Ted Black: NOT buying Rainbow shares isn’t chicken, it’s the rational move

Rainbow Chickens has returned to the JSE, a notable shift after significant financial struggles and losses since its 1998 peak. Johann Rupert humorously reflected on the decision to acquire the company, acknowledging his late mother's caution. A deep dive into cash-based productivity reveals past mistakes and the need for better asset management. Despite improvements from 2003-2009, recent trends, including the 2024 forecast, highlight ongoing challenges in achieving profitability and cash return targets..Sign up for your early morning brew of the BizNews Insider to keep you up to speed with the content that matters. The newsletter will land in your inbox at 5:30am weekdays. Register here..Join us for BizNews' first investment-focused conference on Thursday, 12 September, in Hermanus, featuring top experts like Frans Cronje, Piet Viljoen, and more. Get insights on electricity and exploiting SA's gas bounty from new and familiar faces. Register here..By Ted Black.Rainbow Chickens, taken out of RCL Foods, has relisted on the JSE. In 1998 it posted a result that brought total operating losses for three years to R365 million. Market Cap was R280 million – R1,5 billion lower than it was in 1992 after buying Bonny Bird/EPOL. .___STEADY_PAYWALL___.The dismal results led Johann Rupert to humorously admit at the AGM his late mother told him not to buy the company. A cash-based productivity calculation shows why it was a bad idea to ignore her advice. It's a measure all those brave enough to take the gamble to start and build their own business have front of mind. .Read more: Rainbow Chicken's JSE debut: CEO Stander and financial expert Shapiro on navigating growth.Successful entrepreneurs focus on cash. Unlike accounting profit it's real. The amount of cash they generate soon becomes "House Money" that funds profitable growth..For Rainbow's managers, it means unless they generate a cash profit after paying tax that's at least equal to the owner's "Cost of Equity", they run the firm at a loss. What could Rupert's cost or "demand" of them be?.Given other attractive options his family has so successfully invested in – cigarettes, booze, baubles, bangles, and beads – let's assume he would expect at least a 20% return on his money. Take that away from cash profit after tax before dividend payouts, then this is the picture of Rainbow and rival Astral measured the same way for each year of their listing on the JSE. .Before Rupert bought Rainbow it made economic profits. A year after its 1989 listing it posted its first economic loss under new ownership. Once management bought Bonny Bird/Epol from Premier, the year-on-year cumulative line plunged. The lesson is to be wary of buying market share that adds low return assets to low return assets..There was much improved profitability from 2003 to 2009. Doing the right things and helped by good economic factors, more than doubling operating margins for three years raised market capitalization 1500% from the 1998 low point. Those who bought shares at their lowest level and sold after the turnaround did very well indeed. Of course, managers did too by cashing in share options. Long-term investors stayed stuck at the back of the queue-for-cash. .The downward trend started again in 2010 shortly before the firm bought Foodcorp and became RCL Foods. Was this an attempt to create another Tiger Brands perhaps? If so, the "Me Too" strategy triggered the next steep, downward slide. So far, it is a repeat of the Bonny Bird mistake – low return assets added to low return assets. The effect is a growing, total economic loss of R10 billion with more to come. .As for Astral, albeit with a bit less equity funding the asset base than Rainbow – average 46% compared to 54% – management chalked up an economic loss only four times from 2022. The biggest by far being in 2023 when Eskom's power cuts and Bird Flu whacked all chicken firms. .So, taking this measure a bit further, what Operating Cash Return on Assets (Cash ROAM%) must management achieve to meet the "Owner's" demand?.The next slide shows Cash ROAM performance of both firms since 2013 with its link to economic profit/loss each year. It also shows the "new", not yet improved, Rainbow Chickens on its own for the last three years..The chart helps clarify the Cash ROAM target. It's more than 10%. Newly listed RBW Chickens' results are of concern because the equity number is as low as 10% of assets in 2023. From 2024, based on an analyst's review used to advise RBW Chickens shareholders, equity will go from R700 million to R4,5 billion. .Operating cash profit is to rise from a loss of R200 million in 2023 to R800 million profit this year – a billion Rand turnaround. Given past performance, is that based on optimism or realism? Yet, despite lifting Cash ROAM from -3% to 12% in FY 2024, it won't be enough. An economic loss will be posted every year till 2028. .Finally, there's a strange statement in the lengthy pre-listing statement under the heading Great ListCo People. It starts with: "ListCo's leadership team firmly believes in the business philosophy that People Trump Assets..Shareholders should hope it doesn't mean the Board and CEO back the idea common amongst social scientists and HR functions that it's not whether you win or lose, but how you play the game. If that's the belief, then why keep score?.Management's task is to make the firm more valuable. There are many ways to value a firm, but whichever way you do it, it's rooted in the productivity of the asset base. Assets are the resource managers "own" and use to play the game of business. People don't trump assets, they must manage them..Making money and generating cash from assets is how you keep score. People are "The Horse" and the number they achieve is "The Cart". The number tells you how well the firm is designed and how well people do their work together. .Trouble comes when you put the cart before the horse – you chase numbers instead of designing the right systems and tasks for people to work more effectively together. Could that be the main reason Astral consistently outperforms RCL Chickens … that it has a different, better business design?.Reverting to accounting profit, the next slide shows the effect asset productivity has on the value of a Rand's worth of equity. This one includes AVI and Tiger Brands..It shows two things clearly. First, how much the cash productivity of the firm affects the value of equity and secondly, chicken farming is seen as a high risk/low return business to be in. The people who make most money from chickens are those in the fast-food business – RCL's main customers..But then again, the firm is such a small part of Rupert's interests, but a significant one for South Africa. Backing it through thick and thin is another way of showing his commitment to the country..Read also:.Johann Rupert's listed empire: Remgro, Richemont and ReinetThe chickens are out for Patel – Ivo VegterSun International to cut 2,300 jobs; Mashaba launches Action SA; RCL Foods; ICA

Ted Black: NOT buying Rainbow shares isn’t chicken, it’s the rational move

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