DB Bob's Bottom 9 Holdings: #9 (BOOM)

Hi all.

I’m taking a break from my other projects for now…

Before I dive too deeply into this, I want to disclose that there are eight small holdings that I am deliberately excluding from this list. For those eight holdings, the size of my holding should substantially increase over the next few years. So, I don’t think they are nearly as “interesting” as the other nine.

My write-ups for each of these will be a bit longer - on average - than the treatment given my top holdings. I’ll try to include how I plan to move forward (or not) with the holding. I’ll go from largest to smallest, but even the largest is less than a quarter-of-a-percent of my portfolio.

Instead of one long post, I’ll write several smaller ones. Some will cover several companies and some just one, depending on what I want to say about each company. The first will be a single company, where I have lots to say…

BOOM - Great ticker! Dynamic Materials Corp. (a.k.a., DMC) is primarily known for explosion welding, where two sheets of metal are welded to each other by explosive forces (this is also known as “cladding”). Usually, a thinner specialty metal is welded to a thicker base metal. In chemical manufacturing, for example, the specialty metal may represent the corrosion-resistant inner lining of a vessel, while the thicker base metal is specified to allow for the vessel’s contents to be under pressure. Historically, there have been three methods of performing this type of welding. The best method to use generally depends on the thickness of the plates involved and the chemical reactivity of the metals involved. DMC also manufactures explosives used in oil wells to perforate the casing and allow the flow of oil and gas into the oil well from the surrounding reservoir. As you’d imagine, anything having to do with explosives is highly-regulated, creating a barrier to entry. This small-cap caught my attention - among other reasons - because its corporate HQ is in Boulder CO, where I live. I attended their annual shareholder meetings on a regular basis. They started affectionately referring to me as “our shareholder” because I was often the only shareholder in attendance. This despite my penchant for asking probing - and occasionally difficult - questions. The affection was reciprocated because - despite being competitive businessmen - it was very evident to me that the executives I met were good, honest, human beings. One highlight for me was being invited to an Analyst’s Day meeting held at their main shooting facility outside of Pittsburgh Pennsylvania. The plates are received and assembled in a big warehouse. They are brought by truck to a nearby old limestone mine/quarry. The analyst group was allowed to watch from a nearby, but safe, location, as the DMC team proceeded through the safety protocol. Then, deep inside the mine, the explosives were detonated. The old mine’s many air shafts helped mute the explosive forces experienced outside the mine. Still, what I got to see was an impressive display! First, the ground rumbled in a way that was partially heard, partially felt. Then you could see debris (e.g., dust and leaves - not pieces of metal) eject from the mine entrance. We learned later that the explosive materials used in the shoot we saw were very similar to those used in the Oklahoma City bombing (I know that event was more than twenty years ago, so it may not resonate with everyone, but you can look it up). But our explosion used three times as much explosives! Post explosion, the cladded plate is returned to the warehouse where it is returned back to flat using a multi-ton press (the kind that “terminated” the original Terminator, if you recall the film), and further metallurgical testing is performed to insure that the weld meets every customer specification.

Awesome, right? How does this become a bottom holding for me, and what lessons can be learned?

Well, part of the reason for holding the Analyst Day was to introduce the new Chief Operating Officer and explain the company’s succession plan. I was slow to realize it (probably because I wanted to continue liking the company so much), but the new team didn’t seem quite as adept with the business as the old one. The oil well explosives side of the business had taken off with the expansion of domestic drilling earlier in the decade, but proved very cyclical when oil prices later collapsed and rig counts practically evaporated! Business on the cladding side seemed to have issues too. Management claimed they weren’t losing a disproportionate number of deals and that they didn’t see competitive technologies encroaching, and I took them at their word, hoping better economic times would lead to a cyclical rebound. The first dent in my confidence occurred when I heard IPGP - the fiber laser company I mentioned in my “top holdings” post - use the word “cladding” as an example of new applications. I have yet to confirm that lasers are indeed a competing technology with explosion welding, but I wonder if this was the missing piece that wasn’t seen. Hot roll-bonding and arc welding had been the other two competing technologies, but I can see how lasers could succeed as IPGP was able to increase their power. Eventually, due to poor business and stock price performance, BOOM lost its TMF recommendation. Although I still hold all my shares, they are on my short list for selling when I need a capital loss to offset capital gains.

I think my three main lessons to take away here are:

(1) Don’t let yourself fall in love with a company. I did with this one - no doubt! I only saw it in hindsight, but I think I know enough now to better understand the warning signs. [BTW, Saul, I already “hear” you putting two-and-two together, and I’m also contemplating whether BOOM is my only transgression… I suspect that a good handful of this board’s participants will “get” my reference.]

