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.

ILU – How I saved R3000/month by selling a property at a loss

I have a buy-to-let flat in Centurion, which I have previously written about a few years ago. As anyone with rental property in Gauteng will know, the market has been tough. In fact, in the four years since I have owned the place, rent and agent commissions have remained the same, whilst levies and rates and taxes have increased annually. This means that, when I bought the property, I was paying in approximately R1100/month, four years later, I am paying in R1700/month. This is in those months, where there has been no broken stove or damaged tiles, or faulty electrical wiring.

I bought the property for R640,000, but with attorney fees and bond registration costs, it was closer to R670,000. The yield at purchase was approximately 6.8%. I have now accepted an offer for R635,000, but after agents’ commission, I will receive R608,000, an approximate loss of 10%. Due to the higher rates and levies, the yield for the buyer is lower than my yield on purchase.

I owe R490,000 (I put down a large-ish deposit), which means that I will take out almost R120,000 in equity when the deal has closed. My intention will be to take this money and put it straight into Indluplace (ILU). The company, which owns and rents 9,600 residential units across 170 buildings in South Africa.

Not only will this decision absolve me of single counter party risk, such as the tenant not paying, but I will also be trading into a yield of 13.5%. Indluplace are also struggling in the tough rental market and have experienced severe problems at a complex in Witbank, which they rented to Kusile contractors, therefore they have forecast a reduction in dividend of 3-10% for the coming year. At a worst case, this puts them on a yield of 12.2%.

Better yet, Indluplace is trading at an NAV of R10.10/share, a 40% discount to the current share price. This means that I am literally buying a share of 9600 apartments – just like the one that I sold in Centurion – for 70% of their going price. This would be like buying my Centurion apartment for R450,000.

Yields are higher because Indluplace has a lower cost of debt, they can afford to manage their rentals in bulk, reducing the management fees, and can keep a maintenance team on staff. By putting R120,000 into Indluplace, I expect to receive approximately R1200-R1300/month in dividends (paid twice per year). Therefore, I have traded an expense of R1700 into an income of R1300, by selling my rental property at a loss.

This was done without factoring in any gains in the ILU share prince. In the mean term, I expect that the ILU share price will revert back to its NAV, in the long term, the NAV should grow with inflation at least. Will I wait for these events, I am happy to sit on my 12% yield.

Nu-World: The Old Guard continues to perform

Nuworld.png

Today I attended the Nu-World (NWL) AGM at their head office in Wynberg near Sandton. The office is a no-frills warehouse complex from the 1980’s and probably dates back to the time of the company’s listing in 1987. The CEO and chairman, the Goldberg brothers, both also date back to the listing and have therefore been at the helm for 32 years. As they listed at R1/share and are now trading at around R44/share and paying dividends over R3/share, they have created significant shareholder value over the period.

The business, like the AGM, is an unpretentious affair. No-one wears ties, the muffins are from Shoprite, “not those fancy Woolworth things”, in the words of the CEO, Jeff Goldberg. The meeting took place surrounded by fans, toasters, fridges and various other household appliances that the company distributes and warehouses.

In the current environment of constrained consumers and high unemployment, it could be expected that a company selling fast moving consumer goods would struggle. However, Nu-World’s EPS and dividends per share were both up strongly in the 2018 Financial Year.

Let’s face it, when our fridge, TV, fan or washing machine break, we have to get a new one. These are essentially non-discretionary items, once we have become accustomed to them. Nu-World, as a distributor, are ambivalent as to how we buy these items. Whether on Flipkart in India, Amazon in Australia or at Makro in South Africa, they make their margin on the importation and distribution.

The company is also sheltered from the South African economy, as 25% of the turnover and 38% of income now comes from outside South Africa. Fast growing markets of India and South America are in the mix and management expects offshore contributions to increase further in the future.

Despite the defensive nature of this business and the strong growth in earnings against the odds, the company trades at extremely attractive multiples. Its PE is 5, it pays 7.5% dividends and trades at a discount to the NAV of R52.35. The company is virtually ungeared. Management owns approximately 10%.

I confronted management with the very poor cash conversion of the business, where in 2018 cashflow was negative and most profits were consumed by Working Capital and remained in Inventory. They assured me that measures were being implemented to reverse that and we can expect a significant improvement in this regard in the upcoming half-year results.

Another, more longer term, concern is the composition of the board which is entirely composed of older men. As women and young people are more likely to be the end consumer of the company’s products, it is hoped that the board will be strengthened with a few different people, with potentially different opinions in the future. Nevertheless, it is difficult to be too critical of a board and executive management that has created significant value and that continues to have a firm grasp both on the business and the market.

Nu-World has just over 1000 shareholders, most of whom are probably delighted both with the recent increase in share price and the healthy and growing dividend. One of these content shareholders is me. I will be buying more shares after experiencing first hand how management reflects its frugal mindset with its no-frills head office, hands on approach and positive view of the future. At current valuations, the upside looks promising and a 7.5% dividend is a good incentive to wait for this upside to materialise.