What can cause a 10 per cent sell-off…

What can cause a 10 per cent sell-off…

Unless you attended management or business school, there may not seem to be much of a distinction between a plan and a strategic review. The two terms, however, mean completely different things, and each has significant implications for a company’s long-term value prospects when employed.

A strategic review is typically a reaction to a material decline in a business’ operations. The underlying cause may have been festering for a considerable period of time, and management was either unaware, unwilling, or unable to address the issue. The review will typically mark the beginning of a prolonged, and costly, turnaround program.

By contrast, a plan is a proactive action to achieve a defined outcome. Companies that articulate a long-term vision will typically have a constant focus on improvement, as progress will be assessed according to benchmarks. This reduces the risk of a material earnings decline as the company shapes the industry.

A number of large companies have announced strategic reviews in recent months; Coca Cola Amatil (ASX: CCL) is responding to aggressive price activity by the supermarkets, Qantas (ASX: QAN) has announced another cost reduction program and capital expenditure review, while Metcash (ASX: MTS) requires considerable investment to refurbish stores and optimise its supply chain.

It’s telling that on the day that each of these companies released their reviews, their share prices declined by nearly 10 per cent, indicating that the market was too optimistic and failed to anticipate the issue.

Importantly, such reactions illustrate the presence of downside risk when a company has launched a review. Due to the level of uncertainty surrounding a company’s position, and the absence of a clear direction, it’s difficult to fully appreciate management’s ability to implement the necessary change. When this is the case, how can you properly understand or value a company?

Rather than attempting to profit from companies that are reviewing their operations, we believe it might be better to focus attention on companies that are successfully executing a well-articulated, long-term plan.

For instance, Seek (ASX: SEK) is applying its business model to leading job websites in overseas countries through incremental investments; Flight Centre (ASX: FLT) is transitioning from a travel agent to a travel retailer; and Kathmandu (ASX: KMD) is focused on becoming a global brand, supported by a stable store-rollout strategy.