Putting lipstick on a pig, post haste UPDATED

Posted June 4, 2012                                                                     Twitter: @PaperlinXsuX
Updated June 5

... putting PaperlinX in perspective, post Hastie. 

This isn't pretty and won't be new to the Company's bankers and credit insurers. Please don't blame the messenger.

In this post you'll see why:

1. the imminent review, due before 30 June, will be nothing more than putting lipstick on a pig;  
                                
2. PaperlinhX could go bust sooner than most will admit;   
                         
3. the demise of Hastie Group was a predictable, and predicted by some, despite what Harry Boon still says;
                                     
4. PaperlinX's core problem is the same as Hastie Group's, and unsurprisingly had the same origins; 
                                     
5. PaperlinX needs to shed about 1,200 employees; and
                                 
6. One objective measure reveals the truth and cannot be hidden or glossed over.

The conclusion - if you're smart enough to be here you'll soon see it. Just one helpful clue - the 'independent directors' urgently need to learn what these words really mean.

Update on June 5

Just hours after this post was published, new CFO Richard Barfield made this encouraging statement published by the AFR in its digital edition New PaperlinX CFO lists priorities.

Good to see at least one senior PaperlinX executive agrees with suX. As we requested of him in Welcome Richard Barfield: new CFO @ PPX - "be strong". 

The AFR story carried this picture which hopefully signifies a new openness at PaperlinX.

End of Update

But first, some simple background on a user friendly tool that supports these assertions.

Financial Analysis 101 - Don't leave now. This is simple.

In just 10 minutes this tool will demonstrate why the problems at PaperlinX are real, long standing and must be solved urgently. 

I'll also demonstrate why some of the current Board haven't got a clue which is why changes must happen there too.

Business Basics - Most people measure business outcomes in terms of sales, profit margins and hopefully dividends. Actually, the most important consideration is Return on Equity (ROE) which is a measure of how well a company uses shareholders' funds (our money) to generate a profit. 

For those interested in financial analysis, there is an excellent primer available from the Financial Times.

The Financial Times explains:

"Return on Equity (ROE) is often said to be the ultimate ratio that can be obtained from a company’s financial statement. A company can only create shareholder value, economic profits, if the ROE is greater than its cost of equity capital; 

and

Historically, the average ROE has been around 10% to 12%, at least in the US and UK".

Some other things you may wish to know about ROE:

1. The higher the better;
     
2. Companies with a high ROE generate surplus cash which, after paying taxes and dividends, can be used reduce debt, expand or build a nest egg for a rainy day;
      
3. ROE analysis is valid for any type of business regardless of size, gearing or industry. It therefore allows investors to compare banks vs airlines vs retailers vs high tech or whatever business they choose, big or small;
       
4. There are a couple of ways of calculating ROE, however as long as a consistent method is used then inter-company comparisons are valid;
      
5. A good company will produce a recurring ROE exceeding 20% pa which is  consistent with the quoted average of 10-12% by the Financial Times;
      
6. A falling ROE is like the canary in a coalmine;
      
7. Boards often seek to "grow" a business by increasing sales or geographical coverage or product offering; and often justify doing so by acquisition (HST and PPX come to mind) whereas the only thing equity holders, share and hybrid, really want is for management to grow the ROE of this business - duh;
        
8. If you were limited to just one KPI for measuring financial success it would be Return on Equity; and 
               
9. There is only one thing better than a high ROE and that is ROE Growth, over the previous accounting period (ROEG).

ROE and ROEG are objective measures of management skills - ouch. Here are the harsh figures from the ASX.

At the time of writing, June 1, 2012, my data service lists 1903 entities trading on the ASX. Of these:

• Only 762 have a market cap exceeding $40 million (PPX is $40-45 million)
    
• Of those, only 464 have an ROE > 0% and 176 have an ROE > 20%
    
• Finally, only 81 stocks have an ROE > 20% and ROEG > 0%. 

The challenge - to join the top 10.6% of stocks with a decent and growing ROE.

Putting ROE into practical use for PaperlinX stakeholders

Here is a simple ROE comparison of four Australian companies for the period Dec 2005-Dec 2011.


BHP  - BHP Billiton is the world's largest resources company based in Melbourne. It is immensely profitable, with a ROE of up to 60% pa though it suffers wild fluctuations based on the global economy's demand for raw materials.


CBA  - Commonwealth is Australia's largest bank and has an excellent credit rating. Note that the ROE for CBA is fairly stable, 20-30%, because that is the nature of a strong bank operating in a strong economy. As any borrower knows, interest waits for no man. This is why banks' ROE should be stable if risk is properly managed.


HST  - Hastie Group Limited is the leading international designer, installer and maintainer of technical services to the building and infrastructure sectors — mechanical, electrical, hydraulics and refrigeration, with well established operations in Australasia, the UK and the Middle East. It has over 7,000 employees based at over 110 locations.

