How NOT to run a chocolate factory

In Roald Dahl’s book Charlie and the Chocolate Factory, penniless Charlie Bucket wins a ticket to visit Willie Wonka’s chocolate factory. The other bratty children, like Veruca Salt and Augustus Gloop who are prize winners, meet unpleasant ends in the factory machinery, due to their own greed.  Charlie is the only child left at the end, and wins the prize: the factory itself.  

In real life chocolate companies can be very good investments. Buffett famously bought See’s Candy in the 1970s for 3x book value, and it delivered many years of excellent returns. The purchase was significant, because it taught the famous “value investor” that you can pay well over the price of the accounting book value, and still have a great investment.

“See’s Candy, it was acquired at a premium over book value and it worked. Hochschild, Kohn, the department store chain, was bought at a discount to book and liquidating value. It didn’t work. These two things together helped shift our thinking to the idea of paying higher prices for better businesses.”

When See’s turned out to be an excellent, sustainable business, Munger and Buffett realised how much easier and pleasanter it was to buy a good business and let it roll along, than to buy a deeply discounted but struggling business and spend time, effort energy and more money to sort it out. To quote the sage “it is better to buy a good company at a fair price, than a fair company at a good price.”

About 15 years ago I wondered if Thornton’s was the UK equivalent of See’s. Like the American business, it had been run as a family business, selling chocolate through their own stores. Yet I’m rather glad I didn’t invest.

Back in 1999 the share price was well over 200p, now 15 years later, after yet another profit warning, the shares are worth just 90p. This is a disaster for long term investors. The shares were off 20% on the day, in contrast the chocolate reindeer they were selling at the supermarkets was discounted 40%, because customers were not buying them. In the latest profit warning the company blamed the major supermarkets for not buying enough stock. But that is completely spurious, the reason why the supermarkets weren’t stacking their shelves with Thornton’s chocolate was because it wasn’t selling as well as other brands.

What went wrong?

The company has a long history of disappointing investors with poor results, and coming up with rubbish excuses.  

  • Dec 2011 Poor consumer sentiment blamed for third profit warning in centennial year
    Easter 2011 Hot weather blamed for poor sales
    January 2011 Snowy weather blamed for poor sales
    May 2010 Two profit warnings in a month
    April 2010 Competition from supermarkets blamed
    July 2009 Hot weather blamed for poor sales
    January 2009 Collapse of Woolworths hits sales
    January 2006 Dismal Christmas sales
    May 2003 Blames hot weather for downturn
    June 2000 Fourth profit warning as rapid expansion backfires
    Nov 1995 John Thornton blames hot weather
    Source: The Times

There is something more fundamentally wrong with the company than poor weather.  Given the consistent disappointment they may as well have been selling chocolate teapots for all the good that it did them.

I asked a friend who works for Green and Black’s, and previously Lindt what she thought. She suggested that management had not invested in the brand, and also that they gave up selling through their own stores, and were at the mercy of the supermarkets. My friend suggested there was room for chocolate stores, because Hotel Chocolat has been enjoying a lot of success with their upmarket brand.

Brand is important. A company like Diageo, which owns Guinness, Smirnoff vodka and Johnnie Walker whisky trades on almost 7x book value. But that is where the limitations of accounting exist. If you spend money on machinery, this can be recorded as an asset on the company balance sheet, and count towards book value. If you spend money on advertising and promoting your brand, this must be fully deducted from profits. Yet sometimes investing in your brand is much more effective than buying more machinery and increasing capacity. To try and grow the business beyond it’s natural “moats” is like expanding a castle beyond it’s own defences. The money is wasted, and actually leaves the company more vulnerable.

I think this is an area where retail shareholders have an advantage over professional investors. The professionals tend to spend time analysing the reported accounting numbers, and meeting management. Retail investors can go shopping, and use their intuition about the brand. They can notice when goods are being heavily discounted, which is likely to be very negative for the share price. And conversely you can ask yourself about any brand – whether it is a pint of Guiness or a SuperDry leather jacket, how likely is it that this company can raise prices and people would still buy the product? It is an interesting test of a business, not to try to sell more things cheaply, but to ask yourself what service would I have to deliver for customers willing to pay a premium? An example is The Circus Hostel in Berlin, which is by no means the cheapest hostel, but always ranks very high on the hostelworld reviews and feedback. Partly it is location (a natural moat – which competitors can’t copy) in Rosenthaler Platz. But the hostel is also full of well thought out touches: an attention to detail that delights the guests – and probably the most important thing of all: hiring cool people to work there 🙂 That is the sign of a well run business.

By contrast, the UK chocolate company would have far better to sell less chocolate at higher price. Hotel Chocolate shows what Thornton’s could have been. Instead management got greedy, invested in the wrong areas and tried to expand too much. Like the spoiled children in Charlie and the Chocolate Factory, Thornton’s lacked self control, and the fate of the chocolate company is hardly much better than the children in Roald Dahl’s story.


1 Response

  1. andrew

    Bruce – Nice blog website by the way. I might try and do one myself so maybe let me know who did it for you? I am not expert on this area but will throw in my two cents worth.

    Upmarket – I think it was possible to take up market just look at Hotel Chocolate. Or smaller boutique chains like Paul’s Chocaltier. Retail is surely about offering a good value to quality ratio versus the rest of the market. And also doing so in a way that gets good margins. The clothing group Next offers clothes buyers in the UK a great quality to value ratio.

    To my mind Thorntons didn’t innovate and lift quality. It wasn’t inspiring to go in their stores. If you look at Pizza Express they seem to remodel their restaurants every 10 years to make them stay fresh. Thorntons appeared to focus on the mid-market but that segment will just purchase chocolates at the supermarket. If I go to the supermarket I can get a selection of chocolates – Lindt to Fair trade chocolate – so why bother going to Thorntons? I had a Thorntons in my home town and went in once and never went back. I think it is a similar story at Mothercare which doesn’t offer an uplifting feeling. Thus Mothercare has been usurped by newer chains like Petit Bateau and Thorntons by Hotel Chocolate. The lack of quality at Thorntons was highlighted by having features like Chocolate fountains which just looked unhygienic – to me anyway.

    Interesting thing on Thorntons is that you can get a lot of apparently good investment factors – long-term history, simple business, family stewardship – but these are only good factors if they support sustaining the quality/value product offering versus the competition.

    Contrast Thorntons with say Paul’s Chocolatier (about 5 in London). Yes Paul’s is expensive but the quality is great and it is an uplifting experience. I take your point Bruce that as consumers we can see these things. But probably the financial analysts would also have seen poor returns on capital at Thorntons too?