Seprod continues to improve in critical areas, but can they find the missing pieces to link growth with cost savings under supply chain pressure?

This article refers to Seprod Limited's financial data, retrieved from the Seprod Limited Audited Financial Statements (2010 - 2021) available on www.jamstockex.com

I am not a financial analyst, although I try to discern helpful information from the available data. This article and the opinions therein are not intended to guide investment or any form of speculation and should not be treated as such. It is instead a review of financial statements with a particular interest in the insight to be gained into supply chain management.

It has already been a whole year since my last article on Seprod Limited, and the firm has been taking bold steps toward achieving its strategic objectives. But how successful has the firm managed trade-offs between the three strategic fits? Have they overcome the complexity within their product and portfolio mix? Do they still contend with the growth trap and their continuous drive to improve margins? In this article, we will look at these issues as we seek to discover Seprod's core strategies to determine if they have maintained or improved their place in the FMCG arena.?

In Seprod's most recent Interim Report for the period ended 30th June 2022, the conglomerate posted strong numbers showing improvements in revenue, net profit, earnings per share and shareholder equity. However, I am less interested in the numbers themselves and more interested in the story that those highlights tell about Seprod's strategic objectives.?

You may have heard the expression?'what is not measured is not managed'?I'd like to put another slant on it to say?'what is measured is what is valued'. Seprod has shown us aspects of their strategic objectives by focusing on these key results areas.

Revenue?-?there are only a few ways for a firm to improve revenue, sales growth/ market share, price increases, and portfolio growth (depth and breadth). Seprod's propensity to value revenue growth drives strategic decision-making towards improvements in any one, two possible three of the ways described. Their acquisition of AS Bryden has provided them with substantial revenue improvement from sales and portfolio growth.?

Net Profit - Yes, tracking net profit shows your organization's strategic footprints. Net profits speak to operational efficiency; how well does your firm generate profits from sales? Furthermore, net profit outcomes are inextricably linked to supply chain performance, specifically SG&A costs and Cost of Sales.?

Earnings Per Share (EPS) - shareholders can stomach a lot, but declining EPS isn't one of them. Moreover, strategic decision-making has a solid link to EPS. For example, as investors seek a return on their investment, management must often curtail spending to show improvements.??

Stockholder Equity - similar to EPS it is a measure of the 'investability' of the firm and is a pretty good indication of good management practice and decision making.?

Seprod has given us insight into the workings of their internal, external and dynamic strategic fits. The interim report states that?'growth in net profit is less than that of revenue growth.'?These are keywords for the supply chain-minded individual as it directly indicates the erosive effect of supply chain complexity. They also mention absorbing costs, magnanimous but not a long-term solution to global supply chain issues.?I won't talk about cycles as we discussed them in the previous article, and Seprod seems to have a pretty tight grip on managing cycles (I've put some interesting data at the end for those interested in the numbers).

Let's jump into the meat of the matter. I have gone deep into the data from the financial statements to unearth key insights into Seprod's supply chain operations. Hopefully, we can discern how decisions are made and why they make them and learn if they are working to help them to achieve their objectives.

Figure 1. - Score Card of Interrelated Metrics

The diagram above shows 12 years of historical data and is a good indication of the firm's strategic struggle and managing the trade-offs between interrelated metrics. Let's talk about complexity - Days Inventory on Hand has been steadily increasing since 2016 with a corresponding decrease in the Inventory Turnover Ratio. Seprod has been improving revenues year-on-year through sales growth, product growth or a combination of both. Product growth can be achieved by improving either product mix or depth; either way, you end up with more SKUs.

The added SKUs reduce the efficiency and increase the cost/ complexity of supply chain operations; this is confirmed by the SG&A Ratio (SG&A Costs as a percentage of Sales Revenue) graph. Another malady of a growing product mix or depth is an extending long tail of slow-moving products, which extends your days' inventory on hand and reduces inventory turns.

When data is presented one-dimensionally, it can be difficult to see management's response to certain issues. Orbit Charts are a good way to show the interrelatedness of the data and how strategic goal attainment in one area can have an unintended effect on another.

Figure 2. - Orbit Chart showing Operating Margin v. Inventory Turnover Ratio

Seprod has been struggling to maintain its operating margin in a consistent way or to duplicate the performances of 2010 or 2020. Their five (5) year average margin is 9.65%, which is indicative of a firm involved in customer intimacy strategy, but Seprod is essentially a commodities trader and a manufacturer. Why would they be seeking a 15% operating margin? This is because they don't want to be a commodities trader anymore - commodities trade on thin margins, and they want to move up the value chain. How can you improve your position on the value chain and earn higher margins? Simple, a better quality product. But better products mean better raw materials, equipment and employees. You can see in the graphs that the SG&A expense increased in 2016 and has not relented. Their corresponding PPET - has also increased steadily from 2016 onwards as they sought to reposition the company from operational excellence (cost leader) to customer intimacy.

