Understand Growth Stalls So You Can Avoid GM, JCPenney and Chipotle

Understand Growth Stalls So You Can Avoid GM, JCPenney and Chipotle

Companies, like aircraft, stall when they don’t have enough “power” to continue to climb.
Everybody wants to be part of a winning company.  As investors, winners maximize portfolio returns.  As employees winners offer job stability and career growth.  As communities winners create real estate value growth and money to maintain infrastructure.  So if we can understand how to avoid the losers, we can be better at picking winners.
It has been 20 years since we recognized the predictive power of Growth Stalls.  Growth Stalls are very easy to identify.  A company enters a Growth Stall when it has 2 consecutive quarters, or 2 successive quarters vs the prior year, of lower revenues or profits.  What’s powerful is how this simple measure indicates the inability of a company to ever grow again.

Only 7% of the time will a company that has a Growth Stall  ever grow at greater than 2%/year.  93% of these companies will never achieve even this minimal growth rate.  38% will trudge along with -2% to 2% growth, losing relevancy as it develops no growth opportunities.  But worse, 55% of companies will go into decline, with sales dropping at 2% or more per year.  In fact 20% will see sales drop at 6% or more per year.  In other words, 93% of companies that have a Growth Stall simply will not grow, and 55% will go into immediate decline.

Growth Stalls happen because the company is somehow “out of step” with its marketplace.  Often this is a problem with the product line becoming less desirable.  Or it can be an increase in new competitors.  Or a change in technology either within the products or in how they are manufactured.  The point is, something has changed making the company less competitive, thus losing sales and/or profits.

Unfortunately, leadership of most companies react to a Growth Stall by doubling down on what they already do.  They vow to cut costs in order to regain lost margin, but this rarely works because the market has shifted.  They also vow to make better products, but this rarely matters because the market is moving toward a more competitive product.  So the company in a Growth Stall keeps doing more of the same, and fortunes worsen.

 But, inevitably, this means someone else, some company who is better aligned with market forces, starts doing considerably better.

This week analysts at Goldman Sachs lowered GM to a sell rating.  This killed a recent rally, and the stock is headed back to $40/share, or lower, values it has not maintained since recovering from bankruptcy after the Great Recession.  GM is an example of a company that had a Growth Stall, was saved by a government bailout, and now just trudges along, doing little for employees, investors or the communities where it has plants in Michigan.

tesla going up a hill

Tesla- enough market power to gain share “uphill”?

By understanding that GM, Ford and Chrysler (now owned by Fiat) all hit Growth Stalls we can start to understand why they have simply been a poor place to invest one’s resources.  They have tried to make cars cheaper, and marginally better.  But who has seen their fortunes skyrocket?  Tesla.  While GM keeps trying to make a lot of cars using outdated processes and technologies Tesla has connected with the customer desire for a different auto experience, selling out its capacity of Model S sedans and creating an enormous backlog for Model 3.  Understanding GM’s Growth Stall would have encouraged you to put your money, career, or community resources into the newer competitor far earlier, rather than the no growth General Motors.

This week, JCPenney’s stock fell to under $3/share.  As JCPenney keeps selling real estate and clearing out inventory to generate cash, analysts now say JCPenney is the next Sears, expecting it to eventually run out of assets and fail. Since 2012 JCP has lost 93% of its market value amidst closing stores, laying off people and leaving more retail real estate empty in its communities.

In 2010 JCPenney entered a Growth Stall.  Hoping to turn around the board hired Ron Johnson, leader of Apple’s retail stores, as CEO.  But Mr. Johnson cut his teeth at Target, and he set out to cut costs and restructure JCPenney in traditional retail fashion.  This met great fanfare at first, but within months the turnaround wasn’t happening, Johnson was ousted and the returning CEO dramatically upped the cost cutting.

The problem was that retail had already started changing dramatically, due to the rapid growth of e-commerce.  Looking around one could see Growth Stalls not only at JCPenney, but at Sears and Radio Shack.  The smart thing to do was exit those traditional brick-and-mortar retailers and move one’s career, or investment, to the huge leader in on-line sales, Amazon.com.  Understanding Growth Stalls would have helped you make a good decision much earlier.

