| The critical ‘one’

The return on Equity/Cost of Equity (RoE/Ke) table was introduced to the Top 200 survey in 2009 – in a bid to dig deeper into the value creation efforts by companies listed on the JSE.

The initial feedback from readers was mixed.

While appreciating the extra effort from the McGregor-BFA brains trust, a number of readers felt the table was really pitched at the very technical investor.

Indeed the methodology, which we cite below, is complex.

But essentially the table should be very useful for investors in that the RoE/Ke table really offers an equity-based indicator of value creation.

Running a portfolio through the rankings, for instance, could be an illuminating exercise.

Figuring it out

If anything, there are some very interesting – perhaps even contentious – rankings scattered throughout the RoE/Ke table.

As McGregor-BFA has pointed out, the RoE/Ke combines company-based fundamental information and market information as part of a process that essentially works the actual return of a company into the expected rate of return.

The rule of thumb is that a value of less than one suggests executives are destroying value, while a rating above one means management using capital effectively enough to bolster sentiment for the company’s shares (and ultimately creating value).

It sounds fairly simple.

But the methodology used in calculating that value-based indicator can be intimidating (even for notoriously “equation fearing” financial hacks).

The methodology is rather convoluted and does require some application by investors.

  • The RoE is calculated in the usual way – by dividing the profit attributable to ordinary shareholders by the total book value of ordinary shareholders’ equity.
  • The Ke is quantified by using the well-known capital asset pricing model, which is expressed as Ke = Rf + Beta (Rm – Rf).
  • Ke = Cost of capital.
  • Rf = the risk-free rate of return (the R153 Government bond is used).
  • Beta = a measurement of market risk.
  • Rm = Expected market return.
  • Rm – Rf) = Market risk premium (6% used as default throughout).

Okay? Now concentrate

The beta, as a measure of market risk, is quantified by shifting back the monthly market returns (less the risk-free rate) of the company against the monthly returns of the JSE All-Share index (less the risk-free rate) over a period of five years.

The slope of that least square regression line (the beta in statistical terms) is a measurement of market risk. A slope (beta) greater than one indicates share price volatility (risk) greater than that of the market as a whole.

Ultimately, this means a beta of less than one indicates market risk less than that of the market as a whole.

Using the capital asset pricing model to quantify the required RoE or Ke (as required by shareholders), a risk-free RoR or Rf as above (ie, the R157 Government bond) is used as the absolute minimum required RoR.

A premium for company risk is then added to that minimum requirement in the form of the company beta multiplied by the market risk premium.

Last year we a made a point of mentioning that the McGregor-BFA calculations suggested that only around 140 companies listed on the JSE were creating value for shareholders.

Contentiously our RoE/Ke table from last year suggested that the vast majority of companies listed on the JSE were – technically speaking (and we emphasise “technically speaking”) – destroying shareholder value.

This would have included such popular stocks like Tiger Brands, MTN, Group 5, Woolworths, Steinhoff International, ABIL and Netcare.

The rankings

This year’s table ranks 150 listed companies as creating shareholder value in 2009 – with blue chip shares like MTN, Standard Bank and Steinhoff International falling below the value of 1.

Encouragingly some of last year’s “laggards” – Tiger Brands, Woolworths and Netcare all put in much improved showings this time around.

Conversely, we had a few big slips from the upper rungs by companies like Spescom, Yorkcor and Kap International.

A number of reliable small- to mid-cap companies also found themselves outside the critical ‘1’ – including Aveng, Abil, Spur Corporation, Pioneer Foods, Trencor, Gold Reef Resorts and Rainbow Chickens.

The top six rankings on this year’s RoE/Ke table are most surprising – at least to anyone with some background knowledge of this rather motley half-dozen.

Andulela is a bombed out platinum refining play, John Daniel Holdings (JDH) a struggling venture capital investor, Quantum Property Group is a property company with a single hotel development in Cape Town and Beget is a perennial struggler on the ever-changing technology front.

Labat Africa and Village Gold Main Reef are essentially cash shells, which – at the time of going to press – were both subject to deals that could see new mining assets acquired.


One can only hope the heady RoE/Ke rating – which is obviously due to technical rather than fundamentals factors – bodes well for any new endeavours by these two shell companies.

To be perfectly honest we don’t think too many punters would plumb for the “top” six rankings over some of the lower ranked companies like Spur, Pioneer, Abil and Rainbow Chickens.

