The Capital Cycle Podcast - The Long Tail

Episode Date: September 30, 2025

How a book inspired strategy at Richelieu Hardware. Edward Chancellor talks to Tom Wharram, a North American Analyst.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello and welcome to another episode of the Capital Cycle podcast. I have with me Tom Warram, who's a North American analyst with Marathon. Welcome, Tom. Good to see you again, Edward. So Marathon's Capital Cycle Investment Philosophy has always emphasized taking a close look at how management allocates the shareholders' capital. Over the years, various global investment reviews have frequently cited. Warren Buffett's observation, and I quote, the lack of skill that many CEOs have at capital allocation is no small matter.

After 10 years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business. Now, the strong focus on management explains why Marathon portfolio managers and analysts, Spend so much time meeting senior corporate executives, as Neil Ostra, one of the Marathon co-founders, explained in a podcast I did with him last year. So Tom, in your latest global investment review, you've identified the boss of a Canadian company who's taken the idea of capital efficiency to the farthest degree, at least that I've ever come across. But first, can you tell me what you're looking for when you meet with?

management? Yes, so it can be a lot of things and it can depend how well you know the company and whether you've met the CEO before. But often for a first meeting, one useful tool when meeting management is to try and see the industry through their eyes. We want to know the mental models they use, what they really care about and how they think the industry will look far out into the future. Now, of course, we don't always agree with them. You can't take everything they say at face value, but getting inside the head of these people who are ultimately stewarding our client's capital should make for better investment decisions. In this respect, let's discuss the case you mentioned in your latest piece.

Tell us about Richelieu Hardware. Yeah, Richelieu Hardware, they're a marathon holding. It's a Canadian specialty hardware distributor to the woodworking industry. They sell things like hinges, handles, draw slides and other accessories. and those are the parts you need to make kitchen cabinets, bathroom cabinets, closets, that kind of thing. So customers are generally small cabinet makers with under 10 employees. And what caught your attention in particular was a book recommended by the company's CEO? Yeah, so the CEO, he's been running the company since 1987 and he's very much the architect of the business.

And when we met him, he recommended the book which has been most influential for him in formulating the company's strategy. And the book he recommended was The Long Tail by Chris Anderson. At about 20 years old now, it was published in 2006 and was highly influential in retail and also elsewhere as internet-based business models took off and dramatically increased the range of products that could be offered to customers. At the core of the author's argument is that historically companies tried to make what he calls hits, that is making products which appeal to the largest number of people. And because of this, there was this long tail of less popular products which had been neglected. And companies that tried to sell these would find a market that was far larger and more profitable than they expected. So what are the forces that enable a company to go after the long tail? So the author identifies three forces.

First of all, it's democratisation of production. And that lowers the barriers to production and creates a wider range of content. Secondly, it's democratisation of distribution, and this is basically digital distribution, and thirdly, it's tools for connecting supply and demand. So this is recommendation algorithms, search engines, filters, that kind of thing. Over the past 20 years, the notion of the long tail has become pretty well established in business strategy. Yeah, definitely. And these concepts, to some extent, may seem a bit obvious today. We are all familiar with how Amazon and others have profited from the long tail strategy, but they were novel insights relatively recently

and have been a powerful force over the last 20 years. And are still relevant today? Yes, definitely. That was one of the things that came through to me on reading the book. These forces that enable the Long Tail are still very relevant for today's up-and-coming companies. And the one that sprang to my mind was TikTok. So if we think about those three forces,

firstly democratisation of production, TikTok provides simple, free and high-quality video editing tools, that have lowered the barriers to content creation. Secondly, democratisation of distribution, and this is probably the simplest, but clearly infinite scroll and global reach provide that wide and free distribution. And probably the third force is most important for TikTok,

which is their very powerful recommendation algorithm, and that personalises recommendations and matches users to the long tail of content. But even outside of social media, the long tail applies to companies that say, offer slightly more mundane products like Richelah Hardware? Yeah, so Richelieu Hardware is probably a more traditional application of the Long Tail concept. They sell 145,000 products from 48 distribution centres in Canada and 61 in the US.

And they are constantly trying to add new products with the aim of selling everything a customer working with Wood could want. And the key to success with managing such a large number of products is, as the CEO said to us, you have to be obsessed with return on invested capital. And the way this obsession plays out in practice is that they monitor the inventory turn, so that's how fast each product is selling, and they do that on every single product. They then automatically update the price as those inventory turns change, and this ensures that every product is generating a sufficient return on capital. So Tom, tell us how Richelow actually implements its long-tail approach for controlling what

sells. They have a cutoff of two inventory turns. So if you sell a product less than twice a year, then they cut that out of the product list. If you were selling three times a year, they would price it such the margin would be very high, and that keeps the return on invested capital at the level that they need. And then as the product sells faster and faster than that, they reduce the margin and the price, such that that return on invested capital stays constant. It's intended to create a more or less uniform return on invested capital across this tens of thousands of product. Exactly right, yeah. And tell me, see, that's purpose is to control working capital,

but Richer's obsession with controlling its working capital doesn't end there. No, so what we've just talked about is Richelieu's own working capital, and then there's the working capital of their customers. And many small manufacturers pooling inventory at Richelieu's warehouses improves the overall capital efficiency of the supply chain. Typically a small cabinet maker will order inventory just what they need for that week. And the order size is quite small. It would be $3 or $400.

