Ted Black: Afrimat’s Buffett-inspired moat: Cash is king, hubris the foe

Key topics:.Afrimat applies Buffett-style capital allocation for sustainable profits.Efficiency and cash flow drive Afrimat's economic profit and growth.Managing asset productivity is key to Afrimat's financial success..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..Support South Africa's bastion of independent journalism, offering balanced insights on investments, business, and the political economy, by joining BizNews Premium. Register here..If you prefer WhatsApp for updates, sign up for the BizNews channel here..By Ted Black ___STEADY_PAYWALL___.Following this year's Biznews conference, fund manager Piet Viljoen published a RECM newsletter headlined "Reflections on Berkshire Hathaway". It summarised some of his favourite investment concepts from Warren Buffett and Charlie Munger. .He included a typical, pithy comment: "We think it's awful, frankly, the way businesses reward executives with absolutely no regard for the cost of capital." In other words, do they surmount that hurdle and profit economically? .It's a cash measure. My simple calculation is Cash Profit after tax less a charge for Owner's Equity of, say, 20%—not unreasonable. Using it for Afrimat shows the firm has made an economic profit fourteen times since its 2008 listing. .CEO Andries van Heerden writes in the 2024 Annual Report that he also looks to Warren Buffett "for inspiration now and again". Read what he has to say, and you see why. Taking Buffett's advice, "Never invest in a business you don't understand", he spells out clearly for shareholders where and how they compete, diversify, and their ongoing focus: "prudent capital allocation, robust cash generation targets, and production efficiencies". .The first exhibit, using the Return on Assets Managed Model, explains the economic profit link to that focus. It combines key financial sales-driven productivity ratios with their effects on a rising cash curve..Using Buffett's concept of "Moats", Afrimat builds its first defensive barrier with production assets bought at a discount. A higher Production ATO means less cash spent and a "Lower Capital Cost per physical unit" produced..Secondly, "spinning" inventory and debtor assets through the value/cost stream of activity—reducing the time from paying to being paid—means fewer "snafus," less waste, and lower "Ready-for-Sale" COGS. .With OPEX, they seem to focus a lot on people development—a "cost of the future"—and fighting bureaucracy. Put them all together, and you have a cash-generating, low-risk, high-return business. .Most growth through diversification doesn't work. Firms tend to match opportunity with weakness and pay too much. Afrimat doesn't. It buys distressed company assets and gets them at a discount. .Furthermore, they buy assets that relate closely to what they know and do well. This strategy matches opportunity with strength. As he says: "Anyone can dig a hole in the ground, but without the correct combination of people and culture, it will remain just that. Our approach ensures we deliver a beneficiated product from that hole that can be sold successfully"..He laments how many firms "cut costs dramatically, sometimes year after year … because they don't measure and manage costs consistently … at Afrimat, our focus on being a low-cost operator means we are always on top of this". If that's the aim – and for most firms, it should be the prime one – you measure and control operating costs but also have the right asset mix. So, what do their results tell us? .First, the asset productivity ratio trends. .They head down because, from 2014, management grew the total asset base 4.6 times, production assets 5.9 times, and made sales at a lower rate of 2.6 times. .Adding R3 billion assets in FY2025, including Lafarge, the critical task ahead is to halt the downward trends and, over time, aim to get the overall ATO back to 1.0 or more. .When below 1.0, it deflates the ROS% margin and lowers the overall ROAM%. It's a key measure for making an economic profit. .Next are the cost expense trends—both rising—which had a big impact on the Cash Operating Profit margin (ROS%), which improved by 54%..It seems they probably use measures to motivate people to do their best work and to improve continually. If so, it shows in these numbers and the next one—economic profit..As they are now in the cement industry, I thought it worth comparing their results with PPC's. In 2018, Transnet's problems severely affected Afrimat. Economic profit was achieved every year from 2015, even with 4.3 times asset growth. That's some going..However, PPC is now moving in a northwesterly direction and may well be above the line for FY2025. Still digesting Lafarge, Afrimat is unlikely to get above the line this time, but you never know. .Finally, we come to Value-of-the Firm..In companies, few people, even managers with stock options, fully appreciate the value of equity or what fundamentally drives it. As this chart clearly shows, the productivity of the asset base does – especially its cash productivity. It pays for Afrimat's profitable growth and the higher value of its equity..Just a final word of caution from another common sense source. Top of the list of achievements in the report was van Heerden's News 24 award as CEO of the year. They used to say that appearing on the cover of Fortune was the "kiss of death" for a CEO. .With the addition of Lafarge, It brings to mind an observation made by Robert Townsend's 1970 management classic "Up the Organization". It was headed "Hubris, the sin of – and went on. "Managers tend to make their biggest mistakes in things they've done best. In business, as elsewhere, hubris is the unforgivable sin of acting cocky when things are going well. As the Greeks tiresomely told us. Hubris is followed inexorably by Nemesis.".It's also wise to always keep Murphy's Law in mind. The last time he struck was in 2018 through Transnet. However, based on results achieved by management and its people, the omens for Afrimat look good..Read also:.Afrimat CEO Andries van Heerden: Tough times, turnarounds, and future growthBNC#7: Piet Viljoen and Kokkie Kooyman – Lessons from Warren Buffet and Charlie Munger, The Oracles of OmahaJSE shares are now tradeable on Standard Bank's forex and investment platform Shyft .*Afrimat has been added to the BizNews Shyft portfolio. Watch the latest webinar and BizNews portfolio update here.

Ted Black: Afrimat’s Buffett-inspired moat: Cash is king, hubris the foe

Related Stories

Old School SA’s Stellenbosch brothers riding Bafana Bafana fever sweeping the country

The hollowing out of Eskom: De Ruyter's prophecy becomes reality

Beyond the metros: Where SA's real political battle in November is brewing

Hedge Fund thinking meets the beautiful game — Inside America's World Cup ambition