The Best Performers
Ouch. There hasn't been a business climate this brutal in decades. But forget growth strategies or novel accounting: The top rankings this year go to companies that have made themselves indispensable to customers -- by extending inventive new services
During the whoop-it-up '90s, BusinessWeek's annual rankings of the nation's 50 best-performing major companies read like a corporate version of American Idol. The list was dominated by companies with gravity-defying stock prices like Cisco Systems (CSCO
), Capital One Financial (COF
), and Oracle (ORCL
) -- companies that were young, hip, and treated like pop stars by fawning investors. But the grim reality of a tech and telecom implosion, combined with a sour economy, stagnant stock market, and the regulatory crackdown on fraudulent bookkeeping has made this year's compilation more like an episode of Survivor. Of last year's members, fully half were kicked off the island -- casualties of what has become one of the toughest operating environments in decades. (Profiles of the 2003 BW50 companies and an Interactive Scoreboard containing a ranking of the S&P 500 companies are available online.)
Entire sectors have all but disappeared from our seventh and latest BusinessWeek 50. The exclusive list favors companies that boost revenue without sacrificing margins and remain resilient amid stock market declines. For the first time, we have also factored in a long-term debt-to-capital ratio to reward those that achieve growth without accruing heavy debt.
The result: With the exception of Dell Computer Corp. (DELL
) (No. 9) and Microsoft Corp. (MSFT
) (No. 15), technology outfits are in short supply. Gone, too, are the glitzy energy companies such as Dynegy (DYN
), Calpine (CPN
), and Duke Energy (DUK
). Former icons of the brave new world of energy, they have succumbed to humbling restructurings since the deregulatory boom of the '90s was proven to be tainted by fraud and earnings manipulation. Also departed are once high-flying lenders such as Capital One Financial Corp. and MBNA Corp. (KRB
) They racked up huge profits by doling out easy credit, only to be burned when many overleveraged borrowers couldn't repay.
In contrast, the industry that emerges as the biggest winner this year is the health-care sector. Drug and health-care companies dominate the list, accounting for seven of the top 10 spots -- including this year's No. 1 performer, drugmaker Forest Laboratories Inc. (FRX
) With its 20th-place showing, Merck & Co. (MRK
) is the sole company to grace the BW50 in each of its seven years. All told, 16 health and drug companies made this year's list, six more than last year. Chalk that up to an aging nation that's clamoring for the latest in pills and medical services, regardless of the soaring costs.
This edition of the BW50 boasts marquee names that have the size and the savvy to endure this brutal climate. The Class of '03 is full of food and household product stalwarts like Procter & Gamble (PG
) (No. 29) and Coca-Cola (KO
) (No. 45) that have historically fared better during tough times. And while Wall Street's dealmakers have had their wings clipped, the ongoing mortgage and housing boom gave a lift to a group of consumer-driven lenders like Washington Mutual (WM
) (No. 13) and Wells Fargo (WFC
) (No. 23), as well as well run builders like Pulte Homes (PHM
) (No. 19).
This year's BW50 also includes four newcomers -- United Parcel Service (UPS
) (No. 14), Electronic Arts (ERTS
) (No. 17), eBay (EBAY
) (No. 30), and Quest Diagnostics (DGX
) (No. 48) -- that became eligible for the ranking for the first time this year. All four were added to the Standard & Poor's 500-stock index, the universe from which the BW50 is selected, in 2002.
The turmoil in the markets over the past year has meant that today's hero can become tomorrow's goat almost overnight. That's why using the BusinessWeek 50 as an investment guide could be somewhat treacherous. Our ranking is, at heart, a growth index. The momentum in an up market tends to carry BW50 companies faster and further than the market as a whole. But when the market turns, look out. While the companies in our index handily outperformed the major indexes during the 1990s, they suffered heavy losses in 2001 and again in 2002: For the year ended Feb. 28, the BW50 index lost 23.9% -- less than the 24.3% drop in the S&P 500, but more than the 22% slide in the Dow Jones industrial average. There were other factors, too. Some members of the Class of '02 -- including Tyco International Ltd. (TYC
) and Dynegy Inc. (DYN
) -- were pummeled by the market over suspicions that their robust performances had been juiced by dubious means.