Hastie has just gone bust this week. Harry Boon has been a Director since early 2005 when HST first listed on the ASX.

Notice how the ROE for HST fell from 40% to 5% in a near straight line over 5 years to June 2011 then collapsed dramatically to -15% by December 2011. The downward trend is obvious, it means a -ve ROEG, but the directors of HST apparently took no notice.

If you accept that ROE and ROEG are objective measures of management skill, then draw your own conclusions about the directors of Hastie Group.

PPX - PaperlinX, where Harry Boon is Chairman, has an ROE sitting well below the average of 10-12%. This average is shown by the green band on the ROE comparison.

At less than 7% the ROE of PaperlinX has been consistently poor for the six years under review. Now consider the annual ROE since PaperlinX floated in 2000. You'll see PaperlinX's ROE has declined from +15.6% in 2002 to -ve in 2009, a progressive decline similar to Hastie Group. 

Another view, same result - share price relatives

There are lots of reasons why share prices fall, but only one why they fall consistently over time - a poor or falling ROE.

The above chart is a plot of share prices of PaperlinX (green) vs ASX200 (red) and Sequana, holding company for Antalis (blue) for 2003-current, or an up to date chart in new window for PaperlinX vs Sequana vs ASX200: 2003 - current

Notice how PPX under performed the other two during the 2003-07 bull market; always a sure sign of problems. So what happened in 2003?

PaperlinX is still paying the price of one massive mistake made in 2003. A fairly ordinary business with a ROE of +11.57% embarked upon a massive acquisition which it was incapable of executing for reasons which are irrelevant here. This is the before and after snapshot, PaperlinX 2003-2012.

This exhibit tells the story in simple numbers. PaperlinX is now a much weaker business operationally than in 2003. Tragically some delusional fools in high office think otherwise. You be the judge; 2011 sales of $4.67 Bn is no improvement over $4 Bn eight years earlier in 2003, yet it required about 1,200 more employees.

PaperlinX needs to shed about 1,200 employees to bring it back to the same level of operational efficiency it enjoyed in 2003. If anyone has a better idea, please tell me.

But PaperlinX is different and has special challenges? That's what the Chairman and CEO consistently say in reports to shareholders.

Remember that Chairmen and CEOs have egos like everyone else and find it difficult to admit failure. The Chairman of PaperlinX is now on the public record blaming banks for the demise of Hastie Group and stupidly claims even at this late stage, 

"This was not a ship that was sinking". 

This comment alone will probably banish Harry Boon from the boardrooms of Australia forever.

You be the judge - which business is the least complicated of the four above; BHP, CBA, HST or PPX?

I say PPX because  paper merchanting is a relatively uncomplicated business. It is the middleman between paper manufacturers and commercial paper users and rarely needs to add value. Paper isn't perishable, or subject to the whims of weather or fashion or seasonal cycles; and pricing is localized within regions. By this I mean that the printer in Manchester doesn't get quotes from paper merchants in Munich.

Here is the unpalatable truth - the simplest business of these four has the lowest ROE, and it has the natural advantage of allegedly being a world leader in its field.

Ah you say, but its the margins, the competition, the AUD etc. More weasel words. If you still believe this tosh maybe a quick review of the Financial Times primer on ROE is necessary or keep reading.

A more detailed view of ROE for those who really want to know.  It's really important that lay persons understand ROE as suX expects EGM2 soon. 

Incompetence, not Profit Margin per se, causes low a ROE - Food and staples retailing is about the lowest margin and most cut throat business in the world. Australia's largest pure food and staples retailer is Woolworths. It hasn't produced a ROE of less than 34% in a decade, and usually returns greater than 40%.

Below is a small selection of Australian companies with a market cap greater than $1Bn plus the four directorships held by Harry Boon. It also includes Harry Boon's former employer Ansell (ANN) and Lindsey Cattermole's other directorship, Treasury Wine Estates (TWE).

We see businesses with low profit margins and respectable ROEs such as petrol refiner Caltex and grocery wholesaler Metcash, marked in yellow. One of Toby Marchant's justifications for diversifying into 'other materials' is that they have better margins than paper. In isolation this is correct but won't translate to an improved ROE until PaperlinX learns how to make profits on all product ranges. 

Revisiting food and staples retailing. A duoply in Australia is Woolworths and Wesfarmers (Coles). Obviously they have comparable Profit Margins because they essentially buy the same products from the same or similar suppliers and sell to identical consumers. Both profit margins are just under 6%, but the ROEs are 40.7% and 13.8% respectively.

Why is this so? These figures are a snapshot of one period in time. It's the trend which is important, then other factors.

Wesfarmers was traditionally a diversified conglomerate with some very successful retail components. It bought the previously listed Coles Group right at the top of the market in late 2007 for an eye-watering $18Bn.

