Management can make or break a company.
This statement is particularly true for a company in a commodity business. A good manager will save the company whereas a bad manager can force the company into bankruptcy. For a company operating with barriers to entry, a good manager will expand the company’s moat, whereas a bad manager “may diminish a franchise’s profitability, but they cannot inflict mortal damage” according to Mr. Buffett’s 1991 letter to Berkshire Hathaway’s shareholders.
When talking about Stella Jones (SJ), a company that manufactures pressure treated wood products such as railway ties and utility poles, the current CEO of 18 years, Mr. Brian McManus, has indeed expanded the company’s franchise. He managed to increase Stella Jones’ competitive advantage by bringing together high demand advantage (high switching and search costs) with economies of scale forming a formidable moat that, in my opinion, is sustainable. This is reflected in the company’s stock, which during his tenure rose from $0.55 as of June 1, 2001 to $48.8 as of June 21, 2019. However, what happens now that he has announced that he will be leaving the company to pursue other interests?
Value investors love superior managers who are not only good operators, but good asset allocators and Mr. McManus fits the bill.
Value investors also believe that it is difficult to replicate and sustain superior management. Additionally, they believe that superior management is already reflected in the stock price and upon their departure, a negative adjustment must be made to the company’s earnings power and stock price as chances are, the successor will be inferior.
There is one exception - if a company has well thought of succession and transition planning programs and internal training programs. Companies with such programs can perpetuate excellent management. Unfortunately, succession planning has not been a priority for companies. In a 2013 Robert Half Management Resources survey, chief financial officers were asked: “Have you identified a successor for your position?”. Seventy-eight per cent said no. And when asked why not, most replied that they do not plan on leaving in the near future.
Has Stella Jones had such programs in place?
While I do not think they have a clear formal succession planning program, in a recent interview in the Globe and Mail, Mr. McManus made the following comments: “I have never voluntarily lost a member of my senior team”; “my not being there is not going to change the direction of the company”; “one thing we have is a strong team that works well together”. These comments are good to hear. They reveal that SJ may have some sort of informal internal training program that focuses on company culture. On the other hand, I wish he had not made this comment: “I would suggest finding someone that can maintain our culture”. Mr. McManus should have made sure that one of his colleagues had been trained via internal transition planning and training programs to meet this requirement. However, he did go on to say that, “I think an internal candidate will probably end up being the best”. I cannot agree more. A successful company like SJ, with a moat, does not need an outside CEO who will be parachuted to the company. An internal candidate will be the best.
"firms with top rated training programs outperformed the market 9 out of 10 times"
There is a lot of research to substantiate this. A study at the University of Maryland found that firms with top rated training programs outperformed the market 9 out of 10 times. A study at INSEAD found that CEOs who have moved up through the ranks of their organization tend to be more effective and better managers than those who have been recruited to the job from the outside. But we, here in Canada, do not have to go far back to see the benefits of good transition planning for companies. Two family owned businesses in Canada, both in the same industry, had different results since one had a good succession plan and the other none at all. They are Shaw Communications and Rogers Communications. A 2009 Globe article brings the differences in focus. “A decade later, the transition of power at Shaw Communications has become a case study in passing the torch from one to the next. In a more glaring way, though, it stands in stark contrast to the debate that played out at Rogers over the past four months since the death of Mr. Rogers … uncertainty who would get the top job caused the stock to fall in recent months..”.
What should SJ’s Board of Directors do?
If SJ was a badly run and unsuccessful company, and GE comes to mind, an outsider may make sense, but not for this company. They must choose an internal candidate. It is simply the right thing to do.
UPDATE:
As a follow up to my blog post above, on September 12, 2019, according to the Globe Newswire, Stella-Jones Inc. announced the appointment of Eric Vachon as its new President and Chief Executive Officer. Mr. Vachon is a veteran of Stella-Jones and has held a variety of positions including Director, Treasury and Financial Reporting, Vice President Finance, U.S. Operations and Vice President and Treasurer since joining Stella-Jones in 2007. I am happy that Stella-Jones' Board of Directors has agreed with my analysis and has made what I consider the ONLY right decision.