Value–based management considerations in the listing of an agricultural company on the food producers sector of the JSE Ltd

Abstract

In order for a company to operate effectively it needs to have sufficient capital, structured to such an extent that capital charge in the form of interest cost and required return is minimised. A strong capital base lays the foundation for the ability to generate revenue by implementation and management of a well laid out strategy to trade in either goods or services. Capital is a depletable resource and usually limited in respect of availability. The use of capital for income generation will be a process applying the capital to the most profitable project or venture. The cost of capital can be defined as the possible profit generated from an alternative application. This cost is defined as opportunity cost and it is mitigated by the risk involved in its application. Opportunity cost can also be related to the various investment choices which owners of capital have. Investors will base a decision on the risk return relationship of possible investments. Should an investment yield an acceptable return for the perceived risk, an investor will choose that particular investment. This will obviously depend on whether there are alternatives producing similar or better yields at similar or lower risk levels. Having an appropriate strategy will only yield acceptable returns through effective balance sheet management and decision–making. Balance sheet management entails the use of debt and equity finance in a way which results in the most profitable financing method or the lowest cost of capital. Equity finance entails the use of shareholders’ funds for financing capital requirements. This is usually done by issuing and selling shares over the counter or in the official market in order to finance operating requirements or to fund investments. For a company to list it means offering its shares to the public on an open trading system. In essence this means that investors have to be recruited. In South Africa, this trading system is the Johannesburg Securities Exchange (JSE) The purpose of this research is to identify the financial variables or value drivers through which management of farming product traders or food–producer companies can evaluate the expected performance of its shares, should it be listed on the JSE. The results were achieved by defining a comprehensive set of financial diagnostic, accounting and valuation ratios and testing it against the response of the share price. The test was done on the basis of developing multiple linear regression models for each relevant year and all companies listed in the particular sector on the JSE, in the defined period. Net Operating Profit after Tax (NOPAT) per share emerged as the most reliable measure of share performance. Second on the list was residual income calculations and more specifically, derivatives of EVA® principles as developed by Stern and Steward. Research into factors influencing share prices resulted in non–financial factors also coming to light. These factors, however, impact on the long term financial performance. The end result was a proposal to break down NOPAT into its key elements and identify the operations where these elements can be managed. A system of incentive driven measures is to be developed to drive behaviour, possibly through a balanced score card in order to introduce share value–based management. This will ensure that there are no surprises by the time shares are introduced to the open market.