In an environment where stock market returns have been disappointing, avoiding companies that have suffered a significant share price decline has been even more important than usual.
And in 2018 there were many. EOH plummeted 55%, Tongaat Hulett fell 51%, Aspen dropped 50% and British American Tobacco tumbled 41%. MTN lost 31% of its value, Naspers 16% and Glencore 13%.
Spectrum of credibility
“There is this spectrum of companies right on the dodgy end and companies that are pretty good,” he told delegates at the 2019 Investment Forum.
Plaut says that ultimately investing is not about trying to spot the landmines – although it is helpful if you can – but about determining whether the price is attractive enough to compensate the investor for the risk.
Allan Gray, Kagiso and PSG have all had exposure to Tongaat Hulett; PSG to EOH; and Allan Gray to British American Tobacco.
Shaun le Roux, portfolio manager at PSG Asset Management, says EOH and Tongaat have cost their clients. In the case of Tongaat, the management team’s capital allocation left a lot to be desired and debt levels were high, but there should also be acknowledgement that the company was hit by a perfect storm.
“That is the nature of investing. You can’t foresee everything.”
Tongaat was hit by the severe drought, government neglected to impose sugar tariffs on certain imports, and the company experienced problems in Mozambique and Zimbabwe.
“These are things you just can’t model for, but having said that, clearly our initial valuation was wrong,” Le Roux says.
With regards to EOH, he says the business has done really well for investors over a long period of time and PSG placed too much faith in management – in particular their assertions with respect to the balance sheet.
“We’ve learned our lesson,” he says. “We circle back and do the post mortem, and it is part of investing – but avoiding the landmines has been very important in the last few years and will remain very important over the years going ahead and management [is] absolutely critical to that.”
EOH has brought forensic investigators on board to scrutinise its public sector contracts amid corruption allegations.
Le Roux says given the local environment over the last 10 years it is very likely that investors will read about other well-known companies where some staff members have sailed too close to the wind.
Scrutiny and discontent
In the aftermath of Steinhoff’s share price meltdown, and as many of these landmines emerged in 2018, independent boards, auditors and large shareholders have come under significant scrutiny. There has also been a lot of discontent about the exorbitant remuneration packages paid to the CEOs of listed companies.
“I don’t think you can blame the system,” Plaut says. “I think we’ve got to look at what we can do, and actually there is a lot more asset managers can do.”
Unfortunately, even when a major shareholder votes against a company’s remuneration policy, most shareholders often still support it. This is not something regulators or auditors can be blamed for.
Gavin Wood, chief investment officer at Kagiso Asset Management, says the auditing profession has a lot to answer for. It has let investors and the public down massively – particularly with regards to Steinhoff and possibly some other firms.
But asset managers also need to take responsibility.
“I think what investors need to look at out there is the asset manager.
“We are the custodian of that capital and at the end of the day we need to have scepticism where we see things that perhaps are too good to be true.”
Asset managers need to be a lot more sceptical around some of the common attributes of some of these so-called landmine companies, Wood adds.
These attributes include very charismatic management who charm the board, investors and auditors. Combined with poor disclosure, intricate financials that change from year to year and lack detail, an acquisitive growth strategy and a rising share price, it makes for a cocktail many asset managers have bought into.
If more scepticism was applied, it is possible that some share prices wouldn’t have rallied so significantly, and companies wouldn’t have been regarded as landmines.
“Perhaps, with some of these companies, there is nothing really wrong with them other than that the share price went too high and now has fallen a lot. So I place a lot of the blame at the asset manager’s door. We were paid to do due diligence. We need to do it properly.”