Ted Black: A closer look at Richemont, Steinhoff and Naspers’ ATO problem

JOHANNESBURG — The likes of Naspers and Richemont have become valuable companies on the JSE. In a report this week on Bloomberg, it was revealed that because of these two companies’ strong foreign focus areas (Naspers has a 34% stake in Tencent and Richemont is headquartered in Zurich), the companies have largely helped keep the JSE in positive territory, despite a mass exodus of foreign buyers from other stocks. Steinhoff has also embarked on a global expansion. Ted Black, then, looks at all three countries and the single problem that they all face Asset Turnover (ATO). He makes some interesting findings, especially around the risk that Naspers’ faces in terms of a possible, unstoppable value destruction curve. – Gareth van Zyl

By Ted Black*

I am no financial analyst, so treat the thoughts that follow as questions up for debate.

Looking at Richemont, Steinhoff and Naspers financials through management eyes shows they all share something in common. They are capital intensive. However, the reasons for it differ in each company.

Johann Rupert, founder and chairman of Cie. Financiere Richemont SA. Photographer: Chris Ratcliffe/Bloomberg

During his last presentation to analysts, Johann Rupert talked about buying firms to grow. He said, “Our shareholders expect us to build brand equity – not pay other shareholders goodwill. They exit at a huge premium and we have to eat it up.” He speaks from experience. He wrote off around €3bn in goodwill after the dotcom bubble burst.

Not long ago, Richemont and Steinhoff had similar sized asset bases. Today after some big acquisitions, Steinhoff’s is €35bn to Richemont’s €20bn. While Richemont’s intangibles and goodwill are 3.8% of Richemont’s total assets, Steinhoff’s are 50%.

Taking a long view with international strategy, paying lots of goodwill does not stop Marcus Jooste and his team from walking away from what they see as the right deals. Since 2008, intangibles have never been less than 30% of Steinhoff’s total assets. They are now 50%. What does that mean for operating managers?

Cash is cheap. The finance costs at the half-year are less than 3% of total borrowings. The Steinhoff business is designed to control costs. This it does well. COGS, cost-of-goods sold, is about 60% of sales which provides a healthy gross profit to fund aggressive marketing.

Read also: Ted Black: Pricking the Naspers bubble? Declining Cash ROAM

However, there’s another “Cash Cost” that doesn’t appear in the Income Statement and that’s the Cost-of-Equity. If Marcus Jooste were to levy a charge on operations for that, at say 15%, average for any company of repute, that’s another cost of €2,5 billion – more than the profit his management generates.

The problem is not sales profitability (ROS% – Return-on-Sales), it’s asset productivity, or Asset Turnover (ATO). It’s the same problem all three firms have. It doesn’t matter what level of management you look at, there is a constant problem (with acknowledgements to Stephen Leacock, Canadian humourist and political scientist in the early 20th Century):

“If you forget to prioritise ATO, you can dash out tomorrow, leap upon your ROS horse and ride madly off in all directions and never reach ROAM.”

A Steinhoff International Holdings NV logo sits on display outside the company’s offices in Stellenbosch, South Africa. Photographer: Waldo Swiegers/Bloomberg

ROS, ATO and ROAM are the three most important measures of operating management and ATO is the one that’s least measured, yet the first of the three. Jeff Bezos understands that and most people don’t. Even a recent article in the UK’s Daily Telegraph on a potential new Dotcom bubble, he remarked that Amazon has “only just got around to making a profit”. Utter nonsense.

Bezos focused on Cash (not accounting) profit from the start. Since 2004, Amazon’s Cash ROAM has averaged 18% and the firm has generated a cumulative economic profit (after charging 15% Cost-of-Equity), of $45bn over that period. That’s an average of $3.5bn a year for thirteen years.

Read also: Academics discover why Amazon shares outperform Google’s – it’s called ROAM

At the same cost of equity, in the last two and half years, Steinhoff has begun accumulating an economic loss of about €2bn. That’s understandable given the re-positioning strategy. The problem is that both Poundland in the UK and Mattress Firm had also been on the acquisition trail so their balance sheets show intangibles of more than 50% of the asset base.

It seems to take the capital markets a very long time to wake up to the implications of an economic value destruction curve but eventually the trend becomes unstoppable and the chickens come home to roost.

So, what does it mean for Steinhoff? The good news is that their recent acquisitions, despite some hiccups, seem to be high ATO firms. Mattress Firm “spins’ its inventory 16 times a year. For every $1 of inventory, they generate $15,80 of sales. That’s no mean feat.

The task is clear. Given the re-positioning strategy of the past few years, the chart below shows the link with productivity. Steinhoff must now get into a yellow box – Asset Productivity (ATO).

In the end, productivity drives positioning, not the “Big Deals”. Value is created by exploiting competitive advantage – creating customers through providing quality products, at higher relative ATO and lower relative COGS, not the accumulation of assets. The aim is to dominate markets by being good at what you do.

Richemont took a blow to the bottom line last year. An operating ATO that has fallen from 1.5 to 1.2 links to that and resulted in an economic loss. Ironically, the loss could be a penalty of success. Even though the operations generated a Cash ROAM of 18%, almost 80% of the asset base is now funded by the equity that has been built over the years. As equity is expensive, it gets tougher to beat its cost.

Lastly there’s Naspers. The reality is that it generates only 30 cents in sales for every $1 of assets. Using the same 15% Cost of Equity and despite Tencent’s contribution, Naspers’ cumulative economic loss since 2008 is around R50bn.

There’s a lot operating management must do to lever up asset productivity. Unlike Steinhoff and Richemont, all its ROAM trends head south west. If it doesn’t start doing something soon, then the value destruction curve will become unstoppable.

Of course, that’s if you agree with a 15% charge for equity!

  • Ted Black runs workshops, and coaches and mentors using the ROAM model to pinpoint opportunities for measurable, bottom-line, team-driven projects. He is also a freelance writer with several books published. Contact him at [email protected].
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