This recent quarter Chipotle Mexican Grill saw analysts downgrade the company, and the stock took another hit, now trading at a value not seen since the end of 2012.  Chipotle leadership blamed bad results on higher avocado prices, temporary store closings due to hurricanes, paying out damages due to a “one time event” of hacking, and public relations nightmares from rats falling out of a store ceiling in Texas and a norovirus outbreak in Virginia.  But this is the typical “things will all be OK soon” sorts of explanations from a leadership team that failed to recognize Chipotle’s Growth Stall.

chipotle employeesPrior to 2015, Chipotle was on a hot streak.  It poured all its cash into new store openings, and the share price went from $50 from the 2006 IPO to over $700 by end of 2015; a 14x improvement in 9 years.  But when it was discovered that ecoli was in Chipotle’s food the company’s sales dropped like a stone.  It turned out that runaway growth had not been supported by effective food safety processes, nor effective store operations processes that would meet the demands of a very large national chain.

But ever since that problem was discovered, management has failed to recognize its Growth Stall required a significant set of changes at Chipotle.  They have attacked each problem like it was something needing individualized attention, and could be rectified quickly so they could “get back to normal.”  And they hoped to turn around public opinion by launching nationwide a new cheese dip product in 2017, despite less than good social media feedback on the product from early customers. They kept attempting piecemeal solutions when the Growth Stall indicated something much bigger was engulfing the company.

What’s needed at Chipotle is a recognition of the wholesale change required to meet customer demands amidst a shift to more growth in independent restaurants, and changing millennial tastes.  From the menu options, to app ordering and immediate delivery, to the importance of social media branding programs and customer testimonials as well as demonstrating commitment to social causes and healthier food Chipotle has fallen out-of-step with its marketplace.  The stock has now lost 66% of its value in just 2 years amidst sales declines and growth stagnation.

We don’t like to study losers.  But understanding the importance of Growth Stalls can be very helpful for your career and investments.  If you identify who is likely to do poorly you can avoid big negatives.  And understanding why the market shifted can lead you to finding a job, or investing, where leadership is headed in the right direction.

I'd like to receive newsletters.

logo-footer
GET THE BOOK
Adam's book reveals the truth about how to use strategy to outpace the competition.
Create Marketplace Disruption book
PRESS & MEDIA
Follow Adam's coverage in the press and in other media.
FOLLOW ADAM
Follow Adam's column in Forbes.

The Three Steps GE Should Take Now – And The Lessons For Your Business

The Three Steps GE Should Take Now – And The Lessons For Your Business

Monitor displays General Electric Co. (GE) at the New York Stock Exchange (NYSE) October, 2017. Photographer: Michael Nagle/Bloomberg

For years I have been negative on GE’s leadership.  CEO Immelt led the dismantling of the once-great GE, making it a smaller company and one worth quite a bit less.  The process has been devastating to many employees who lost their jobs, pensioners who have seen their benefits shrivel, communities with GE facilities that have suffered from investment atrophy, suppliers that have been squeezed out or displaced and investors that have seen the value of GE shares plummet.

But now there is a new CEO, a new leadership team and even some new faces on the Board of Directors.  Some readers have informed me that it is easier to attack a weak leader than recommend a solution, and they have inquired as to what I think GE should do now.  I do not see the GE situation as hopeless.  The company still has an enormous revenue base, and vast assets it can use to fund a directional shift.  And that’s what GE must do – make a serious shift in how it allocates resources.

Step 1 – Apply the First Rule of Holes

The first rule of holes is “when you find yourself in a hole, stop digging.”  (Will Rogers, 1911) This seems simple.  But far too many companies have their resourcing process on auto-pilot.  Businesses that have not been growing, and often are not producing good returns on investment, continue to receive funding.  Possibly because they are a legacy business that nobody wants to stop.  Or possibly because leadership remains ever hopeful that tomorrow will somehow look like yesterday and the next round of money, or hiring, will change things to the way they were.

In fact, these businesses are in a hole, and spending more on them is continuing to dig.  The investment hole just keeps getting bigger.  The smart thing to do is just stop.  Quit adding resources to a business that’s not adding value to the market capitalization.  Just stop investing.

