The unfolding Steinhoff-saga sheds a light on many of the key factors that equity investors need to take into account when assessing the viability of a company as a long-term investment.
A couple of weeks ago I was tasked with doing an in-depth assessment on the investment merits of global luxury retailer Richemont. My findings were very positive and in the face of the unfolding Steinhoff-sage, I decided to compare the merits of both companies.
There might be a minor parallel between Steinhoff and Richemont, with both companies hailing from the Cape Winelands and incorporated in Europe, but this is where it ends - it is clear which horse should be backed for long-term success.
1. Business strategy - Building brands versus building an empire
Richemont owns a portfolio of the world’s iconic and timeless luxury brands such a Cartier, Mont Blanc, Van Cleefs & Arpels and Dunhill. These brands have proven to be extremely durable, with some having been in existence for over a century. They have withstood multiple economic cycles and fashion fads.
Steinhoff’s attraction was always the perceived ability of now ex-CEO Markus Jooste to extract value from a series of strategic acquisitions. Creating value through acquiring businesses is not uncommon, but it has been apparent for some time that Jooste executed poorly - Steinhoff’s return on capital has been well-below double digits during the past five years.
Johann Rupert is opposed to large acquisitions, as reflected by the following statement at Richemont’s latest annual results presentation: "We know the business, we know the management. We don’t have to pay a takeover."
2. Strength of balance sheet
A natural consequence of Steinhoff’s aggressive acquisition strategy is its high debt level. Its balance sheet carries "published" debt of € 16.3 billion versus equity of € 15.9 billion. Not extreme, but well above its industry peers on a debt-to-equity basis.
Richemont has a pristine balance sheet, with € 4.5bn of cash almost enough to offset its liabilities of € 4.6bn. There is basically zero chance that Richemont will will run into debt problems.
3. Cash flows and funding
Due to its strong free cash flow generation, Richemont effectively funds its own growth through reinvestment. As such, the company doesn’t have a need to raise capital by issuing new shares. Steinhoff regularly issues new shares, which has placed a drag on its earnings and dividend growth on a per share basis.
4. Track record
All the factors mentioned above contributes to a company’s track record, which can be evaluated through its long-term growth in dividends per share (DPS).
Richemont, while displaying volatile earnings over short-term periods, has been exceptionally successful in growing its DPS over the long-term (as seen in the table below). Steinhoff, while not bad at all, has grown at a more pedestrian rate.
DPS growth per annum (in ZAR-terms):
It’s easy to get caught up in the hype of a share when the CEO states that he intends to double the company’s market value over the next five years. However, it remains important to go back to the basics and assess the time-honoured qualities of companies that have proven successful investments over multiple decades.
Richemont - given its strong cash flows, iconic brands and a healthy balance sheet - has many of the qualities of the exceptional business. This is reflected in its successful track record.
Steinhoff is a mediocre business that was run by an enigmatic CEO. But an enigma is a complicated puzzle that is mysterious and difficult to understand. So, let’s end off with sound advice from Peter Lynch: "Go for a business that any idiot can run - because sooner or later any idiot probably is going to be running it".
Wim Prinsloo, CFA
Portfolio Manager at True North Capital Management
Wim Prinsloo serves as portfolio manager at True North Capital Management. He holds an honours degree in investment management from the University of Pretoria and is a CFA charter holder.
Wim’s work at True North includes the management of the firm’s equity and property unit trusts, development of its investment processes and ensuring best-in-class service to clients. He benefits from 7 years of experience in the investment industry and is a member of the Investment Analyst Society of South Africa.