Not rushing out of Russia
Most companies spend a fortune on wordy corporate governance statements which are often glossed over by investors wading through the financial reports.
The only way of finding out just how committed a company is to these words is when it actually has to act and make tough — often financially painful — decisions in accordance with its own governance statements. Take, for example, Barloworld’s worldwide code of conduct, as per its website, where it states: “We also expect that our host countries will recognise the need for stability, growth and business success, and that they will honour human rights and their agreements, including those relating to the rights and properties of citizens of other nations.”
No matter how you analyse Russia’s stance on Ukraine, Russia has, without being provoked, invaded a sovereign country. This is not only significantly affecting the rights of Ukrainians but is also having an adverse economic impact globally. Despite this, Barloworld’s only action so far has been to impair its Russian business (albeit by a whopping R1bn pencilled in at its interim results last year).
According to a recent interview, Moneyweb’s Fifi Peters had with Barloworld CEO Dominic Sewela, it seems Barloworld has no intention to exit Russia. There is also no indication as to what action it will take should a host country not “honour human rights and their agreements, including those relating to the rights and properties of citizens of other nations”.
However, investors don’t seem to be ignoring the Russian exposure completely, judging by the current cheap valuation metrics and recent lacklustre share price movement. The share price fell steeply when Russia invaded Ukraine in late February 2022 and, at the time of writing, has not recovered. But another view might be that the valuation of the business reflected in the share price is instead discounting uncertainty around future profit contribution and the potential of more impairments of the Russian business still to come, rather than any moral issues arising from the Russian invasion.
Despite pressure mounting on the group’s Eurasia business (at year-end Russia contributed the bulk of revenue and operating profit of this segment), businesses in its Equipment Southern Africa division and Ingrain segment continued to perform well, as reported in its September year-end results (at the time of writing, there had not been any guidance on what to expect for March interim results).
Of the R3.654bn operating profit from its core operations reported at Barloworld’s recent year-end, Equipment Southern Africa and Ingrain contributed about R2.098bn and R708m respectively, indicating just how important these two businesses are to the group. The Eurasia business unit contributed about R1.17bn to the operating profit from total core operations, but impairments of R1bn to the Russian business wiped out this unit’s contribution to the group’s bottom line profit (further down the income statement) and indicate what a drag it is on the group.
With Russia stubbornly continuing its war in Ukraine, there is no clear resolution to the conflict, so there’s a low probability of the Russian business contributing any profit growth to the group over the next year or so.
A value-add to investors who did not shy away from the Russian issue would have been the value-unlock strategy from the recently unbundled Zeda to shareholders (this incorporates the Avis and Budget car rental brands as well as vehicle leasing). Though Zeda’s share price now trades below the initial listing price, there may still be some upside in holding on to these shares as leisure and business travellers start moving again.
Looking through a purely financial lens, continuing to operate in Russia despite the war may just prove lucrative in the long term, depending on how long the war drags on and the global consequences Russia will face over time. However, continuing to do business in a country which has wreaked such havoc on another sovereign state might prove morally and reputationally damaging.
Many large global companies acted quickly to sever their ties with Russia, often at great financial cost. Time will tell how history judges these actions.
Investors need to keep an eagle eye on debt as at the end of last year, net debt ballooned by more than 100%. This is still, however, within its covenants and gearing targets.
Because it operates in a country that is an aggressor in a war, investing in Barloworld should clearly be challenging the fashionably chanted ESG mantra of many institutional investors. This is an interesting test of where potentially cheap valuations of a business and stated ESG principles conflict, and will surely be a hot topic of debate during research meetings.
Setting any moral issues aside, if an investor discounts the company valuation for the potential negative overhang from the Russian exposure, then on most valuation metrics Barloworld does not appear excessively priced at current levels.