Tag Archives: Sunday Times

What moved your favourite share’s price?

Learn about “Roam” – return on assets managed – and you’ll be all the wiser, writes Gaenor Lipson.

Ted Black

SABMILLER SHOCK: Ted Black says the brewer’s asset turnover no longer looks very healthy.

HOW do you measure what a company is worth at present, and therefore how much a share in it should cost? In other words, how do you rate a firm’s financial health in order to get a feeling for its prospects in the future?

The authors of Who Moved My Share Price? made a name for themselves by picking holes in Dimension Data’s operating principles, and — in the minds of many people — predicting the former JSE highflier’s demise.

The book is about the importance of “Roam” — return on assets managed — in determining the value of a company.

The ratio is calculated by comparing two figures. The first is asset turnover, derived by dividing sales by assets. The second is return on sales. To get this figure, divide profit (or earnings before interest and tax) by sales, and convert it into a percentage.

More recently, Ted Black and Andy Andrews have turned their guns on SABMiller. Based on their formula, the brewer fails the test of strength.

What makes Black so sure that it is worth investors taking a long, hard look at their favourite company’s operational history?

Asset turnover is the most important measure in the equation, he says. In the case of SABMiller, “I am not saying they are going under. I am simply pointing out that their asset turnover halved from 1.6 to 0.8 before the Miller acquisition, and Roam plunged,” he says.

“This is despite a very healthy return on sales of 16%. A sharply declining asset turnover is a warning bell and SABMiller’s management had better pay attention to it — as should their shareholders.” Black is critical of SA’s top management, which he says rarely uses the Roam formula.

“Some look at assets versus earnings and others ignore the assets altogether and focus purely on earnings in isolation. This can and has led to ill-advised acquisition strategies. Meanwhile, people lower down in the organisation do the asset managing, but don’t know about Roam.”

Many managers look only at the immediate business information, such as comparisons on a quarterly basis, says Black.

“They do not look at the data trends or the history of the company, the so-called big picture. Therefore, when the company runs into problems, such as poorly thought-out strategies that lead to a decrease in the productivity of assets, management’s response is to lay off workers.”

Black says a key question to ask managers is: “What is the smallest, easiest, least expensive change we can make that gives the largest measure of sustainable improvement?” Roam, he says, allows managers to design projects that can leverage both productivity and their own personal growth.

He and a colleague, Gerard van Hoek, are teaching Roam at Sasol to everyone from senior managers to mechanics, with a focus on projects that make assets more productive. Black regards US personal computer manufacturer Dell as “getting asset management right”. He says: “It has negative working capital ... a stock turnover of 90 per year and they get paid before they pay their suppliers — just like Pick ’n Pay, another company that knows about asset turnover.”

Keep an eye on how assets perform

RETURN on assets managed is a vital measure of a company’s value, say Arjen Lugtenburg, a portfolio manager at Allan Gray, and Rodger Walters of Abvest Associates.

Walters says: “It is one of the ratios I look at in understanding what a company does and how profits are generated.”

He says companies can have a declining Roam for valid reasons, such as the start-up of a new business or division. In this situation, there could be a large outlay of capital before a profit is made.

Another good reason could be a large capital outlay for assets that will last for years, even decades — for example, the stainless steel vats that brewers use, or printing presses that can last up to 20 years if they receive proper care.

However the purchase of an existing business is not a valid reason for a decline in Roam, says Walters: “If Roam declines, it means that the new business does not have sufficient earnings, but has increased the size of the company’s assets.”

He says it is important to know what was paid for the new business and what the competition would have paid.

Lugtenburg says assets that generate relatively high returns come with a relatively higher price tag. This is because the company can grow faster with less new capital. But companies must ensure that they do not overpay, which is what happened with Dimension Data. He says the IT company did not account for its equity properly.

If it had, it would have been apparent that the asset base had enlarged without earnings increasing to the same extent.

“This fact was hidden by the issuing of new shares at a very high multiple.

“This enabled them to access capital at a very low cost.”

Roaming for the right measure

CHARTERED financial analyst Charles Hattingh is a great fan of the “return on assets managed” ratio.

Roam, he says, gives a clearer picture of a company’s health than a commonly used measure, Ebitda — earnings before interest, tax, depreciation and amortisation.

