All change: How new management can be good for companies and their share price

We look at who is in charge of UK companies and the challenges many of them face
Thursday 19 Apr 2018 Author: James Crux

One of the key ingredients in the success or failure of a company is the quality of its management. When change at the top of a struggling company occurs, it can often act as a catalyst for an underperforming business and trigger a share price boost.

Evaluating the skill sets of boardroom leaders is no easy feat, yet there are CEOs out there with proven pedigree in turning companies around or taking them to the next level. In business as in football, recruiting a best-in-class manager can make all the difference between success and failure.

Thomas Wilson, UK Equity Fund Manager at BMO Asset Management, says management change can be important in ensuring a high-quality business that is currently under-earning can fulfil its potential and hence fairly reflect its prospects. ‘Poor management can be extremely detrimental to businesses and share prices. A change of management can however be the catalyst needed for a company to meet its capability,’ he adds.

In agreement is Alex Savvides, manager of the JOHCM UK Dynamic Fund (GB00B4T7HR59). ‘Positive corporate changes, particularly new management teams with new strategies, can be a major driver of stock market returns,’ says Savvides.

‘Investors are quick to discount known or quantifiable threats, but they are typically slow to identify and assess how company management teams are responding to these threats and tackling issues in their businesses. This often results in these stocks trading at pronounced discounts to their intrinsic long-term values, which is where the opportunity lies for investors.’

Savvides reckons backing the right management team is a critical component of investing. He and his team spend a long time meeting management in order to form an informed view on their abilities.

‘It’s a qualitative judgment but an essential part of investing in corporate change stories, one centred on understanding the management team’s approach to capital allocation and cash flow and ensuring that they really understand why the company was previously struggling,’ he adds.

‘We want senior management to show rational thought but also to exhibit an activist mentality, being unafraid to challenge the status quo and drive through positive strategic change.’

Simon Gergel, manager of The Merchants Trust (MRCH), pays ‘close attention to the management teams of the businesses we invest in. This is particularly important in turnaround situations where a change of management can provide a powerful catalyst to drive performance.’

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Gergel says Leo Quinn has been instrumental in the recovery strategy at Balfour Beatty (BBY), bringing in rigorous controls and disciplines, which are critical in construction businesses, as well as numerous other changes to operational processes.

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Nevertheless, investors shouldn’t buy part a doomed business solely on the appointment of a new CEO, seasoned or otherwise. As Warren Buffett once quipped: ‘Our conclusion is that, with few exceptions, when management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.’

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THE LATEST CHANGES

Management change is a hot topic right now. Advertising agency WPP (WPP) ihas parted ways with CEO Martin Sorrell amid an investigation into his personal conduct, while Tesco’s (TSCO) turnaround has triggered fresh speculation that its CEO Dave Lewis is in the frame for the top job at Marmite maker Unilever (ULVR), with long-serving Paul Polman preparing to step down by the end of the year.

Meanwhile, the London Stock Exchange (LSE) has appointed Goldman Sachs veteran David Schwimmer as its new CEO.

Quoted company leadership undergoing significant change is the fast-evolving retail sector. Struggling baby goods purveyor Mothercare (MTC) recently ousted Mark Newton-Jones and appointed retail industry veteran David Wood as its new CEO, tasked with completing its transformation plan and return to growth.

The new Mothercare head honcho has form in turning around retail businesses, notably US grocer-to-pharmaceuticals business Kmart, and a return to growth in the Middle East, where the heritage brand has cache, gives Wood something to work with.

Fresh leadership is in play at electricals-to-telecoms retailer Dixons Carphone (DC.), which has drafted in Shop Direct boss Alex Baldock for his digital expertise succeeding Sebastian James as CEO and recruited Halfords (HFD) bean counter Jonny Mason as its new numbers man. Nick Wilkinson, known for his stewardship of Evans Cycles, is the new CEO broom at homewares leader Dunelm (DNLM).

HAIL TO THE CHIEF(S)

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Two of the country’s biggest retailers are being successfully turned around by a pair of ‘Daves’; Tesco’s Dave Lewis and rival David Potts at WM Morrison Supermarkets (MRW).

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Stephen Message, manager of the L&G UK Equity Income Trust (GB00B6HBD759), recalls about Tesco: ‘Current CEO Dave Lewis joined the business in 2014 with the task of restoring profitability and improving the health of the balance sheet. Tesco had suffered through overexpansion, accounting issues, lost market share to discount retailers, deteriorating supplier relationships, poor brand perception and customer loyalty. This ultimately led to the business suspending dividends until performance improved.’

Message continues: ‘Having previously spent 27 years at Unilever, the new CEO initiated a restructuring programme to reduce operating costs whilst improving the range and Tesco’s brand perception to win customers back.

‘Move forward three years and profit margins have started to recover whilst the dividend was recently reinitiated. Another interesting development in the recovery phase has been the recently completed merger with food wholesaler Booker.

