Goodwill impairment warranted

At €1.8tn, the goodwill inventory in the AlphaValue coverage is at an all-time high and accounts for a bit more than 20% of the same universe's market cap. At 31% of the equity, it is about stable over the period if one does not look into sector by sector changing exposure to the issue.

The goodwill inventory expansion reflects the lack of organic growth substituted for by acquisitions. This helps the top line and, with a bit of financial engineering, the bottom line and thus management compensation. AlphaValue holds the view that acquisitions are management games not a value creation act.

Goodwill rise, unabated

Excluding Financials and Telcos, which have been hard at work amortising their past excesses, the ratio of goodwill/equity has risen from 31% in 2006 to a current 38% confirming that sectors which can afford to grow did it the inorganic way.

Digging deeper and excluding Oils and Metals that pollutes the sales trend (as theirs are commodity denominated), it looks very much as if the rising goodwill pile is not really generating superior growth. This was the case well before COVID-19 hit.

More assets (goodwill in red), less than impressive sales growth (pink, lhs)

The above chart is perplexing so we looked at ROCEs vs. goodwill. The verdict is direct: acquisitions do not deliver in ROCE terms. It is fortuitous that the cost of risk free money has been going down so that Wacc compressed a bit (depending on how risk spread evolved of course).

ROCEs do not improve while goodwill ties up more resources

The COVID-19 hit to sales and profits is supposed to be a 2020 one-off but should lead auditors to wonder whether the longer term disruption that it caused (we agree with The Economist's view that the new normal is GDP -10%) should not lead to substantial goodwill impairments. This will help ROCEs but should also lead to a degree of accountability of managements.

Here is a summary view of where problems are by plotting the goodwill/equity ratio against the absolute amounts of goodwill.

The problem sectors in absolute terms are Food & Beverage and Pharmas while, in proportion terms, issues could surface in Media, IT Services and Software, Health and Leisure & Hotels. 

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