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Is there a witch-hunt for the next Steinhoff?

In an environment of negative sentiment, mispricing may create opportunities.

In the aftermath of Steinhoff’s spectacular meltdown, there have been various examples of local firms whose share prices have fallen significantly more than one would have expected after even the slightest bit of bad news.

Still bruised from the losses suffered in what will possibly be remembered as South Africa’s biggest corporate scandal, investors fled for the exits at any sign of trouble, scared that history would repeat itself.

Of course, three years of very disappointing local stock market returns have fuelled a lot of negativity and short-seller Viceroy’s reports didn’t help. And with Steinhoff’s demise having highlighted the problems posed by a charismatic leader, an acquisitive growth strategy and a lack of disclosure, these issues remain top of mind when other firms are analysed.

There are numerous examples of companies that have experienced sharp share price declines over the past 16 months – even if only temporarily – including Capitec, EOH, Tongaat Hulett, Aspen and the Resilient Group.

The power of a negative headline

Speaking at the Investment Forum 2019, Shaun le Roux, portfolio manager at PSG Asset Management, said that in an overall environment of terrible sentiment, negative headlines can have a pronounced impact on share prices.

“If you are reading the press and following social media it almost feels like there is a witch-hunt for the next Steinhoff on the go, and that is an environment in which mispricing is more likely to occur.”

But there may also be an opportunity to use these kinds of events to one’s benefit.

Le Roux says investors should do their homework, avoid the landmines and invest in companies that are going to be mispriced in such an environment because the return profile should be very attractive.

Unfortunately, humans are poor at understanding statistics and probabilities.

Gavin Wood, chief investment officer at Kagiso Asset Management, says one of the biggest mistakes people make is to take a small number of events and use them to make a rule, even though the events are unrelated.

‘Bad news’ in perspective

While there was one particular case where the share price collapsed due to corporate fraud, at Steinhoff, there were others where share prices were too high and corrected.

This has resulted in a situation where investors overreact as soon as there is some trouble or a Viceroy report.

“I think there is a huge opportunity that [this] presents to investors who have a long-term view and are doing their homework,” says Wood.

The South African market is not particularly familiar with short-sellers, and some of the hype Viceroy created around management, acquisitive growth or the lack of disclosure was overdone.

Distortions

But while scepticism can be a good thing where it is warranted, it becomes problematic where a short-seller exploits a platform to distribute one-sided or selective information that distorts the picture and causes panic, Wood says.

This is particularly problematic with regard to companies in the financial and banking sectors, he adds.

Banks are generally highly leveraged and require investor and depositor confidence to operate.

“If there is misinformation sowed about them, I think it can be quite a damaging activity and I think to Capitec’s credit they went out and addressed the concerns head-on, put lots of information out into the market and weathered the storm,” Wood says.

Jacques Plaut, portfolio manager at Allan Gray, says while this can be quite damaging for a bank, it gave them a fantastic buying opportunity for Capitec.

He says it is difficult to understand why investors got rid of their Capitec shares because of Viceroy’s opinion, which relied on the bank’s annual reports, filings and court cases – information that was already available.

“If you own Capitec you should know that stuff.”

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Rather than looking into the financials, the next big mess is likely visible in the rest of the annual report.

Clue 1: a board composed mainly of connected parties.
Clue 2 : a belief / culture of unique skills or strategic advantage – god complex.
Clue 3: a complex shareholder structure whereby some investors have more rights than others
Clue 4: a voting pool of shareholders effectively are in control the company. Normal shareholders are just a feedlot.
Clue 5 : massively acquisitive

In the AFS some clues:
*. Pathetic return on capital invested
*. Low correlation between reported earnings (big) and cashflow from operations (small or negative)
* regular abnormal and restructuring and special items in P&L

On global scale, think of Microsoft in the Ballmer era versus Apple. Microsoft post Ballmer is a different company. A few of the biotechs also flew too close to the sun.

The whole problem which Steinhoff showed is what do we do when the auditors aren’t doing their jobs properly? If everybody relies on the AFS and the AFS has a US$4 billion hole in it, it helps zero to look at e.g. return on capital reported earnings and cash flow from operations because these figures aren’t worth the paper they are written on. That is why mandatory audit rotation is long overdue despite all the bitching and moaning from the big 4.

There’s a reason an audit opinion only gives “reasonable” assurance that the financials provide a true and fair view of the company as opposed to absolute assurance. Auditors will always miss things even if the job is done correctly especially if there is someone smart enough to know how to hide it. In my opinion, the only chance an audit has of coming close to giving absolute assurance is if it’s performed by a computer which will probably happen in the next 15 to 20 years.

Spending lavishly on every fad (eg fintech, China) and on acquisitions, but where is the cash and scale to be sustainable, or even just to repay the debt?

“If you own Capitec you should know that stuff.”

Is it different for banks as one surely does not expect all depositors to “know that stuff”?

… just a thought.

I see PWC finally agreed to stop accepting consulting work (aka bribes) from the companies they audit. Slow progress. Now maybe they’ll start applying basic accounting principles / aims e.g. fair/market/recoverable value of balance sheet components (taking net FCF after maintenance capex into account to test recoverability), matching and amortization of capitalized costs to the revenues streams created by the capitalized costs (Steinhoff intangibles should have been valued more realistically and amortised faster), explaining differences between cash and IFRS earnings etc

@Mamba – Plaut is referring to shareholders, not depositors. If you deposit money with a bank, all you need to know is that it is properly registered and in good standing. When you buy a bank’s shares, you should know the “stuff” Plaut is talking about.

‘He says it is difficult to understand why investors got rid of their Capitec shares because of Viceroy’s opinion, which relied on the bank’s annual reports, filings and court cases – information that was already available.”
Give us a break already .. please tell us who was it again that backed Tongaat , and which broker spilt the beans .

In response to Ryan B
Tongaat was backed by Investec.
A fortune was made by those connected who got out at R112 a year ago.
Need I say more ……

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