(2) Don’t underestimate the fluctuations that business cyclicality can inflict on stock market prices. BOOM’s oilfield products business growth seemed secular, not cyclical. Until it didn’t. I should have paid more attention to the broader industry and not just the niche.

(3) When business is slowing beyond what cyclicality would imply, and you can’t explain it and management can’t explain it, don’t assume that means it will be temporary. Either keep digging for a reason, or sell and move on.

More as I have time. I think the next few will be shorter. But I’ll also have a disproportionate amount to say about my tiniest holding too!

Thanks and best wishes,
TMFDatabaseBob (long: BOOM)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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[BTW, Saul, I already “hear” you putting two-and-two together, and I’m also contemplating whether BOOM is my only transgression… I suspect that a good handful of this board’s participants will “get” my reference.]

Thanks Bob, for a very interesting discussion. I can’t put two and two together though. You may have to explain it.

I do know that I fell in love with Skechers and ignored warning signs (like a year ago, when I walked into a big Skechers store in NYC, and there were few other customers and lots of salesmen standing around, and they gave me 40% discounts on three pairs of shoes just to get me to buy them. I should have paid attention, instead of being happy with my bargains. Actually, it worried me some, but I thought it was just an anomaly. It wasn’t).

I still love the shoes, but fell out of love with the company.

Best,

Saul

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I was figuring you’d point out that perhaps INFN was another transgression. As I said, I’ll have to ponder that… :slight_smile:

Thanks and best wishes,
TMFDatabaseBob (long: BOOM, INFN)
See my holdings here: http://my.fool.com/profile/TMFDatabasebob/info.aspx
Peace on Earth

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Cyclical is difficult! By definition it’s not buy and hold, you play the cycles, buy at the bottom, get out at the top except no one knows when and where the bottom is. Housing is cyclical and I got burned quite badly in the last cycle so I swore off only to break my swearing off by investing in the oil cycle (CLB)! Core Labs also sells the explosives to oil producers to perforate the well’s casing:

http://www.corelab.com/owen

What I like about Core Labs is that it is an asset light oil service company unlike most others in the business. I’m also following OII which could have a terrific rebound but I’m not doing anything for the next month or so until I see where the new adimistration is going.

http://invest.kleinnet.com/bmw1/stats20/OII.html

For people interested in cyclical I believe Peter Lynch has a chapter dedicated to the subject.

Change of management can be traumatic specially when the founders leave. Two such cases I’ve followed were Chico’s FAS (CHS) and Home Depot (HD). Lululemon (LULU) also had trouble with the departing founder.

Chico’ founders sold out somewhere around 2005

http://invest.kleinnet.com/bmw1/stats20/CHS.html

Ouch!

Denny Schlesinger

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Hi Saul,
I would like your thoughts and anyone else’s thoughts on SKX.

I have been watching Nike and Under Armour also. They have been having problems selling their shoes also. This all started with the Sports Authority bankruptcy. Only Adidas seems to be doing good. But my thoughts are that Nike and UA had to sell their shoes at a cheaper price in order to move their inventory. This brought them down into Skx’s market and when people found they could get Nike and UA for the same price as Skx they decided to for go the SKX shoes. This seemed to only hurt Skx in the U.S but in the overseas their growth is still impressive. My thoughts are that Nike and UA will have moved their inventory by the next earnings report and that SKX should start growing again in the U.S in 2017.

Does this seem right to you or where do you see the fault in my thinking.

Thanks
Andy

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…I walked into a big Skechers store in NYC, and there were few other customers and lots of salesmen standing around, and they gave me 40% discounts on three pairs of shoes just to get me to buy them. I should have paid attention…

I will note that especially with retail, one has to be aware of regional differences. In CA where I live, Teslas are everywhere, Whole Foods stores are always pretty crowded, there are no Casey’s, etc. What may be true for where you live may not be true nationally or globally.

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Hey Andy,

Obviously not Saul, but I would like to offer some scattered thoughts.

I think your theory may be correct. If it is, I think us SKX shareholders will do very well next year. But let me offer an alternative theory.

Before I begin, full disclosure, SKX is my largest position.

Adidas is enjoying a renaissance. I do not know if this will be short-lived or not. UA has only recently entered the athletic shoes market. Any market share they capture will almost certainly come from Nike. What if it was because of this renewed competition - and not inventory problems - that Nike lowered their prices. In an effort to capture market share, all three now might engage in a prolonged price war, where they sell their wares for lower than recent historical averages. This would drop all sneaker prices and margins.

When we bought pairs of Skechers for the little ones before school this year, we were able to get all of them at substantial deals. Now, SKX is known for deals like this, but it did seem more than normal.

Anyway, I’m not so sure the lower prices are due to Sports Authority or short term inventory problems.

