BWN – From Crystal Lagoons to demographics a worthwhile investment

Balwin Properties (BWN) listed just over a year ago, and has seen its shareprice perform poorly, dropping from an IPO price of R10.20/share, to a low of R6/share and is now trading at approximately R7.50/share. Balwin develop large scale residential complexes with 1, 2 and 3 bedroom apartments, which they for R750k – R1.5m. Their strength is on focussing in development nodes in Gauteng and the Western Cape and aiming at middle income, young, first time buyers with an offering of security, lifestyle and quality finishes.

Their recent interim results were impacted by accounting challenges related to the late registration of units, but management is confident that this will be resolved for the full year results. Making adjustments for these impacts, and annualising the results, BWN currently trades at a PE of 7.5 and a healthy dividend yield of 4.5%. BWN will sell approximately 2500 apartments in the financial year at an average selling price of just under R1m/unit. Their margin is excellent at 40%, due to the economies of scale that they achieve in their large developments (500-1000 units).

BWN has secured land – particularly in Gauteng – for 35,000 units in the next 10 years or so. If we assume that their selling price and margins remain the same and that BWN will register an average of 3000 units per year in the next years, then the company has a secured annual EBITDA of approximately R2.60/share and estimated Earnings per Share of R1.50/share.

The following reasons outline why I feel that these healthy earnings are fairly secure and that BWN should be regarded as a cheap buying opportunity at these levels:

  1. First Time Buyers and Emerging Middle Class

I live in a Balwin estate, which bought straight from the developer. The bulk of the fellow home owners in the estate are young, first time buyers and professionals, reflecting Balwin’s target market very accurately. The chart below from the Actuarial Society of Southern Africa shows the forecast of South Africa’s youth bulge, the young age group that is likely to be a first time home buyer in a Balwin development. Clearly, this demographic is growing and peaking in the next 10-20 years.

youth-bulge

  1. Demographics

According to Stats SA, 56m people lived in South Africa in mid-2016, of which 13.5m live in Gauteng. This is up from just under 55m and 13m respectively in mid-2015, representing an increase of 1m people in South Africa in a year, half a million of which in Gauteng alone. A combination of fertility, migration from other countries and urbanisation (migration from other provinces) will continue to drive rapid population growth in Gauteng.

Assuming that this trend continues, SA’s population will grow by 10m in the next 10 years, with Gauteng growing by 400,000 – 500,000 people per year. Balwin stands to benefit from this growth, as their future development is heavily focused on Gauteng. If Balwin sells, 3,000 units per year, with an average occupancy of three people per unit, they will still not even be available to provide housing to even 1% of the added population in the nation. In this context, BWN’s rate of development is minimal and should be easily absorbed.

  1. Safety

There is a growing demand for safe residential estates, to replace standalone houses. Increasing rates, taxes and utilities and decreasing incomes are also supporting a trend towards downscaling. With people choosing smaller apartments closer to work over houses in the suburbs.

  1. Lack of available land

Balwin has secured a large tract of land for development in the Waterfall node. This is some of the last available land in Gauteng that is available for large scale developments.

  1. Crystal Lagoons

Balwin’s CEO announced recently that they will be the first developer in the country to integrate Crystal Lagoons into their estates. This is a technology that has been pioneered in Chile, which significantly reduces the costs of large scale swimming pools, to the extent that lagoon or lake style water resorts can be developed around a very large man made clear water pool. Pictures of precedent developments  are abundantly available on the internet. I find this type of development extremely exciting and would certainly consider an estate with this type of infrastructure. I am convinced many South African consumers will pay a premium for this.

  1. Shareholding by Management

I am always a fan of large shareholding in the hands of management, as this ensures that their incentives and interests are aligned with those of shareholders. Balwin is particularly impressive, with directors holding just over 47% of the shares and CEO Steve Brookes alone holding 35% of the issued shares.