Will rogers, american humorist

When Steve Jobs took over Apple he discontinued several Macintosh models, and cut funding for Macintosh development.  The Mac was not going to save Apple’s declining fortunes.  Apple needed new products for new markets, and the only way to make that happen was to stop putting so much money into the Mac business.

When streaming emerged CEO Reed Hastings of Netflix quit spending money on the traditional DVD/Video distribution business even though Netflix dominated it.  He even raised the price.   Only by stopping investments in traditional distribution could he turn the company toward streaming.

Step 2 – Identify the Trend that will Guide Your Strategy

All growth strategies build on trends.  After receiving funding from Microsoft to avoid bankruptcy in 2000, Apple spent a year deciding its future lied in building on the trend to mobile.  Once the trend was identified, all product development, and new product introductions, were targeted at being a leader in the mobile trend.

When the internet emerged GE CEO Jack Welch required all business units to create “DestroyYourBusiness.com” teams.  This forced every business to look at the impact the internet would have on their business, including business model changes and emergence of new competitors.  By focusing on the internet trend GE kept growing even in businesses not inherently thought of as “internet” businesses.

GE has to decide what trend it will leverage to guide all new growth projects.  Given its large positions in manufacturing and health care it would make sense to at least start with IoT opportunities, and new opportunities to restructure America’s health care system.  But even if not these trends, GE needs to identify the trend that it can build upon to guide its investments and grow.

Step 3 – Place Your Bets and Monetize

When Facebook CEO Mark Zuckerberg realized the trend in communications was toward pictures and video he took action to keep users on the company platform.  First he bought Instagram for $1 billion, even though it had no revenues.  Two years later he paid $19 billion for WhatsApp, gaining many new users as well as significant OTT technology.  Both seemed very expensive acquisitions, but Facebook rapidly moved to increase their growth

chess pieces and cash

and monetize their markets.  Leaders of the acquired companies were given important roles in Facebook to help guide growth in users, revenues and profits.

Netflix leads the streaming war, but it has tough competition.  So Netflix has committed spending over $6billion on new original content to keep customers from going to Amazon Prime, Hulu and others.  This large expenditure is intended to allow ongoing subscriber growth domestically and internationally, as well as raise subscription prices.

This week CVS announced it is planning to acquire Aetna Health for $66 billion.  On the surface it is easy to ask “why?” But quickly analysts offered support for the deal, ranging from fighting off Amazon in prescription sales to restructuring how health care costs are paid and how care is delivered.  The fact that analysts see this acquisition as building on industry trends gives support to the deal and expectations for better future returns for CVS.

During the Immelt era, there were attempts to grow, such as in the “water business.”  But the investments were not consistent, and there was insufficient effort placed on understanding how to monetize the business short- and long-term.  Leadership did not offer a compelling vision for how the trends would turn into revenues and profits.  Acquisitions were made, but lacking a strong vision of how to grow revenues, and an outsider’s perspective on how to lead the trend, very quickly short-term financial metrics built into GE’s review process led to bad decisions crippling these opportunities for growth.  And today the consensus is that GE will likely sell its healthcare businessrather than make the necessary investments to grow it as CVS is doing.

Successful leadership means moving beyond traditional financial management to invest for growth

In the Welch era, GE made dozens of acquisitions.  These were driven by a desire to build on trends.  Welch did not fear investing in growth businesses, and he held leaders’ feet to the fire to produce successful results.  If they didn’t achieve goals he let the people and/or the business go.  Hence his nickname “Neutron Jack.”

For example, although GE had no background in entertainment, GE bought NBC at a time when viewership was growing and ad prices were growing even faster.  This led to higher revenues and market cap for GE.  On the other hand, when leaders at CALMA did not anticipate the shift in CAD/CAM from dedicated workstations to PCs, Welch saw them overly tied to old technology and unable to recognize the trend, so he immediately sold the business.  He invested in businesses that added to valuation, and sold businesses that lacked a clear path to building on trends for higher value.

Being a caretaker, or steward, is no longer sufficient for business leadership.  Competitors, and markets, shift too quickly.  Leaders must anticipate trends, reduce investments in products, services and projects that are off the trend, and put resources to work where growth can create higher returns.

This is all possible at GE – if the new leadership has a vision for the future and starts allocating resources effectively.  For now, all we can do is wait and see……
will rogers quote: Even if you're on the right track you'll get run over if you just sit there.

