchies could not buy chocolate biscuits.
And I learnt to watch DPO as an important indicator of corporate health.
Till next time.
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