August 16, 2018

Burn, baby, burn - EVA, big European retailers and shareholder money

Burning money (photo: noskaphoto/stock.adobe.com)
What sounds like a radical protest slogan from the summer of 1968, ought to be the new motto for European retail managers this summer, or at least for those who run big publicly-quoted companies. However much highly-paid board members may talk about nurturing shareholder value, Bloomberg figures tell a different story. In fact they seem to have been merrily burning investors' money.

According to the US financial news company, many had a negative Economic Value Added (EVA) in their last reported business year. These include such illustrious names as Ahold Delhaize, Carrefour, Metro, J. Sainsbury and Tesco.

While Ahold Delhaize, created from a merger in 2016, and Metro, which demerged in 2017, have only just gone negative, others look alarmingly consistent. Tesco has clocked up a whopping total of around minus €12.8bn since 2014. Over the same period Carrefour's EVA has increased astronomically from minus €57 to minus €1,360m.

EVA can be variously defined. We presume that the metric used by Bloomberg puts the Weighted Average Cost of Capital (WACC) in relation to the operating result before interest and after taxes, whereby a higher WACC means the destruction of shareholder value.

When the larger retailers were asked to comment, reactions varied. These ranged from silence on the part of Carrefour, through "no comment" from Ahold Delhaize and Tesco to criticism of Bloomberg methodology by Metro.

As any discussion about EVA quickly becomes technical and gives analysts and CFOs a wonderful chance to talk Persian to the layman, we asked Insead professor Marcel Corstjens to talk us through this yardstick and what the Bloomberg figures really mean for retailers, managers and shareholders.

EVA of leading European retail plcs (source: Bloomberg)
Firstly, however, it is only fair to record at least the gist of the feedback received from the retailers concerned.

J. Sainsbury replied that: "The focus of the board will always be on driving shareholder value; Trends are improving. We delivered Underlying Profit Before Tax growth of 11 per cent in H2; We believe the proposed Asda-Sainsbury's combination would create value for shareholders; The market agrees, with our shares up 24 per cent since the announcement of the proposed combination and up 39 per cent since the start of the year."

The response from Metro was considerably longer and more technical. In essence, the international C&C giant and local hypermarket operator criticises the lack of historic data on market capitalisation and claims that this has led to an "incorrect" calculation of its cost of capital. Metro also maintains that the tax expenses employed in Bloomberg's calculations do not reflect the real situation "in any way".

The Dusseldorf-based company also points to extraordinary expenditure totalling €254m during the company's past business year which "largely" reflects the cost of its demerger in 2017. Metro argues that this should have been recognised by Bloomberg in its EVA calculations, thus creating a "distorted picture". Metro emphasises that, had this extraordinary expenditure been taken into account, its EVA for 2016/17 would have been "positive".

With duty done, let's read what Marcel Corstjens has to say...


"Negative EVA means value was destroyed"


Professor Marcel Corstjens, INSEAD (photo: Mark Mackenzie)
Marcel Corstjens
Professor Corstjens, how good a yardstick is Economic Value Added (EVA) in judging corporate performance? Is it really meaningful or just a trendy concept for CFOs and analysts?

It is meaningful and has been used extensively, although less so today. Companies employ it as a yardstick, but sometimes under a different name. McKinsey, for example, calls it 'economic profit'. This has something to do with the intellectual property of the term 'EVA' owned by value-based management consulting company Stern Stewart.

Personally, I like EVA as a quick, understandable way to summarize a company's performance.

How reliable are Bloomberg EVA figures generally?

Bloomberg is a reputable company and they are trusted in the financial world. It's true that, like with most performance indicators, there are debatable issues in the computation of EVA: the cost of equity for a specific company; how the capital employed is measured, etc. But Bloomberg has been using these EVA computations for many years, and I therefore assume they are reasonably reliable.

Put in layman's terms what does a negative EVA really tell us?

It means value was destroyed. The company's 'NOPAT' (net operating profits after tax) could not cover the opportunity cost of the capital they have used during the period.

But can't companies also generate negative EVA in times of restructuring when capital investments are needed and the returns will not be immediate?

Yes. Negative EVA is possible if in a given year important capital investments were made which will only have a return in future years. Therefore, if the capital does not produce profit in the year of the investment, the investment will dilute the EVA.

So, for example, AB InBev, a very effective and efficient brewing giant, has had negative EVA over the last couple of years because they invested a lot of capital (debt actually) to buy SABMiller. This was a once-in-a-lifetime opportunity for them and one which is widely expected to pay off in the near future.

If Bloomberg's figures are correct, many of Europe's top publicly-quoted grocers, including Carrefour, Tesco, J. Sainsbury and Morrisons, are burning cash. Is all of food retailing in a global crisis?

Carrefour has been a real problem for many years – just look at the tenure of their CEOs over the last ten to 15 years.

The really interesting case, however, is the UK. If all retail was in a phase of restructuring, as UK retailers might wish to argue, then that would also be the case abroad. In fact, the Americans, especially Walmart, and many other foreign, publicly-quoted retailers, such as BIM, Jerónimo Martins or Colruyt, achieve positive EVA.

I don't have the data, and nor does Bloomberg because both discounters are not publicly quoted, but I have no doubt that Aldi and Lidl have hugely positive EVA.

Why do you say this?
I base this on the results of publicly-quoted BIM, a Turkish copy of Aldi, and those of Polish discounter Biedronka which I was privy to as a board member of parent company Jerónimo Martins.

Metro's EVA also turned negative in 2017. Yet Metro proudly announced in 2000 that it would use EVA as a metric. Do you think they regret this now?

