So often we observe sell-side analysts and external investors basing a large part of their investment theses on the sentiment and intentions offered by the senior management team of the companies in which they are investing. We caution such an approach. All too often, CEOs of publicly listed companies are communicating a well-crafted, well-intended message that may or may not reflect the true underlying reality.
We see this time and time again. A couple of recent examples come to mind.
Take ConocoPhillips (NYSE: COP), the Houston-based oil and gas explorer and producer, for example. Naturally, it has been feeling the pain of the falling oil price from $115/bbl in mid-2014 to below $30/bbl in January this year. Now, we do not blame the company’s management at all for not predicting the decline in the oil price: very few people in the world did. What we found fascinating was management’s blind commitment to paying its dividend.
As the oil price was falling, so too was ConocoPhillips’s projected revenues, earnings and free cash flow available to pay dividends. So how could management honestly commit to maintaining its current level of dividend payout without knowing where the oil price would land?
With respect to the company’s dividend, here’s what the company had to say about it on their quarterly conference calls:
- April 2015: “We also reaffirmed our commitment to a compelling dividend.”
- July 2015: “The dividend is safe. Let me repeat that, the dividend is safe… We also recently increased our dividend… We believe this was an important message for our shareholders.”
- October 2015: “Our dividend continues to be a top priority… We think of a dividend as something that really should only go one direction.”
- February 2016: “We’re reducing the quarterly dividend to $0.25 per share [a reduction of 68% versus the prior quarter], effective with the first quarter 2016 dividend payment.”
Investors believing the words of management through the course of 2015 sure would have been shocked when all of a sudden the company’s dividend was slashed by two-thirds in February.
Or consider Glencore (LSE: GLEN), the Swiss-based commodity producer and trader. As prices for coal and copper – the two that matter most to Glencore – continued to fall, its management too were adamant that its dividend was safe and that they did not need to sell assets to service its significant debt load.
Here’s what the company had to say on their conference calls:
- August 2015: “We’re not selling assets. We’re not looking at the dividends.”
- September 2015 (just two weeks later): “A decision has been taken to suspend the dividend until further notice… Glencore is announcing that it intends to raise up to US$2.5 billion by way of a proposed equity issuance… Glencore today confirms it is in discussions regarding a number of strategic transactions which will generate proceeds for the Group.”
Once again, anyone taking the word of management in August at face value received a rude shock just two weeks later when the precise opposite of what management said turned out to be true.
CEOs and other senior executives of businesses can be quite brilliant people. Yet their brilliance is often in the art of leadership, political tactics and the ability to inspire and influence others. It is rarely in economic or competitive forecasting. As such, analysts and investors should not expect them to be able to predict the future better than anyone else and should instead make their own assessment from the enormous amount of fundamental data that is available to all of us.
Montaka is short the shares of ConocoPhillips (NYSE: COP) and Glencore (LSE: GLEN).
Andrew Macken is a Portfolio Manager with Montgomery Global Investment Management. To learn more about Montaka, please call +612 7202 0100.
