GRT – My favourite REIT keeps on giving

Watershed-Edited.jpg

Watershed Piazza in Mahalapye owned by LLR Properties

I first decided to be a shareholder in Grit Realty (GRT), when they were still known as Delta Africa and controlled only three properties: A mall in Morocco (which has since been renovated), a building in Mauritius and an office block in Maputo. I spent a long weekend in Maputo in 2015 and the energy, vibrancy and potential of the city was palpable. The country is on a path to becoming a major gas exporter and the capital city’s infrastructure is woefully under equipped to deal with the expected influx of people, business and wealth.

Grit is a way to benefit from growth in demand for quality property in dynamic African destinations and I have been accumulating shares in the group since that first experience in Maputo. The business has grown to encompass 24 assets in 7 countries across Africa. Whether it is office building in fast growing business friendly cities, logistics warehouses, housing for expats, hotel properties, that benefit equally from a growing European travel market and an increasing African traveller, or malls for the rising middle class, Grit is diversified to benefit from all these trends.

This rapid growth has been supported by strong discipline. In an environment where “shady” counter parties and local currency fluctuations are the norm, Grit has acquired only assets with solid international tenants in US$ or EUR denominated leases. Often they ensure that the seller maintains “skin in the game” by partially paying for assets with Grit stock. I have previously commented on an acquisition of a Mozambican mall and in November they announced another deal that perfectly reflects the investment discipline shown by this team.

Letlole La Rona Ltd (LLR) is a property holding company in Botswana, a country with enviable growth and stability in Southern Africa. Grit already held around 6% of LLR and in November 2019 they announced the acquisition of a further 23.75%. LLR has an NAV of $70m, but Grit are paying US$13.8m a discount of 20% to the NAV of their stake. Furthermore, they are paying for this stake by issuing Grit shares at NAV of $1.40/share. In South Africa, these shares currently trade at R16.50 or a further 20% discount to NAV. This means that JSE shareholders are actually receiving the LLR assets at a 40% discount to NAV at their current prices. LLR made $5m in profits last, year implying that the Grit acquisition is at a PE of around 10, but this assumes that no additional leverage will be introduced into the properties.

It is this type of deal discipline that has ensured that, despite the rapid growth in asset base, the dividend has grown steadily in US$ terms. In 2019 a dividend of US$12.20c or R1.75 was paid. At current prices, this puts the stock on a dividend yield of 10.7% in US$ with no exposure to South Africa. Even better, Grit is not actually a REIT on the JSE. They do not require this status as all property income is outside South Africa. Practically, this means that dividends are taxed at the dividend withholding tax rate of 20% for private investors and not at the personal income tax rate.

The growth and discipline has attracted new investors, with a listing on the LSE completed in 2017. This brought several institutional, yield driven shareholders to the registry.

I happened to be in Mauritius last week, so I decided to attend the Grit AGM at their offices in la Croisette shopping centre in Grand Baie. Imagine Melrose Arch in the middle of a northern Natal sugar cane field at the height of summer and you may be able to visualise la Croisette. The Grit team is striking in its youth. CEO, Bronwyn Corbett is in her late 30’s and the CFO is just over 40. I met other senior staff, all young, dynamic South Africans, eagerly hinting that there were more exiting deals in the pipeline.

Given the recent developments at Nampak, I asked how management ensure that they can repatriate cash from countries that may impose currency controls in the future. Grit has full cash repatriation insurance, covered by Lloyd’s. Whilst this insurance is not cheap, I am happy that this is a further safeguard to maintain the dividend in the long term.

In summary, Grit remains my favorite REIT. The dividend yield is in US$, not subject to marginal tax rate and not exposed to the South African economy. The management team is young and dynamic and has a proven record to execute disciplined and conservative growth via acquisitions. They are growing with quality properties in a continent that has the highest global population growth and may well be at the forefront of global economic growth in the coming decades. While I wait for the thesis to play out, I am happy to collect my dividend of just under 11%.

Nampak vs Bowler Metcalf – The lopsided battle of the packaging companies

Everything we buy, whether groceries, consumer goods, household consumables, drinks or take aways, it’s wrapped in plastics. Not surprisingly, global consumption has grown at 4% per annum since 2009 and this is unlikely to change, particularly in the developing world, as ever more people purchase fast moving consumer goods. Actually any goods. In this post, I will analyse two JSE listed packaging businesses that may stand to benefit from this trend.