‘This should provide the combined group with more levers to make improvements. Booker itself was also subject to a turnaround under CEO Charles Wilson, who joined Tesco as part of the merger and will become the UK division’s CEO.’

Annual numbers (14 Mar) from Morrisons confirmed the Bradford-based grocer has become far more competitive under Potts, appointment to the hot seat in early 2015 and developing the vertically-integrated food retailer’s wholesale business into an underappreciated additional growth engine.

For the year to 4 February 2018, Morrisons reported an 11% increase in underlying pre-tax profit to £374m and net debt reduced to £973m. Shareholders were also treated to a surprise 4p special dividend reflecting Potts’ confidence in continued cash generation and growth.

Away from retail, sweeteners giant Tate & Lyle (TATE) has a positive catalyst in the promotion of CFO Nick Hampton to CEO, providing the prospect of a renewed strategy to accelerate the £2.63bn cap’s transformation to a higher margin speciality ingredients play. Recently (1 Apr) handed the CEO baton from Javed Ahmed, Hampton has an opportunity to enliven Tate & Lyle’s share price when communicating his exciting plans for the business at May’s full year results.

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REPAIRING THE MESS CREATED BY PREVIOUS MANAGEMENT

BMO Asset Management’s Wilson cites Bovis Homes (BVS) as a recent successful management change story. ‘Although a cyclical business, Bovis has on average generated a return in excess of its cost of capital, even when allowing for the credit crisis,’ says Wilson. ‘The returns are driven by a competitive advantage compared to smaller players, with its technical expertise allowing it to construct big and complex sites, and its relationships with local authorities allowing it to get planning permission and add-value through the design process.’

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Sadly, for shareholders, Bovis lost its way and was poorly run with previous management ‘prioritising growth over returns’.

‘The quality of homes built fell significantly and the company generated operating profit margins well below those of peers,’ Wilson says. The company issued multiple profit warnings during 2016. Unsurprisingly, share price performance, especially when compared to other listed UK housebuilders, was extremely poor through this period.’

A poor strategy, execution and culture triggered the parting of the ways between the company and its CEO of eight years, David Ritchie, in January 2017. New CEO Greg Fitzgerald was installed in April 2017 and ‘subsequently set out a strategy to shrink the business to improve the quality of the product, ensuring customers were happy with the house they were buying and ultimately improving profit margins’.

Wilson notes progress has been ‘exceptional’ with the company enjoying a 4-star Home Builders Federation rating from its customers.

‘Ultimately this was a case of a high-quality business not being valued to fairly reflect its prospects because of poor management,’ Wilson says. ‘A change in management team changed all that.’

JOHCM UK Dynamic’s Savvides says one of his largest active positions, component distributor Electrocomponents (ECM), is a good example of where a change in leadership transformed a company’s fortunes. Lindsley Ruth was appointed as CEO in April 2015 at a time when the company was underperforming.

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‘He implemented a new, multi-faceted strategy that has succeeded in the face of market scepticism and the share price has risen sharply as a result,’ says Savvides. ‘Of course, not every new management team we back will deliver. That’s part of the challenge.’

Elsewhere, Aviva Investors’ Head of UK equities Trevor Green comments: ‘Paper and packaging is not at first sight a glamorous sector, but under Miles Robert’s watch he has made DS Smith (SMDS) an attractive investment culminating in the stock entering the FTSE 100 index last year.

‘Every time someone buys anything from Amazon in the UK, the item has to come in a package. Most likely, this package will come from a DS Smith factory. Miles became CEO in 2010 and quickly moved the company away from being a highly cyclical paper company into a more stable higher-returns business, which has been applauded by shareholders.’


MANAGEMENT CHANGE IN ACTION

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Bleak UK high street conditions and a rapid shift to the internet that many argue foretells the demise of physical stores are key factors behind the weak share price of structurally challenged Marks & Spencer (MKS).

Yet M&S has carried out a senior management overhaul which bulls argue means the right team is in place to improve its lacklustre performance. The British retail institution is steered by CEO Steve Rowe, appointed in 2016 and whose transformation programme is beginning to stop the rot; Marks & Spencer’s Christmas trading was mixed rather than disastrous.

He is trying to bring the FTSE 100 stalwart back into full favour with shoppers by getting the fashion basics right, focusing on quality rather than price, cutting down on store space and getting the online operations right. Ruthless Rowe – nicknamed ‘Nails’ – has also shuttered stores in loss-making international markets. Crucially, he is now being assisted by Archie Norman, the British business titan who joined the board as non-executive chairman on 1 September 2017.

Very much hands-on, Norman is shaking up the culture at Marks & Spencer and is the ultimate trouble-shooter for the ultimate turnaround, previously instrumental in transforming ASDA and Kingfisher (KGF).

Marks & Spencer also now has former Halfords boss Jill McDonald in place as managing director of Clothing & Home; Stuart Machin takes up the new role of managing director Food in late April and the senior management team will be joined by new finance director Humphrey Singer from Dixons Carphone in July.

