Distell’s charm offensive seems to have worked again this year.
At is AGM last week a remarkable 99% of shareholders voted in favour of the non-binding resolutions on executive remuneration – despite the group’s rather grim seven-year profit record and the steady erosion of its market cap over the same period.
The story was the same at the 2019 AGM: 99% of shareholders backed the two resolutions. The overwhelming support means it isn’t just Remgro and the Public Investment Corporation, which control a combined 73% of the drinks group, that are enthusiastic supporters of a remuneration policy that appears not to have delivered the goods for shareholders.
No doubt the promise of significant changes to the policy helped to keep supporters on side.
Hours before last week’s AGM the board released a trading update and a reminder of proposed changes to its remuneration policy aimed at “aligning performance with shareholders’ interests”.
So shareholders were voting in support of the changes to what the remuneration policy is measuring and rewarding for the allocation of short- and long-term incentives. For the short-term incentives, which have generated sparse returns for Distell executives since around 2015, revenue growth and free cash flow will be key variables in future; various programmes the group has adopted, such as sustainable development, will also be factored in.
But the big change is what gets measured for the awarding of long-term incentives (LTIs).
Headline earnings growth will replace earnings before interest, taxation, depreciation and amortisation (Ebitda) and carry a 30% weighting in the overall LTI scorecard; revenue growth remains with a 30% weighting; and return on invested capital will have its weighting doubled to 40%.
The remuneration committee reckons that these changes strike the right balance.
“Based on Distell’s positioning as a global business with roots in South Africa, and on the group’s strategy, there is a clear requirement for the board and the executive management to balance growth with returns,” the board explained to shareholders. “The group’s divisions are in different stages in terms of strategic focus.”
But while 99% of shareholders attending the AGM voted their support, not everybody is happy.
Outspoken shareholder activist and long-term Distell shareholder Chris Logan’s major criticism is the lack of alignment between the interests of executives and those of shareholders.
For starters, says Logan, only one board member owns Distell shares. That’s CFO Lucas Verwey, who has a mere 100.
Logan tells Moneyweb that Remgro chair Johann Rupert has acknowledged the importance of ‘having skin in the game’, which is a principle, he says, that works very well at FirstRand.
Logan noted that at Remgro’s 2019 AGM Rupert said: “If the directors all owned a lot of shares they would watch the management and make sure that they get performance.”
During financial 2014, after he was appointed CEO, Richard Rushton was allocated 230 000 shares as a once-off award in lieu of benefits forfeited on termination of his employment at his previous employer, SABMiller.
In 2016 the board paid Rushton an estimated R38 million for the shares.
Share appreciation (or not)
The group’s previous remuneration policy focused on awarding executives through share appreciation rights (SARs), which only pay out if the share price increases.
For a variety of reasons the Distell share price has been on a downward trajectory since 2016.
The SARs awards were allocated at R129 and upwards, which means the executives have received little or no value from them. They have not all expired, which means there is scope for some payment from them.
The encouraging news for those who reckon it’s important to have ‘skin in the game’ is that changes to the share awards system in 2017 will see management taking up a combined 114 000 shares next month.
Despite receiving little in the way of short-term incentives since he joined halfway through financial 2014, Rushton hasn’t done too badly. His total remuneration has increased from R6.2 million in 2015 to R11.2 million in 2020, after peaking at R13.5 million in 2019.
Logan accepts that the sums are reasonable in the context of out-of-control executive pay.
“I’ve never said Rushton gets paid too much,” Logan tells Moneyweb.
“My concern is that his incentives are not sufficiently aligned to shareholder value, which is why shareholders will continue to lose out.”
By almost any measure you choose, Distell’s performance over the last five years has been disappointing; it’s hardly surprising that even ahead of the disastrous Covid-19 lockdown the share price was close to six-year lows.
Costly measures will pay off ‘soon’
But the board is adamant that costly measures taken to address the much tougher trading environment – including not just the more competitive SAB and Heineken, but also pressure from the increasing power of the likes of Spar, Shoprite and Pick n Pay – explains most of the strained profit performance.
Years of investing in acquisitions, enhancing production capacity and beefing up its sales force will soon pay off and the revised remuneration policy will ensure executives and shareholders will see the benefits, says the board.
Logan, who has closely analysed a number of JSE companies – Tongaat, Nampak, Bell Equipment – where management has overseen a long-term erosion of shareholder value, believes the absence of an owner-managed culture is what lies behind most of the value destruction.
Metrics can incentivise the wrong behaviour
He contends that Distell’s revised remuneration policy will do too little to produce the increased efficiency needed for sustained growth in shareholder value.
He is particularly troubled by the continued heavy weighting given to revenue growth, which he says is very susceptible to incentivising the wrong behaviour, such as uneconomic sales, brand erosion and value destruction.
“Reducing prices is an obvious way to boost sales but not always a smart way.” And return on invested capital (ROIC) is also not always aligned with growing shareholder value because the measure of ‘return’ and ‘invested capital’ can be subject to accounting distortions such as impairments.
Logan points out that Distell uses ‘normalised’ ROIC in its calculation, a figure that excludes a significant number of charges – most notably the hefty impairments against Best Global Brand, which was only recently acquired.
Writing to the board ahead of the AGM, Logan noted “an almost total lack of share ownership by directors since 2014″.
“Aggravating this lack of share ownership has been Distell utilising misaligned incentive schemes,” wrote Logan, who argues that remuneration should be based on increasing ‘economic profit’, which measures the growth in profit after allowing for the cost of capital used to generate that profit and, he says, is highly correlated to shareholder value.
“While Distell has revised its incentives they continue to be insufficiently aligned to the objective of increasing economic profit.”