When good stocks go bad (part 2)

Good morning. South Korea’s embattled president Yoon Suk Yeol was impeached by the country’s parliament over the weekend. The country’s main stock index, the Kospi, is now trading at around the same level as before Yoon surprised the nation and the world by declaring martial law. The saga is probably far from over, but Korea’s investors remain unconcerned. Email us: [email protected] and [email protected].

Good stocks gone bad, part 2

A week ago Unhedged wrote about the worst performers among US megacap stocks over the past decade — a period of incredible returns for the group as a whole. A couple of patterns emerged. Several of the stocks were either leading companies in industries that have undergone structural change (media, money management, mall real estate); players in structurally difficult industries (airlines, autos); pharma manufacturers that had been at the top of their blockbuster drugs’ life cycles; or companies swamped by “transformational” mergers that were transformational in the wrong way. In one case, that of Boeing, management has simply played a good hand badly. 

But that left a bunch of companies on the list of 25 underperformers (see the list below) whose weak showings I didn’t understand. So I called some analysts and got some answers. 

Occidental falls squarely into the bad merger category. Less than a year before the pandemic it levered itself to the gills to buy rival oil company Anadarko in what one oil exec called the “dumbest deal in history.” The stock collapsed in 2019, recovered by 2022, and has drifted down since. If oil prices are firm in the long run, the deal may end up looking wise. But it’s been a brutal rise so far. A volatile (at best) decade for oil prices also explains much of the weak showing of oilfield services company Schlumberger; all of its peers have struggled mightily, too. In Schlumberger’s case, I’d call this an exogenous shock.  

3M sells into industries that are growing more or less at the rate of GDP, so it would probably not have been a crackerjack stock in the past ten years under the best of circumstances. But, as Nicole DeBlase of Deutsche bank explained to me, the shares had another burden to carry. 3M was a major manufacturer of PFAS or “forever” chemicals, which are increasingly a target for legislation and regulation. The company is ending PFAS production and has signed a major legal settlement. Is 3M’s involvement in PFAS best categorised as a strategic error, or was it the realisation of the dangers involved an exogenous shock? I don’t know. 

UPS has struggled to adapt to the rise of ecommerce and the flood of packages that it has brought. That might fit it in the bucket with companies that were overtaken by industry change (along with Disney, Intel, Franklin Resources, and Simon Property). But, as with all these companies, there is a case that management could have handled the change more competently. The bracingly plain-spoken David Vernon of Bernstein calls UPS and its peer FedEx “the worst-run duopoly in Western business history.” Their basic mistake, Vernon says, was assuming that they had extra capacity on their networks and could therefore charge Amazon and other ecommerce companies on the basis of the marginal cost to deliver additional packages, rather than the average network cost. The result was bad deals in which “the package industry has subsidised the first 20 years of the ecommerce boom.” 

The huge branded paper goods company Kimberly-Clark fits, a bit uneasily, in the category of companies that were hit by industry change. It just hasn’t been a great decade for branded consumer goods; Colgate, for example, has not been a great stock, either. Smaller niche brands have become more popular with consumers, says Lauren Lieberman of Barclays, including in diapers, Kimberly’s key category (they make Huggies). On top of that, investors became less keen on staples as defensive stocks; “tech companies became the new staples,” she says.  

The story of casino operator Las Vegas Sands’ lost decade is a bit complicated. It makes the bulk of its money in Macau, the one region of China where casino gambling is allowed, and uncertainty about the regulatory/competitive environment there has been a persistent overhang for the stock. The broad question of course: how should investors think about the unique risks of doing business in China? It is hard to imagine anywhere in the world where Sands could have made as much money as they have made in Macau. But live by the sword, die by the sword.

This taxonomy leaves various companies on the list of 2014-2024 underperformers uncategorised (Kinder Morgan, Dominion, Lyondell, and US Bancorp). I haven’t yet been able to find a clear narrative in those cases — please do email with your thoughts. But it is striking how the same themes come up again and again. Big mergers are dangerous. Incumbents struggle mightily to adapt to structural industry change. Management skill is no match for secular headwinds — be they oil prices or regulatory regime shifts. And some luck always helps. 

Here’s the full list again (the bottom 25 total return performers over the past ten years, among US companies that had a market cap of at least $35bn at the outset; it excludes companies whose share prices fell because of divestitures):

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