Value destruction at cement producer PPC: Figures that’ll make your eyes water – Ted Black

PPC is a JSE-listed company that supplies cement and related products across Africa. It’s the type of business you’d expect to do really well as countries develop. The company performed poorly when Covid-19 containment measures brought business activity to a standstill, but the pandemic seems to have exposed hidden vulnerabilities. This is underscored in in-depth number crunching by independent analyst Ted Black. He sets out his data to highlight that PPC has been a poor performer when assessing its returns on assets managed. Black notes that value destruction has been massive, with the company worth about R5bn compared to R30bn in 2007. The PPC stock has shown signs of recovering in recent months, which Black sees as a sign that it might be draining its swamp.  – Jackie Cameron

Marketing the Firm (Part 1)

By Ted Black*

Today, share buybacks and employee option schemes are headline news. However, many view them as a means of value extraction, not value creation, and for good reason. If the prime purpose of stock options is to get management and employees to walk in an “Owner’s shoes” – to think like a long-term shareholder, an exemplar being Warren Buffett, and then to behave like a genuine entrepreneur who puts customers first, then they don’t seem to work too well.

Ted Black

Buffett says: “I like businesses I can understand … that narrows it down by 90% … anyone can understand this.” He holds up a Coke bottle. “It’s a simple business, but not an easy one. I don’t want an easy business for competitors. I want one with a moat around a valuable castle and the Duke in charge to be honest, able, and hard working.”

“People buy a share, and they look at the price next morning to decide if they’re doing well or not … that’s crazy. You aren’t buying a share … you’re buying part ownership in a business. That’s what it’s all about.”

How many members of company share option schemes have that explained to them? Do they understand how valuable the free equity they’re given really is, let alone what the critical numbers are that build the moat and castle? As Buffett says, “I want a business with great economics, and then I can see in a general way where they’ll be ten years from now. If I can’t, I don’t want to buy it.” His one message for managers of companies Berkshire Hathaway owns or invests in: “Widen the moat!”

That means throwing crocs and sharks into it through brilliant business design, low costs, good service, high product quality, patents, and choosing carefully where to compete – to have a “Game Plan” that acts on the right tasks – opportunity and productivity-driven ones.

Productivity and profitability of assets drive a firm’s long term value. The only valid measures of management’s intent and results are productivity ratios – not a share price. The Return on Assets Managed financial model below (ROAM), contains the most important of them. It is a simple but certainly not simplistic way to measure the “economic moat”.

The three most important measures of operating management are ATO, the ROS% – both link to sales – and the ROAM%. They are closely followed by the “Ready-for-Sale” Cost of Goods Sold (COGS) – usually about 80% or more of total cost and expenses (OPEX).

This chart shows the correlation between EBIT ROAM and value of the firm (VOF) measured as market cap Ă· total assets. The sample size is 142 firms on the JSE.

The link’s clear. You don’t need complex measures like EVA or Cash Return on Invested Capital to get the message across to people. Moreover, you only have to focus on the assets on the balance sheet and stop at operating profit, or earnings, before interest and tax on the income statement (EBIT).

The productivity moat and castle start with assets and their sales productivity. This prompts the first strategic marketing question: For each Rand of assets we own, how many Rands of sales do we generate? That’s ATO – the asset turnover number. Here’s a chart that shows how it is the foundation stone for building up the defensive productivity barriers …

To illustrate, let’s use a sample of one – PPC Cement, a highly asset intensive business and one that has faced many headwinds in recent years – not least one that blew away its, protective cement cartel umbrella.

The first measure, a hybrid one, is the “Capital Cost per Ton of Cement Sold”. If you need more production assets than your rivals to produce and sell a ton of cement this will hobble you before you even start to compete.

The next chart shows PPC’s Property, Plant and Equipment (PPE) asset productivity decline since 2012.

The link between ROAM and the VOF correlates perfectly at 1,0.

The three charts paint a picture that I bet less than 5% of PPC’s managers, let alone any employees with shares, would have seen or had explained to them. They also reveal one of the biggest barriers to productivity improvement in all firms – financial ignorance. It spreads like a virus from boardroom to the lowest levels – a problem but also an education opportunity with a huge payoff.

That was the moat. Now to the final stage – the castle. After announcing their annual results, CEOs and CFOs perform a key task for the firm, a marketing one. It does in a similar way what marketing managers must do for products and services – make it easy for customers to buy them.

The task of marketing the firm is to influence capital market perceptions – to maximise its value in the minds of long-term investors and lenders. Done credibly, it lowers risk, cost-of-capital and lifts the P-E Ratio and VOF.

Two questions start the process:

  • How do we wish to be viewed?
  • For which opportunities and achievements do we want to be most highly valued?

If results show the firm as being a low cost producer and/or the most differentiated, the capital markets will likely view it as a low risk, high return investment. By doing that, you dispel a widespread management myth: All things being equal, higher risks are rewarded with higher returns, at investment, industry, and company levels.

The reality is that successful entrepreneurs are highly disciplined, and know that winners achieve a high return, low risk position. Losers are forced into a high risk, low return one. That’s where PPC still seems to be today, but hopefully now starting to drain the swamp it’s in.

Next is the subject of share buybacks … also part of the corporate marketing task.

  • Ted Black is a mentor and coach, he uses the ROAM financial model and a 100-Day Action Project method to pinpoint and convert fuzzy problems and opportunities into high-precision, team-driven projects. Their aim is personal growth; to jack up learning fast, and to measure with tangible results. They are management on a small scale – the rule is less talk, more action. Black has written and co-authored several books that include “Who Moved My Share Price?” published by Jonathan Ball.