Sometimes, divisions need to hit the road

Barloworld operates a variety of businesses. A conglomerate from an age when conglomerates were cool, Barloworld is now a bit of a dinosaur as a corporate structure.

The problem is that the group is too diversified. Investors can’t take a clear view on just one sector or geography within the group but must instead invest into the full story. In this case, the story isn’t much of a fairy-tale.

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The group is still profitable at operating profit level (R1.8bn, down 54% on the prior year) but swung into a loss at headline earnings level. With revenues down by 17% and operating margin down from 6.6% to 4.1%, it’s a year that Barloworld will try to forget.

Perhaps it would’ve been different if Barloworld had moved faster to do something about the unattractive businesses in the group.

For example, I simply cannot understand why the car rental market hasn’t consolidated into a maximum of two players. Uber disrupted that market completely, diverting corporate rental spend away from committing to a car for a day so that someone can drive to two meetings in the same area.

Barloworld owns Avis Rental. By continuing to play in a clearly and obviously unattractive space, Barloworld is now paying the price.

Avis: locked down

The impact of lockdown, which brought travel to a standstill, is clear to see in the Avis results.

With listed company results, you can always split the revenue into the two reporting periods of the year. Because JSE-listed companies report interim results for the first six months, the performance for the second half of the year is a matter of deducting the interim number from the full year number.

Note: this only works for income statement items (e.g. revenue or expenses), not balance sheet items which are a snapshot in time.

Splitting the result into two halves reveals an interesting trend:

  • H1 (6 months to March 2020): Revenue R3.16bn vs. R3.30bn prior period (down 4%)
  • H2 (6 months to September 2020): Revenue R1.96bn vs. R2.94bn prior period (down 33%)

The problem with the car rental business is that the operating leverage is high. This means there are extensive fixed costs (the fleet of cars) which help drive profitability in busy times but create a lot of risk when revenue takes a knock. I unpack this concept in more detail here.

Although revenue was only down 18% for the full year, operating profit plunged from R523m in the comparative period to a loss of -R143m in this period.

If we break it down into halves again, the H1 profit of R194m was decimated by a -R337m loss in the second 6 months (H2). This is a direct result of a combination of high operating leverage and huge pressure on revenue.

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Car dealerships

This is another business model that doesn’t win any awards from me. Margins are paper thin to say the least.

In the 2019 financial year, which was unaffected by Covid, the dealerships business generated R561m operating profit off a revenue base of R18.7bn. That’s an operating margin of just 3%.

This year, the division saw revenue plunge nearly 33%. As a result, profitability collapsed to a loss of -R12m. Sales activity has started to pick up again thankfully, but it’s still a marginal game on a good day.

This division needs to hit the road

Barloworld’s automotive and logistics division achieved R1.7bn operating profit in 2019 off revenue of R33.5bn, an operating margin of 5.2%.

Considering the asset-heavy business models in this division that require such significant investment in fixed assets, these margins simply aren’t attractive for investors. The return on invested capital is poor in the context of the risk.

This year, the division managed to squeak out a R136m operating profit, thanks (ironically) to Avis. That’s an operating margin of 0.55%.

Barloworld management has indicated that there is going to be action taken to restructure this division or dispose of parts of it.

The sooner, the better. The Equipment division, which houses Barloworld’s Caterpillar operations, is a vastly superior business (R2bn profit this year at an operating margin of 8%). I don’t think shareholders will miss the Automotive and Logistics side of things.

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