A large number of Australian companies are failing to deliver the cash returns which will fulfill the expectation created by rising share prices, according to a recent analysis conducted by management consulting firm, PA Consulting Group.
The analysis revealed however that many of these 'low-return' companies continue to trade on the sharemarket at a significant premium to book value, disguising their poor performance to investors, riding on the expectation that their return on equity will improve dramatically.
"According to our research, years of low shareholder returns are unsustainable. This has the potential for a significant impact on the performance of the Australian sharemarket," said Mark Pinchen, PA Consulting Group.
"While the recent sharemarket correction can be attributed to a number of factors, we believe it was strongly influenced by investors who have grown impatient with companies who are failing to meet expectations and moving their money elsewhere.
"Experienced investors, for example, are having trouble finding companies that are delivering value and have moved partly into cash as demonstrated by the booming cash management sums and sharebroker cash trusts," he said.
"In addition we have already seen some stretched valuations corrected on top of a series of disappointing company results. If companies continue to fail to deliver returns, investors will become increasingly vocal which should be a major concern to the management of these low-return companies," warned Mr Pinchen.
According to Mr Pinchen, PA's analysis indicated only three industry groups out of 15 are delivering the required levels of shareholder value. These were the chemicals, development and contracting and the banking industries.
"While we might conclude that the majority of Australian companies are overvalued, our experience indicates that a large number of organisations are simply not realising their potential.
"By focusing on the activities required for managing shareholder value, these companies can substantially improve their performance. Most organisations are too busy working out how to measure shareholder value and not actually delivering it."
In addition, PA Consulting Group also linked executive compensation to the performance of industry groups and found that those organisations who structured bonuses based on the delivery of shareholder value into executive compensation deals performed better than their counterparts.
"Companies must consider what they require from their senior executives in terms of returns and gear their compensation to reflect this," he said.
According to PA Consulting Group low return companies must act now to deliver shareholder value, and sustained returns for investors.
A company which is not delivering shareholder value needs to consider:
- what are the sources of its cash and the productivity of its assets
- how does it make its lazy assets work harder
- what should be the focus of its investment.
"A company is not just bricks and mortar, the skills of its people and the relationships with suppliers and customers are potentially its most valuable assets," said Mr Pinchen.
To improve shareholder returns a company needs to take the following steps:
- reallocate capital: focus on winners and deploy as much capital as possible into growing them, while starving all other businesses
- reengineer fixable parts of the business by identifying problems that cause low returns, reinventing the way business is done to create the potential for acceptable returns
- reduce (to a profitable core) or exit unfixable parts of the business.
"Without the ability to deliver shareholder value companies will falter sooner or later," said Mark Pinchen. "We think this will be sooner rather than later given the increasing competition in the Australian and global marketplaces."