In the Orbit Chart (Figure 2), margins have sharply declined in 2021 relative to 2020. The inventory turnover ratio has also reduced in 2021 relative to its position in 2020. How can this be when revenue from sales has increased? Surely there should be an increase in the turnover rate? These facts tell us two things for sure 1. revenue growth is as a result of an increase in portfolio breadth, not cycles (namely inventory turnover cycles) and 2. more products have been added to the long tail of the inventory. It would seem that their efforts to improve operating margins have yielded some undesirable outcomes. A look at figure 3 will show more clearly how the push to improve operating margins has, in fact, helped to reduce them via increased SG&A costs which is a key indicator of supply chain cost/ complexity.

Figure 3 - Orbit Chart showing Inventory Turnover Ratio v. SG& A Ratio

As can be seen, while decisions were being made to improve operating margins by strategically shifting from operational excellence (cost leader) to customer intimacy, investments in PP&E that support higher quality product portfolios have been negated by increasing supply chain costs attributable to SG&A and COGS. Seprod has made improvements since 2018 however, these improvements probably have more to do with the increasing revenues than SG&A expenses. To see the real impact, you would have to look at the SG&A expense on its own, not as a compound metric, as shown in the graph in figure 1, which indicates that SG&A expense has not relented since 2016. This means that increasing complexity in the Seprod supply chain has eroded and will continue to erode profitability despite investments made to improve them, trapping them in a vicious circle.

At this point, you may be asking how can Seprod improve margins and reduce supply chain costs. The truth is they cannot. At least not at this time; if Seprod wants to adopt a customer intimacy strategy by improving their product's look, feel, and value, they must continue to invest. If they can sustain this level of investment, they will eventually be able to charge higher prices for their products, and it is not until they have changed their position on the effective frontier that they will be able to reduce the costs of their supply chain.

Let's look at Seprod's performance relative to established target metrics related to defining organizational strategy.

Figure 4 - Key Strategic Metrics Relative to Strategic Positioning

As seen in the tables, there is some misalignment of Seprod's operational reality and established target metrics related to strategic objectives. For instance, their Gross Margin is still indicative of an operational excellence (cost leader) player; this is primarily due to the fact that gross margins are an indicator of the customer's willingness to pay, and the customer's willingness to pay is indicative of the value/ quality of a firm's goods or services. Customers will pay more for a perceived higher value; this is the customer intimacy arena. This is where dynamic fit comes in; what are the likely outcomes if Seprod raises its prices? Especially in markets where it is not the market leader, simply changing prices without a real and perceived increase in value/ quality will not change Seprod's position within the effective frontier. The price change may change the customer's consideration set and cause Seprod to lose sales to the market leader due to the real or perceived value/ quality. It's a delicate dance that must also be done slowly and with great patience.

Operational excellence or cost leader strategy supports an SG&A Ratio of around 20%, and Seprod is right there. But Seprod wants customer intimacy, which requires even more investment in PP&E and SG&A as well as other increases in COGS. At this point, you may be thinking, why can't they have both a customer intimacy strategy and a lower SG&A cost? The answer is simple; higher-quality products cost more to make, sell and market furthermore, a business must choose. You can't be all things to all people. If they want those higher margins, they will have to continue to invest in getting and maintaining them.

Seprod's operating margins are actually where they should be at around the 10% mark for customer intimacy, but perhaps their goal isn't customer intimacy. Maybe they want all the marbles. They want product leadership - this would explain Seprod's 71.92% capital employed percentage. I doubt it though the table is a generalization. Not even market leaders in the local FMCG marketplace can achieve growth margins of 50%; 28% is a more reasonable target for operating margins within the customer intimacy arena within the local FMCG market.

It isn't easy managing trade-offs within a complex environment while pandering to stakeholders both internally and externally. However, the management team a Seprod continues to do a good job; it's left to be seen how the added complexity of AS Bryden will affect the firm's strategic decision-making. As well as how global geopolitics, supply chain issues, fuel shortages, raw material shortages and the threat of war will impact Seprod as they seek to de-risk on their supply side and improve sales on their demand side.

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Appendix

Below - Operational Cycles Data and Important Ratios

Above - Revenue v. Operating Margin (Growth Trap)

Below - Strategic Ratios and Five (5) Year Average; Financial Statements