Reading between the lines of company guidance can reveal a great deal, explains Simon Shields, Principal at Monash Investors. “Ardent Leisure’s Main Event business in the United States provides family entertainment centres with bowling, rock climbing, etc. Ardent bought this business when there were only five centres in Texas and it was rolling out just one or two a year.” In its guidance, Management was non-committal around whether the roll out would accelerate, stating there was more work to be done and the board hadn’t made a decision. “As it turned out, they hit the accelerator, a number of times, and now they’re looking at a target of 200 stores in the United States.” In the video and transcript below, Simon Shields explains how to read between the lines and decipher the real meaning within company guidance.
Limitations of company guidance come about for a number for reasons. One reason is the need for management and boards to follow due process. That can help us identify positive opportunities and it can also help to identify negative opportunities.
A positive opportunity
What’s an example of a positive opportunity? Companies that are thinking about rolling out more stores, or rolling out new products need to go through a process where they justify that to their board. They might be trialling some stores, testing some concepts and then they can put a report together. Then they can go to the board, and the board thinks about whether they will proceed and if needed raise capital. Once the board's made a final decision, then they can go to the market.
What we do know is we know that if a board finds an opportunity in its core area, where it can get really high return on equity, it's almost certain they will do it. Apart from making that seldom seen opportunity as a decision, the board is mostly bogged down in the day-to-day minutiae of supervising the company.
As an example, Ardent Leisure has the Main Event business in the United States. They’re family entertainment centres with bowling, rock climbing, laser tag, mini-golf, and so forth. Those centres get circa 30% return on capital. They bought this business when there were only five centres in Texas and it was rolling out one or two a year, of course, it looked like management would do a large roll out. Analysts went to ask the company if they would roll out more stores and the company would say "Well we have to see how we go, the board hasn't made any decision on that yet." As it turned out, they hit the accelerator and now they’re looking at a target of 200 stores ultimately in the United States.
A negative opportunity
A negative example of following due process was seen in the case of Myer. When Myer was doing a strategic review, the Managing Director left, the CFO left, and the Chairman had to deliver the announcement to the market. He was asked if they would be raising more debt, or would be issuing equity? It wasn't appropriate for him to comment, as the strategic review hadn't been completed- he hadn't taken it to the board, but would have had a fair idea where it was heading. So he did his best to avoid answering these questions and ultimately said: “we're still doing the strategic review” and words to the effect that “they had no current intention to raise debt or equity”, which was factually correct. That is an example of looking through the limitations of what he could say. That’s one aspect of limitations of company guidance.
It’s what they’re not telling you that matters
The other aspect of limitations of company guidance is what they're not telling you. It's not because they can’t tell you, it's because they don't want to tell you - you have to look through that. This was brought home to me by Roger Corbett, the ex-CEO at Woolworths some years ago. In a conversation we had, he was talking about walking around a store and looking at the fruit and vegetables section, which was pretty empty in Woolworths. He looked across the arcade and saw quite a few people in the greengrocers across the arcade and he said to the Manager of the store "What are the customers telling you?" And the Manager said, "Well they are not telling me anything Roger", and Roger said, "Yes they are, they’re screaming at you!" Often, the management and board of the company are screaming at you without saying anything at all.
I've got a lot of examples of that from situations where management removes things from their presentations that they had included for many years. Sky TV in New Zealand was a great example of this, where they removed the composition of their subscriber numbers - a slide that had been in their presentation every Half for 15 years, but they didn't want to talk about that because subscriber numbers were starting to fall. We see that over and over again in company conversations.
Recently I asked a company I was talking to about their cash. He gave a very helpful answer, but he didn't actually tell me what his cash position was, so I went back and asked again. When people don't want to lie, they try to be helpful, but they try to avoid answering the question. We see that time and time again.
Management departures are a key signal
When you see directors and management leaving a company, even though they say things are ok, that's a very strong signal. An extreme example again, Myer; Independent Directors were leaving and even management was leaving. Alternatively, Fairfax many years ago. Managing Directors and Independent Directors of this rather prestigious company were leaving. Managing Directors often leave when the best days of the company are behind them. They won’t say: "Oh, the best days of the company are behind us", particularly when they have large share holdings. They often know before the board knows that the best days are behind them - we see that again often when people leave abruptly.
Another classic example is when you have a Managing Director who's come on to a company and has only been there for 9 months or so and has very big plans for the future. Maybe the analysts were expecting a 3 or 4-year plan of change and then they leave abruptly for one reason or another.
Read between the lines
All these signals are limitations of a company's guidance, more often to the negative than the positive, but it's about reading between the lines and truly trying to understand that these real people have to follow real processes. They just can't do what they want, and from a behavioural point of view, they don't want to lie, and they want to avoid bad situations. Whether that means leaving the company, or if they avoid talking about things that might otherwise be important to investors.
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Monash was established in 2012 by Simon Shields and Shane Fitzgerald. The Monash strategy is benchmark unaware, style and stock size agnostic, and is both long and short.