Although one can’t really account for taste, or the willingness to take risks.

Perhaps what is more fascinating to gauge is the number of “obvious” blue chips not listed on the Top 200 table.

These would include AngloGold, Liberty International, Richemont, Old Mutual, BHP Billiton, SABMiller, British American Tobacco, Anglo American and Sasol.

Any some popular second liners are also conspicuously absent. Here we would think of the opportunistic PSG, a robust Argent, inventive Investec, reliable Brimstone, cohesive Datatec, thick margined Medi-Clinic and value-laden AECI.

Over the long term there can be no doubt that most – if not all – these popular counters have created value for shareholders.

Perhaps 2009 was just not a great year?

Pinch of salt

Whatever the case, readers should perhaps not read too much into these omissions.

But if there’s any doubts about this table picking up “value destroyers” we can assure readers that the bottom rungs of this table – which is not shown here – contained some really ugly minus numbers.

Chief destroyers included former industrial giants Super Group and Dorbyl as well as the JSE’s largest diamond miner, Trans Hex and ambitious gold venture Pamodzi Gold.

Other value-crunching culprits were health products specialist Imuniti, empowerment group Vunani (which recently undertook a rescue rights issue), technology group Faritec, building supplier company AGI, technology group IFCATech, junior miner Absolute (now subject of a reverse takeover involving platinum assets), financial services group Industrial Credit Companu (ICC), micro-loans and mortgage origination business Finbond, mothballed fluorspar miner Sallies and energy-metering group Zaptronix.

Few investors, though, would quibble with industrial conglomerate Remgro’s ranking in seventh place with an excellent RoE/Ke rating of 8.59 times.

Remgro, which Finweek has described as “the share all South Africans should own”, has an impeccable record of creating long-term value for shareholders through holding an array of investments spread over the financial, industrial and technology sectors.

The legend has it that an original “honderd pond” (hundred pounds) investment in Remgro in the late Forties is worth many millions of rand today.

A recent exercise in value creating was the unbundling of its 10% stake in British American Tobacco and the creation of new offshore investment vehicle Reinet Investments.

Last year Remgro also added to its investment bulk by completing the acquisition of former corporate cousin, Venfin (which owns stakes in unlisted companies like e-tv, Tracker and SEACOM).

Other strong showings on the RoE/Ke table included cement giant PPC (7.39), base metals giant Kumba (3.68), highly rated pharmaceutical group Aspen (2.5), base metals mining group Assore (2.25) and recently listed cellular services group Vodacom (3.53).

It might be worth pointing out that Assore, Aspen and Vodacom feature prominently (in a favourable manner) across more than a few tables in this year’s Top 200 survey.

That, in itself, should provide plenty food for thought when mulling longer term prospects for this trio.

Industrial group Howden, which also seemed to show up well all over this year’s Top 200 survey – also featured strongly with a ranking of 7.39.

If there was a trend to highlight in this year’s RoE/Ke rankings it might be that retailers seemed to fare soundly.

Supermarket group Pick n Pay was by far the most impressive ranking with 4,94 with Shoprite also coming through strongly with 3.66.

Other retailers that made their mark in 2009 would include New Clicks (3.19), Spar (2.55), Truworths (2.45) and Mr Price (2.42).
Movers, shakers

Junior mining counter Anooraq – which is being increasingly tipped as a share to watch – ranked well with an impressive 7.62.

Steel group Highveld – so often overlooked for the bigger ArcelorMittal – earned a commendable 3.88 ranking.

Some of the other strong performing small caps on the table would include Mercantile Bank (5.79), Mazor (3.19), African Media Entertainment (2.95), Kelly (2.3), Adapt-IT (3.38), Country Bird Holdings (2.73), O-Line (2.07) as well as metals traders Insimbi (4) and Metmar (3.19).

More than a few regular Finweek readers will be heartened to see Telemaster Holdings – one of the few companies on the JSE to pay a quarterly dividend – given a decent ranking (4.12).

That should provide some reassurance that Telemaster – whose chairman Mario Pretorius is one of the combative shareholders in the Reserve Bank – is in a position to keep the payouts coming.

Hopefully we can assume the same for small-cap dividend payers – some of which are cited above.

Universal Industries, which specialises in oven and refrigeration equipment, given a sound ranking of 2.77.

Universal has recently seen its profits dive as the global financial meltdown dampened demand in its export markets.

 – Finweek

For the RoE/Ke Table, click here


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