I'd like to receive newsletters.

logo-footer
GET THE BOOK
Adam's book reveals the truth about how to use strategy to outpace the competition.
Create Marketplace Disruption book
PRESS & MEDIA
Follow Adam's coverage in the press and in other media.
FOLLOW ADAM
Follow Adam's column in Forbes.

Why to Worry About Apple

Why to Worry About Apple

 Apple AAPL -0.72% announced sales and earnings yesterday. For the first time in 15 years, ever since it rebuilt on a strategy to be the leader in mobile products, full year sales declined. After three consecutive down quarters, it was not unanticipated. And Apple’s guidance for next quarter was for investors to expect a 1% or 2% improvement in sales or earnings. That’s comparing to the disastrous quarter reported last January, which started this terrible year for Apple investors.

Yet, most analysts remain bullish on Apple stock. At a price/earnings (P/E) of 13.5, it is by far the cheapest tech stock. iPad sales are stagnant, iPhone sales are declining, Apple Watch sales dropped some 70% and Chromebook breakout sales caused a 20% drop in Mac Sales. Yet most analysts believe that something will improve and Apple will get its mojo back.

Only, the odds are against Apple. As I pointed out last January, Apple’s value took a huge hit because stagnating sales caused the company to completely lose its growth story. And, the message that Apple doesn’t know how to grow just keeps rolling along. By last quarter – July – I wrote Apple had fallen into a Growth Stall. And that should worry investors a lot.

Growth Stall primary slide

Ten Deadly Sins Of Networking

Companies that hit growth stalls almost always do a lot worse before things improve – if they ever improve. Seventy-five percent of companies that hit a growth stall have negative growth for several quarters after a stall. Only 7% of companies grow a mere 6%. To understand the pattern, think about companies like Sears, Sony, RIM/Blackberry, Caterpillar Tractor. When they slip off the growth curve, there is almost always an ongoing decline.

And because so few regain a growth story, 70% of the companies that hit a growth stall lose over half their market capitalization. Only 5% lose less than 25% of their market cap.

Why? Because results reflect history, and by the time sales and profits are falling the company has already missed a market shift. The company begins defending and extending its old products, services and business practices in an effort to “shore up” sales. But the market shifted, either to a competitor or often a new solution, and new rev levels do not excite customers enough to create renewed growth. But since the company missed the shift, and hunkered down to fight it, things get worse (usually a lot worse) before they get better.

Think about how Microsoft MSFT -0.42% missed the move to mobile. Too late, and its Windows 10 phones and tablet never captured more than 3% market share. A big miss as the traditional PC market eroded.

Right now there is nothing which indicates Apple is not going to follow the trend created by almost all growth stalls. Yes, it has a mountain of cash. But debt is growing faster than cash now, and companies have shown a long history of burning through cash hoards rather than returning the money to shareholders.

Apple has no new products generating market shifts, like the “i” line did. And several products are selling less than in previous quarters. And the CEO, Tim Cook, for all his operational skills, offers no vision. He actually grew testy when asked, and his answer about a “strong pipeline” should be far from reassuring to investors looking for the next iPhone.

Will Apple shares rise or fall over the next quarter or year? I don’t know. The stock’s P/E is cheap, and it has plenty of cash to repurchase shares in order to manipulate the price. And investors are often far from rational when assessing future prospects. But everyone would be wise to pay attention to patterns, and Apple’s Growth Stall indicates the road ahead is likely to be rocky.

Why McDonald’s and Apple Investors Should Be Very Wary

Why McDonald’s and Apple Investors Should Be Very Wary

Growth Stalls are deadly for valuation, and both Mcdonald’s and Apple are in one.

August, 2014 I wrote about McDonald’s Growth Stall.  The company had 7 straight months of revenue declines, and leadership was predicting the trend would continue.  Using data from several thousand companies across more than 3 decades, companies in a Growth Stall are unable to maintain a mere 2% growth rate 93% of the time. 55% fall into a consistent revenue decline of more than 2%. 20% drop into a negative 6%/year revenue slide. 69% of Growth Stalled companies will lose at least half their market capitalization in just a few years. 95% will lose more than 25% of their market value.  So it is a long-term concern when any company hits a Growth Stall.

