Capex and Moat

[Saluki]

I was thinking recently about Buffett (and some others like Tom Russo) who have a penchant for brands.  Sees Candy doesn't take much capex (it doesn't grow) and just kicks off cash every year.  Ditto for KO, which owns the Coke brand, the costs are borne by the bottlers.  Both have great moats.  Car companies and fashion brands are recognizable, but they aren't really moaty.  Each car company must design new cars and spend capex to improve cars every year.  And a fashion brand that stops advertising quickly loses it's appeal. The ability to raise prices in an inflationary environment is evidence of a moat.  But what about the ability to operate for years without spending a lot of capex, isn't that evidence of a moat?  What does KO have to do to stay in business besides cashing their checks every year?

 

I was thinking about this recently when looking at an ammo company.  Gun companies, like Smith and Wesson, have to come up with new models every year, like car companies, but bullets are just bullets. So it would seem like gun companies are like car companies. Wouldn't a respected ammunition brand be a moaty business because it doesn't require capex and can command more $$$ than no name range ammunition? I looked at SWBI and RGR to see how much they spend per year in R&D capex.   RGR spends about $20mm total capex and R&D is about $8mm.  SWBI capex is bloated now b/c of the new factory costs, but the R&D capex is also about $7-8mm per year. I realized that it's not a huge amount for two of the biggest brands.  Smaller brands, who (are private and we don't have the numbers) have to spread that cost over fewer sales, so the % cost is likely a lot higher. So is this evidence for the strength of their brand moat? I.e. that they can spend so little on R&D and still run circles around the competition for the mid/high end sales. 

 

Somethings are not brands, but obviously have moats that don't require a lot of capex (patented drugs, FCC licenses, lowest cost commodity producers etc.)  I wonder if there are other ones out there that I'm not seeing.  Just thinking out loud here. 

[Luke]

11 minutes ago, Saluki said:

I was thinking recently about Buffett (and some others like Tom Russo) who have a penchant for brands.  Sees Candy doesn't take much capex (it doesn't grow) and just kicks off cash every year.  Ditto for KO, which owns the Coke brand, the costs are borne by the bottlers.  Both have great moats.  Car companies and fashion brands are recognizable, but they aren't really moaty.  Each car company must design new cars and spend capex to improve cars every year.  And a fashion brand that stops advertising quickly loses it's appeal. The ability to raise prices in an inflationary environment is evidence of a moat.  But what about the ability to operate for years without spending a lot of capex, isn't that evidence of a moat?  What does KO have to do to stay in business besides cashing their checks every year?

 

I was thinking about this recently when looking at an ammo company.  Gun companies, like Smith and Wesson, have to come up with new models every year, like car companies, but bullets are just bullets. So it would seem like gun companies are like car companies. Wouldn't a respected ammunition brand be a moaty business because it doesn't require capex and can command more $$$ than no name range ammunition? I looked at SWBI and RGR to see how much they spend per year in R&D capex.   RGR spends about $20mm total capex and R&D is about $8mm.  SWBI capex is bloated now b/c of the new factory costs, but the R&D capex is also about $7-8mm per year. I realized that it's not a huge amount for two of the biggest brands.  Smaller brands, who (are private and we don't have the numbers) have to spread that cost over fewer sales, so the % cost is likely a lot higher. So is this evidence for the strength of their brand moat? I.e. that they can spend so little on R&D and still run circles around the competition for the mid/high end sales. 

 

Somethings are not brands, but obviously have moats that don't require a lot of capex (patented drugs, FCC licenses, lowest cost commodity producers etc.)  I wonder if there are other ones out there that I'm not seeing.  Just thinking out loud here. 

Yeah many good things said, not a gun expert but id say that bullets are not as difficult to produce and distribute as something like coca cola and their specific global network. And yeah, these insanely high margin low capex businesses that are similar to coke have great moats and profitability metrics. (liquor companies, maotai). Another aspect is the nature of the item IMO, cars cant be sold many times over but everybody drinks their regular coke. Same probably also true for bullets which you dont just buy one time and then are done for life. There are some who buy ferraris whenever they are released but the nature of the product is different. Just some thoughts!

