Monday, April 17, 2006

Berkshire buys Russell-The Advantage of Long Term Horizon

Russell Corp (RML) is being purchased by Berkshire Hathaway (BRK.A) for $18 per share. A leading manufacturer of fleecewear and athletic products with brand names such as Russell, Spalding, and Huffy, the business has just come off a rather poor and disappointing 2005.

Return on invested capital was a paltry 3.5%, down from 5.5% to 6% a couple of years ago. CFFO for 2005 was only about $50 million compared to $89 in the previous year. Manufacturing issues in Honduras resulting in problems with quality, a shift to hooded fleece resulting in labor inefficiencies, hurricane related expenses resulting in higher shipping costs…the litany of problems last year along with severance costs for a departing CEO resulted in really poor earnings.

But the company appears to be in the midst of a significant restructuring. Aggressive cost-cutting actions appear to be in place or at least forthcoming. Spalding is a decent $400 million brand that could be much bigger with the right promotion. Ditto for Brooks athletic sneakers. Getting back control of the Spalding license for apparel could improve the visibility of the brand. An ongoing shift to offshore production will be complete by 2007 and costs should drop significantly. Most of the savings are coming for 2007 and will be only partially realized in 2006.

Though Wall Street estimates for earnings growth remained quite high at a median 12%, even with modest improvement in operating margins, and a growth rate of only about 5%, the $18 price should prove to have at least a 30% margin of safety in my estimation. Berkshire, by virtue of its Fruit of the Loom franchise and its newly acquired Russell franchise should have significant bargaining power with its largest buyers of apparel, namely WalMart (WMT) and Target (TGT.)

Buffett’s ability to see through the short term crisis in order to capture the long term value demonstrates the importance of investment horizon. A balance sheet that allows him to roll with the punches obviously is a luxury that provides financial sustainability to live through these crises.

Disclaimer: Neither I, my family, nor clients have a position in Russell Corp or Target. I, my family, and clients have a current position in Berkshire Hathaway.



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