Bowler Metcalf Limited (BCF) is a medium sized plastic business with 800 employees and operations exclusively in the plastics in South Africa. They are well entrenched into the supply change of producers of personal care, chemical and food packaging items. After the huge windfall from the sale of the Softbev business last year, they paid an approximately 30% special dividend, handsomely rewarding patient shareholders. In the 30 June 2019 Annual Results they reported earnings and revenue that were operationally steady. These results should be regarded as a win in an environment that was hampered by violent strike action, load shedding and a depressed market reflective of the overall economy.

At a share price of R7.20, or a market cap of R650m, earnings of 88c reflect a PE of 9 and dividends of 40c yield just over 5%. Importantly, BCF is essentially ungeared, so earnings are also reflective of the return on equity, which is sitting at just over 10%.  However, the company has a cash pile R380m and if we strip out the cash and the interest income from this cash, the plastic operation is currently trading at a PE of approximately 6.5 and a higher ROE.

Management recognises the undervalued nature of the business and is utilising at least some of the cash hoard by progressing a share buyback program of around R40m or 6% of the outstanding shares.

Management is well invested to share in the future prospects of the business with a holding of around 26%. The CEO, Paul Sass, in particular, controls in excess of 20% of the company and has recently increased this stake at the current share price.

Nampak Limited (NPK) is Africa’s largest packaging group with a leadership position in beverage cans and some involvement in metal, plastic, liquid carton and paper packaging with presence in 13 countries including SA, Angola, Nigeria, Zimbabwe and the UK. The groups 49 manufacturing operations and 5600 employees outsize BCF significantly and hence the group trades at a market capitalisation of approximately 8 times BCF, at R5bn.

A decade ago, they were almost 100 times the size. Several overaggressive expansions, troubles in some very difficult African jurisdictions, an overall Africa sell off and high leverage have decimated the share over the last decade.

The contrarian value investor in me immediately springs to attention at the face of such share price devaluation. Perhaps, this is the perfect cheap entry point into business with a plethora of African operations, including Malawi, Ethiopia, Nigeria and Angola, consumer markets that are set to grow very rapidly in the coming decades? This might be a value play that beats boring old South Africa focussed BCF’s pure plastic business.

As a result of the many moving parts in Nampak, it is difficult to find sustainable earnings estimates. EPS stood at R1.69 for the 2018 Financial Year. This included “abnormal items” of R450m. Abnormal items in the previous year (2017) were R490m. How many years of abnormal items does it take, before they become normal to the cost of business in Africa? We should therefore assume that these “once offs” are set to continue.

In stark contrast to BCF, Nampak is heavily geared with R12bn in debt more than twice their market cap, resulting in interest payments of close to R500m per annum. Of even more concern is their cash flow, with cash of R3.5bn held in Zimbabwe and Angola, countries with notoriously difficult repatriation of forex. If we include Nigeria, the cash “stuck” in dodgy destinations is approximately R4bn; 80% of the market capitalisation of the business or around three years’ worth of profit. If they fail to recover even some of this cash, liquidly will be severely impaired. Not surprisingly, given the cash flow constraints, the company has not paid a dividend in years.

Results for the 2019 financial year end were announced on 26 November 2019 and contained many of the expected surprises. Huge currency write downs in Zimbabwe and further “abnormal items” of R270m brought earnings down to 54c. Even if we are generous and add back the currency losses from Zimbabwe, the business made around R1.40 for 2019. At a share price of R6.5, this puts them on PE of approximately 5, only slightly lower than the BCF operation.

Three Nampak executive directors were paid R35m in 2018. In comparison, the two BCF executive directors took home R9m. Unfortunately, Nampak does not disclose management shareholding or any shareholder information for that matter. However, it is safe to assume that management does not have the same amount of skin in the game that their BCF counterparts share with shareholders. To add to the worries for Nampak shareholders, CEO Andre de Ruyter will leave on relatively short notice to try and fix Eskom. This means they are on the hunt for a new CEO in the middle of a debt crisis.

In summary, in BCF we have a small steady operation that is sitting on huge cash pile, no debt, pays a handsome dividend, has a history of shareholder wealth creation and has a management team that is aligned with shareholder interest. In Nampak, we have a large multi-country, multi-asset operation that is well positioned across the continent, profitable and cheap, but that is struggling with cash held in questionable jurisdictions, a huge debt load and upheaval within the management team.

I remain a happy shareholder in BCF and will give Nampak stock a hard pass.

