HIDING BEHIND THE FISCAL CLIFF
Abacab Fund Sees Mispricing In Options As Black-Scholes Has Become “Inadequate”
Abacab Asset Management's flagship investment fund, the Abacab Fund, had a "very strong" 2020, returning 25.9% net, that's according to a copy of the firm's year-end letter to investors, which ValueWalk has been able to review. Commenting on the investment environment last year, the fund manager noted that, due to the accelerated adoption of many Read More
The US corporate governance system is based on the principle of operational freedom for the management and oversight by the non-executive directors (NED). This free hand given to the managers, including the Chief Executive Officers, is a strong reason for the shareholders to hold them majorly responsible for poor performance.
However, in case of earnings misses, any action which can be taken through the board’s oversight mechanism has a lag effect. This lag makes the oversight system totally dependent on the depth of analysis which the independent directors undertake subsequently.
This, in turn, depends on the professionalism, expertise & independence of the NEDs. How much of this professionalism is practically possible, especially in closely held, small companies, is not hard to imagine. It is possible that the roles of these independent directors have been “pre-defined” or they simply do not have the expertise or intent to take the management to task for failures.
Going by past experiences in the U.S. corporate world, it is easy to believe that worse (e.g. fraud, collusion, doctoring of balance sheet etc.) is possible, especially when companies declare financial results. Often, the managements blame earnings misses or losses on factors which may not be relevant to their company.
This is because, at all times, new excuses keep floating around like fads and disappear after serving their purpose of concealment of the real reasons behind lower revenue / profits. Recently, the European debt crisis, Hurricane Sandy and the noise about Fiscal cliff/debt ceiling has been in vogue. Whether the company does business with Europe or not, whether the clients were impacted by the hurricane or not, and most importantly, whether the fiscal cliff was crossed or not, all these “reasons” have supposedly negatively impacted the earnings.
Citigroup Inc. (NYSE:C) has been preparing to use the fiscal cliff excuse since the third quarter. In its recently released earnings review, Chief Financial Officer, John Gerspach referred to the fiscal cliff in the context of its impact on Citigroup’s business. The CFO said “… And at the end of last quarter, we pointed out to – we wanted to see the U.S. get past the whole fiscal cliff issue. Well, unfortunately, at the end of the year, the resolution of the fiscal cliff was basically kicking the can down the road. So I think that what we would like to see now is how the U.S. deals with the ongoing debt ceiling debate, and the upcoming sequester on expense reductions. We get through that, and we see how the economy performs, we see whether or not those trends that we see now are sustainable, and then we’ve got decisions to make”.
However, a closer look at the trend, highlights the fact that at least the revenues of Citigroup Inc. (NYSE:C) have been on the decline since 2009 (from $91.1B in 2009 to $70.1B in 2012). The net income, for these banks, is hostage to provisioning for bad loans etc.
Thus if net income decreases due to higher provisioning, some inferences can be drawn about managements confidence in asset quality rather than the expected slowing economy due to fiscal cliff. Comparing with the peers, how did JPMorgan Chase & Co. (NYSE:JPM) & Wells Fargo & Company (NYSE:WFC) manage to post higher revenues during the same period?
Was it that the housing market or any particular segment did better and they took advantage of it? After all these three companies are existing in the same economic environment and are doing business on the same planet. Though their focus segments may be different but perhaps they did something better than Citi.
Forget the banks, even retail (apparel) company Jos. A. Bank Clothiers Inc (NASDAQ:JOSB) CEO R. Neal Black said: “Q4 went slowly, impacted by Hurricane Sandy, unseasonable warmth and “distractions” from the presidential election and fiscal-cliff talks”. The company expects a 20% drop in net income for 2012 (fiscal year ending 2nd February 2013) as compared with 2011.
A question which can be asked is, what was the reason for the dismal performance of Q3’12 where the net income decreased 11.2% to $13.3M. How could fiscal cliff et.al. lead to a 20% drop? Is it possible that the management could have taken some strategic management initiatives to avoid this fall?
Even companies like Constellation Brands, Inc. (NYSE:STZ), (manufacturer of alcoholic beverages – premium wine to be precise!!) have apparently being impacted by the fiscal cliff. The management said: “…The whys and wherefores of the slowdown are hard to know for sure. We pretty much think that it’s probably related to all of this fiscal cliff business which impacted retail in general across all consumer goods but that’s about the only thing that we can really say with respect to that.”
That’s the best excuse they can come up with? The cliff? People in US, Canada, Newzealand reduced drinking wine because of anxiety regarding the fiscal cliff ? With due respects, that is a bit difficult to swallow.
Even the tech companies were expected to be hit by lower spending due to the uncertanty over the debt ceiling issue. However, the recently released earnings of Intel Corporation (NASDAQ:INTC), Microsoft Corporation (NASDAQ:MSFT) and even Apple Inc. (NASDAQ:AAPL) were not that bad. Any fall in revenue or reduction in pace of growth was attributable to other fundamental factors or the base effect rather than the alibi of the cliff.
In any case, how can one month of the fourth quarter be responsible for a major dent in the financials for the year? Importantly, no one, including the financial markets, belived that U.S. politicians would miss the chance to reach the agreement at the last moment and immediately come forward to take credit for it!
Well, all you great companies, now that the fiscal cliff is out of the way, the Europe debt crisis is forgotten & Sandy is over, we the ordinary shareholders expect you to perform better. Or at least we want you to come up with better excuses to hide your mistakes.
As the earnings season unfolds and several misses are recorded, it is possible that many managements come up with ideas to twist the tale and sweep strategic & operational mistakes under the boardroom carpet. The shareholders should, especially the major ones, should actively analyze the performance of their companies and not blindly depend on the board for taking corrective action. Shareholders, especially the major ones, should always remain sceptical of these excuses and alibis. Ask simple questions and you will be able to see the devil in the detail!!