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WIKI ANALYSIS
Wesco Financial Corporation(AMEX:WSC) is a multi-faceted company that has operations in three main areas: the property and casualty insurance business, the furniture rental business, and the steel industry. Moreover, since 1973 it has been controlled by Berkshire Hathaway (BRK) who, through one of its many subsidiaries, owns an 80.1% equity stake in Wesco.[1]
Starting in the second quarter of 2008, Wesco, like many other companies, began to feel the impact of the financial crisis, posting a 22% year-on-year drop in net income. Wesco blames most of this loss on reduced demand for its insurance services, which are aimed primarily at a commercial property industry that has seen double digit declines in value since the beginning of 2008.[2]
In 2008, Wesco expanded its furniture rental segment by purchasing Roomservice Group located in the United Kingdom as well as a division of Aaron Rents located in the United States.[3] These acquisitions come at a time when the rent-to-own industry, as a whole, is experiencing mixed results as sales to consumers grow due to the lack of traditional bank financing and credit that would have ordinarily allowed customers to purchase expensive products upfront while sales to businesses decline due to lower economic growth.[4] The economic slowdown, however, will have a negative impact on Wesco Financial's steel business as manufacturers reduce production in order to cope with reduced consumer demand.[5]
One aspect of Wesco Financial that has drawn attention from shareholders is the extent to which management decisions are influenced by Warren Buffet, who effectively controls Wesco Financial through his 28.1% ownership of shares in Berkshire Hathaway. In an interview with the CEO of Wesco, Charles Munger (a close friend of Buffet's), it was revealed that the strength of his influence causes many Berkshire subsidiaries, including Wesco Financial, to voluntarily check in with Buffet before engaging in any major transactions.[6] The fundamental issue that such an ownership structure brings up is the potential for a single individual, Warren Buffet, to override minority shareholder interests.
Business Overview
The three divisions of Wesco financial are formally designated as the Insurance, Furniture Rental, and Industrial segments. Operations within each segment are carried out by distinctly named subsidiaries that are directly managed by Wesco Financial.
Business Financials
In 2009, WSC earned a total of $813 million in total revenues. This was a slight increase from its 2008 total revenues of $799 million. However, despite the slight increase in total revenues, WSC's net income took a hit. Between 2008 and 2009, WSC's net income declined from $82 million in 2008 to $54 million in 2009.[7]
Business Segments
Insurance Segment
Wesco engages in both primary insurance as well as reinsurance through two subsidiaries called Wesco-Financial Insurance Company and The Kansas Bankers Surety Company. Unlike primary insurance, reinsurance is a way for WSC to provide insurance to other insurance companies. In this process these other insurance companies are able to take on greater risks then they would be able to do without reinsurance contracts.[8]
Furniture Rental Segment
Wesco operates its furniture rental segment through a subsidiary called CORT Business Services Corporation which offers a large selection of desks and other assorted office furniture to customers who can either lease or rent-to-own the products. This segment is extremely sensitive to economic conditions since many of its customers are other businesses.
Industrial Segment
The Industrial Segment for WSC is operated through a subsidiary called Precision Steel that has plants in both Chicago, IL and Charlotte, NC. Revenues are generated through the purchase of raw metals that are then cut to a customer's specifications and sold. The market share that is controlled by Precision steel is relatively small; it manufactured only 20 thousand tons of steel in 2007, in total market of more than 60 million tons - only .03% of the total steel market. However, unlike its larger competitors WSC specializes in producing niche steel products for a small number of customers.
Key Trends and Forces
The 2008 Financial Crisis and ensuing recession will affect all segments of WSC
All three segments of WSC are positively correlated with the economic cycle.
- Insurance: During economic upturns, as businesses buy capital and expand operations, they seek to purchase the exact type of insurance offered by WSC.[9] During downturns ,though, not only will WSC have a more difficult time getting new customers, many existing customers will reduce their insurance coverage in order to lower their premium payments, which will negatively affect Wesco's revenue.Traditionally, WSC has also offered insurance of bank deposits above the FDIC insurance level of $100K.
- Furniture Rental: The same logic holds for this segment - during times of economic growth, businesses seek to acquire the necessary equipment for their offices. However, during periods of slower growth, WSC will have to deal not only with diminishing demand but also with the increasing costs of holding furniture as inventory in warehouses.
- Industrial: This segment, like the broader manufacturing industry, is intricately tied to consumer demand, which has historically diminished during economic downturns. These fluctuations are most strongly felt in the specialty stainless steel products produced by WSC.
Economies of scale amongst competitors could hurt profits in the Industrial Segment
The steel industry, while made up of many firms, is dominated by two: Rio Tinto (RTP) and ArcelorMittal (MT) which together make up almost 50% of the market.[10] The large scale of production that these two firms are capable of allows them to have profit margins of 25% and 11%, respectively, compared to WSC's profit margin of only 3%.[11]
One of the main benefits from a larger operation is the higher return that can be achieved on the expensive capital outlays that are required in order to mine, manufacture, and/or mold the raw materials into useable products that can be sold to distributors and wholesalers. However, both types of manufacturers will see reduced profits as a result of declining economic conditions. For generic bulk manufacturers such as Rio Tinto (RTP), falling profits result from falling market prices of steel as demand for raw materials decreases.[12] On the other hand, specialty steel makers such as WSC, are heavily dependent on a limited number of customers which may be responsible for a large proportion of the profits.
The potential influence of Warren Buffett on dictating the actions of WSC is significant
The 2008 CEO of Wesco Financial, Charles Munger, has been close friends with Warren Buffet for many years. The two have often appeared in public, and many publications have suggested that the two often discuss the details of the large businesses that they own and operate.[13] More important, however, is the fact that Munger has publicly revealed that he has sought Buffet's advice regarding investment and capital allocation decisions within Wesco.[14] While there are no perverse incentives for Warren Buffet to make decisions that harm WSC's shareholders, the potential for one individual, who is proximal to a company's daily operations, to affect share price can make them more volatile, as well as override the interests of any smaller shareholders.
Competitive Analysis
The unique organizational structure of WSC in terms of the types of business that it is engaged in makes it difficult to find direct competitors. However, there is one other company, Blackstone Group (BX) that owns a diversified array of companies and competes against WSC both in terms of the amount of income that is brought in and the level of returns that these companies can provide for shareholders. Using the performance metrics outlined above it is also possible to compare the individual segments of WSC with other companies that offer similar products.
References
- ↑ Wesco Financial Company Homepage: Links to Affliated Companys
- ↑ Boston Globe 12/23/08: "US Developers Seek Aid from Government"
- ↑ The Atlanta Journal-Constituion 9/15/2008: "Warren Buffet Company buys Aaron Rents Division"
- ↑ Atlantic City Press 12/25/08: "Rent-to-own business is booming"
- ↑ Time Magazine 10/10/08: "Is Cheaper Oil a Good Thing?"
- ↑ Notes from Wesco Annual Shareholders Meeting: page 8
- ↑ WSC 10-K 2009 Item 6 Pg. 19
- ↑ Insurance Journal 7/4/2005: "What is Finite Risk Reinsurance? A Definitive Explanation"
- ↑ The Guardian UK 10/17/08: "Insurance Company investors push panic button"
- ↑ Yahoo Finance: Steel Industry Browser
- ↑ Rio Tinto Income 2007 Income Statement
- ↑ Associated Press 12/25/08: "JFE Steel to shut blast furnace as demand falls"
- ↑ Smart Money Magazine 9/2/2008: "Warren Buffet's Best Man"
- ↑ The Charleston Post and Courier 6/1/08: "Warren Buffet's $2 billion right-hand man"
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