Different Makes a Difference

The Odlum Brown Research Blog

Excuses – A Saviour of Mediocrity

By Stephen Boland CFA Equity Analyst
Thursday, September 22, 2016

A few years ago, Tyler Leverty of the University of Iowa and Martin Grace of Georgia State University conducted a study in which they found that many CEOs routinely blame underperformance on external factors, but often the poor performance is the result of bad management. “Structural differences” is a commonly used phrase to help explain underperformance, and the rationale usually sounds reasonable. However, it is worth approaching “structural difference” arguments with a hint of skepticism. Such defences can be an excuse by underperforming management to protect their jobs, which can leave a company and its shareholders mired in mediocrity.

We have benefitted numerous times over the years by investing in good companies that have gone through managerial change. Two recent cases come to mind: Air Products and Canadian Pacific Railway (CP). Air Products sells industrial gases, such as oxygen, nitrogen, and hydrogen. CP is one of North America’s largest railroads with 21,000 kilometers of track across Canada and the U.S.

In each of these cases, the company’s profitability was significantly lower than that of its closest competitor. Similarly, the CEO at each company was replaced by an extraordinary new CEO who subsequently closed the profitability gap.

Interestingly, previous management blamed “structural issues” for part of the profit shortfall. And even when management was replaced, many investors questioned the degree to which profitability could be improved. The naysayers were wrong.

In 2013, Air Products earned an operating profit margin of 15.4% while industry leader Praxair earned 22%. One of the excuses touted by Air Products’ then management was that more of the company’s revenue was earned from hydrogen, which was said to earn a lower margin due to a more energy intensive production process. Blame was also attributed to the fact that the company did not have a packaged gas business in the U.S., unlike Praxair which benefitted from this vertical integration.

In 2011, CP earned an operating profit margin of 18.7%, while industry leader CN Rail earned 36.5%. Part of the difference was said to be that CP had to run through the mountains in Western Canada, which resulted in higher fuel and other costs. Canadian National, on the other hand, ran north of the mountains and thus had a more favorable route. (CP never highlighted that running through the mountains was a more direct route to end markets – clearly a benefit).

In 2012, industry legend Hunter Harrison became CEO of CP Rail. In 2014, Seifi Ghasemi became CEO of Air Products. From the start, both CEOs noted that they saw no structural impediments to earning best-in-class profitability. Subsequently, both men drove remarkable turnarounds at their respective companies and both now earn profitability similar to their top performing peers. There is nary a mention of structural issues any more, and shareholders have benefitted mightily.  

There are certainly times when one business has a structural advantage over another. And it is important to remember that turnarounds do not always turn around. But when exceptional management takes charge of a company that has a real improvement opportunity, the result can be outstanding. Excuses fall to the wayside and shareholders gain. We continue to seek out such opportunities with vigor.


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