Bollworms and share prices
Forget about the PE – check whether banks are going to start lending companies money again
YEARS AGO we had a small citrus farm near Mooinooi in North West province. Mooinooi lies between local platinum mines. The town and its golf course belong to Lonmin. We produced oranges for the Magaliesberg Citrus Co-op. They extracted the juice from the oranges and are still the juiceprocessing company in South Africa that pay the best prices to their producers. One weekend – it was early in September or October – I was walking through the orchard and noticed a small, fresh hole in one of the juicy oranges. It looked as if one of the neighbourhood’s mischievous youngsters had taken a shot at it with a pellet gun. And, indeed, on the other side of the orange was another hole where the pellet had exited. For a while I pondered the question of who the perpetrator of the deed could be. But then I saw another orange with the same two holes. Then another, and another and, later, almost the entire orchard. Then, of course, I realised there was something more going on here than a boy armed with a pellet gun.
I collected a few of the oranges and drove to my neighbour. He was sitting on his stoep in a mood of depression and said just one word when I showed him my oranges: “Bollworm.” He went on to tell me that we weren’t allowed to sell those oranges to the co-op and that I had to prepare myself to write off half my crop.
He said he was going to spray his orchards from the air with insecticide the following week and that that should stop the plague. The good news was that the bollworms don’t harm the trees in any way. They also eat some of the excess buds, which ensures a better crop the following year.
But why the two holes in the oranges? I wondered. That’s where the bollworm enters and leaves. The juice was quite OK, he assured me, but the co-op wasn’t allowed to process it. Because we produce citrus juice, not worm juice, continued my neighbour, who was also a director of the co-op.
I simply had to accept the situation. All I could do was squeeze out the juice of some of the oranges for our own use.
Let me try to explain what bollworms and oranges with two holes have to do with share prices. First, the bollworms didn’t damage the trees in any way. They weren’t stemborers destroying the entire orchard.
The plague ended by itself even a week before the aircraft arrived to spray the orchards. Though our crop was cut by a half, the following year’s bumper crop nearly made up for that loss. However, the most important thing was that the prices of citrus farms in the Mooinooi area didn’t fall at all as a result of the bollworm having destroyed half of one year’s crop. In fact, prices kept rising, especially when my friend Hans, manager of the Magaliesberg Citrus Co-op, managed to extract more juice from oranges every year and sold it for increasingly better prices.
However, if the Mooinooi citrus farms had been listed shares, announcing a 50% fall in turnover – not to mention the loss of profit – their share prices would have fallen by 25%, 50% or perhaps even 75%. People who invest in shares are a suspicious bunch. They just don’t believe that it’s bollworms that are only eating up this year’s crop (profit). Or perhaps two years’ profit.
Investors currently don’t only believe that Caterpillar’s current sales are bad. No, they think there’s a stem-borer going to destroy the entire orchard and that’s why the price of this old big gun – which has been producing yellow tractors for many years – is being marked sharply down. There are many similar examples on the JSE.
Why are investors so suspicious of a company that has a year or two of hardship while the prices of citrus farms don’t fall when bollworms destroy one year’s profit?
Confidence – or rather, a lack of confidence – in the overpaid managers is one reason. But the most important reason for the lack of confidence is debt.
The business world out there is much harsher than Hans, the manager of Magaliesberg Citrus. In this current uncertain climate if a company records a major loss because consumers suddenly buy less – not because it has a useless product (like General Motors) but because consumers have a bee in their bonnet about something or banks don’t want to give any more credit – investors in the shares also suddenly take fright. They look at the half crop destroyed by the bollworms and wonder whether the company has sufficient funds to pay the interest on its debt. That’s called the company’s ability to service its debt.
If it looks as if the company is going to come short and may have to borrow money, investors disappear in a flash, because they know the banks aren’t keen to lend new money. Suddenly, the business starts faltering. The citrus farmer can no longer borrow money to tend his trees because the bollworms have destroyed half of one year’s crop. The trees are neglected and die off. And that’s the end of the farm.
The almost innocent bollworms, which eat two holes in a nice ripe orange before they become larva and later turn into moths and fly away, have suddenly destroyed an entire orchard. That’s unfortunately what’s currently happening in the business world, because there’s no longer any confidence.
There are plenty of opportunities here for investors in ordinary shares. Look for shares whose prices have fallen sharply as a result of bollworms having eaten one year’s crop. There are lots of them. Forget about things like earnings multiples and dividend yields. Look at how much short-term debt the company has and whether it can service that debt. In a nutshell: Will the banks lend them money again? If the company has money in the bank, it will still be in business next year, regardless of the bollworms.
Sell that citrus farm whose price hasn’t fallen and buy those shares.