Weekly Impressions: org | anz | WOW

The two key company announcements in Australia in the past week were Origin Energy’s launch of a $2.5 billion entitlement offer designed to strengthen its balance sheet and CEO succession at ANZ, with Mr Mike Smith stepping down after eight years in the role.

Origin Energy (ORG) shores up its balance sheet

In addition to the $2.5 billion entitlement offer, ORG announced that it would adopt a number of other measures to shore up its balance sheet, including cutting dividend guidance, selling non-core assets, and reducing capital expenditure and working capital requirements.

This has occurred against the backdrop of a lift in the company’s ratio of total debt to equity to over 90%, its highest level in a decade (see chart).  If the proceeds from the 4 for 7 rights issue are used to pay down debt –as the company has announced – the gearing ratio will decline to below 70%.  ORG announced on Friday that there had been 92% take up by eligible institutional investors at the $4.00 offer price.

The weight of the academic literature shows that firms undertaking seasoned equity raisings tend to under-perform because company insiders are more likely to issue equity – to finance acquisitions and investment projects - when they believe that their scrip is overpriced.  But the international evidence is more supportive of capital raisings that are designed to strengthen a company’s balance sheet.  In fact, many of the capital raisings in Australia through 2008 and 2009 in the wake of the financial crisis, were associated with subsequent out-performance as investors assigned lower default risk to many of these firms.

The balance sheet impact of lower capex and working capital requirements – up to $1 billion across FY16 and F17 should not be under-estimated.  ORG’s capex spend in FY15 was $1.7 billion, so the planned cut would amount to a 30% reduction in each of the next two years (see chart).  Much will hinge on the outlook for oil prices, but the measures to streamline the asset side of the balance sheet and lift the equity component of the company's liabilities should re-position the company in the event that oil prices remain at current levels.  But it also gives shareholders greater participation in the upside if the outlook for oil prices improves.

Sizing up Mr Smith's footprint

Mr Mike Smith announced that he would be stepping down as ANZ's CEO after eight years in the role.  Much of the media commentary has focussed on the bank's Asian footprint as his legacy.  Has the strategy to expand into banking markets more competitive than Australia to get exposure to the region's rising middle classes been a sound one? 

The company's growth prospects relative to other banks represents a good starting point.  Analysts' forecasts for ANZ's EPS are 20% higher now than when Mr Smith commenced in his role in 2007.  Although this is well above the NAB's performance, it is substantially lower than CBA and slightly lower than WBC (see chart).


 Analysts downgraded the bank's growth prospects more aggressively than WBC and CBA during the financial crisis, and never fully recovered.  In fairness to Mr Smith, ANZ's business exposure - already a feature of the bank's loan book prior to his tenure - largely contributed to the significant downgrade to the company's growth prospects during this time.  The chart below shows that the spike in the sector's non-performing assets during the financial crisis was larger for business loans than for either personal or housing loans.

The fact that the company's price to book ratio remains comparable to NAB's - as it was at the start of the Mr Smith's tenure as ANZ CEO - but worsened relative to WBC and CBA's book multiple confirms that Mr Smith's strategy has not improved the bank's growth prospects relative to its key peers (see chart). 

The difficulty with sizing up Mr Smith's footprint is not knowing the counterfactual; that is, what strategy would Mr Smith have pursued if he had not sought to expand ANZ's Asian footprint?  With the benefit of hindsight, the rapid growth of housing credit - particularly for investors - suggests that ANZ might have benefited from gaining market share from WBC and CBA  in this space and reducing its reliance on business lending, which has remained anaemic.  But this approach could have led to a price war, which would have been detrimental to sector wide profitability and attracted the attention of APRA and the RBA. 

Woolworths: The quest to combat poor value for money perception

The senior management ranks at Woolworths remain in a state of flux, while its CEO succession 'planning'  drags on; it has been over three months since Mr Grant O'Brien announced he would be stepping down.

WOW has been much criticised across a number of fronts, including its willingness to maintain and expand already fat profit margins at the expense of delivering value to the customer, at a time when Coles and Aldi have been competing aggressively on price.

WOW has started to embark on its quest to neutralise its perceived poor value for money. On a recent visit to the local Woolies supermarket, Evidente noticed that staff had put a trolley at the store entrance, with a price comparison that showed that the items in the trolley were 20% cheaper now than at the start of the year. The trolley also drew attention to the fact that prices had dropped on over a thousand products, presumably over the same period (see photo).  Evidente will shortly be releasing a research report, reviewing the investment case made for WOW earlier this year.