SNV – Building a Global Network

Santova (SNV) is an asset-light logistics company. They don’t own the ships, cranes and trucks that move your goods, but they arrange and track the moving of freight and goods. They have the computer systems, network, warehouses and connections to organise cross-border transport of goods, facilitate customs and clearance and expedite issues if required.

I see great demands for these services from companies with global supply chains, who increasingly focus on improving working capital and managing their inventory. If goods move faster, they spend less time in inventory. Secondly, large multi-million dollar construction projects are often extremely time critical and a networked logistics company can ease pressure on a constrained project schedule whilst savings costs.

The important barrier to entry for a business of this nature is to have a truly connected global presence. Santova is in the process of building this network through a chain of acquisitions. Whilst it is important to remain wary of acquisitive growth, in SNV’s case the acquisitions are well priced and structured and improve the value of the entire operation. This is demonstrated by the three most recent deals below.

  1. In August 2018 – they completed the acquisition of ASM Logistics in Singapore, which has a presence across South East Asia. The purchase price is not mentioned, but “less than 5% of the market capitalisation” suggests something around R20m.
  2. In October 2018 – they completed the acquisition of SAI logistics in the United Kingdom:
  • The previous owner is staying on as Managing Director for at least 3 years.
  • A 3 year profit guarantee is provided.
  • The price is 3.2m GBP, with an annual EBITDA of 0.6m GBP, suggesting an EBITDA margin of 5.5. Depending on the tax rate and gearing used, the acquisition PE is around 7.
  • SAI has a strong presence and network in India. India is likely to be an engine of global growth for decades and this connection can be leverage across the Santova group.
  1. In March 2019 – they completed the acquisition of MCL in Hamburg, Germany:
  • The previous owner is staying on as Managing Director and taking the lead of the Santova Germany operations, giving them a well-connected replacement for their current retiring MD.
  • A 2 year profit guarantee is provided.
  • The price is 1.9m EUR, with an annual EBITDA of 0.35m EUR, suggesting an EBIDA margin of 5.5. Depending on the tax rate and gearing used, the acquisition PE is around 7.
  • MCL has a strong presence in Northern Europe.
  • They specialise in shipping and handling of explosives, an expertise that can now be employed across the Santova group.

With such a global supply chain, it is no surprise that 61% of the 2018 earnings are offshore, a number that is likely to increase with these recent acquisitions. The company is therefore an excellent Rand hedge. However, Santova, like most of the JSE small cap market, is trading at incredibly discounted levels.

Earnings are 21c for the last 6 months, placing the company on an annualised PE of around 7. A growing dividend of 2.5% is also in the offing. Cash on hand is approximately 15% of the company’s market cap of R440m, and cash conversion, whilst weaker in the last interim results, remains positive and is likely to improve as investment initiatives come to fruition. Despite the recent spree of acquisitions, the group’s gearing remains low at 25% of equity. Whilst NAV per share is at R3, slightly higher than the current share price of R2.75/share.

Directors hold 20% of the business. However, in contrast to some other companies, where the founder holds a large stake, the ownership of the business is spread across approximately 20 directors and managers of subsidiaries, probably reflective of the acquisitive culture of the company. I sleep well at night knowing that the managers and operators are working towards the same ends and I am happy to share in any gains.

An international fund, the Barca Global Fund, shares this view and has also taken an interest in this fabulous investment opportunity. They now hold 10% of the business, which they acquired on the open market at discounted prices in mid-2018.

I share the view of management, which wrote in the last interim results:

“… as the Group enters its annual peak trading cycle the Board is optimistic that the Group’s geographic, business activity and currency diversification will help to provide a solid platform for future growth.”

MDI – Deep value, great prospects

The last time I wrote about Masterdrilling (MDI) two years ago, I was impressed with its earnings growth. It’s last annual results, published two weeks ago, showed flat earnings and dividend at 142c/share and 26c/share respectively. However, as MDI’s share price has declined together with all other shares in the South African small cap sector, it remains on a very cheap PE of 7.4 and a dividend yield of around 2.5%.

The company has continued to grow internationally, with presence on most continents and in major mining markets. In the 2018 financial year, the investment in growth initiatives included partnering with Italian construction company on tunnel boring, acquiring the rest of Scandinavian raiseboring company Bergteamet, acquisition of the Atlantis Group and further development of the vertical shaft boring machine (a huge potential industry game changer). The continued diversification across geographies, whilst the bulk of the team remains South Africa based, ensures that this company is an excellent Rand hedge.