Growth StallA new CEO was hired, and he implemented several changes.  He implemented all-day breakfast, and multiple new promotions.  He also closed 700 stores in 2015, and 500 in 2016.  And he announced the company would move its headquarters from suburban Oakbrook to downtown Chicago, IL. While doing something, none of these actions addressed the fundamental problem of customers switching to competitive options that meet modern consumer food trends far better than McDonald’s.

McDonald’s stock languished around $94/share from 8/2014 through 8/2015 – but then broke out to $112 in 2 months on investor hopes for a turnaround.  At the time I warned investors not to follow the herd, because there was nothing to indicate that trends had changed – and McDonald’s still had not altered its business in any meaningful way to address the new market realities.

Yet, hopes remained high and the stock peaked at $130 in May, 2016.  But since then, the lack of incremental revenue growth has become obvious again. Customers are switching from lunch food to breakfast food, and often switching to lower priced items – but these are almost wholly existing customers.  Not new, incremental customers.  Thus, the company trumpets small gains in revenue per store (recall, the number of stores were cut) but the growth is less than the predicted 2%.  The only incremental growth is in China and Russia, 2 markets known for unpredictable leadership.  The stock has now fallen back to $120.

Given that the realization is growing as to the McDonald’s inability to fundamentally change its business competitively, the prognosis is not good that a turnaround will really happen.  Instead, the common pattern emerges of investors hoping that the Growth Stall was a “blip,” and will be easily reversed.  They think the business is fundamentally sound, and a little management “tweaking” will fix everything.  Small changes will lead to the  classic hockey-stick forecast of higher future growth.  So the stock pops up on short-term news, only to fall back when reality sets in that the long-term doesn’t look so good.

Unfortunately, Apple’s Q3 2016 results (reported yesterday) clearly show the company is now in its own Growth Stall.  Revenues were down 11% vs. last year (YOY or year-over-year,) and EPS (earnings per share) were down 23% YOY.  2 consecutive quarters of either defines a Growth Stall, and Apple hit both.  Further evidence of a Growth Stall exists in iPhone unit sales declining 15% YOY, iPad unit sales off 9% YOY, Mac unit sales down 11% YOY and “other products” revenue down 16% YOY.

This was not unanticipated.  Apple started communicating growth concerns in January, causing its stock to tank. And in April, revealing Q2 results, the company not only verified its first down quarter, but predicted Q3 would be soft.  From its peak in May, 2015 of $132 to its low in May, 2016 of $90, Apple’s valuation fell a whopping 32%!  One could say it met the valuation prediction of a Growth Stall already – and incredibly quickly!

But now analysts are ready to say “the worst is behind it” for Apple investors.  They are cheering results that beat expectations, even though they are clearly very poor compared to last year.  Analysts are hoping that a new, lower baseline is being set for investors that only look backward 52 weeks, and the stock price will move up on additional company share repurchases, a successful iPhone 7 launch, higher sales in emerging countries like India, and more app revenue as the installed base grows – all leading to a higher P/E (price/earnings) multiple. The stock improved 7% on the latest news.

So far, Apple still has not addressed its big problem.  What will be the next product or solution that will replace “core” iPhone and iPad revenues?  Increasingly competitors are making smartphones far cheaper that are “good enough,” especially in markets like China.  And iPhone/iPad product improvements are no longer as powerful as before, causing new product releases to be less exciting.  And products like Apple Watch, Apple Pay, Apple TV and IBeacon are not “moving the needle” on revenues nearly enough.  And while experienced companies like HBO, Netflix and Amazon grow their expanding content creation, Apple has said it is growing its original content offerings by buying the exclusive rights to “Carpool Karaoke – yet this is very small compared to the revenue growth needs created by slowing “core” products.

Like McDonald’s stock, Apple’s stock is likely to move upward short-term.  Investor hopes are hard to kill.  Long-term investors will hold their stock, waiting to see if something good emerges.  Traders will buy, based upon beating analyst expectations or technical analysis of price movements. Or just belief that the P/E will expand closer to tech industry norms. But long-term, unless the fundamental need for new products that fulfill customer trends – as the iPad, iPhone and iPod did for mobile – it is unclear how Apple’s valuation grows.