Also, not trying to get political, but if trade problems developed between us and China, that would be obviously very bad for SKX.

Now, I am still fine holding SKX here. My cost basis was pretty good on it. I’m down, but not that much. But its a very profitable business that has hit growth snags. The valuation is attractive and I like the market they’re aiming for. I think this market is underserved by Nike, UA, and Adidas. FWIW, I think long term investors will be fine holding.

But I’m also not sure if the next year is going to be any better than the last.

These are just my thoughts and, it should be noted, I have been very wrong about SKX this past year, when I thought this was a short and long term slam dunk. But investing has a way of turning our arrogance into humble pie, doesn’t it?

Matt
Long SKX
MasterCard (MA), Nestle (NSRGY), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

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Hi Matt,

Also, not trying to get political, but if trade problems developed between us and China, that would be obviously very bad for SKX.

I have thought about this Matt and I have decided that I can not make it part of my investing thesis. Trump has changed his mind to much and some times his words are just posturing. I suspect this could go any direction so I have decided to ignore his words. (not a political statement just how I see it)

Any market share they capture will almost certainly come from Nike. What if it was because of this renewed competition - and not inventory problems - that Nike lowered their prices. In an effort to capture market share, all three now might engage in a prolonged price war, where they sell their wares for lower than recent historical averages. This would drop all sneaker prices and margins.

That is well thought out Matt and is something I didn’t think about. If that does happen it could really blow my thesis out of the water. I need to think that through more. Especially how this could effect SKX’s margins.

I have been very wrong about SKX this past year, when I thought this was a short and long term slam dunk. But investing has a way of turning our arrogance into humble pie, doesn’t it?

Lol, this seems to happen to a lot of my slam dunks.

Andy
Getting more humble every year

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I would like your thoughts and anyone else’s thoughts on SKX.

Hi Andy,

I tend to have the same worries. Look, Skechers are spending lots of money opening retail stores when retail in general is in trouble, and sales are moving to on-line. When I saw that they had a huge store in Union Square in Manhattan, I thought “That’s gotta be expensive!” Then they opened a “Flagship” store in Times Square! And then a SECOND flagship store in Times Square! And one on Fifth Avenue, And one on 34th near Macy’s, and one downtown… Can you imagine the overhead on stores like that? And with US sales in a slump for all the shoe stores, Skechers is in the middle of a dog-fight. Skechers is no longer a growth stock, but is now a hoped-for turn-around. They had a huge March quarter last year. It will be a disappointing comparison this year.

Now let me say I could be totally wrong on this and Skechers could do great. I sure have been wrong about various things before!

Best.

Saul

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There is no question that the shoe market has become more competitive. Margins are down at both Nike and UA and yes at SKX. Valuations have dropped substantially, removing any sort of premium.

Nike is selling at about 2.1x next year’s revs, UA just a little bit more, like 2.3 or 2.4 x, SKX is a little over 1x revenue. Absent recession, the downside risk is much less than the potential upside for any of these companies.

China is a big wildcard. Utterly critical for SKX and Nike. Not as much for UA at the moment, but it is clearly critical to UA’s long-term growth plans, and those will be built into future share price so critical for all.

Anti-American trade sentiment, yes, that could disturb brand strength in China for a generation…we shall have to see how this is handled. That is one of the “Black Swan” events that are foreseeable.

All in all, if economic growth returns to the once normal 3-4% in the U.S., retail sales are going to boom. This will lead to renewed growth at all of these companies. Thus another potential Trump effect, but this one positive. Give some here, take some there sort of thing.

I personally like UA best of the three myself. It is “sexier”. Not a good reason to make an investment, but it is, and it also has Kevin Plank running it. A man who went from inventing, and then selling t-shirts from the trunk of his car university to university to growing it into a multi-billion a year business while taking on one of the world’s finest brands who was (and still is) the dominant force in retail around the world. You gotta like that. That is the type of person you want to invest in.

Current estimates are based on the “new normal” of 0-2% growth (as that is all we have had the last 8 years) and it has become embedded in our expectations, as has free trade under the status quo with China.

Trump brings change to both embedded expectations. If we can get the increased growth without killing trade (and remember, Trump does business internationally so he knows what free trade means), all of these companies should present us with upside surprises.

Tinker

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Thanks Saul,

Look, Skechers are spending lots of money opening retail stores when retail in general is in trouble, and sales are moving to on-line. When I saw that they had a huge store in Union Square in Manhattan, I thought “That’s gotta be expensive!” Then they opened a “Flagship” store in Times Square! And then a SECOND flagship store in Times Square! And one on Fifth Avenue, And one on 34th near Macy’s, and one downtown… Can you imagine the overhead on stores like that? And with US sales in a slump for all the shoe stores, Skechers is in the middle of a dog-fight. Skechers is no longer a growth stock, but is now a hoped-for turn-around. They had a huge March quarter last year. It will be a disappointing comparison this year.

