Podcast: Avoiding the next Steinhoff

Simon Brown JSE Direct, Latest

Simon Shares

  • No Brexit deal with 8 days to go. A mess of epic proportions.
  • Load shedding is in full force (well only force 4 with more stages to go) and it’s bad. Seems we can expect a ‘stable’ electrical grid sometime towards the end of the year, albeit stable may still include stage 1 load shedding according to experts I have spoken to. The reasons we know and frankly don’t matter. It also doesn’t matter who wins on 8 May, this is not a problem that goes away over night. For us individually it s a hassle, a real hassle. For business it is a major issue. Our expected modest GDP growth for 2019 is going to be even more modest while Moodys eyes us for junk status. Most exposed will be retail (extra costs) and property(lost sales and extra costs) while mining has largely managed to get off grid.
  • Metrofile* (JSE code: MFL) results were a horror show with the tax rate hitting 40%, up from 24%. Seems the two now fired CFOs messed up the Kenyan deal so that interest was not deductible as an expense. They out, new CFO will be able to fix and get the tax rate back to normal. Debt should be easy enough to pay off in 5-7 years. That all said it is currently my worst performing share in my portfolio and I continue to hold. Sure the pain has been plentiful, but the business model still stands, some issues (re tax rate) should be easy to fix and I wonder if a take over may not be on the cards?
  • Up coming events;

* I hold ungeared positions.

Avoiding the next Steinhoff

Up front let me state you’re unlikely to be an investor in individual stocks and over a life time of investing never invest in what turns out to be a fraud. So far I have been lucky in that my only fraud was way back in the mid 90’s (I can’t even remember the name of the company) when the CEO suddenly rushed off to Australia and my loss was fairly modest (as I was poor), albeit I did make the horrid mistake of doubling up when the price had halved.

Back to Steinhoff, the PWC report is finally out. Three thousand pages and four thousand attachments, albeit we only got a ten page summary that detailed over R100billion in fraud over the 2009-2017 period. Profits for this period were only some R60billion and while the fraud number may include some double counting, it basically means Steinhoff (JSE code: SNH) was a ponzi from day one.
So how do we avoid being suckered into a ponzi scheme?

  • Avoid the cult of the personality. Far too many people said that they didn’t fully understand the business, but were happy to follow (and trust) Markus Jooste. Big mistake. I remember somebody on twitter saying if accounting was an olympic sport Markus Jooste would be a gold medal winner every time. To which I responded that hopefully he wasn’t a drug cheat – turns out he was. I am not saying that every great person is a crook, but being great is not an investment case. Sure management is important, but we need more.
  • Other red flags on the cult of personality is when they attack critics. Sell reports on Steinhoff were meet with rage from Markus Jooste and demands that they be retracted and the person involved be fired. Remember the recent Investec report on the Tongaat (JSE code: TON) CEO that got the company all upset and complaining to the Investec bosses? That was in June 2018, the share was over 8000c, now under 2000c.
  • Avoid complexity. As humans we believe in complexity. We think complex is great, complex is best. It’s not. In large part we believe in complexity because it is easier to do so. It helps explain why our portfolio growth is modest, why we’re not hitting it out of the park with our trading. Truth is luck plays more of a role than complexity (read Fooled by Randomness by Nassim Taleb). The other issue with complexity is that it is easy to hide the fraud and diss naysayers. The reason I avoided Steinhoff is because I couldn’t get the balance sheet to balance nor the debt to reconcile to the balance sheet. I am no CA nor a rocket scientist, so I go for the easy and these two should be easy. But I couldn’t get them working so I just walked away. (Disclaimer, I did trade Steinhoff a few times, mostly in my momentum portfolio and can’t remember if I made money or not).
    • As an aside, I hold a complex stock ~ Discovery (JSE code: DSY) and when Viceroy was threatening to come after a second JSE stock last year, I ran my eye down my list of stocks and figured Discovery was a potential candidate. Point is I hold the stock knowing it is complex. Knowing its accounts are beyond my ability. Knowing that maybe it’ll all collapse one day. I have built this understanding into my risk tolerance in that to is the only complex stock I hold and I cap the percentage weighting.
  • Debt, always watch debt especially when paying top dollar for assets, such as the 100% premium offered for Mattress Firm. As Buffett said, debt is like Russian roulette. It’s fine until it’s not and then it is fatal. Know the debt ratios, watch them and compare to previous periods and their peers.
  • Watch governance. Independent execs, are they really independent? Do we have a strongman CEO who has been there forever? Again a double edge sword, some such as Gore and Saad are important to the business. But so was Asher Bohbot to EOH, and now he’s gone. They’re great till they’re not. What we then need is a strong, diverse and truly independent board. Can a non-exec really be independent after ten years on the board?
  • Denial is another issue that we should largely ignore. We’ve had two execs at parliament saying, no not us. Yet both are named in the report. Ask yourself, how many guilty people confess when first accused? How many ever confess even when finally convicted? Remember the chairman, Christo Wiese on the radio flatly denying concerns. Now he claims he didn’t know (and he is not named in the report), but then why the flat denial?
    • Another aside. Why did the so smart Wiese sell his Pepkor holdings into the ponzi scheme in return for Steinhoff shares? Maybe as a rushed and easy way to offshore his money?
  • Avoid falling darlings. We have lots of examples locally of once high flying darling stocks under severe price pressure. We missed them on the way up but now that they’re lower we’re buying, but they keep on falling. EOH R180 to under 2000c. Aspen (JSE code: APN) was over R400 now under R100. This is tough because sometimes the sell off does offer a great entry, but we need to be extra sure that the sell off is not the start of a collapse. Best way to do this is on a valuation and full understanding of the business. Aspen is maturing so the +30 PE levels were not reasonable and the price needed to come down while EOH was always built on using script as currency and that uravels as the price falls.

So what next? Well Steinhoff is bust, 100% bust. Sue they have some assets (such as c70% in Pepkor and Conforama and bankrupt Mattress Firm in the US) but the claims against the company are in excess of R200billion and current shareholders are last in line. The process will take a while, maybe a decade, and by the end there is nothing left for shareholders. If you’re holding or buying Steinhoff, understand you’re trading because you can’t invest in a share that’s going to zero.

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