Shareholders carry can for strategic blunders at Sasol, Group Five.

MOOI RIVER - Economic activist Nassim Taleb has written a couple of bestsellers containing countless examples of how, when it comes to money, it's better to be lucky than brilliant (they can be purchased from the Moneyweb Shop) . Often, business mediocrities have been massively rewarded through factors other than their own talent. Taleb is not the only one to make a strong case that many of those earning large executive salaries have done so because of being in the right place at the right time rather than the possession of any special talents.

This philosophy will attract legions of new supporters as the economic downturn continues to reveal examples of poor executive decision-making. Or, to use investment guru Warren Buffett's terminology, when the tide goes out we get to see whose been swimming without any trunks.

The problem with all this is by the time the mistakes surface, those who made them have often banked their millions, leaving shareholders to pick up the tab. So it has been in the case of construction business Group Five (JSE:GRF), which reported results last week; and oil-from-coal giant Sasol (JSE:SOL), whose interims were released on Monday. In both cases, shareholders would have been better off with managers who had sat on their hands - rather than embark on what proved to be expensive blunders.

Although the overall figures from Group Five were solid with earnings and dividends up 8%, those willing to dig deeper would have picked up that a business bought for R750m just three years ago has turned into an unmitigated disaster. CEO Mike Upton tells me the business, Quarry Cats, currently operates at no better than break-even. At the time of the acquisition, done entirely through the issue of shares (which diluted each shareholder's stake by 14%),  his predecessor Mike Lomas made the off-beam forecast that the deal would be "strongly earnings enhancing".

Lomas is long gone, but surely a decision like this wasn't his alone. The Group Five board should be asked why they did not consider well documented research which tells anyone who cares to read it that, worldwide, 80% of acquisitions fail. They have served shareholders poorly. Perhaps we will see some impact in the next round of executive bonuses and director remuneration.

The detail within today's half -year results from oil-from-coal giant Sasol raises similar questions on the ability of the board to fulfill its primary purpose of taking sensible strategic decisions.  

As our table, tracking each of the half years results since 2007 shows, Sasol's earnings are extremely volatile. This is because despite large investments in chemicals and mining, the group's performance is dependent on a single factor over which neither its managers nor its board has any control. That's the rand price of oil - the figure that determines the revenue it receives for its dominant product, the fuel produced from coal.

In recent years, both the global oil price and the exchange rate of the rand have been highly unpredictable.  For instance, operating profit hit a record R21.5bn in the half-year to December 2008, then collapsed to just R3.1bn during the next six months.

One can argue that a major responsibility for boards faced with this kind of profit volatility is to tuck away excesses earned in the good times; and be sure its managers are not rewarded (or penalised) for that which they cannot influence. As with Group Five, Sasol's board failed shareholders on both counts. And did so despite ample research freely available - and we're not referring here to the disastrous Nigerian adventure which cost billions nor the continuous commissioning delays in Qatar.

Buffett might be the highest profile voice against them, but he's by no means alone in his criticism of companies repurchasing their own equity. Academic research reveals that share-buybacks are often promoted by executives focusing on the short-term issues (the share price) than the long- term requirements of the business.

Rather than taking heed, Sasol's board approved and implemented a double jeopardy strategy in 2008. Not only did it give the thumbs up for management to buyback Sasol shares at what hindsight shows was inflated prices, but the group actually borrowed heavily to do so. Some R12.5bn in debt was raised in 2008 to be spent on share purchases in the open market at prices significantly higher than the current R288. Only when the financial crisis hit during the six months to June last year - smashing Sasol's profits to a fraction of their normal level - was this costly strategy reversed.

Linked to this blunder was the board's inability to reward executives only for what was within their control. So the first half bonanza followed by the collapse in profits had the perverse effect of putting a hefty R3bn into the pockets of executives through "share based payments" - the cost of share options to staff. At the current run rate, that's equivalent to three months' total attributable profit. And in spite of "ordinary" six months to December 2009, a further R524m was gifted to management in this manner by its shareholders. Ordinary, that is, in the sense of a commentator being kind to a sportsman having an off day.

The good news is Sasol's numbers lifted off the trough of the previous half-year (to June 2009) and its interim dividend was raised 12% in spite of a 51% earnings drop from the record of the directly comparable period. But the numbers don't travel as well when compared with the most recent half year when it received a similar price for its major product.

At the risk of being accused of over simplifying the analysis, the best comparison for Monday's results would be during the six months for the half year to end December 2008. Then the oil price averaged R568 a barrel compared with the R545 a barrel in the half year under review.

In 2008, headline earnings per share were 36% higher than those reported on Monday, primarily because Sasol's profit margin has fallen from the 25% norm of the past few years to a less flattering 18%.  Employee costs - something which management can influence in a group like this - have jumped from 11.6% in 2008 to 14% of revenue now. Operating cash flows, long Sasol's strength, have fallen more than a third from R14.1bn to R9.2bn.

For a group that churns out more than R1.5bn in free cash every month, shareholders can and should expect better from both the strategic direction provided by the board, and the group's well-paid managers.  Until that is shown to be the case, those who want a punt on the rand price of oil may do better by investing directly into the JSE's Oil Futures.  At least with that vehicle there's no sharing of super profits with those who haven't earned them.

Write to Alec Hogg: alec@moneyweb.co.za or follow him on www.twitter.com/al echogg. Alec Hogg is Moneyweb's founder and editor in chief. You can hear him every weeknight on SAfm's Market Update with Moneyweb just after 6pm.

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