This year's winners show a decidedly conservative bent compared to earlier BW50 rankings, with many tending to favor organic growth over nonstop acquisitions. It's easy to see why: The financial markets that were so conducive to dealmaking in the '90s have turned frigid. Look at Procter & Gamble -- which vaulted from No. 137 in last year's rankings to No. 29. Under new chief executive Alan G. Lafley, P&G has proven adept at devising new, higher-margin variations of mainstay brands like Tide, Pampers, and Crest -- such as Crest Whitestrips, and Crest SpinBrush, which almost overnight helped Crest become P&G's 12th brand to top $1 billion in sales. In the two years since Lafley took the helm, this look-inward approach has enabled P&G to double its cash flow from operations. "We are going to build and profit from the core," says Lafley. "It's a Sesame Street-simple strategy, but it works."
In an era when technology and globalization have conspired to turn many goods and services into mere commodities, top companies also have learned to make themselves far more valuable to customers through innovative extensions of their services. UPS, whose employees were once seen as faceless deliverymen, has added higher-margin layers of service. It manages the entire supply chain for many of its customers, and even provides trade credit and other financial services to small-business customers. "Companies are going to increasingly have to drill down into their current customer bases to look for growth opportunities," says Chris Zook, head of Bain & Co.'s worldwide strategy practice. And with the economy likely to grow much slower than in the '90s, companies like Dell (DELL
), Wal-Mart Stores (WMT
) (No. 47), and Cardinal Health (CAH
) (No. 11) that have established themselves as the lowest-cost operators in their fields suddenly have a huge competitive advantage.
The winners don't have to be big. Forest Labs, our top performer, boosted its profits 65% annually over the past three years, to $537.8 million on just $2 billion of sales in 2002. And it managed to do that without a vast sales force, bottomless research-and-development budgets, or the aggressive legal tactics employed by larger drugmakers to fend off competition. Instead, the New York company has identified and licensed promising drugs from smaller European pharmaceutical companies. Its big hit, an antidepressant called Celexa, almost slipped away when executives at Danish manufacturer H. Lundbeck initially gave Forest chairman and CEO Howard Solomon the cold shoulder. Undeterred, Solomon finally landed a meeting, hopped a plane the next day -- and won over Lundbeck with a pledge that he could devote more attention to promoting Celexa than larger drugmakers. "We didn't have anything in our pipeline, so we weren't diverted by other products," says Solomon.
Lacking the salesforce of his larger U.S. rivals, Solomon opted to negotiate a "co-promotion" deal with Warner-Lambert Co. to sell Celexa. With Warner-Lambert's sales army deployed, sales of Celexa soared -- making it a $1.4 billion blockbuster for Forest. Rather than banking those profits, Solomon plowed them into nearly tripling the size of his salesforce. Good timing, given that Forest loses exclusivity on Celexa in 2004. With 2,300 reps of his own now, Solomon has the manpower to mount a campaign behind Lundbeck's next-generation Lexapro, which SG Cowen Securities Corp. analyst Ian Sanderson predicts will become a leading antidepressant because it eases symptoms of depression faster than Celexa, and with fewer side effects.
Of course, the drugmakers on this year's list have benefited from the broad patent protections they enjoy, making them less vulnerable to the pricing pressures that have squeezed so many other industries. But at the same time, management experts believe those industries could learn from the heavy R&D spending by companies like Johnson & Johnson (JNJ
) (No. 4), St. Jude Medical (STJ
) (No. 10), and Medtronic (MDT
) (No. 21), as well as their use of clinical data to convince customers to embrace higher-priced permutations of existing products. That willingness to invest in their business is a hallmark of many BW50 companies. "Every six months, someone has something new out," says Terry L. Shepherd, CEO of St. Jude, which makes defibrillators and other devices. "You better be ready."
The health-care industry could be in for a rougher time in the months ahead. Those rising medical costs have caught the eye of politicians and corporations, which could make it harder for drug and health-care companies to push through price hikes. Certainly, the squeeze on programs like Medicaid and moves to make consumers pay a higher share of medical costs are likely to bring those healthy margins under pressure. And insurers are increasingly resistant to covering the costs of name-brand drugs and try where possible to push consumers into cheaper generics.
Then there are the legal questions swirling around Tenet Healthcare Corp. (THC
), the target of several federal investigations related to Medicare billing practices. In essence, Tenet had been exploiting a loophole that accounted for 20% of profit growth. Although it has since altered practices, we elected to take Tenet out of the BW50 this year (it would have ranked No. 36) because the quality of its past performance is now in doubt. Tenet maintains its actions were legal and that billing was changed in anticipation of new regulations. Even so, spokesman Steven Campanini notes that CEO Jeffrey C. Barbakow is committed to providing "greater clarity about our financial performance." In addition, we did not rank Mirant (MIR
), Nicor (GAS
), and Bristol-Myers Squibb (BMY
) in our S&P 500 list because all delayed their fourth-quarter results and said that they would have to restate the results of previous years due to accounting changes.
