CUNDILL VALUE & CUNDILL SECURITY FUND'S
PETER CUNDILL & TIM MCELVAINE
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OID: You still haven't told us how Reitman's achieved those returns in its core business.
   McElvaine: Let me answer you this way. Reitman's and Chateau have several things in common. First, they're in very fragile businesses.

OID: Fragile in what sense?
   McElvaine: One problem with retailers, of course, is that their asset side tends to be fairly weak -- because it tends to be only inventory and leaseholds. And, similarly, their liability side tends to contain hidden liabilities -- especially the cost of closing stores.

OID: Something Charlie Munger and Bob Goldfarb have discussed in the past.
   McElvaine: Therefore, one of the things that we were concerned about was how happy customers were with their stores, and, therefore, how likely they were to close them. If there was any suggestion there might be store closings, we tended to stay away from retailers.
   But in the case of Chateau Stores and Reitman's, both were very happy with the stores that they already had.

OID: Although aren't stores virtually guaranteed to become outmoded from time to time -- whether it's due to societal changes like where people live or shop, competitive developments or technological changes?
   McElvaine: Yeah. But if you're in a situation where a turnaround is underway, you're in particular danger. Concept changes in retailing are very difficult to execute --not that people haven't done them successfully. They're just tough. And to do that with a weak balance sheet and some locations you're not comfortable with -- well, let's just say that it's usually not very pretty what happens.

OID: And there are other problems with retailers, too, I gather. Leaseholds generally add lots of leverage...
   McElvaine: But the flipside is that if the company's happy with its stores, it's like any other leveraged business -- although the leverage here may be off balance sheet. If you're happy with your locations and you're continuing to run out your leases, the business takes very little capital and can be an enormous free cash flow generator -- especially if it's not expanding.
   In part, that's true because even if your inventory can't be financed 100% by payables, it can be financed to a very large degree. And leaseholds may or may not require a lot of maintenance each year. So if you're not expanding, your margins fall through to the bottom line.

OID: Gotcha.
   McElvaine: And that's the case with both Chateau and Reitman's. Their sales have been fairly constant the last eight years. So neither of them is a growth company. These are more mature businesses. They continue to add stores and take others off as they fine tune their business.
   Chateau's book value, for example, is only up 4% per year in the last nine years. Also, both Chateau's and Reitman's capital expenditures are below their depreciation. So operating earnings are a little higher quality than those of some other retailers -- many of whom may be incurring capital expenditures significantly in excess of depreciation.

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