McLane Company - Buffett and McLane Company

[yan]

Berkshire owns McLane Company, which is a "wholesale distributor of grocery and non-food products to retailers, convenience
stores and restaurants. McLane’s business is marked by high sales volume and very low profit margins." (Annual Report, Bershire Hathaway)

It seems that the economic moat of this company is very small. Anyone can offer any insights as to why you think Buffett bought it?

[FFNow]

I don't think the moat is small as it's a food service supply chain company. Supply chain companies have a good moat due to coverage all the way from the supplier to the end-customer. I can think of Olam in Singapore. It has thin margins too.

[cif5000]

Berkshire owns McLane Company, which is a "wholesale distributor of grocery and non-food products to retailers, convenience
stores and restaurants. McLane’s business is marked by high sales volume and very low profit margins." (Annual Report, Bershire Hathaway)

It seems that the economic moat of this company is very small. Anyone can offer any insights as to why you think Buffett bought it?

Are you correlating the 2?

[Nick]

The mega supply chain companies like Wilmar, Olam and Noble are good examples of companies with thin margins but pretty large moat. I can't see any company toppling Wilmar in one day.

Similarly, leasing companies like ship operators (in good times), REITs, shipping trust etc have excellent margins but I dare not say all of them have great moat.

I guess high margins doesn't translate to high returns and vice versa.

[FFNow]

Most of the time, high margins is equated to a large moat in terms of Buffett's style of investment. Most of the consumer brand names like Coke, etc have high margins and have huge moat. Higher margins = competitive advantage over competitors with lower margins, but not 100% of the time. There are always exceptions to everything.

[shanrui_91]

The way I see it is that we are in a free market and thus there’s not many companies that can remain profitable forever. Under perfect competition scenario (theoretical but will never happen), in the long run the price = cost and thus most companies profit margin will get eroded. Let’s put it this way, when the first successful bubble tea shop is being set up, everyone knows how profitable it is and will all jump in to open another bubble tea shop. Sooner or later, the supply will far exceed demand and the lousier performers will close down their shops due to the lack of sales while the stronger is hardly profitable. This is a classic case of the lack of durable competitive advantage.

Thus, it is very likely that a company will have some form of durable competitive advantage if it is able to sustain its high profit margin for the past years. Why does some seek high profit margin in a company? The reasons are 2 fold. Firstly, there is a margin of safety in terms of profit. Should revenue come down sharply; the high profit margin will serve as a cushion and prevent a company from making a loss. So long as there is a loss, shareholder’s equity will decrease. Secondly, profit margin is a function of ROE and thus a high profit margin will usually mean a high ROE.

However, high profit margin is not the only way to earn profit. In some industry, by selling cheaper you can get much higher sales through higher turnover. This is what we call as price elastic good. In this case, the high turnover is more preferred than high profit margin and usually they have high inventory turnover too. E.g. Walmart, Macdonald, Dairy Farm.

Therefore, you have to understand the business model of the industry to know if high profit margin or a high turnover is better. Seldom will you have high profit margin and high turnover.

[mrEngineer]

In business, it is always better if we can analyse the business in terms of variable cost and fixed cost. Most of the accounting structures prevents that but sometimes this kind of information is available in the analyst reports. It is especially important to analyse and benchmark commodity or supply chain companies in these cost structure to better understand their viability of the business model.

[FFNow]

In business, it is always better if we can analyse the business in terms of variable cost and fixed cost. Most of the accounting structures prevents that but sometimes this kind of information is available in the analyst reports. It is especially important to analyse and benchmark commodity or supply chain companies in these cost structure to better understand their viability of the business model.

Hi mrEngineer, could u explain more? I don't have accounting background so I would like to know more about this. Thanks.

[mrEngineer]

ok.. let me put it this way

usually the finance people likes to consider VC (variable cost) before the gross margin line and FC (fixed cost) before the OIBD (operating income before depreciation & amort) line. Let us exclude the financing cost, taxes etc first as these are usually managed by the CFOs and not the operating lines (but i must say it depends on the company structure as well). However, this is not really correct by the definition of VC and FC. For e.g. for overtime wages should it be considered as VC or FC? Intuitively it should be considered as VC as your sales increases, more work is required to be done, VC increases. Another example, maintenance cost should be VC or FC? Some equipment will have maintenance as VC, some as FC and some both.

The biggest problem is when you put 2 competitors together but you are actually still comparing apples to oranges due to how they classify some items in their income statement..

That is why industry players usually have more information than public as they know what equipments the companies are using, their cost structure and their profitability. Of course, WB will have access to such information easily upon his request. But we retail investors can only suck thumb.

Sometimes, in analyst presentations, these cost are reported and it can give you great insights to the company especially if you are able to benchmark them. Also, it may be helpful to look at the MD&A as it may report more operational business figures.

Typically, instead of Gross Margins and Net Margins, I prefer to look at OIBD margins to compare against the industry and evaluately the finance costs separately.

This is especially important for supply chain companies as their cost structures and manufacturing equipment are quite repeatable. Therefore, any increase in VC (energy price, raw material cost etc) will greatly impact your business and profitability whereas FC is expected to be more stable. Project type of companies are different ball game although especially for project management companies as it will depends on their reputation, quality of employees they have, the technical expertise and how hungry are they for the business.

[FFNow]

Thanks for ur explanation!