Other industries and companies are going to face new challenges in 2003 as well. Several of the trends that carried companies onto this year's list are winding down. The housing and refinancing booms that lifted Freddie Mac (FRE
) (No. 16), Wells Fargo, and Pulte Homes into the ranks of the BW50 may lose steam when interest rates turn up again. And investors ran scared after a top Federal Reserve official recently raised questions about the financial viability of government-sponsored Freddie Mac and sister lender Fannie Mae (FNM
) if the economy falls back into recession. Execs at Freddie Mac wave off the fears, pointing to forecasts showing it could endure a 6-point spike in interest rates and a huge plunge in home prices with at least $12 billion in capital to spare.
With the deflationary forces in the economy already making it difficult for Corporate America to raise prices, companies are looking for ways to get their customers to buy more. For PepsiCo. (PEP
) (No. 22), that means broadening its range of products -- which include Frito-Lay snacks, Tropicana juices, and Quaker cereals, as well as Pepsi drinks. "Any one consumer has different needs at different times of the day," says CEO Steven S. Reinemund, who has his staff working on everything from breakfast bars to more "healthful" potato chips. "We want to make sure that we cover all those needs."
Others are determined to become more deeply embedded in their customers' businesses. The more critical they become, the more they can charge. Some of the smartest companies do that by selling themselves as partners who can help customers run more efficiently or become more productive. "In a 'zero sum' world, [suppliers] have got to go beyond cost," says James A. Champy, chairman of Perot Systems' consulting practice.
The performers that made this year's BW50 have already stepped up to the challenge. Consider No. 39 Altria Group Inc. (MO
) (which changed its name from Philip Morris in 2002). At Kraft Foods Inc., where it's the majority shareholder, managers have assumed marketing functions that used to be performed by its grocer customers. Kraft uses a software application that lets grocers analyze their sales trends far faster than before. It also lets them make quicker decisions about stocking the shelves, setting promotional pricing, and dropping nonperformers.
But few companies have gone the extra mile like drug distributor Cardinal Health Inc., which rose to No. 11 this year from No. 33 in 2002. Caught in a margin squeeze between drugmakers pushing through price hikes and cost-conscious hospitals or pharmacies, the Dublin (Ohio)-based distributor has responded with a broad expansion of the services it provides to supplier and customer alike. "We're an enabler," says Robert D. Walter, chairman and CEO. "We help customers get to market more efficiently or do something unique that they couldn't do themselves. We do that by having some expertise that they don't have."
In recent years, Cardinal has begun to manufacture and package some drugs for the pharmaceutical giants, even going so far as to develop its own proprietary technologies for producing faster-dissolving tablets. At the same time, it has taken over drug management and distribution within hospitals, providing round-the-clock pharmacists who, via Internet and phone, can review prescriptions and patient records and then help nurses dispense the right dosages during off-peak hours. Such moves helped the $53 billion company boost its profits 28% last year, to $1.25 billion.
Among the tech companies, Dell Computer also stands as one of the few expansionist forces in an otherwise stagnant industry. Rather than merge, it prefers to strike joint ventures to extend its reach into other markets such as printers (with Lexmark International Inc.), storage gear (EMC Corp.), and systems integration (Electronic Data Systems). In fact, Dell serves as an example of how the canny use of partnerships can help companies stretch their own R&D budgets. While other PC makers spent far more than Dell on product innovation -- its larger rival, Hewlett-Packard Co. (HPQ
), dropped $4 billion last year on R&D, vs. the $455 million spent by Dell -- Dell has chosen to ride piggyback on the R&D budgets of suppliers like Intel Corp. (INTC
) and Microsoft as they developed the faster chips and easier-to-use software that drove consumer demand.
Dell's own efforts, and 60% of its patents, are focused on gritty operational details like getting payment from customers long before it builds their orders, streamlining products and packaging so they move faster along assembly lines, and reducing working capital by turning over inventories in as few as three days. While a slump in demand for computers and a vicious price war have brought the price of a PC and monitor as low as $399 -- decimating industry profits -- Dell is using its leverage to steal gobs of market share and ring up record revenue and profits. Gloats CEO Michael S. Dell: "Only Dell has the cost structure required to profitably grow market share."
