Where’s the Beef?

Way back in 1984, Wendy’s, the hamburger chain, ran a commercial that featured a little old lady, played by actress Clara Peller, and the tag line “Where’s the beef?” The commercial became an instant classic because it played to the common sense of the audience to look past marketing hype to try and find the substance of the product. You can find a video of the commercial here: http://www.youtube.com/watch?v=Ug75diEyiA0

I bring this up because I often feel the same way when I hear about the benefits of corporate restructuring programs. These programs are often announced to great fanfare by corporations when they take massive one-time write-downs. The benefits are then discussed in diminishing amounts as the ensuing years unfold and we are left to take the company’s word that they in fact achieved the benefits claimed. So I thought I would go back and look at an example of one of these programs to see if I could understand the savings claimed.

Here, for example, is Walgreens President, Greg Wasson, as quoted by StreetInsider.com on January 8, 2009:

"Our Rewiring effort is finding ways for Walgreens to be more effective and efficient so that our growth strategy can move forward"

In its entirety, Rewiring for Growth targets $1 billion in annual savings by fiscal 2011. The company will achieve savings through:

• strategic sourcing on indirect spend (all goods not for resale),

• reduction in overhead and labor,

• and the POWER project, which is designed to enhance patient-pharmacist interaction while reducing costs.

Walgreens expects to incur costs of $300-$400 million over FY09 and FY10 as it implements Rewiring for Growth. 50% of the project’s benefits are expected to accrue beginning in FY10, with the full $1 billion in targeted annual savings beginning in FY11.”

This sounds like great stuff. If Walgreens could take $1 billion out of its expenses, with 2011 sales of $72.184 billion, they should reduce their expense ratio by 1.38%, which presumably should go straight to the bottom line. So I went and looked at what has happened to expense ratios since 2008, the base year of the announced “Rewiring for Growth” program. When I looked at the S, G & A expense ratio for the company here’s what I found:

2008 (base year) 22.36%

2009 22.68%

2010 23.02%

2011 22.94%

In other words, not only has the expense ratio not gone down, it has gone up in two of the three years since the program was announced and the ratio is 58 basis points higher now than when they started. In fact, if Walgreens had just maintained the same expense ratio that it had in 2008 before the program began, expenses would have been $476.4 million lower than they were in 2011. So I have to ask: “Where’s the beef?” How can you have an expense reduction program that results in rising expense ratios?

In their 2011 Annual Report, Walgreens states way back on page 19: “We have realized total savings related to Rewiring for Growth of approximately $1.1 billion compared to our base year of 2008. Selling, general and administrative expenses realized total savings of $953 million, while cost of sales benefited by approximately $122 million.” If you go and look at some of the company presentations they go to great lengths to try and justify their calculations, but when I read it I find myself in a time warp back to the late 1990s where companies routinely issued press releases about “earnings without the bad stuff”. There must be a method to their calculations – but it’s a little too subtle for me and I always worry about how they decided what to leave in and what to take out. (And let’s not forget that they said they would be getting $1 billion per year savings by now, not over the life of the program.) I mean, they’ve got sophisticated accounting systems and I’m just one guy with a calculator, but I really would like to see it in the income statement numbers, because what they’re saying doesn’t make sense to me. It’s not a successful expense reduction program if you don’t lower expenses.

From an investor relations standpoint, this stuff certainly doesn’t help management’s credibility. Maybe this is just the way things are done, but it’s quit frustrating for your average investor. When I get frustrated, I tend to take it out with food, so I think I’ll go fix myself a hamburger… and find some real beef.