A Metro Cash & Carry Outlet in China (photo: Metro Group)
A Metro Cash & Carry Outlet in China
The notion of using EVA as a key performance measure at Metro was the baby of Stefan Kirsten who was promoted at a very young age to Chief Financial Officer for Metro in 2000 and who wanted to do something new and modern. Once he was replaced, EVA became less of a critical variable for Metro.

How did Metro achieve positive EVA in business years 2015 and 2016 and are these figures reliable?

Metro figures look reliable for business year 2017, but the earlier ones are slightly awkward because of the demerger.

When one compares the share of debt in their total liabilities, Metro is extremely debt-driven and particularly so in the years 2014 to 2016. Notwithstanding the very low cost of debt, relative to the cost of equity, in 2014, they were still not able to create economic value.

Why is this important?

Because the cost of equity has been far higher than the cost of debt in recent years. If you take Metro, the cost of equity, according to Bloomberg, was 10 per cent and the cost of debt 0.3 per cent. This is in part due to Metro's exposure, through their C&C business, to the volatile Russian market. So, you can manage the sources of capital on your balance sheet to make your EVA look better.

Tesco facade (photo: Mark Mackenzie)
Tesco has declined to comment on its negative EVA. However, 'sources habitually close to the company' stressed that the business is 'cash-generative' and that it pays 'dividends'. Is this a satisfactory reply?

Cash generation and dividend payments, the latter, by the way, being both extremely small and very recent, have little to do with EVA and the quality of a company's ROI. It sounds to me from those types of comments that you have been speaking to someone very junior. A seasoned financial person or a CEO with a good grasp of finance would not argue with the fact that a company has to get EVA at least equal to zero in the long-run in order to create value.

Much of the commentary about what has gone wrong at Tesco focuses on Philip Clarke, who took over as chief executive from Sir Terry Leahy in 2011, as if everything had been going swimmingly until then. A look at the decline in ROCE during Leahy's tenure from a very good 19 per cent to a less than adequate 10 per cent clearly shows that this was not the case.

Such a dramatic drag on average ROCE probably indicates that returns on new investments in those years were not just inadequate, but in some cases negative – as the ill-starred US expansion proved to be.

What are the consequences of this?

A company can have negative EVA for ever yet still have positive profit and cash flow but shareholders should stop investing extra money in that business.

The thing that is worrying for the UK is that it is not just a single retailer who has a negative EVA for only one year. In fact three of the Top 4 UK retailers have all destroyed value simultaneously and for several years in a row. The fourth retailer in the Top 4, Asda, has just thrown in the towel as well by announcing that it wishes to merge with rival J. Sainsbury.

The UK used to be 'king of the castle' in international retailing with great margins and quality private label. They could also recruit top talent from Oxbridge etc. But these results reveal a sector in trouble.

Why do you think EVA is so negative for UK retailers?

Five main factors have played a role. Firstly, marvellous CEO Terry Leahy may have left Tesco a market leader, but he also left it in dire straits with a poor Profit & Loss as I have just described. This situation was subsequently badly managed by his successor, Philip Clarke;

Secondly, German hard discounters Aldi and Lidl have successfully pushed for market share at the cost of other retailers;

Thirdly, the change in shopper behaviour has driven the rise of smaller convenience stores, leaving most local retailers with too many large stores and a need to invest capital in the convenience sector;

Fourthly, although e-commerce promises some growth, it hasn't provided all the oxygen originally promised;

Fifthly, a pretty flat total market is saturated by rather undifferentiated retailers who are therefore prone to price wars;

So UK retailers haven't got a leader today to point the industry in the right direction. This results in ludicrous and dubious ideas like Tesco starting a hard discount chain and more market consolidation.

But more drunks in a car still don't mean that you have a good driver!

One could argue that some of these changes in the UK retail landscape could be structural and require significant capital investments, therefore explaining negative EVA. However, many of the factors impacting the UK, including changes in shopper behaviour, e-commerce, flat markets, hard discounters etc., are also found in many other countries.

Foreign retailers, or at least a subset of them, have still created value while coping with such structural changes. These include Walmart, Kroger, Costco, Colruyt and Jerónimo Martins.

J. Sainsbury wouldn't agree with you. The UK's second-largest retailer points to a 24-per-cent increase in its share price since the announcement of the proposed combination with Asda in April…

This is completely beside the point. The proposed link-up merely indicates that Asda's US parent company, Walmart, has given up on the UK and that J. Sainsbury doesn't believe that they can hack it on their own.

Amazon is meant to be the dark angel of the world's grocers, so how do you explain that its EVA is also highly negative?

Professor Marcel Corstjens, INSEAD (photo: Mark Mackenzie)
Amazon has had negative EVA for several years because they have invested heavily in infrastructure and technology (e-Commerce, iCloud, etc.) and the return will come later as they become world leader in several fields, including retail.

Note that they simultaneously generate tremendous sales growth even in the short term – something which English retailers don't. They also know where they are going, and investors believe them – rightly so.


Read in German: "Europas Tophändler verbrennen Milliardenwerte" (paywall) & "Es geht auch um Wertvernichtung" by Mike Dawson on page 10 of Lebensmittel Zeitung, no. 33, 17.08.2018


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Comments for this article are closed.

  1. Tim
    Created 16 August, 2018 17:34 | Permanent link

    Comparing oranges with lemons

    The Amazon business model is of course a wholly different beast than the dinosaurs. Seems their view is to blow the EVA concept out of the water, or perhaps not even recognise its existence.

    https://www.theinnovativemanager.com/wp-content/uploads/2014/06/Amazon-Revenue-and-Profit-over-time.jpg?a4c06d

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