Ladies and gentlemen!
It’s time for the Africa Stock Showdown, the contest that pits two similar companies against one another to determine which one boasts the best combination of profitability, growth and value.
Squaring off are two stalwarts of the African fast food industry. In one corner, we have Famous Brands, parent company of Steers, one of South Africa’s favorite burger chains. In the opposite corner is the challenger, Spur Corp., which bills itself as South Africa’s leading sit-down restaurant group.
The match will consist of six rounds with each one focused on a different facet of the business. The company that wins the most rounds will be declared the victor.
Let’s get ready to rumble!!
A business isn’t much of a business if it’s not profitable, so that’s where our showdown begins. We want to see which company does the best job of deploying the resources available to generate cash in the bank. To do this, we compare return on assets (ROA), which measures the amount of net income a company earned in proportion to its average assets over the past year. We also want to see whether the companies are becoming more or less profitable, and we’ll do this by measuring the change in ROA over the preceding year.
With its higher, and more rapidly-growing ROA, Famous Brands is clearly the more profitable business.
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Winner: Famous Brands
Profitability is essential, but great companies also consistently find ways to grow. While growth is often measured in terms of earnings, I prefer to use cash flow from operations (CFO). Why? Because it measures the amount of cash that is actually moving in and out of the business as a result of its daily operations. Earnings figures, meanwhile, often include non-cash items and are more easily manipulated with accounting tricks.
Famous Brands grew its operating cash flow at almost double the rate that Spur did. Famous Brands clearly wins the round.
Winner: Famous Brands
Now, let’s consider how much of each company’s sales is eaten up by inventory, distribution, and administration costs. To do it, we’ll compare their operating margins (which is simply operating profit divided by revenue). We want companies with high, widening operating margins.
Spur’s got a significantly higher operating margin than its competitor, but it narrowed significantly from last year. I’m awarding the round to Spur, though, because Famous Brand’s margin deteriorated, too.
Big debt loads squeeze profit margins and can be a constraint to growth. We should look for companies that have low levels of long-term debt in relation to total assets, and for management teams that do a good job of reducing this ratio from year to year.
While Famous Brands has a very manageable debt to assets ratio, Spur has a near-spotless balance sheet and has reduced its already minuscule debt load even further over the past 12 months. The advantage is clearly with Spur.
We also need to make sure that the company is able to meet its short-term cash obligations like taxes and accounts payable. To do this we will compare the health of both companies’ current ratios. This helpful metric simply divides current assets (like inventory, cash, receivables) by current liabilities. The higher the ratio is, the more nimbly the company can deploy capital.
Spur’s current ratio is substantially higher than its competitor’s, but it also deteriorated over the past year. Meanwhile, Famous Brands marginally improved its ratio. I’ll call this one a draw.
Finally, we need to see which company is least favored by the market. We’ll do this by comparing two important value metrics – the price/book ratio, which measures the price placed on the company’s net assets, and the price/cash-flow ratio, which shows us how much the market currently values each dollar the company generates. In both cases, lower ratios indicate less-demanding valuations.
No doubt who wins this round. Spur is the bigger bargain according to both metrics.
And the winner of this edition of Africa Stock Showdown is:
Spur! The fast food conglomerate eked out a win over its larger rival thanks to its wider profit margins, lower debt loads, and cheaper valuation.
Do you agree with the outcome? Tell us what other factors we should have considered in the comments.