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All roads still lead to ROAM, or ruin

September 28, 2006
All roads still lead to ROAM, or ruin. Check it out:
(Business Day (South Africa) Via Thomson Dialog NewsEdge) ASSETS AND PROFITS/ All roads still lead to ROAM, or ruin MOST company results this year reflect a positive economy. They also confirm something that causes many senior executives much discomfort. Growth through acquisition, or investment in modern technology to mechanise jobs and raise labour productivity, often results in an asset burden that depresses profitability.



The accompanying chart, based on results published this year, illustrates the issue. It compares the sales productivity of each firm's asset base asset turnover with ROAM (return on assets managed).

The correlation of higher asset turnover with a higher ROAM is clear. Asset turnover drives ROAM. It is the most important productivity measure of all for operating managers.

The worst performing companies on this chart are in the information technology and paper sectors. Sappi comes last with a ROAM of 3,5%. That's not surprising. In 1974, in Management: Tasks, Responsibilities, Practices, the late Peter Drucker observed that since the Second World War the pulp and paper industry had swapped labour for capital on a massive scale. He called it a thoroughly uneconomic tradeoff. In fact, he wrote, the paper industry represents a massive triumph of engineering over economics and common sense. With an asset turnover of about 0,8, Sappi hasn't recovered its cost of capital for the past 20 years. Cumulative value destruction is massive and its downward momentum is unstoppable. More share options for management won't matter a jot.

SABMiller's asset turnover is even lower, at 0,6. There are three reasons. First, 60% of its asset base, $16bn of it, is goodwill and intangible. Second, Miller is proving to be a burden. It has yet to start recovering its cost of capital. Pitted against Budweiser, the straight and narrow brewing road in the US can lead only to perdition. Because of their beer war, Anheuser Busch's ROAM fell from 42% to 33%. They are both in a lose-lose situation. Maybe SAB's new man in the US will couple his drink skills know-how with SAB's to take Miller on to non-beer brands. Third, Bavaria in Latin America cost about $8bn. But it had an extremely low asset turnover of 0,2 before SAB bought it: that means $1 of assets generated just 20 of sales. Now the company has announced it is to invest even more to increase capacity. Management's asset turnover task for the next few years is clear. Beat 1. After that, aim for 2.

Another company that had an abysmally low asset turnover of around 0,3 before its collapse was Didata. After writing off the $3bn premium it spent on acquisitions, it has inched up sales profitability slightly. However, it still carries the burden it bought overseas. International operations generate 80% of its sales revenue at only 2,1% return on sales. To make things worse, central costs wipe out any profit they make. Meanwhile, its African operations generate a 10% return on sales. Again, it's clear what top management has to do. If it doesn't, then the company seems doomed to perform poorly for a long time.

Business Connexion's ROAM is also bad but this company suffered from taking its own medicine last year. It sapped itself with the introduction of an enterprise resource planning system. According to management, this increased costs and expenses and contributed to a lower return on sales. It confirms that there seems to be no tested, proven, positive correlation between an investment in enterprise resource planning systems and value creation. That doesn't bode well for Richemont, which has done well. Using executive chairman Johann Rupert's colourful segmentation of the luxury goods market, clearly lots of wealthy chaps all over the world have been buying beads, baubles and bangles to get lucky on a Saturday night! Management, after writing off 6bn of acquisition premiums, has increased ROAM to a respectable 14% which is no mean achievement. In fact, there is proud acknowledgement of the ROAM result for the first time in the annual report. However, there is need for caution. Like Business Connexion, they are about to sap themselves with an enterprise resource planning implementation. Let's hope they do it to support line managers with value creation in mind, instead of a Teutonic application of the latest technology and bureaucratic procedure.

An ill wind blows nobody any good. Maybe Richemont learned something from the Rainbow Chickens disaster. This company levered up its asset turnover to 2,4 before making long overdue reinvestment in operating assets. Today it has a lower asset turnover of 1,5 with a return on sales of 14,3% that takes it back to the halcyon days of its entrepreneurial founder, the late Stanley Methven. However, this record ROAM result of 21,5% does not compare with Astral's. During its reported last six months, Astral achieved an asset turnover of 2,5. Over the past six years its asset turnover has not fallen below 2,2, and once reached 3,0. Today, its return on sales is 17% and ROAM 42,5% a brilliant achievement for a company in the agricultural sector.

Finally, there is Tiger Brands. After divesting Astral, its asset turnover was 1,3 and return on sales 13,9%, generating a ROAM of 18,1%. Three years later, asset turnover improved 39% and return on sales 8%. The effect is a ROAM of 27,3% an improvement of 50%.

Despite its leverage, you seldom hear executives talking about the asset turnover effect. We tend to focus myopically on sales, margins, and profits in isolation. Yet, if the last market collapse showed us anything, it is that in times like the present consult Murphy every day, and add assets with care and fear. If you do add them to reposition the firm, give the asset turnover effect higher priority than the profit effect on the business.

If you don't, you may find yourself writing them off one day.

Black, writer, coach, and performance improvement consultant, is a partner of Schaffer Consulting and co-author of Who Moved My Share Price?

Copyright 2006 Times Media Ltd.. Source: Financial Times Information Limited - Europe Intelligence Wire.


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