The high street doyen therefore boasts a strong brand, a compelling plan backed by experienced leadership and investors are also being paid a 7% dividend yield while they wait for the recovery to bear fruit. The task won’t be easy – clothing, home and food like-for-like sales weakened in the third quarter to 30 December.

While Marks & Spencer remains over-spaced, shoppers still like to see and feel products, socialise while they shop and enjoy the experience of some retail therapy.

This gives the bricks-and-mortar, operationally geared shopkeeper an advantage if Rowe and Norman can get the tills ringing again. Ahead of full year results (23 May), Shore Capital forecasts improved adjusted pre-tax profit of £593.2m (2017: £584.5m) and a maintained dividend of 18.7p. (JC)

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Shareholders in LED lighting systems designer Dialight (DIA) are pinning their hopes on new leadership drawing a line under manufacturing execution problems. The £170m company is at the cutting edge of LED technology, specialising in modern and efficient lighting solutions for hazardous and challenging industrial applications.

Think power plants, utility installations and oil rigs, or vast factories, warehouses, distribution centres, for example. It also supplies warning lights for tall buildings, mobile masts and wind turbines, among other things, designed to stop planes and helicopters crashing into them at night.

LEDs are brighter and about 10-times as energy efficient as normal light bulbs, so there are large cost savings to be had for big energy users.

This creates long-run demand, something that Dialight has struggled to manage over recent years. Failure to meet production targets led to the decision in 2017 to outsource manufacturing so it could concentrate on the design process. Silicon Valley-based Sanmina was selected as its partner, but the transition has been beset with problems, including product launch and production delays.

This led to two profit warnings during 2017. Those problems came to a head in early January this year and cost former chief executive Michael Sutsko his job. It is early days for his replacement Marty Rapp, but analysts believe the new boss has the engineering and manufacturing background to turn things around.

Rapp is a former executive at electronics designer and manufacturer Laird (LRD), which recently agreed to a £1bn takeover. He has also held engineering positions at Monsanto, the Fortune 500 agriculture giant.

‘His main priority is to accelerate the recovery after the relationship with contract manufacturer Sanmina began so poorly,’ say analysts at Investec. Results for the year to 31 December 2017 show the scale of the job at hand, reporting expected declines in underlying pre-tax profit and operating cash flow on pretty much flat revenue.

‘Even the deliveries that were achieved incurred additional costs, reducing margins,’ pointed out Investec in February. But there is firm belief that Dialight’s destiny is in its own hands, with Investec continuing to believe that Dialight’s production problems can be remedied, enabling it to achieve strong growth and restore investor confidence.

If it is right, then there is scope for significant share price appreciation in the months and years ahead. Investec has a 12-month target price of 790p, implying 49% upside from the current 530p level. This is a company who’s shares traded at close on £14 levels just five years ago.

Analysts at investment bank Berenberg believe there may have been large market share declines during months of upheaval. Winning back lost customers means regaining trust. In our view there is scope for recovery but evidence of better execution is needed. (SF)

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In some respects, the new chief executive of ITV (ITV) has a hard act to follow but there are reasons for optimism as EasyJet (EZJ) alumni Carolyn McCall gets to grips with the free-to-air broadcaster.

Under the tenure of predecessor Adam Crozier, which lasted from April 2010 to June 2017, the share price advanced 160%, debt was substantially reduced, and the company became increasingly profitable. A 2009 pre-tax profit of £25m was dwarfed by 2016’s total of £847m.

More recently, sentiment towards the stock has soured as advertising revenue has come under pressure. McCall’s challenge, having taken up the reins at the start of 2018, will be to capitalise on opportunities in areas like video-on-demand (VOD) and TV production.

ITV trades on an undemanding valuation of 9.6 times 2018 forecast earnings and the outlook for advertising spend is boosted by the football World Cup in Russia this summer.

McCall has already made some early moves to refresh the strategy of the business, which in the early part of Crozier’s tenure at least was focused on steadying the ship and getting the financial performance back on track.

The network programme budget, or in other words how much its spends on the programming across its channels, is being increased for 2018 to £1.1bn from a little over £1bn in 2017, a level it had roughly been held at since the financial crisis. The money is evenly split between drama and sports rights.

The company also outlined investment of between £15m and £20m on property, online and data investments. The extent to which McCall can monetise VOD might dictate how her leadership of the business comes to be viewed in the future and she may outline her plans in more detail alongside half year results on 25 July.

In theory ITV has a substantial opportunity. In its own words this service offers ‘more targeted demographics and a high-quality, trusted and measured environment for online advertisers’.

The reference to quality and trust is highly relevant given the issues advertisers have faced with other providers of online content. In May 2017 some big names pulled ads from YouTube after their brands were displayed alongside extremist material. This risk is arguably reduced with ITV’s VOD service.

Liberum analyst Ian Whittaker has estimated that if the company was to capture 10% of the online display advertising market by 2020 against his current forecast of 6.5% it could deliver a 7% boost to earnings. (TS)

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