He says Ebitda is “a fad” and adds: “It is a pathetic attempt to arrive at a surrogate for cash flows attributable to the operations of the company.” Here is why:

  • “Earnings can and have been manipulated by management to make headline earnings a share look good.
  • Interest is excluded from this measure, which encourages a company to gear its operations at the expense of increasing financial risk,” says Hattingh. “It also encourages the company to capitalise operating leases, which transfers rental expenses out of operating expenses and into interest and depreciation.
  • Tax is — but should not be — ignored as it is part of cash flow. Accelerated tax allowances can lead to tax being expensed totally out of line with the tax paid. The end result of discounting pre-tax cash flow at a pre-tax rate can be very different to discounting posttax cash flow at a post-tax rate.
  • Depreciation, like tax, is a cash flow, as it includes items such as rental. Capitalise leases and suddenly cash flows increase.
  • “Amortisation would not be a cash flow item if a company never had to replace the asset being amortised.” Against this, Hattingh prefers Roam, which recognises tangible measures such as:
  • Margin (operating profit after tax but before taxed interest, divided by sales); and
  • Operating gearing (sales divided by operating assets).

Written by Gaenor Lipson.

Get real and train people to achieve

Companies should beware of the ‘rain-dance’ approach, write GERARD VAN HOEK and TED BLACK

South Africa’s future depends on managers who can increase productivity. We need them desperately. That’s why companies and government are sitting ducks for improvement gurus, consultants and a host of specialists in leadership and management development.

TALLY-HO: White-water rafting is fun, but does it produce measurable bottom-line results?

TALLY-HO: White-water rafting is fun, but does it produce measurable bottom-line results?

They put people through endless programmes and courses to solve problems, overcome weaknesses, improve relationships and build capability.

It’s a “rain dance” and companies perform it with high hopes. They expect training and workshops to produce, as if by osmosis, improved results.

While some do improve year-on-year, others prance around lecture rooms and bush campfires wasting untold energy and money.

The cash, invested in people, “our most important assets” as annual reports put it, pours out at an ever-faster pace. The return on training “investment”, like rain in the Karoo, rarely comes. Why?

There’s no link to results. The focus is on “motivation” and “knowing”, not “doing”. We squander precious cash resources on lots of learning activity. Without behaviour change, or visible returns, cynicism flourishes.

So what can you do about it? Adopt an approach pioneered by Robert H Schaffer in the US and used successfully all over the world, including South Africa.

Start with a result. Link the learning to bottom-line performance. Instead of using a training situation to learn how to lead, or eliminate politics and conflict in the workplace, organise a well designed attack on a specific, short-term performance improvement goal.

The impact on results and teamwork is fast, visible and measurable. When managers employ new skills to get the results, success reinforces them immediately.

Instead of hoping for education and training somehow to lead to better performance, you achieve improvements in a way that grows people and builds teams. In turn, this sustains a cycle of momentum as one project leads to another.

The business impact approach to leadership development is to get managers to focus on what can be improved, not diagnose what’s wrong. It’s easy to develop a long list of obstacles and to find reasons why things can’t be done.

The challenge is first to convert a problem into an opportunity. Second, it is to carve out a short term goal and achieve it with minimal help. Third, the result must be achievable within the team’s resources and authority.

Go for a result, and use only those new methods and processes that help you achieve the goal.

In a loss-making steel service centre, that’s exactly what happened. The team focused on its bank overdraft for 100 days. They aimed to reduce it by several million Rands.

They didn’t hit target first time around but by day 150 they had a very different company. It generated a return on assets of 30%.

Specific learning points? The project forced them to redesign the business and to tackle many operating problems that leeched out cash and profits.

A cash focus also forced them to think like owners. That’s the only way a manager can act with intelligence or integrity.

No classroom course or business school case study will do that for you.

The education arm of a global IT company set a three-month sales goal to launch some new products. It brought them in 114% above their plan.

It was a wonderful lesson in leadership for the project champion, who acted as change agent, mentor and coach, all in one.

The effects? Two new members of the sales team were integrated far quicker than normal.

Collaboration between regional offices improved. So did the relationship with the field sales team, who found the customers.

Projects like these do more for morale, confidence, team-building and learning than any amount of white-water rafting or abseiling can do.

Our message is: strike off in an exciting new direction. Train for results with a business impact. A new vista of opportunities will open up for you. You’ll grow your people fast, furiously, measurably and productively.

Gerard van Hoek is senior managing partner of GvH & Ass and represents Robert H. Schaffer & Ass (USA) in Southern Africa. Ted Black is an author, independent productivity consultant and associate of Morgan University Alliance, a member of the Adcorp Group.