Steinhoff & the Grandstanders

Steinhoff (SNH) has happened and it is all over the news. Due to this fact, I won’t repeat what everyone already knows.

Rather, let me show you some graphs from Steinhoff’s results over the years as proof of how hard it is to (pre-event) pick up fraud.

There are grandstanders who are all clamouring that “they knew all along” or (even worse) that “they could have worked this out in 30 minutes“. This is pretty much all rubbish and says more about these peoples’ characters than it says about their ability as an analyst or fund manager.

At worst, with the below graphs and ratios (pulled from Bloomberg), all you could really work out was that Steinhoff’s fundamentals were deteriorating. And, at best, that Steinhoff had gone through a tough couple of years.

The rest is purely subjective.

Cash Conversion Cycle: Fraud Rarely Puts Cash Into A Business…

Fraud tends to be accounting based, which makes it non-cash flow. It is harder to fraudulently make cash appear than it is to make it disappear. Or, fraud makes expenses vanish or be capitalised. Even in the latter, this would come out in depreciation and not affect cash flows from operations.

Hence, where a business has bad cash flows or weak cash conversion (from accounting profits into real cash flow), in the absence of a good reason, this should be a warning sign.

Here is Steinhoff’s last decade and a half of cash conversion:

Sure, the cash conversion has deteriorated, but it was not negative. Retailers should generate anywhere between half to full cash conversion. 24% is terrible, but it does show that real cash was being generated. Just a couple years ago, Steinhoff was pumping c.70% cash conversion!

All I would conclude from this is that Steinhoff is a rubbish business.

Correction: The above graph is not my usual % of EBTIDA that becomes operating cash flows. Rather it is the number of days that it takes a company to convert working capital into cash.

In other words, Steinhoff was actually making good and steadily improving cash flows. This is almost never, ever a sign of fraud.

Anyway, my point remains: this measure definitely does not “scream” fraud.

Other Cash Measures: Follow the Money…

Following from the above Cash Conversion, you can analyse Steinhoff’s other cash metrics. All these metrics range from quite good to rubbish, but none of them scream fraud. At best, they just point to a business that is being badly run and, at best, is going through a tough time scaling up into a multi-national (understandably).

Balance Sheet Ratios: Journal Entries Always Have a Contra-Entry…

Fraud can appear on the balance sheet by capitalising expenses (makes your profits look better and gives you a higher NAV), but this comes out in a lower return on capital. Likewise, acquisitive fraud may appear in either intangibles or expansions in non-current assets. Sometimes this can appear in a growing margin between Tangible NAV and balance sheet too.

None of these checks are perfect and can happen naturally when a business does a couple large transactions. For example, when a small business buys Pepkor, and then starts acquiring half of Europe’s furniture and bedding businesses…!

All these ratios tell me is that I would not have bought Steinhoff because it is not a great business. Maybe I am just not clever enough to look at this and see fraud, but I also look at these ratios and see an aggressive Group making large acquisitions as it quickly tries to internationalise itself.

In other words, once again, the conclusion is not conclusive.

Cost of Debt:

Finally, a good way to measure off-balance sheet funding, SPV risk or hidden debt, is to check a company’s Cost of Debt (CoD). As a Group gets larger, its CoD should fall. At worst, this metric should remain flat (if interest rates remained flat).

Hence, you can see that Steinhoff’s CoD rose as it got bigger. It also rose as Steinhoff entered Europe where CoD is pretty much nothing.

Therefore, this CoD analysis is weird and I would have specifically asked management about this. Given that management is smart, I’m pretty sure that they would’ve had a good answer for this.

Hence, at best, this indicates that Steinhoff is rubbish at managing its capital structure. At worst, I would’ve added a couple points to Steinhoff’s Cost of Equity (CoE) to control for this expensive debt and risk balance sheet.


The conclusion here is simple. Either I am not smart enough to have picked up that Steinhoff was fraudulent or the grandstanders claiming they called Steinhoff are full of the same stuff that cooked Steinhoff’s books.

The markets are risky. Equity is risky. Fraud can happen. These are all facts.

Hence, you diversify to control against the unknown unknowns.

Maybe the best lesson here is not to invest in businesses that you think are not good businesses, irrespective of benchmark and stock market peer pressure.

The rest is noise.


P.S. Here is the pro-active answer to a couple things you will be thinking now:

  1. No, we did not have exposure to Steinhoff in the AWSM Fund.
  2. No, we did not have exposure to any of Steinhoff’s satellites in the AWSM Fund.
  3. Yes, CIL had rubbish cash flow too. Yes, we thought it was a risk. No, we thought it was justified because of the +20% y/y growth in Conco’s Order Book which naturally drew-down on working capital in a major way.
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