Who Cares About Working Capital Efficiency?

Number one, cash is king – Jack Welch If I asked you to guess which of the three companies below told their investors that working capital efficiency was a key component of their strategy to deliver shareholder value, which of the three do you think it would be:

• Company 1, rated AA with $107 Billion in revenue and $11 Billion in cash and debt/equity of 45

• Company 2, rated BB- with $21 Billion in revenue and $2 Billion in cash and debt/equity of 439

• Company 3, rated A with $25 Billion in revenue and $3 Billion in cash and debt/equity of 51%

Most people would guess company 2 since they have a significant need to generate cash flow to reduce debt, invest in their business and improve their credit rating. Indeed company 2 does focus on working capital efficiency but so do companies 1 and 3, despite the fact that they are highly rated with plenty of cash and Free Cash Flow. When asked about focusing on working capital efficiency, you won’t hear “no thanks, we have plenty of cash.” Company 1 is Nestle SA, the largest food and beverage company in the world. This global powerhouse, had 2012 operating cash flow of $17 billion on 2012 sales growth of 10.2%. Further margins increased 20 basis points in 2012. Yet they still focus on improving working capital efficiency. You can see this clearly in slide 8 of their presentation on 2012 results. As CFO Wan Ling Martello stated “Our key priority and one which I told you we would be very focused on during my first year was to improve our working capital performance. … As you can see, we have significantly increased our cash flow generation, up around 50% to CHF 15.8 billion at the operating level. The key driver is our improved working capital performance.” That’s nearly $1 Billion in in free cash flow from working capital efficiency in 2012 alone. Company 2 is Goodyear. Given their heavy debt load and underfunded pension obligations as well as their cyclical and capital intensive industry we would expect Goodyear to focus on working capital efficiency in order to improve operating cash flow. As Goodyear’s CEO Richard Kramer stated on their Q4 2012 earnings call “we delivered strong cash results for the year as our progress on working capital helped generate $700 million of free cash flow from operations.” That’s 70% of operating cash flow from working capital efficiency. This is a company that’s executing well on their working capital efficiency objectives and driving cash flow on their way to an investment grade credit rating despite current market headwinds. Finally, Company 3 is Emerson Electric. This industrial technology powerhouse provides investors with great visibility into their business, their 2013 investor presentation is a tour de force. On slide 16 (and repeated elsewhere) Emerson shows a nice graphic of how they create long term value for their shareholders. Featured prominently is Operating Capital Efficiency as a means to drive Free Cash Flow. Emerson’s goal is to get Trade Working Capital / Sales to less than 15% and Free Cash Flow / Sales to between 10% and 14%. There is a reason why Emerson delivers tremendous shareholder value and, according to Seeking Alpha, has the fifth longest dividend growth streak in the world at 56 straight years. During the last 3 years Emerson has generated $7.7 Billion in free cash flow, $1.2 Billion coming from working capital efficiency. What has all that cash flow allowed them to do? From 2010-2012 Emerson distributed $3.2 Billion in dividends to shareholders, bought back $1.8 Billion in stock and spent $2.2 Billion on acquisitions. This is a company that focuses on cash flow and working capital efficiency and the result is shareholder value. We all get why a company like Goodyear focuses on working capital efficiency and free cash flow. Fortunately for their shareholders not only do they focus on it but they have strong operational execution against the vision. Nestle and Emerson might not be so obvious. I hear far too many companies say they don’t need to focus about working capital efficiency because they have so much cash on the balance sheet. Fortunately their shareholders, Nestle and Emerson don‰’t share that view. Operating cash flow drives shareholder value, it’s what makes dividends, share buybacks, M&A and sales growth possible. The impact of working capital efficiency is not only demonstrated through the execution of companies like Nestle, Emerson and Goodyear but also by empirical studies as discussed last week. As we can see from the financials discussed above, without effective working capital management, the shareholders of Nestle, Emerson and Goodyear would have several billion dollars less in their pockets. As an aside, one of my personal non-financial investment guidelines is to look for companies with great investor relations websites who publish rich and illuminating information for investors. Nestle, Goodyear and Emerson all fit that description.