Coles supermarkets had been in the doldrums for years due to - you guessed it, mismanagement. John Fletcher had an illustrious 19 year career at Brambles, a global pallet company.

Someone thought he could run the country's biggest retailer, Coles Myer Group, which held about 20% of the country's retail spend. 

Pause here - see how Boards can be so stupid. At the time of his appointment Fletcher famously said he:

"hadn't set foot in a supermarket for 25 years"

He'll never live that down. It even appears on Wikipedia! It's about as silly as some of Harry Boon's recent utterances about Hastie Group.

Then Fletcher decided to scrap the Coles Myer shareholders' loyalty card which was the subject of this embarrassing comedy piece Clarke and Dawe turn on Coles Myer. Five years later Wesfarmers bought Coles, installed retail experts from the UK and now its supermarkets are making headway against Woolworths after giving them a free ride for 5-7 years.

In summary, Wesfarmers is labouring under an over-priced acquisition, however it is making solid headway. Last year its ROE was 13.8% vs Woolworths 40.7%, but its ROE Growth was +8.6% whereas Woolworths had a ROE Growth of -6.7%. 

Memo to Harry Boon - It takes along time to correct fundamental strategic errors and the team that makes the error is rarely capable of solving the problem.


Click here for a larger view in a new window.

How is ROE relevant to Harry Boon?

Looking at its ROE of 20.9%, why did he ever leave Ansell?

Until last week he held positions on four boards. Two companies are producing acceptable but not brilliant ROE and two are dogs. Last year Tatts Group (TTS) has a good ROE Growth of +4.6% but Toll Holdings (TOL) had a shocker of -11.6%.

The work required at PaperlinX is immense and I sincerely believe is beyond either his skill, interest or available time. 

Never has he demonstrated start up or turnaround skills whereas Clarke, Cattermole and Price have. The demands on his time are well documented and, to be frank, unconscionable.  Time to withdraw and reassess Harry.

It's a matter of record that Harry Boon invested heavily in HST, $423,000, yet only invested $59,000 in PaperlinX. It is to be hoped his poor investment record continues.

Worse still, he was still buying HST as late as July 2010 - July 2011 as highlighted in green below and by arrows on the ROE comparison. Please be sure to check where his buying featured on the ROE declining trend.

Ignore the rhetoric. Hastie Group has been on a highway to hell of its own making for years. Here is an extensive review of the warning signs.

If you believe that rational people act in self interest, and that Harry Boon couldn't see the problems at Hastie Group, either as non-executive director or private investor; then he is grossly inadequate to be a director of company in such dire straits as PaperlinX.

Regular readers will appreciate that suX has campaigned against Harry Boon for months. Here you have irrefutable facts unrelated to PaperlinX.

How is ROE relevant to Toby Marchant?

Where to start? PaperlinX cannot afford Toby Marchant.

Companies with a low ROE are always starved for cash. Yet he insisted on:

• creating what will become his personal mausoleum at Milton Keynes. His weak or financially illiterate co-directors agreed with this decision. Truly appalling and brings into focus the 'independence' of independent directors; and
      
• even worse was his gobsmackingly stupid declaration:
  
  
  “We can’t shrink our way to prosperity”
  
  Wrong. PaperlinX needs to shrink its way to survival which necessarily includes the departure of you, your baggage and your sycophants.

Toby Marchant is being hammered

Does anyone seriously believe that the cost savings to date have been initiated by Toby Marchant? I know of significant changes that were suggested to Harry Boon who then leaned on Toby Marchant.

Closing Milton Keynes is a public humiliation so soon after he vigorously defended its existence at the EGM just two months ago, all the while refusing to answer the question asked - its cost.

As an aside, probably that's one reason why PaperlinX refuses to release its recording of EGM1. Maybe its used for training purposes for EGM2?

After Friday's capitulation, its just a matter of time before Toby and Harry either jump or must be pushed. Expect Toby to resign soon. 

How is ROE relevant to Lyndsey Cattermole?

Her long (Oct 1999 - May 2011) directorship at Fosters was marred by that Company's relatively poor ROE to the point that the business was eventually sold. 

Most "value" analysts cite Fosters as being a poorly managed business with an underachieving ROE resulting from its disastrous diversification into wine. The mixing of beer and wine gave Fosters a hangover.

Hear Stephen Mayne's comments opposing her re-election as a Director of Tatts Group based on her Directorship at Fosters.

Well known value investor Roger Montgomery is scathing of PaperlinX and Fosters. Be sure to watch the video here.

Why are you dismissive of the Strategic Review?

Because nothing meaningful can happen at PaperlinX until three things happen, in sequence:

1. Change of culture by changing people at the top;
      
2. Profits arising from a change of culture and slashing of overheads; and then
       
3. Dealing with hybrid holders in an equitable way to free up the balance sheet.

Only then will PPX holders see any meaningful returns. So far I haven't seen a concrete feasible alternative and trust me, I see a few.