Profits created by such innovation are more durable than returns spurred solely by a buoyant economy or, worse, accounting shenanigans. Some serial acquirers, for example, now find themselves saddled with debt. To take account of the balance sheet, this year BusinessWeek made a small but significant modification to the proprietary model used to calculate the BW50. Up to now, the formula for building the index has consisted of eight financial measures, including growth in sales and profits over one and three years. We also factor in sales volume as a measure to balance the fact that small companies often show higher percentage growth figures. This year we took into account a further variable: the long-term debt-to-capital ratio for each company.
Debt-to-capital is not something investors will find in quarterly earnings releases, where most of the other inputs for the BW50 formula reside. But if the wave of corporate accounting scandals has taught investors anything, it's that they -- and executives -- should pay just as much attention to the balance sheet. That's where you can tell which companies are running a tight ship -- and conversely, which companies may be mismanaging their growth and leaving themselves vulnerable to brewing cash-flow problems. "Way too many companies spend their time focused on their profit and loss statement and not on their balance sheet," says Russ Hagey, a managing director at consultant Bain.
Moreover, in recent years, too many companies focused on growth for growth's sake, without looking at the quality or sustainability of their earnings. While the 2003 list contains players like Pfizer Inc. (PFE
) (No. 8) and Quest Diagnostics that are as voracious as the freewheelers of yesteryear in their appetite for acquisitions, they differ in focusing on strategic targets that build an existing portfolio. Financial prudence is becoming a cherished corporate value as top performers in the 21st Century come to view mergers as a complement to their core businesses rather than the cornerstone of their growth strategies.
Indeed, the only two surviving energy companies on this year's list -- Exelon Corp. (EXC
) (No. 33) and Dominion Resources Inc. (D
) (No. 44) -- are notable for having avoided the heavy dealing that typified the deregulatory frenzy of the late 1990s. While Exelon made some big acquisitions, it avoided the siren of speculative energy trading that lured the likes of Enron Corp. and Dynegy, preferring instead to sell real output from its own power plants. "One of the lessons of the last three years is that people who put growth ahead of value ended up not getting either," says Exelon CEO John W. Rowe.
Among the new breed of BW50 companies, the mantra for dealmaking is to go slow. Consider No. 35 Wachovia Corp. (WB
), formerly known as First Union Corp. By the late 1990s, the bank holding company's take-no-prisoners merger strategy decimated its customer base as people left screaming because of shoddy service. When First Union struck a deal to acquire Wachovia Corp. in 2001, CEO G. Kennedy Thompson vowed he would take up to three years to integrate the two banks. That's at least twice as long as he took in the past, and goes against the usual practice of mixing acquired companies into the pot as fast as possible. "Thompson has taken conventional wisdom in merger integrations and turned it on its head," marvels bank hedge-fund manager Thomas K. Brown, chief executive of Second Curve Capital LLC, a New York hedge fund. Thanks to a sharp fall in customer defections -- 12% annually, vs. 20% four years ago -- Wachovia banked a 121% rise in profits last year, better than double the gains of the top 20 banks.
With fewer megamergers to drive growth, the companies that thrive may not be the home-run hitters of the past. If more growth has to come internally, the winners will be the companies like Mattel Inc. (MAT
) (No. 40) that prove to be more capable of knocking out the singles, doubles, and occasional triples. When Robert A. Eckert took over in May, 2000, the toymaker was still hemorrhaging from the costly acquisition of a children's software company by his predecessor, Jill E. Barad. Eckert essentially gave away the money-losing division, streamlined manufacturing and distribution, and refocused Mattel on core brands like Barbie, Hot Wheels, and Fisher-Price. Eckert has willingly ceded several splashy movie tie-in deals to rivals like Hasbro Inc. (HAS
) -- deals that he felt carried too much risk. "Our strategy is not about swinging for the fences," says Eckert. "We're not here to create souvenirs for movies. We want toys kids want to play with." The result: After suffering an $82 million loss the year before Eckert took over, Mattel booked a $455 million profit in 2002, and its stock is trading at a three-year high.
All of which suggests that for the next generation of BW50 companies, the formula for success won't involve financial engineering, off-balance sheet maneuvering, or striking deals faster than the auditors can track them. Nor will it involve cutting-edge technology that, while dazzling, doesn't help customers sell tires in Toledo. In short, there are no shortcuts. It's about turning business partners into loyal -- even fawning -- supporters through unparalleled levels of value, service, and innovation.
MARCH 24, 2003
By Dean Foust in Atlanta, with Frederick F. Jespersen and Fred Katzenberg in New York, Amy Barrett in Philadelphia, Roger O. Crockett in Chicago, and bureau reports
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