Follow up thoughts on Victoria PLC
Whose return is it anyway?
After a lengthy period of general procrastination I have fired up the 2022 posting.
After my last (and only post) I hadn’t got back to @rhomboid1MF on his comment on the ROCE of Victoria PLC. I also read some good pieces about serial acquirers:
and secondly a piece at:
https://scottlp.com/letters.html#Acquirers
So…….
My starting point is that if we want to assess the underlying business quality of Victoria PLC (which is what ROCE is trying to do) then a measure of the economic returns of the business coupled with the growth trajectory is important. One challenge is how to determine the economic returns - what is the capital base and what profit measure is appropriate? As @10kdiver noted in his tweets:
Given that we have so many Return Ratio variants, a natural question to ask is: which is the best? Which one should we use for our analyses? The answer is: it depends on the situation. Some ratios work better in some situations. Others work better in other situations.
In the case of Victoria PLC we know management have explicitly targeted the acquisition of companies in the same sector and adjacencies via better operations, disciplined valuation metrics and prudent use of capital structure to maximize shareholder value (value per share of equity holders). More specifically:
Victoria’s board strongly believes shareholder value is best created over time by consistently growing underlying free cash flow per share and this is the key metric used in capital allocation decisions (2021 AR)
Furthermore they go onto describe and define the Return on Tangible Assets of the business as a key determinant for driving wealth creation for equity holders:
(2021 AR)
Where you have a company which is acquiring companies and assets to hold indefinitely I think it is appropriate to look at the RoTA in assessing the business quality. You can quibble about the adjustments but in substance it make sense. This gets to the Munger quote that for the long term equity holder the returns of the business will approximate to the returns seen by the equity holder.
So a hallmark of the underlying business quality of Victoria PLC will be consistently high RoTA over a period of time.
ROCE can be an appropriate metric. Are management using capital efficiently and also using an appropriate split of debt and equity to finance the business in an efficient manner? But as @10kdiver notes the return metric used should reflect the situation. Where a business is paying out the profits then a ROCE to assess underlying efficiency is sensible but if the company is acquiring businesses and retaining earnings for continued investment back into the business (organically and inorganically) then as reinvestment is occurring in relation to the tangible assets then underlying ROTA is more appropriate in assessing the business. (Assuming goodwill has not degraded then further investment is not needed in this ‘asset’.)
Furthermore accounting treatment of acquisitions and ongoing and one off costs can obscure the picture which needs to be factored into a ROCE analysis.
Hence in the case of Victoria I think a better measure of quality is the combination of both ROTA and its relation to cost of capital, FCF/share and Net Debt:EBITDA in relation to the leverage policy over a period of time (4/5 years).
I appreciate there may be an accusation of cherry picking - one metric doesn’t produce a favourable outcome so let’s use something else instead! I actually think when it comes to serial acquirers there is much higher degree of faith in management than other investment situations and that faith is built up over a number of years of observation from different perspectives.
Wishing you and your nearest and dearest a happy new year. I am already working on the next post……..