Steinhoff International, the owner of furniture retail brands in Australia such as Freedom, Fantastic Furniture, Snooze, Plush and Bay Leather Republic was last week caught up in an accounting scandal that wiped off US$13billion of shareholder value and led to CEO Markus Jooste stepping down.
Here are 5 lessons investors in Australian retailers such as Harvey Norman Holdings Limited (ASX: HVN), Nick Scali Limited (ASX: NCK) and JB Hi-Fi Limited (ASX: JBH) need to learn from this debacle:
- Compare net income or EBITDA with operating cash flows. They say cash is king and when profits cannot be validated by cash flows, it raises red flags. Of course some businesses sell on credit and will have a lag between the time when the transaction revenues are recorded and when cash is received but ultimately, a business' cash collection has to be a strong indicator of its performance.
- Beware of acquisitions that are not accretive to group earnings. Not all acquisitions are positive news for a company. Sometimes companies pay more for an acquisition than the value they receive in return which leads to a loss of shareholder value.
- Beware of multiple capital raisings. When companies raise additional capital, it can either be through debt which raises the risk profile of the entity or via equity which dilutes existing shareholders. Investors that are asked to contribute additional capital have to ensure that the capital will be used in projects that generate a return that is higher than the company's cost of capital.
- Beware of related party transactions. Whilst transactions with related parties have to be disclosed in the company's financial statements, few investors take note of them or can connect the dots on their impact. These transactions are so common that it can be hard to determine when they are a cause for concern. There is usually never just one cockroach though, and this can be one more red flag to take note of.
- Do your background check on management. It is wise to invest in companies with ethical management teams. The best of businesses can be destroyed when management do not act consistently with shareholders' best interest in mind.
