Buy a Toll Bridge

BYLANES - Buffet's Toll Bridge

Imagine a river with a commercial district on one side and residential on the other. Now, imagine a bridge spanning the river, joining the two districts. And imagine that you own the bridge, and can charge a small fee for using the bridge. A few thousand cars pass over the bridge every day, and you charge each car a little something for using the bridge. I bet you have already started counting the money. Warren Buffet keeps this perspective in mind while choosing a stock.

Some basic advantages of such a `toll bridge` should be understood. One is that the cash register keeps ticking without a stop. The other advantage is that there are no sundry debtors. Further, the maintenance and expenditure is low and the profits can grow at a predictable rate, and that too for a number of years. If you (that is. the owner) do not become irrationally greedy and maintain the fees for crossing at a reasonable level, the customers will continue to use your bridge, and you will make money for a number of years to come.

Many businesses reach the status of a toll bridge because of the strong relationships their products build with the customers. The first sign of such a company is apparent when the customers demand the product by its brand name and don`t even know the name of the company that produces it. The second sign is that it has little, or no competition, and the third sign is that it is essential either as a necessity, or for its universal appeal, and, therefore, every store has to carry it.

Let us consider some examples in the Indian context. `Cadbury`s` chocolate, `Cherry Blossom` shoe polish (how many know the name of the company? (Viz. Reckitt & Coleman), `Dettol` disinfectant, `Aspro` and `Anacyn`--the headache cures--and `Amul` butter easily come to mind. In pharmaceuticals, Glaxo is one such name, which has many products in demand. Can any store afford not to have these products on their shelves? If the store does not have it, the customer just walks over to the next store and gets it.

Companies making such products are in a unique position. They have established the manufacturing process, people have accepted the quality and specifications, they do not have to invest large sums in the plant and machinery every year, and their supply chains and distribution network are well established. The net result is steadily growing profits. These companies have some more advantages. They do not need exceptional management, just an honest management capable of grabbing a good thing when they see it and not to make a mess of it. These companies do not require too much of research and development (R&D), as they invented the formula many years ago and their customers don`t want any change. Would you like Dettol to smell differently? A good friend of mine even used it as an after-shave for many years. The management may add a gift with the purchase of a bottle, or add a new flavor to the product range to grab a little extra of the market share, but a wise management will leave the main product untouched. In Dettol`s case, even the shape of the bottle is important.

Such structurally sound and `in-demand` toll bridges are great businesses to own. They give rise to plenty of free cash, which can be invested in building or buying another such toll bridge. These businesses survive through economic downturns, and continue to give the same returns. This feature makes it easier to predict their profitability. Value investors love this.

The return for the investor is on the one side the earnings per share (EPS) (or dividend) and on the other increase in the share price. If the annual EPS/dividend is predictable, and if the share is purchased at a low enough price, the investor is happy to get such a return year after year. Many times, we see such companies showing an increasing EPS trend. This is still better for the investor, because this increases the price of the share faster.

Much has been said and written about the intrinsic value of the business and how it is to be arrived at, but with insufficient justice to the discipline involved. Value investors eye the company first, but their decision to buy is a function of the price. Everything else about the company may be perfect and the value investor may be itching to own a part of it, but a disciplined investor will wait for the right price. Once purchased, the stock is not sold for a long time. The argument is simple. Why give away something `good` till something `better` comes along? Remember that a good toll bridge has a minimum life of 25 years. If the EPS is in the region of 20% and above on the price you paid, calculate the compounded value at the end of those 25 years and see for yourself. Yet there is a sad side. Like everything else in this world, bridges also deteriorate. Weather and time take a heavy toll of steel, and the bridge becomes unsafe. Those car owners who drove to work over that bridge for a number of years realise that the bridge is no longer safe and avoid using it. Some competitor senses the unease and builds a new bridge, and the owner of the original bridge dies an unsung death.

We know what happened to some automobile companies from the pre- liberalisation days. From the mid-50s to the mid-80s, Premier Padmini and Hindustan Motor`s Ambassador were the two cars ruling the market. For years, they continued to thrive without making any major changes in the models, and Indians had no choice but to buy those cars. Whatever was produced was sold, and that too against cash. Sub-standard goods were produced for years and dumped on the helpless customers. With little R&D and no improvement in the basic car, these plants were just waiting to receive a deathblow, and `Maruti` did just that. Customers had found another safer, newer, and cheaper bridge.

Sometimes, some management decisions cause problems. Excess cash poses a problem. The management does not know what to do with it, and then instead of buying another toll bridge, or improving the existing one, it buys a pyramid, which is just a tourist attraction and a place for the dead. The pyramid bleeds the parent company, and finally both perish. Acquisitions and mergers are good, but only of the same kind. In the recent past, we have seen the merger of Times Bank with HDFC Bank. Synergy in operation was evident, and the balance sheet proved it. The market also appreciated it, and the shareholders have reaped the benefit.

It is easy to say that one should invest in such `consumer monopolies`, as Warren Buffett calls them, but it is another thing to actually buy these shares. No one has monopoly over such a wisdom, and generally we find these shares selling at a high P/E multiple. Yet, occasionally, these shares sell at low prices. John Neff`s advice is worth following while waiting for a good price. He advices the investors to regularly scan the `New Lows` list in the financial newspapers. If you have earmarked a share, then this list alerts you when it starts coming down. Consider this example, In March 2000, Glaxo hit a new low of Rs 422. In August, it is trading at 480/490. Reckitt & Coleman hit a new low of Rs 192 in March. Now it is trading around 210/220. If someone had earmarked the share, then surely it was a good time to buy.

Sometimes, a `consumer monopoly` company remains unnoticed for a long time. These are the companies engaged in manufacturing some product, without which the big guns cannot do. An example could be that of a company manufacturing some critical chemical required for steel making. This company may also own the patent for the product and, thus, the monopoly remains assured for a long time. Such companies spend very little on advertising and, hence, are not widely known. Some event of social or political nature makes it conspicuous, and suddenly the great value of the share gets unlocked, and the price starts climbing. Mario Gabelli, a well-known investor from the US calls the event a `catalyst`. Noticing such a company in advance and then waiting patiently for a long enough time is what is needed. The rewards are great.

The best way to notice consumer monopolies is to visit various stores. If you find the same product on all the stores you visited, chances are that it is a consumer monopoly. Watch for the advertising campaigns. If there is a blitz, rest assured that the company is not confident about the demand. If the advertising is subdued and regular, just to tickle your memory cells, there is a good chance that the monopoly is operating. Some companies don`t advertise at all; for example, Amrutanjan, the headache balm.

Many years ago in Pune, a man started stamping his name on all goods that entered the city. The stamp was inconspicuous, yet readily visible. He did not charge a farthing for stamping the goods. Traders let him stamp their goods thinking of him as some harmless eccentric person, and soon goods which did not have his stamp were overlooked by customers in the city. So the traders started coming to him for getting their goods stamped, and then he started charging a small fee. In due course, he became a rich man. He had created his own `Toll Bridge`.
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