@TMFJMo How do you tell if a company has jumped the shark? Example - is this Whole Foods scandal a red herring or a red flag?
— Warren Kiesel (@wkiesel) June 30, 2015
It’s a great question because there’s no cut and dry answer. Figuring out whether or not a company’s misstep(s) is fatal will more often than not be a matter of opinion and we never know for sure until the luxury of hindsight. Let’s look at two companies that have witnessed some negative press lately: Whole Foods and Lumber Liquidators. Both are relatively well-established businesses that, at their core, deal in commodity-based products.
Whole Foods is in the news thanks to an investigation that revealed some stores are overcharging customers. Yes, it sounds bad, but my strong inclination is that this is nothing more than a blip in the grand scheme of things. Looking at the bigger picture with Whole Foods today, it’s more than just a grocery store; it’s a brand that communicates a lifestyle for many. While it may have done something wrong in this case, let’s also look at all of the things it’s done right to get this far.
Whole Foods has built its brand on quality and management has done a tremendous job in building a brand that means something to a lot of people; that doesn’t just disappear overnight. Customers know that they’re paying more for the quality that Whole Foods is offering and the numbers tell us that they keep doing it. The nature of the business prompts a lot of repeat purchases (people gotta eat) and that won’t change. It overcame the “whole paycheck” crisis by offering its customers more value. It will overcome this pricing scandal as well and as long as management stays true to the brand they have built Whole Foods will continue to grow and this will be but a footnote in the history books.
Lumber Liquidators is another great case study. Talk about a fall from grace; shares are down almost 70% year-to-date thanks to the formaldehyde crisis that has resulted in a mass executive (and shareholder) exodus. Lumber Liquidators has built its name on value, giving customers good flooring at fire sale prices. And there’s nothing wrong with that, but when the quality of the product comes into question and leadership starts heading for the exit doors, investors are going to start wondering what the hell is going on.
So are Lumber Liquidators’ missteps fatal? Again, my strong inclination is to say no, they are not. I don’t believe the company is doomed. It has a large national footprint and the founder of the business is still very involved in righting the ship. Is this enough? Time will tell. But my suspicion is yes, it is. At least from the consumer’s point of view. I’m pretty sure that five years from now homeowners will still be able to get flooring from Lumber Liquidators (unless it’s acquired).
However between the sourcing issues and laminate crisis the fundamentals of Lumber Liquidators’ business will change. I suspect it will result in a higher cost of goods going forward and investors need to take this into consideration as margins will likely take a hit given that it doesn't really possess any pricing power. Further, try performing a Google search for Lumber Liquidators; it’s not pretty. In time this will change, but it’s going to take a lot of time and money to repair the damage to the brand.
So is this a buying opportunity for Whole Foods? How about Lumber Liquidators? In the case of Whole Foods, I say yes it is. Management has the ability to move past something like this very quickly. This is a brand that has built its reputation on quality and given its growth prospects and move towards more value I think there's plenty of upside left. In the case of Lumber Liquidators though, I’m not so sure. I think the market has reacted appropriately given the plethora of bad news that keeps coming out. Given the leadership exodus, the litigation the company faces and the time and money it will cost to repair the damage to the brand I don’t see shares bouncing back anytime soon. There’s no arguing shares look cheap today (and for good reason), but there is still plenty of uncertainty regarding the road ahead. It’s not to say shareholders can’t win from today’s price; they certainly may. But it’s a riskier proposition and it’s going to require a lot of patience along with the understanding that it the business may never fully recover.
Foolishly,
Jason
Whole Foods is in the news thanks to an investigation that revealed some stores are overcharging customers. Yes, it sounds bad, but my strong inclination is that this is nothing more than a blip in the grand scheme of things. Looking at the bigger picture with Whole Foods today, it’s more than just a grocery store; it’s a brand that communicates a lifestyle for many. While it may have done something wrong in this case, let’s also look at all of the things it’s done right to get this far.
Whole Foods has built its brand on quality and management has done a tremendous job in building a brand that means something to a lot of people; that doesn’t just disappear overnight. Customers know that they’re paying more for the quality that Whole Foods is offering and the numbers tell us that they keep doing it. The nature of the business prompts a lot of repeat purchases (people gotta eat) and that won’t change. It overcame the “whole paycheck” crisis by offering its customers more value. It will overcome this pricing scandal as well and as long as management stays true to the brand they have built Whole Foods will continue to grow and this will be but a footnote in the history books.
Lumber Liquidators is another great case study. Talk about a fall from grace; shares are down almost 70% year-to-date thanks to the formaldehyde crisis that has resulted in a mass executive (and shareholder) exodus. Lumber Liquidators has built its name on value, giving customers good flooring at fire sale prices. And there’s nothing wrong with that, but when the quality of the product comes into question and leadership starts heading for the exit doors, investors are going to start wondering what the hell is going on.
So are Lumber Liquidators’ missteps fatal? Again, my strong inclination is to say no, they are not. I don’t believe the company is doomed. It has a large national footprint and the founder of the business is still very involved in righting the ship. Is this enough? Time will tell. But my suspicion is yes, it is. At least from the consumer’s point of view. I’m pretty sure that five years from now homeowners will still be able to get flooring from Lumber Liquidators (unless it’s acquired).
However between the sourcing issues and laminate crisis the fundamentals of Lumber Liquidators’ business will change. I suspect it will result in a higher cost of goods going forward and investors need to take this into consideration as margins will likely take a hit given that it doesn't really possess any pricing power. Further, try performing a Google search for Lumber Liquidators; it’s not pretty. In time this will change, but it’s going to take a lot of time and money to repair the damage to the brand.
So is this a buying opportunity for Whole Foods? How about Lumber Liquidators? In the case of Whole Foods, I say yes it is. Management has the ability to move past something like this very quickly. This is a brand that has built its reputation on quality and given its growth prospects and move towards more value I think there's plenty of upside left. In the case of Lumber Liquidators though, I’m not so sure. I think the market has reacted appropriately given the plethora of bad news that keeps coming out. Given the leadership exodus, the litigation the company faces and the time and money it will cost to repair the damage to the brand I don’t see shares bouncing back anytime soon. There’s no arguing shares look cheap today (and for good reason), but there is still plenty of uncertainty regarding the road ahead. It’s not to say shareholders can’t win from today’s price; they certainly may. But it’s a riskier proposition and it’s going to require a lot of patience along with the understanding that it the business may never fully recover.
Foolishly,
Jason
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