Thursday, November 08, 2007

“An Inflationary Spiral Out Of China”



ACCO Brands is not, as they say, the sharpest knife in the investment drawer.

After all, any company that calls one of its business units the “Laminating Solutions Group”—you know, binding reports nobody reads with nice plastic covers so they can’t go directly into the recycle bin?—has got to have a sort of Dilbert thing going on deep within the corporate culture.

And, indeed, ACCO has been of the over-promise, under-deliver category for quite some time, at least in the eyes of Wall Street’s Finest, who bought the ACCO “story” without doing the appropriate due diligence.

By “appropriate due diligence” I don’t mean traveling to China to visit ACCO’s plants or counting ACCO branded SKUs at Staples.

I mean, just listening to the earnings calls and deciding whether they make sense.

And in the case of ACCO, the earnings calls haven’t made much sense for quite some time—at least to the more skeptical listeners.

For example, the main thrust of the company’s turnaround efforts, which date back to a disastrous merger with General Binding (the aforesaid “Laminating Solutions Group”) has been to raise margins.

Now, that’s not a bad idea. But the way ACCO chose to raise margins was not the usual route—i.e. by slashing costs and turning out new products at higher mark-ups. No, they had a different strategy:

The real news this quarter is the continued substantial improvement in gross margin. This is the third consecutive quarter of gross margin improvement and continues to give me confidence of the steady long term improvement of operating margin after we are able to work through the SG&A investment cycles that we now have underway. The improvement in gross margin was largely driven by the price increases implemented in Office Products and Document Finishing, coupled with cost synergies partly offset by negative volume in all segments.

—ACCO Brands, May 2, 2007


You would think a company experiencing “negative volume” in a screamingly strong economic environment might have given a thought or two as to the wisdom of those “price increases,” and wonder what would happen should things slow down.

Apparently, however, nobody at ACCO asked the question, because management spent a great deal of time on yesterday’s call verbally head-scratching and finger-pointing every which way but at themselves:

In our third quarter July and August started out well. With the continuation of a strong second quarter performance. But September sales proved to be slower than we expected for our sales and across the industry. Our subsequent analysis tells us the underlying markets softened in both North America and Europe during the third quarter. Based on our own analysis and multiple conversations with customers as well as comments from industry analysts, there is a clear consensus that office product sales in September were down essentially for everyone.

—ACCO Brands, November 7, 2007


Unfortunately for ACCO’s shareholders, management seems not at all ready to give up on the price-raising-our-way-to-glory strategy now that business had turned emphatically down:

We see this downturn as part of a broader consumer trend which appears to be particularly affecting the retail and small business sectors. While we see ourselves as well-positioned, ACCO Brands is not immune to the economic forces pressuring American and European businesses. Nevertheless, we are holding firm to the fundamentals of our business strategy…

As I said in yesterday’s preview, ACCO is not the Hope Diamond of the office products world.

Nevertheless, the company did provide a fascinating first-person view of the inflationary trend in China, and it is no prettier than we here at NotMakingThisUp have been discussing for months:

There is a shortage of ocean freight capacity coming out of China which has driven up ocean freight rates particularly to Europe where, again, maybe you we don't perhaps realize this, but, Europe became a bigger customer for China than the United States at the end of last year and that's causing freight rates going to Europe, particularly, to go up.

And within China, what you are seeing is all the way down the coastal area of China which is a more developed area, we've seen significant labor inflation, coupled with a reduction of what used to be what I'll call start-up incentives that were given through Chinese VAT. Those -- elimination of those start-up incentives plus the significant labor inflation in that area is starting to cause an inflationary spiral coming out of China which you can then couple with the flotation of the Yuan with the U.S. dollar.

So, my biggest concern from a price pressure point of view right now, is China followed by oil and its trickle down effect to all the other commodities and energy….


So the only price pressures ACCO is seeing are:


1. “An inflationary spiral coming out of China”
2. Oil
3. “All the other commodities”
4. Energy
5. Ocean freight.

Other than that, I guess the Fed has it all under control!


Jeff Matthews
I Am Not Making This Up


© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes investment advice, nor is it a solicitation of business in any way. It is intended solely for the entertainment of the reader, and the author.

2 comments:

pudgeman said...

Does the word "stagflation" worry anyone at this point...Fed with "helicopter Ben" out of control and destroying the value of the dollar...real inflation rising significantly all over the world...and the ECRI business cycle forecast pointing towards a US business recession starting late spring 2008

cadamyale said...

Jeff,

With all due respect, I think you are a bit off the mark with your comments about ACCO's management.

Without passing judgement on the merits of acquiring GBC (I think it is a bit early to determine whether or not this was a success), ACCO's management rightly chose to shed some unprofitable business and raise prices on some GBC products.

Prior to acquisition, and on the front end of the current inflation cycle, GBC guaranteed its customers' pricing for two years. ACCO raised prices this year. The resulting sales attrition has been more than expected, but buyers will come to see that ACCO offers a better product and value-added service than private label whiteboard suppliers and competing "laminating solutions"

The new product development cycle is coming. It includes a document finishing system that will allow the hapless assemblers of pitchbooks to change out pages without disassembling the entire book. It ain't sexy, but it is a better product.

GBC is a major restructuring and integration project that management has always targeted for completion in 2009. It took the same tack in assembling the legacy portfolio, which, while not the sharpest knife in the drawer, does generate 20%+ returns on tangible assets.

In my opinion, this is more a case of lack of investor/WSF patience than incompetent management.