Edited August 23, 2023 by Luca

[Saluki]

Yes, even though guns can last 100 years, people like to buy them and just keep buying more. That's what took me a long time to come around to for gun stocks.  If someone already has a gun, why do they need another one?  They don't NEED it, but they think they do. "This is my home defense gun, this is my everyday carry, this is my small gun that I use for jogging, this is the backup gun, this one is my bugout gun, this is my hunting rifle for small game, this one is for big game, this is for target shooting etc." But I'm very interested in the ammo as a kind of model where someone is selling the razors and you sell the razor blades.  Maybe someone will prefer the Beretta over the Smith and Wesson, but no matter which he chooses, he still needs to buy ammo for it, and he needs to keep buying it.  And with Olin and Vista owning all 4 domestic primer manufacturers, even if the customer buys a cheap brand for use at the range, the no-name brand is probably still paying Olin and Vista.  I'm not sure to what extent they are able to use foreign primers (the small ammo makers are private and don't share details), but it's something that I'm looking into. 

 

And yes, with Coke people drink it over and over again.  Since the ban on tobacco advertising, despite the decline in smoking, it seems like it is calcifying the existing moats.  People keep smoking and if they don't see ads for other brands, there is no social pressure to switch.  And ditto for R&D in tobacco. They bought into companies that make vaping products because tobacco is not very innovative. The last piece of "tech" introduced by a tobacco company was the flip top lid in a cigarette pack. So if the moat wasn't so powerful, the lack of R&D could have invited an innovative competitor to disrupt them. Eventually vaping happened, but for decades they just chugged along and made money without having to develop new products because no one was foolish enough to try start a new tobacco company. 

 

I heard performance psychologist Gio Valiante say that "beliefs blind your observation."  Railroads were terrible for a hundred years, but then when they weren't most people didn't notice because they had a belief about them that prevented them from looking at it with fresh eyes. Ditto about the consolidation in the aircraft and chip industries. I have some energy, shipping, and other things that hopefully have a better near future than recent past, but maybe the reason I was able to get in cheap is because of people's beliefs about the industry. The other possibility is that  they are still cheap because I'm wrong, which would not be a good alternative theory. John Neff's "measured participation" method seems to be a good way to split the difference. 

[LC]

I have near zero firearm knowledge - is there a significant difference between ammo? 

 

In other words, is ammo like tobacco, where everyone is selling generally the same stick but people have brand loyalty?

 

Or is it like gasoline, where my brand allegiance is to Porsche or Mercedes (or Remington, Beretta) and I don't care whether I buy gasoline (ammo) from shell or conoco?

Edited August 24, 2023 by LC

[Saluki]

48 minutes ago, LC said:

I have near zero firearm knowledge - is there a significant difference between ammo? 

 

In other words, is ammo like tobacco, where everyone is selling generally the same stick but people have brand loyalty?

 

Or is it like gasoline, where my brand allegiance is to Porsche or Mercedes (or Remington, Beretta) and I don't care whether I buy gasoline (ammo) from shell or conoco?

 

I'm not a hunter or a gun guy, but I looked into it quite a bit before investing.  My understanding is that when people go to the shooting range to practice, they generally buy what is cheapest.  If the ammo is low quality and occasionally misfires it's not a big deal, it's only range practice. When they buy the "self defense" rounds (i.e. hollow point), or when it's purchased by police, or the hunting rounds, they pay up.  And for those, they tend to have brands they prefer. 

 

The ammo is fairly easy to make (which is why several low-end, or specialty brands exist). You need the gunpowder, the brass casing and the primer. The first two are easy to get and with some machinery you can set up a factory and start making bullets. The primer is difficult to make, and currently only four companies in the US make it (3 are owned by Vista Outdoor and one is owned by Olin). Recently, due to a primer shortage and unhappiness about the price spikes, a low-end brand (Expansion) tried to open their own primer facility.  It failed miserably.  So their is a kind of toll bridge that independent (US) ammo makers have to pay to get the primers.  A foreign company, Fiocchi, which makes primers in Europe, is building a US primer facility for lead free primer (more expensive), but I don't think that will alleviate the toll bridge problem for the little guys. 

 

 

[ValueArb]

2 hours ago, LC said:

I have near zero firearm knowledge - is there a significant difference between ammo? 

 

In other words, is ammo like tobacco, where everyone is selling generally the same stick but people have brand loyalty?

 

Or is it like gasoline, where my brand allegiance is to Porsche or Mercedes (or Remington, Beretta) and I don't care whether I buy gasoline (ammo) from shell or conoco?

 

I also admit I know little about guns as I stopped shooting around age 13. But are guns be the opposite of razor blades, where once someone settles on a razor blade they keep buying same since only specific blades fit their handle and they don't want to spend time and money switching, especially if it involves abandoning packs of existing blades.

 

Does anyone ever buy a gun because it handles their existing ammunition, and replace it with same gun from same maker because it fits their existing attachments? In my very limited experience seems like you have a huge number of potential gun models for each caliber of ammunition, and that even custom attachments for semi-auto rifles can be used across a good number of different models.