Tuesday, April 17, 2007

The Brick Dhando:

As the title suggests, I just finished reading Mohnish Pabrai's new book, The Dhando Investor. Mr. Pabrai is an exceptional investor and his book focuses on the concept of Dhando- minimizing risk and maximizing return. As Pabrai likes to explain it, "Heads, I win. Tails, I don't lose much." Overall, the concept provides another useful way of approaching investing, especially for investment such as Harvest Natural Resources (HNR) which faces two distinct possible outcomes. Outcome 1, the political risk in Venezuela that Harvest faces is very real and they end up losing control of their oil assets, leaving them with just the net cash on their balance sheet. Or there is outcome 2, where Harvest gets to keep the terms that the Venezuelian government has recently proposed and they can continue on their business, resulting in a very profitable investment. I haven't done the analysis myself, but it must be highly favorable if Pabrai is willing to make it one of his largest positions.

But the Brick Group seems to also be utilizing this Dhando concept, too. The Brick is a large Canadian retailer of furniture, mattresses, electronics, and appliances, controlling 8.1% of these markets. What is interesting is the economics behind the business. Brick's strategy is to have a large centralized distribution center and then roll out numerous stores in each market. This concept works out very well because most of the goods they sell require delivery. So once a distribution center is up, each new store requires less inventory and less space for warehousing. The result is that each new store can be started up for about $750,000 in capital will average revenues of 5 million. "Heads, you win, tails, you dont lose much!" And, their overall results display this. The Brick is not exceptional at retailing, but it has a very profitable warranty and credit business that goes along with it, giving them an overall return of investment nearing 100% (25% for just the retailing side)

What becomes real interesting is when you look at this entire sector. Brick has many publicly traded competitors to compare to.

Note: I assume 10 million of cash on the balance sheet as needed for operations, and ROI refers to EBITDA/Invested Capital. (so, it is pre-tax)

420 million revenue
27 million ebitda
??? invested capital

1.33 billion revenue
69 million ebitda
ROI -100%++

505 market cap +57 million net debt = 562 EV

211 inventory to 800 cogs
approx 25,000 sq ft / store
$320 sales / sq foot

Tax Free for next 4 years
Higher ROI than peers due to Credit business

Leon’s Furniture
289 million revenue
37 million ebitda
79 million invested capital
47% ROI

591 million revenue
94 million EBITDA
177 million invested capital
53% ROI

1076 market cap -110 net cash = 966 EV
10.3 x EV/EBITDA

75 inventory to 341 cogs
89,000 sq feet per store
$188/ sq foot

Disadvantages: No central distribution, resulting in larger stores that require warehousing.
Advantage: Owns it's property, resulting in savings on lease costs.

BMTC Group
423 million revenue
22 million ebitda
74 million Invested Capital
30% ROI

835 million revenue
70 million ebitda
114 million invested capital
61% ROI

700 market cap - 109 net cash = 591 EV

82 inventory to ??? cogs
47,000 sq feet per store
$629 sales / sq foot

Advantages: Centralized Distribution, Owns its property.

Overall, BMTC seems to be the best run business, while Leon's is arguably the worst. What is really amazing, however, is the phenomenal returns all of these competitors are making. Why have all of these companies been able to able to earn such great returns for so long? Has Capitalism been caught falling asleep? (no pun intended) Here, even I am unsure. An arguably important aspect is regional market share. From Sleep Country Income Fund:

Regional market share is particularly critical to operating successfully in the mattress retailing industry in
Canada. The retail mattress industry is characterized by the existence of substantial regional fixed costs (advertising, management and distribution), that are independent of the number of stores in a particular region. Sleep Country believes its strategy of becoming a regional market leader with multiple stores brings regional fixed costs to an effective level on a per-store basis, which allows the Company to invest in creating competitive advantages.

When you compare locations, BMTC is the most concentrated, dominating the Quebec market and having the best per-store economics. Leon's has the worst economics, and Brick is in between. So perhaps, regional dominance is a very important factor.

Do you, the readers, see any other competitive advantages that allow these companies to make such great returns? If so, please leave a comment sharing your thoughts. Brick Group is pretty cheap regardless. But a strong moat could add more safety and make it a phenomenal investment.

Disclosure: I own a small position in The Brick Income Fund.

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