Evaluating the effectiveness of turnaround strategies amongst industrial companies in South Africa

Abstract

This research analyses companies who experienced at least one performance shock during the period under study. It is set out to answer four specific research questions viz.: 1. How many companies that experienced performance shocks did manage to turn around their operations? 2. How many of the turnaround companies became "successful" turnarounds by improving on pre-shock operating performance? 3. How long did it take these companies to reach the turnaround operating performance? 4. Which turnaround actions were applied by successful companies? The concept of OPR (Operating Performance Ratio) is used in this study to define performance shocks as well as when a turnaround had occurred. OPR is defined as the earnings before interest tax, depreciation and amortisation (EBITOA) divided by the total assets (TAS) of the company. A performance shock is said to have occurred if a company's OPR had dropped to being in the lower quartile of its industry while in the previous year its QPR was still above the median OPR of the industry. Similarly a turnaround situation is defined as being a performance shock company which has managed to return its QPR to above the industry median. The adoption of these definitions is in line with the latest research in the field. The research methodology adopted is predominantly based on quantitative analysis. The source data stems from the McGregor-BFA database which can be considered as the most sophisticated financial system to analyse South African listed companies. To control for diversification, the chosen sample frame consisted of companies belonging to two similar geconomic groups", which are classified as being part of the "industrials" sector as per the JSE/FTSE Global Classification System. The final sample frame consisted of 46 companies. The sample frame companies were studied over the period 1995 to 2005 Companies that did go through at least one performance shock in this period - a totat of 16 companies - made up the final sample. For these companies the year in which the performance shock occurred was labeled as T0. The first analysis was done PREAMBLEcomparing pre- and post-shock years to TO in order to establish whether the correct performance shock year had been identified. A further analysis between TO and postshock years was done to determine in which year recovery took place (as per statistical significant difference with year T 0). Eleven variables were identified for testing the application of turnaround actions. Each of these variables was analysed in the following two situations: • For turnaround companies, whether there was a difference in the variable in the year before and the years after the performance shock; AND • In the years after the performance shock, whether there was a difference in the variable between turnaround and non-turnaround companies. In addition to this quantitative analysis, the chairmen's extracts for all the sample companies were qualitatively analysed for the year of the performance shock and the year immediately after the performance shock. This research found that 34. 7% of the sample frame companies did experience at least one performance shock during the study period. Of the sample companies - those that experienced a performance shock - a comparatively high 44% managed to achieve a turnaround. This study furthermore found the effective period to achieve a turnaround as being three years. In this study it was decided to distinguish usuccessful" turnaround by separating companies that recovered to a level just above the industry median from companies that recovered to an QPR level in the upper quartile of the industry. The terminology "ordinary turnaround" (OTA) and ugood turnaround" (GTA) was adopted respectively. 43% of the turnaround companies managed to reach a GTA level ... a significant achievement when considering that only 17% of these companies were at a GTA level prior to the performance shock. This study found the immediate turnaround actions after a performance shock (in year T+1) as being protecting gross margins as well as increasing available cash. The results further suggest that turnaround companies focus on improving turnover and debtors levels in the years after T+1. It was also postulated that non-turnaround companies engage in excessive asset selling in post-shock years which seems to be to their detriment. It was furthermore postulated that the increase in dividend level for PREAMBLEturnaround companies in the years after T+1 indicate an eagerness to signal a recovery message to the market. The analysis of the chairmen's extracts also revealed that turnaround management is highly correlated to changes in top management. Top management changes occurred at 86% of the sample companies. One of the objectives of this study was to compare the research findings with international studies. The literature research revealed the following findings related to this study's research questions: • The number of companies that managed to turnaround after a performance shock varied from 10% to 33%; • The number of years required to achieve a turnaround after a performance shock ranged from 1 to 4 years although it was concluded that ... "the effective duration to achieve a turnaround was approximated to be three years"; • Several turnaround actions have been identified that were categorised as actions impacting on i) the top line (growth based actions), ii) net income (cost-cutting focused on reducing expenses) and iii) balance sheet or owners' equity actions (reducing owners' benefits or assets to generate cash flow). This study concludes with a recommendation to prudent investors and company owners alike, viz.: • Prudent investors should analyse the extent of the liquidity issues amongst companies that are experiencing a performance shock and seek the short term value-add by managing debtors and inventory le~els efficiently. Equally important is the protection of gross margins; a strategy that can be met by discontinuing product lines or customers which tead to the deterioration of gross margins Company owners should ward ott corporate raiders by implementing the actions put forward to prudent investors