By now, we are probably all aware of the significant decline in the Steinhoff share price.
Sitting here in Australia, it has been interesting to read the various commentaries.
Alec Hogg (Biznews) published a comprehensive article from London on the 7th December.
It certainly was an eye opener.
Then he followed up with an even more detailed update on the 8th December.
I noted with interest his comment “Futuregrowth’s Andrew Canter – who didn’t have a cent of his company’s R180bn in assets exposed to Steinhoff – unpacks the detail in our interview on Biznews Premium.”
And so, out of curiosity more than a fear of loss, I asked Roger Williams, of Centaur Asset Management, whether we were exposed in any way to Steinhoff.
Here is his response:-
“After numerous queries from Centaur clients regarding Steinhoff, we are pleased to inform you that both the Centaur BCI Balanced and Flexible Funds had ZERO shareholding in Steinhoff.
At Centaur we run a rigorous and disciplined analysis of stocks before purchase. We did investigate Steinhoff however it failed to meet our investment criteria mainly due to:
• Management’s irrational corporate activity, paying excessive prices for acquisitions;
• A persistent lack of free cash flow when analysing the financial statements;
• Numerous allegations of tax irregularities.
The Centaur team is committed to caring for your capital as if it were our own and we remain committed to using our investment skill to preserve and grow your investment.”
I responded “Congratulations Roger – well done. The truth always comes out sooner or later”
Clearly I am not a portfolio manager, nor nearly as astute as Roger Williams, and clearly I have no inside knowledge about the “irrational corporate activity” or the “tax regularities” – but I do know about free cash flow and the essential need for its existence in a corporate environment.
It would appear that the management at Steinhoff does not!
Some years ago a leading South African financial academic, based on empiric research, determined that if s a company’s net cash flow was less than 5% of its total debt, it had a high probability of going into bankruptcy.
His research once again identified the essential need for adequate cash flows.
What constitutes “adequate” of course varies from company to company and its determination is based on such issues such as the debt/ equity ratio, the cost of debt, loan conventions, future capex and working capital requirements. – and of course shareholder dividend expectations.
Free cash flow can be defined in simplistic terms as that “bucket” of cash available to reward both lenders and shareholders – after all capex requirements, operating expenses and tax – calculated as if there was no interest – had been paid.
The absence of free cash flow would clearly indicate fundamental structural financial shortcomings and should send a strong warning message to management – particularly if it endures for some time.
Some financial management and persons involved in private equity erroneously believe that
EBITDA (earnings before interest, tax, depreciation and amortization) equals free cash flow.
Of course, this may be true on the rare occasion when there is no tax, no working capital and no capex.
None of these concepts are new – or revolutionary – and yet somehow this basic metric either eludes management or is deliberately ignored.
Of course in properly built financial models designed to assist management to make informed decisions, and provided the models are based on international best practice to ensure financial integrity, free cash flow is a standard output used in DCF valuations, IRR and NPV calculations.
So – a fundamental indictor of performance.
It’s amazing how sentiment and smoke and mirrors can trump fundamentals of good financial management;
As seems to be the case at Steinhoff.
Colin Human CA (SA)