You can tell a lot about a company and its board by the actions of its CEO. Sudden resignations are never good. I’m yet to meet a CEO who resigns for “personal reasons” when his company is flying and he is likely to be granted a bucketload of shares or options.
CEOs selling shares is another warning sign. I get that CEOs, like everyone else, need money to buy things, pay their tax or fund divorces. And that CEOs, like every shareholder, have a right to capitalise on higher share prices (and their hard work) and take some profits.
But care is needed when CEOs and directors are sellers rather than buyers of shares in their company. Insiders have unique knowledge of the asset they manage, and research shows their share sale, on average, is often followed by a period of underperformance in their company’s stock.
CEO pay is another tell-tale sign. Those who are paid far more than comparable peers, or have a tenuous link between pay and performance, might report to “captured boards”. That is, boards that do whatever the CEO wants because he or she has all the power.
CEO recruitment trends are also worth watching. Companies that usually recruit “outsider” CEOs (those from other firms) may be weak in succession planning. Sometimes, an external CEO is the right move, but insider CEOs invariably provide more continuity and certainty.
Consistent change in the executive team is another sign. Usually, the best judge of the CEO’s calibre and performance are his or her direct reports. If the Chief Financial Officer or Chief Operating Officer unexpectedly resigns, it might be a sign he or she has lost confidence in the CEO. Conversely, some CEOs force out underperformers and astutely refresh the management team.
Antony Catalano’s sudden resignation as CEO of Domain Holdings Australia brought this issue into focus this week. The last thing the Fairfax spin-off needed was the CEO to resign, only months after the demerger, for family reasons. Domain’s shares were belted on the news.
Also in property, McGrath CEO Cameron Judson and most of the board of the troubled real estate firm resigned suddenly this week after yet another profit warning.
With Domain, the market speculated that the timing of the CEO’s resignation might have to do with the release of the February interim result. Catalano would not be the first CEO to resign before a softer-than-expected profit number, using family as reason, to save face. Who knows?
Either way, the CEO resignation is a bad look for a company with minimal listing history and its majority shareholder, Fairfax Media. Investors liked Domain’s entrepreneurial approach under Catalano and the company’s other executives do not have the same market visibility.
I liked Domain’s prospects and market position but cautioned that demergers often underperform their parent for the first six months after listing, then outperform. The first part of that equation looks true of Domain as its share price tumbles and the property market cools. Demergers are often best bought six-12 months after listing.
So is Domain a buying opportunity? There’s too much management uncertainty for now to dive in, and the company’s credibility, as a listed entity at least, has been questioned. I’d watch and wait for the new CEO appointment and February interim result before buying, depending on price.
Chart 1: Domain HoldingsSource: The Bull
My preferred approach now is to focus on REA Group, a potential beneficiary of Domain’s management uncertainty and investor backlash. I wouldn’t be surprised if more fund managers rotated from Domain to REA over the next few months.
REA Group, owner of reaestate.com.au, is a fabulous business with a consistently high return on equity. REA rose by less than a per cent after the Domain news – a surprisingly muted reaction given the company’s arch rival has lost its star CEO and entrepreneurial force.
REA reported revenue growth of 21 per cent for the first quarter of FY18, above most broker estimates. Strength in the residential listings business and gains from its new financial-services operation drove revenue growth over the quarter.
The concern is whether REA can maintain growth and price increases in new listings as the property market slows. A larger fall in proprety prices, so far unlikely, would hurt house-sale volumes, property listings and advertising revenue.
REA is never cheap. An average share-price target of $76.94, based on a consensus of 13 broking firms, suggests it is marginally undervalued at the current $74.26, but does not provide a sufficient margin of safety to buy, given the valuation risks.
Gains will be a slower from here after the magnitude of REA’s share-price rise in 2017. But REA is an exceptional business with a prime position in its sector- and now a number-two rival that has been weakened so soon after listing.
REA looks more interesting after falling from a 52-week high of about $81.10 in late 2017. Further share-price falls would put it firmly on the radar for growth investors.
Chart 2: REA GroupSource: The Bull
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• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at January 23, 2018.