5 Smart Management Decisions

There's no question that executives have had their hands full navigating the rocky economic environment of the past year. Although we at Morningstar prefer a quality business over topnotch management--as it is much easier for a company to change management teams than industries--recent events have brought home the point that management decisions can have a dramatic effect on a company's fate.

Some executives' boneheaded moves have been thrown into the spotlight as yesterday's red flags have turned into today's red ink. While criticism is both easy and fun, to paraphrase Homer Simpson, hammering overpaid and underperforming executives is a little too easy these days. Instead, in this article, we'd like to focus on the good moves that management teams have made and some lessons that can be drawn.

On Nov. 6, executives from 18 of our favorite companies will be presenting at our annual stock conference (click here to see the list of companies presenting and click here to register for the forum). Within this group of presenters are two former Morningstar CEOs of the Year, Will Oberton of  Fastenal (FAST) and Robert Silberman of  Strayer Education (STRA). We can't think of a better sample set to mine for canny and instructive management decisions.

Hope for the Best, Prepare for the Worst
When we look at the companies that have outperformed during these times of stress, it is not so much what they have done recently that has mattered, but how they behaved when times were flush. REITs have had a particularly hard time lately, as their leveraged balance sheets and exposure to the real estate market acted as a double whammy. One of our favorite REITs,  Realty Income (O), while not completely immune to the crisis, has fared much better than most. More than two years ago, Realty pulled back from major property acquisitions, content to wait for a more attractive buying market. The company's relatively low use of debt compared to its peers also helped it to weather the storm. Realty Income was able to cover the small amount of debt maturities it had occurring in the near term with cash flow and a modest equity raise in the fall of 2008, and now it does not have any material debt maturities until 2013. Furthermore, Realty has nearly $500 million available to fund strategic property acquisitions, should any attractive distressed sales become available. We not only like Realty's odds of riding out and possibly exploiting the downturn, but we think its common sense, low-risk approach will pay dividends over the long haul.

The Top Line May Be Uncontrollable, But Costs Are
Most companies haven't been hesitant about cutting costs lately, as the ballooning unemployment rate can attest to. This has helped to stabilize many firms' margins in the face of revenue declines. We can't help but wonder, though, if this reactionary cost-cutting, while propping up results today, might have negative consequences down the line. The odds of any company cutting exactly the right amount of costs in an uncertain environment are essentially zero, and those who are one step behind will find themselves constantly reacting to the economic situation, as opposed to exploiting it. Conversely, we think companies that always maintain a sharp focus on costs are poised for success in any environment.  NSTAR , for instance, achieved 13% earnings growth in the second quarter through operating expense reductions, despite a 6% decline in electric sales volumes. We like that the company took proactive measures to preserve and increase earnings in the face of strong head winds to its top line. But these latest reductions build on management's long and consistent record of cost control, which in our view is one of NSTAR's key strengths and points of differentiation. Weaker sales volumes were attributable largely to abnormally cool weather and a sluggish economic environment, both of which are temporary in nature and should normalize over time. With its lean cost structure, NSTAR could see handsome earnings expansion when sales conditions improve.

Protect Your Turf
 Stericycle (SRCL) has carved out an enviable spot in the medical waste niche of the waste management industry. Stericycle built out its footprint over the years through small, bolt-on acquisitions and is a preferred partner based on its positive reputation in the industry. But, as we all know, profitability draws competition, and the larger waste management players have been eying the medical niche for some time. When another relatively large player within this niche, Medserve, came on the market,  Waste Management (WM) saw a rare opportunity to gain a foothold and threw out a bid. Recognizing the threat, Stericycle's management acted quickly, and stole Medserve out from under Waste Management's nose. But just because this acquisition was defensive doesn't mean it was value-destroying. Stericycle's strong balance sheet allowed the company to obtain financing for the deal and pay cash. This helped to short-circuit a potential bidding war, and we think the company paid a fair price.

Use Tough Times to Improve Your Position
The economic downturn has been tough on everybody, but the pain is often disproportional, even within industries. Times like these allow the strong to get stronger, if they play it right. For instance, take  Sysco (SYY), the largest food-service distributor in North America. The company entered the recession with a conservative capital structure and has doubled its cash reserves over the past year to almost $1.1 billion as of the end of June. At first glance, this move might be seen simply as an abundance of caution on management's part. But we think this gives the company the financial flexibility to take advantage of potential acquisition opportunities. This is particularly important given that about 75% of the market remains fragmented and Sysco's smaller competitors, which lack scale, are under greater pressure and could be willing targets.

Adapt Your Plan as Necessary
Fastenal is a classic case of a smart strategy held to and executed over a long period. This provider of close to a million fasteners and other maintenance products grew revenue 27% annually from 1987 to 2008, as it rapidly expanded its store footprint. But its dependence on the faltering manufacturing sector has led to a substantial top-line decline in 2009. To combat this, management has slowed the pace of new store openings and focused on improving profitability at existing locations. We think this evolution in its strategy makes sense from both a near-term and long-term perspective, and management is not only working to stabilize near-term results, but also recognizing that the company has reached a maturation point where bottom-line efficiency matters as much as top-line growth. Management probably says it better, noting in the release of its third-quarter results, that "we remain practical optimists and we always attempt to balance long-term opportunities for growth with the necessary short-term reactions to our current reality."