‘Marlboro Friday’ Stock Lesson: Giants Must Wake Up to Competition

“It’s time to buy the depressed food, tobacco and drug stocks in the U.S. These were great growth stocks of the last decade and their superb management will maintain that record.” This is the song sung by a growing chorus of Wall Street analysts, especially since the rout of many of these equities after “Marlboro Friday,” April 2, when Philip Morris announced it would attack the generic cigarette threat head-on. But I am not singing that tune.

Sure, these analysts admit, the switch to cheaper house brands and generic foods and cigarettes is real, as U.S. consumers struggle with sluggish income growth and mountainous debts. Look at the skyrocketing sales in the cheaper generic cigarettes. Their supermarket sales gained almost 200% in the course of 1992, while sales for Marlboro--one of the most popular of the big brands--fell 5.6%.

Discounted cigarettes--which sell for about half the price of name brands--now account for 36% of the market, up from 11% in 1988. It’s one thing to stop feeding Kitty her Feline Haute Cuisine in favor of dry generic food, but quite another for confirmed smokers to give up their favorite brands for unfamiliar cigarettes in black and white boxes. The tobacco companies and governments that tax them assumed--correctly, in past years--that prices and taxes could be raised continually without scaring away smokers. Not any more!

And the trend toward buying generics and house brands is spreading to all kinds of household goods. The drug makers and other medical companies also face the current Administration’s drive to reform health care and drive medical costs down. Consequently, my firm shorted a number of national brands and pharmaceutical stocks in portfolios we manage, and our action proved fruitful.

Wall Street gurus know that this spate of consumer downgrading is widespread and that the quality of private-label goods has risen to nearly the level of national brands. Only the price is different, sometimes by 40% or 50%. And analysts know that their favorite food and tobacco companies are suffering from prolonged recession in Europe. Nevertheless, these wizards believe their corporate favorites will quickly adapt to the new competitive environment. Thus they see the selloffs of stocks such as Philip Morris, Kimberly-Clark and Merck as buying opportunities, not preludes to further declines.

We are not so sanguine, however. From our standpoint, the problem is that all of these companies basically have enjoyed cartel-like environments, and the resulting corporate cultures virtually repudiate any change.

Furthermore, these cartel-culture companies are driven by marketing and all the pizazz that goes with promoting the brands people simply must buy to maintain the good life. This is far different from the orientation now needed--emphasis on low-cost production of high-quality commodities.

Typically, firms trying to shift from cartel to competition don’t see any real results until they have thrown out their old, hidebound management in favor of new guys who will chop away at high costs and low productivity.

Look at GM. As the stock tanked, the board of directors read the riot act to management many times. But only when CEO Robert C. Stempel was fired in late October, 1992, did the stock rebound. Digital Equipment stock finally hit bottom in the summer of 1992, after a long slide that reflected the firm’s many problems. Founder Kenneth Olsen was fired by the board in July of that year.

IBM, the quintessential cartel of the postwar era, failed to admit--until its stock price collapsed in 1992--that the PC and other developments had killed its control over prices and that drastic changes were necessary. The jury is still out, but IBM’s stock appears to have bottomed almost simultaneously with the exit of John F. Akers and the old regime in January of this year.

Even with downward slides, these aren’t companies that will disappear in the main, although further falls in stock prices are likely.

But before you cover your shorts or jump back into these stocks, you’ll need to see managements admit to the new reality of competition. You’ll need to see them emphasize efficient production, not dwell almost entirely on marketing. They’ll need to look for growth in new products and new markets, not rely on price increases. Most of all, they’ll need to cut costs.

Bottom line: Be cautious about buying food, tobacco and drug stocks. Our managed portfolios are still short many of them. Their cartel-like profits are under withering fire, and their corporate cultures will require massive changes before solid earnings gains can resume.