SA Inc acts in bad faith when it blames the economy for its failures
by Andrew Dittberner - CIO at Old Mutual Wealth Private Client Securities
The state of the local economy, rising social unrest and uncertainty around policy make it very easy to understand the lack of faith that investors have in the local equity market.
Investor sentiment is further dampened by the blows to corporate SA following the numerous corporate scandals that have erupted in recent times. Right now, it is difficult to see the light at the end of the tunnel, and this is only exacerbated if one reads a newspaper, watches the news or listens to the radio. It will likely result in the conviction that SA is the next Venezuela or Zimbabwe, the rand is on a one-way trajectory, foreigners are unwilling to invest in SA, the consumer is overburdened, corruption is rife, or something along those lines.
Such narratives, however, carry little to no value anymore and can best be described as exhausting and repetitive. Yet, as an investor what is more repetitive, more exhausting and equally lacking in value is the ongoing narrative from company financial results presentations of locally listed companies.
It is not easy to find an SA Inc company whose commentary in its financial report does not, at the very least, make mention of the local economy impeding its progress. Some go even further to blame the economy for their situation. Not for one minute do I believe that the economic environment does not play a role in the functioning of corporate SA; it absolutely does. And we see this, both locally and globally. When economic growth abounds, corporate sales typically follow suit, which in turn should lead to improved investment returns, assuming all else is equal (valuation included).
The issue though is that when times are good, management teams are very quick to receive the accolades associated with solid performance — which very often include misaligned, over-the-top incentives, bonuses and pay cheques — with very little mention of the fact that the tailwind provided by the economy played a significant role.
Similarly, when times are good, investors and analysts — not to mention auditors — are too blasé in their role as corporate watchdogs, looking past potential red flags. Because, as share prices rise and the punch is flowing, little else matters. But when the music stops playing, as it always does, the skill of the previously perceived brilliant management teams who steered the ship so superbly in calm waters is now nowhere to be found and instead it is an economic problem, a rand problem, a political problem, or a combination of all three.
Great management teams have the ability to weather difficult market conditions, not through manufacturing top-line growth, financial engineering or the like, but rather through ensuring that the businesses they lead have the ability to withstand tough economic environments. This requires financial prudence and sound capital allocation decisions, in both good times and bad.
Looking back over recent history, there is a long list of SA companies that have seen their share prices wipe off billions of rand from the local market. Such companies include Steinhoff International, Tongaat Hulett, MTN Group, Aspen Pharmacare, Tiger Brands, Resilient, EOH, Group Five, Taste Holdings, Mediclinic, Sasol, Calgro M3 ... the list goes on.
The question that needs answering when looking across this list of names is: how much of the value destruction can be attributed to the economic environment and how much to poor management decisions at best, or pure unethical behaviour at worst?
The precise answer is obviously not straight forward. However, poor management decisions have not played an insignificant role in the plight of corporate SA. Some may point to the fact that the environment pushed management into taking decisions and actions they otherwise might not have, and there may be an element of truth in that.
Yet some of the behaviour that has taken place inside SA boardrooms is inexcusable. Cutting corners, deceiving shareholders, fiddling financials, putting one's own interests ahead of minority shareholders, giving scant regard to corporate governance, not heeding regulators' warnings and attempting to build empires through overpriced acquisitions or overly ambitious projects with capital that does not belong to them has very little to do with the economic situation.
Alongside this, SA auditors who were once held in high regard globally are busy picking up the pieces of their previously solid reputations. Again, through no fault of the economy's.
As always though, there are a few shining stars proving their worth through good times and bad. SA Inc companies that spring to mind include Afrimat, AVI, Hudaco, Capitec, Clicks, Italtile and CMH. These companies are all heavily exposed to the local economy yet are managed by superb management teams with the ability to navigate through good and bad times.
Against this backdrop, you may be asking yourself where the silver lining could possibly be in all of this.
Periods such as the current environment, where corporate SA has not done itself many favours, should afford us the opportunity to reflect on our mistakes of the past and to clean up our act. Similarly, companies that may have been operationally inefficient, overly indebted or carrying a lazy balance sheet would have had to adapt in this environment in order to survive.
The result is that corporate SA may slowly start to rebuild its once excellent image as corporate governance takes a step in the right direction. Auditors may start to repair their tarnished reputations by doing the right thing, and regulators will be more determined than ever to keep order.
The investment community needs to play its part too. Becoming more active and engaged with management teams is critical in order to ensure that the interest of minority shareholders comes ahead of those at the helm.
Although difficult to see right now, getting all these right must surely be positive for investor sentiment, which will ultimately play out through local market valuations. Why would improving operational performances, improving transparency and solid corporate citizenry not be good for sentiment and valuations?
Having said that, it is up to us to ensure that we get it right. And while I am often reminded that hope is not an investment strategy, with just a little bit of hope would it not be great if the economy provided the market with the much-needed impetus?