The acquisition of the Atlantis group is a case study into how this company conducts its business:

  • The acquisition was for R107m, meaning that it was small enough to ensure that cash reserves can be used
  • It was at 4 times profit, at the bottom of the market, it should therefore be significantly earnings accretive for MDI shareholders
  • It strengthens the presence in key growing mining markets India and Zambia as well as the established market of Zambia
  • The assets, several large raiseboring machines, were acquired at below replacement cost and have now taken the machines in the fleet to 149, no other competitor owns more than 50 machines

Due to the size of MDI’s fleet, it has established itself as a key partner to major mining companies. For example, Codelco, the world’s largest copper miner is using them for their major expansions in Chile and Byrnecut, Australia’s largest contract miner, is leasing one of their machines to execute a contract. It is therefore not surprising that they see their orderbook and pipeline at a healthy US$578m. Assuming that this work is executed at their current margin of +/- 30%, implies that they have close to $200m profits secured. This is almost double the current market cap of the company.

MDI has been caught in the general small cap depression that has plagued shares on the JSE in the last two years. However, the business is truly global, and is guaranteed to profit from continued capital investment in mining. Shares are trading at a 35% discount to NAV, earnings are in US$ and the cash conversion is excellent. The company is cautiously optimistic and provides the following gems in its outlook and prospects section:

“We are experiencing strong demand with increased enquiries across the various regions and commodities and expect this to continue.”

“Various opportunities in first world countries such as Australia, Canada and USA are coming to fruition and are expected to increase the Group’s footprint across the world in the near future.”

“The upswing in the commodity cycle has had a positive impact … Although not immediately reflecting in our numbers, we do expect a positive impact on our revenue during the next reporting period.”

ARH – Time to return more cash to shareholders

ARB Holdings (ARH) is my favorite boring wholesaler of cables. The business model is simple. They import and/or manufacture cables and lighting and then distribute these directly to construction companies, contractors and other operators in the construction industry. The barrier to entry is relatively high, as they have distribution licenses for certain products in the lighting division, have the land and real estate to keep bulk cables in stock, as well as relationships to source them economically at scale.

The share price, like everything else in the South African small cap market, has taking a pounding dropping from around R6.50 two years ago to R4.20 today. The market cap is R1.1bn, with the company ungeared and a net cash position of R148m.

When ARB acquired lighting company Eurolux, they issued a Put option tied the the ARB share price. As the value of the share price changes, the option’s value is adjusted on a mark-to-market basis and these fluctuations confuse earnings and make them difficult to compare. Ignoring the put option, operating profit for the 6 months is down 15% to R92m. But HEPS is only down 12.8%, as a result of share buybacks. This means that they earned 33c or 66c annualised, placing the company on an undemanding PE of 6.2.

The results were impacted by the electrical division, which is struggling with no new work from Eskom. This division will continue to struggle as the unbundling and squabbling over Eskom will likely take several years. However, the division continues to generate cash and whilst construction currently has a bad reputation, activity in the sector is ongoing. ACSA announced a large expansion to the OR Tambo International Airport, Balwin keeps churning out apartments, Vedanta is building Zinc mines at Black Mountain, The Leonardo is about to become the largest building in Africa, the Northern parts of Durban are being developed at a lighting pace and all this activity taking place in a depressed economy requires cables and lighting. Eskom, too, will race to keep existing infrastructure functional and government will cough up the cash, so cash flow is likely to continue in the short and medium term, with growth in the longer term.

The lighting division is growing earnings and will increasingly do so with the Radiant acquisition at an opportune time in a depressed market.

The company continues to generate substantial cash of around R150m per year. This is easily sufficient to cover both the normal and special dividends of R0.25 and R0.10 that have been paid in recent years. A continuation of this policy would put the company on an 8.5% dividend yield. I am of the view that they should maintain both dividend streams. In addition, at these depressed prices it will be pleasing if they continue to buy back shares. It may even be worthwhile to consider introducing some gearing into the company in order to buy back shares with a current cash yield that is significantly higher than the expected cost of debt.

SSS – Why I sold my shares

Stor-Age Property (SSS) are the new-REIT-on-the-block in South Africa. During their listing in November 2015, I picked up some shares, as I was impressed with the business model of self-storage. In self storage, there is virtually no counter party risk from a tenant, as you can simply pawn his possessions to cover outstanding rent and the business is extremely resistant to economic cycles. I was also impressed with management’s rapid expansion plans and they have delivered both in terms of asset growth (organically and via acquisitions) and in dividend growth.