Building Palaces when the stores are burning down. That is never a good idea. I wasn’t thinking about that Saul thanks for your views.

Andy

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I personally like UA best of the three myself. It is “sexier”. Not a good reason to make an investment, but it is, and it also has Kevin Plank running it. A man who went from inventing, and then selling t-shirts from the trunk of his car university to university to growing it into a multi-billion a year business while taking on one of the world’s finest brands who was (and still is) the dominant force in retail around the world. You gotta like that. That is the type of person you want to invest in.

I agree Tinker, I put some money recently into UA because of Plank. Although I did go into their stores in California and picked up some great deals on clothing. I suspect this might be the time to invest in these companies because everyone is down on retail but Like Saul said this is no longer a growth company but a turn around. The problem I have in ditching this stock right now is that I believe it is at the bottom but I could be wrong. If the economy does start picking up, and there isn’t any trade wars, I agree with you that it will be a great investment. If there are trade wars, well then just about any investment that does any trade over seas will be taking a big hit.

Andy

Andy, Saul,

Let me ask a follow-up question. Do you think locations like the ones mentioned (e.g. Times Square) are a way for Skechers to also build up its brand? To give it a bit more prestige maybe? Sort of like a form of advertising?

I had previously thought - though I am more than open to being wrong on this - that maybe those types of locations were strategic in building up Skechers’ brand and appeal.

Matt
Long SKX
MasterCard (MA), Nestle (NSRGY), PayPal (PYPL), and Verizon (VZ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx

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I agree Matt. New Brands need to build a mix of own stores and shop in shops to a reasonable ratio. It is the law for brand building retailers - the question is whether Amazon and the internet changes all of that. I suspect footwear is one of the areas of apparel and consumer purchasing that folks would want to physically try on - unlike books or banking services.
Ant

Hi Matt,

I wasn’t paying attention to this until Saul pointed it out but after reading his post this is what I am thinking.

Let me ask a follow-up question. Do you think locations like the ones mentioned (e.g. Times Square) are a way for Skechers to also build up its brand? To give it a bit more prestige maybe? Sort of like a form of advertising?

I think if you asked the CEO of sketchers that is exactly what he would tell you but I think it seems a little excessive. One store would have been enough. Also I do not consider SKX a premium brand so having stores in premium retails spots seems that someone is trying to boost their ego. But having said that I am hanging onto my shares because I do think they will have a turn around and come back. I like the growth in the overseas market but if that was to dry up I will most likely bail.

Andy

“I do not consider SKX a premium brand so having stores in premium retails spots seems that someone is trying to boost their ego”

It may not be a premium brand in US, but SKX is becoming a premium brand in the EU, and the location of the flagship stores is a factor for that.

ZARA is not a premium brand in Spain, where the brand was born, but many people consider so outside, because of the premium location of its stores around the world. Just saying!

Thanks to Saul and to all contributors of this great board. Happy and profitable New Year for all of us!

Maria

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Hi Maria,
That is interesting. I consider a premium brand as a brand that can charge more for their shoes. I haven’t ever seen a Sketcher shoe that cost over 200 dollars but Nike has had several shoes that cost over 200 dollars. But what I find interesting about your post is that in the EU you say they are becoming a premium brand. Could you expound on this? Why do you say they are a premium brand? This could be a big boost to the stock and would be very important.

Does having premium locations of stores make a brand premium? Or does the price they can charge for their product make them a premium brand? Two different ways of thinking about this.

Thanks for your thoughts Maria,
Andy

My wife keeps telling me to buy stock in Zara, but I think it’s not on any US market, right?

Does having premium locations of stores make a brand premium? <>

No, premium locations just increase foot traffic. Having recently been to Milan, Paris, London, New York, LA, and Boston (and living near SF), stores like H&M in premium locations are always packed with people buying $10 blouses, then window shipping at Burberry.

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No, premium locations just increase foot traffic. Having recently been to Milan, Paris, London, New York, LA, and Boston (and living near SF), stores like H&M in premium locations are always packed with people buying $10 blouses, then window shipping at Burberry

Right Smorg but if they really are a premium brand in the EU then it could be a big deal. Because not only will they have increased foot traffic but they can also raise their prices. So while premium locations can be great for foot traffic, and possibly building their brand, it would even be nicer if they were a premium product. Even though Skx’s has premium locations in the U.S I do not think anyone would call them a premium brand. It would be nice if they were I just do not think that is the case.

Andy
Who has been wrong on multiple occasions.