And customers are comfortable with this because Richelieu has very fast delivery and a strong online proposition. So around half of the company's products are sold online while competitors are closer to 15%. And you say that Richelah has achieved a position of market dominance in their niche, which creates a virtuous circle? I think for every distribution business, or certainly most distribution businesses, scale is critical. And Richelieu estimate that their market share in Canada,

which is close to 60% of their sales, is 50% to 60%. And in the US, if you look at the markets they serve, they've got about 25% market share. And that scale provides cheaper purchasing, it provides logistics efficiencies and technology efficiencies. and that then to the customer provides lower cost, wider range and better service for customers who buy from Richelieu rather than their smaller competitors. So what you're really saying is that Richelieu looks well positioned from the perspective of Michael Porter's Five Forces, an analytical framework which is incorporated into Marathon's capital cycle approach.

Yes, and what we like to see for a distribution business is a market structure which looks like an hourglass. so that fragmented suppliers and fragmented customers with the distributor sitting in the middle connecting the two sides. And that's exactly what we see for Richelieu. And the reason that market structure is good for a distribution business is it reduces the risk of disintermediation. So it's not worth one of your customers forming a relationship with hundreds of suppliers and vice versa.

I should also probably say a word on Amazon because I think most listeners will be thinking doesn't Amazon pose a risk here. and that is right, but I think there are a few things that mitigate the risk. Firstly, over half of Richelieu's products are own label or exclusive products, and replicating this for such a niche market would just not really be worth Amazon's time. And Richelieu actually made use of Amazon's marketplace by selling their own label products through their Amazon store. Secondly, Richelieu have specialist sales reps who can provide advice to customers.

They have design showrooms where customers can go and look at the products, And they also provide training to customers, and none of that is part of Amazon's proposition. And the reason you're writing about Rishu now is that you believe it's potentially an attractive investment today owing to cyclical weakness in the US residential housing market. Yes, so one of the things that makes Rish Loo interesting today is the company's weak share price, thanks to a temporary depression in earnings. approximately three quarters of revenues are for residential renovations, and the US home improvement market fell 4% in 2023 and 3% in 2024 after a very strong 2021 and 2022. What explains the current housing downturned?

It is, of course, interest rates, and there are two parts to this. Firstly, large home improvement projects are often financed by credit, and secondly, projects are often initiated by home moves. So that's either people preparing the property for sale or buy new owners when they move in. And people are delaying moving because they've locked in low rates. And if they move, they will lose those low rates. So US existing home sales are about $4 million a year at the moment. That is the lowest level, certainly in the data that I've seen, which goes back 20 years,

and it's about 20% below the 10-year average. However, even if interest rates don't fall, I think people can't delay moving indefinitely because they change jobs, they have children, they get divorced, and that means that in the medium term, existing home sales are likely to rise from here, and that should be positive for home improvement projects and for Richelieu Hardware. We don't tend to spend too much time worrying about quarterly commentary, but the latest commentary from Home Depot and Lowe's, who are exposed to exactly the same home improvement trends,

suggest that the market is starting to show green shoots. Now, optically, the stock doesn't look that cheap. Yeah, that's right. So 2025 consensus P-E ratio is 24 times. That doesn't look that appealing, but bear in mind, earnings per share has approximately halved since the 2022 peak. And we think the dynamics that we've just discussed mean that earnings are currently well below the long-term earnings power of the business. And finally, last word on Richelieu's Chief Executive. He's a type that appeals to marathon.

Well, firstly, he's clearly someone who is very passionate about the business. and that really came through when we saw him. Most CEOs don't give us book recommendations. And I think by doing that, he showed himself to be someone with a very long-term mindset who thinks deeply about the industry he's in. Those are the kind of CEOs we would want to be invested alongside. The book also handed us the lens through which he sees his company and his business model, and that has helped us to understand the business more deeply

and become confident in the investment case despite the currently depressed market. which reminds me that not very long ago the chief executive of United Airlines on an earnings call recommended Marathons Capital Cycle book, Capital Returns, which shows there's also hope perhaps one day for the US airline industry. Anyhow, thank you, Tom, and we will speak again soon. Thank you for having me. Thank you for your time today. I hope you will listen to the next edition of the Capital Cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.