Since their initial growth in South Africa, they have made a fast and aggressive move into the UK, by acquiring Storage King a Self-Storage business operating there. The initial acquisition has resulted in a split of 28% of their assets being in the UK and over 40% of their profits coming from that country. The much lower cost of debt means that higher returns on assets can be achieved then in South Africa. Therefore, it is not surprising that the rate of expansion in the UK has accelerated significantly, with two further acquisitions announced within a week this month. They are buying the Storage Pod for R213m at a yield of 6.5% and Viking Self Storage for R224m at a yield of 6.7% (the latter’s yield was not provided and had to be back calculated).

After this second round of UK acquisition, the company will make close to 50% of its profits from the UK. This is a country that will struggle for years with the Brexit hangover, has stagnant economic growth, has burned many other South African companies fingers and – most importantly – will likely see a declining currency, declining property prices and rising interest rates. In my view, this is the worst place to be buying property at the moment.

Furthermore, in order to finance this acquisition they have already concluded a placement of shares in an accelerated bookbuild, raising R585m. The company issued equity yielding 8% dividend to finance acquisitions yielding 6.6%.  Of course, the yield of the UK acquisition can be enhanced by using leverage, but if that is the case, why are they are raising more capital then what is required for these two deals?

Given this heavy focus on the UK and the suspicious issuing of high yielding equity for the purchase of lower yielding y, I have decided to divest my holding in SSS. This money is better invested in my favorite REIT, Grit Realty.

BWN – The cheapest company on the JSE?

 

When I first wrote about Balwin Properties (BWN) in 2016, they were planning to sell approximately 2000-3000 apartments per year and I predicted that they would have earnings of around R1.50/share which would hopefully underpin a healthy share price and dividend. Part of this prediction has spectacularly backfired. The BWN share price is down 70% and they have stopped paying a dividend. Nevertheless, management have followed through on many of their key promises and I believe the company is well positioned to continue earnings, improve cash flow and patient shareholders should be handsomely rewarded at current depressed prices.

When Balwin listed in 2015, they needed money to acquire a large tract of land in Midrand to secure a 10-15 year development pipeline, they intended to grow outside of Gauteng, they were planning to deliver apartments to a stand alone rental business by 2019/2020 and they were planning to sell around 2500 apartments by year. Management has delivered on all these promises despite a stagnant economy.

In their business update published on 14 March 2019, BWN suggest that they will sell approximately 2350 apartments in the 2019 financial year. They have also already pre-sold 1000 for the 2020 financial year. I am not at all surprised by this. In February, I visited the Blyde in Pretoria, sub-Sahara Africa’s first crystal lagoon. It is an astonishing development that appeals to the middle-income family (see photos). The scale is also fascinating. They expect to develop over 3000 apartments in this development alone. And access to the lagoon will make all these apartments appealing to buyers.

On my travels in December and January, I passed Balwin developments in Cape Town, Somerset West and Umhlanga, all popular fast growing nodes, showing that they have extended their popularity beyond Gauteng. I am confident that the popular crystal lagoon will be repeated in other areas in due time. BWN has established and owns a 25% share in Balwin Rentals, which will absorb certain developments over the next decade, earmarked specifically for rental. The first 252 apartments were sold to the partner, suggesting that only 10% of sales were to this entity at a slightly lower margin of 30%.

Despite delivering on their listing aspirations, the company share price has drifted to a point where it is ridiculously cheap. Stephen Brookes bought R1m of shares at the end of February at R2.50/share showing his belief that the company is undervalued. The market cap of R1.1bn is the same as half year revenue. Earnings are likely to be 95c, putting the company on an approximate forward PE of 2.5. Cash flow has improved and they expect to have R300m on hand. That is approximately 25% of the market cap in cash. Excluding cash, the company is trading on a PE of just over 2.

The fund manager Keith McLachlan argued that construction companies are uninvestable, as the margins are thin and due to risk that one failed construction contract could develop into a ruinous one (see Group 5). However, with current margins at 33% and targeted margins of 35%, I do not believe that this risk applies to Balwin. Furthermore, even if they fail to sell their apartments, they can simply roll them into their residential rental portfolio which they have previously set up.

They have land for a secured pipeline of over 46,000 secured. This will keep them going for the next 20 years, without the major outlay of further land acquisitions. The company is carrying an NAV of R5/share, twice the current share price. Surely, Balwin is the cheapest stock on the JSE and patient investors will be rewarded.