  1. Rental

Balwin is committed to maintaining their margin. If they do not achieve their desired selling price, the company prefers to rent properties, until the market in that particular area changes. At the BWN cost of construction and going rental rates, I estimate that BWN achieves net rental yields in the order of 12-13%, significantly above the cost of debt. This means that BWN, can happily sit on their completed units, without compromising on their price expectations. Management has alluded to the possibility of spinning off their rental portfolio into a REIT at some time in the future, if the property market does not turn.

 

NED – Where are the retail customers?

nedbank-first-interactive-atm_

This Silly Season, I have been particularly unfortunate to have had to make several trips to large, frightfully busy shopping malls in both Gauteng and the Western Cape. The queues, the lack of parking space, the crowds of shoppers all take their toll. The worst is standing in queues four deep at banking courts, wondering how long it can take a fellow to withdraw some money from an ATM or observing a grandma punching in her pin in slow motion, one finger at a time.

The upside – if you can call it that – of this is that I had time to observe the trends at the four large retail banks in South Africa, as these ATM’s are always grouped together. Queues are equally busy at Standard Bank, ABSA and FNB, but across the various malls, the Nedbank (NED) ATM’s were standing consistently empty and unused. When a lucky customer did approach, he was in and out of there in less than two minutes, while the observers in the other queues heaved a collective sigh, as the grandma at the machine removed her card, only to put it back in again.

We have to assume that all customers, who are not bound to a certain bank’s ATM, such as international visitors, Investec clients, etc., also use the freely available Nedbank machines, which implies that the number of actual Nedbank customers, is even less than what can be observed. As a Business Muser, I ask myself where all the Nedbank customers are. Does NED still want to compete in this market? They are likely more focussed on their business banking business. But why then incur the cost of an ATM network? Essentially, this is the banking equivalent of walking passed that corner Tea Shop and never seeing a customer and then not being surprised, when it closes down three months later.

With visible question marks of this nature, I am certainly staying away from an investment in NED.

APF – Insiders Buying

fourways-mall

Accelerate Property Fund (APF) is a small-ish REIT focused on retail properties in South Africa. Keith McLachlan, in his excellent blog smallcaps.co.za, perfectly describes the rather worrying prospects for retail REIT’s in South Africa. Whilst, I agree with his findings, I believe that APF offers a unique opportunity in this market segment, due to their focus on grade A retail destinations in up-market growth nodes.

APF has been busy with a few new acquisitions and the holdings of the company have changed significantly. By my estimates an investment in APF will be weighted into the following properties:

35% – Fourways Mall Development

20% – Further investments in the Fourways area such as Cedar Square, Cedar BMW and another smaller mall in Fourways.

More than half of APF’s market cap is in the Fourways area, which is where I live. This area is a bustling hub, mostly populated by young affluent professionals, who are tired of traffic and happy to shop and spend in proximity to home. Fourways is also forecast to grow and is certainly on the shortlist of destinations for the next phase of the Gautrain development. I am convinced that retail in this area will continue to outperform the South African average.

20% – OBI retail warehouses in Europe

APF recently acquired nine warehouses in Austria and Slovakia. OBI is essentially like Builders Warehouse in Western Europe. I am generally not a fan of South African companies moving into developed markets, as I feel their strength and area for growth is in developing markets with the right demographic trend. The acquisition is acceptable, with a yield of 7% (above the cost of debt) and a discount to independent valuations, but I am investing in the company despite this deal, not because of it.

10% – A share in the Portside Tower in Cape Town

5% – The Eden Lifestyle Center in George

Both these destinations are grade A prime destinations in growing towns, with limited room for expansion and therefore fit well into the APF strategy.

The remaining 10% is made up of small locations in Sandton (excellent) and other provinces.

APF currently yields 8.6%, which is higher than the average yield in the sector, and is growing distributions despite the investment costs the company is incurring at the Fourways Mall development. At R6.50/share, the company is also trading at discount to NAV of R7.10/share.

One of the exciting aspects of the company is that management have participated heavily in the recent private placement, which was held to fund the European acquisition.  Andrew Costa the COO has put in R105m of his own money, while CEO Michael Georgiou, who already own just over 33% of the company, has put in a further R125m. This is a sign of a management team very confident in its own strategy, direction and investment fundamentals. The company’s chairman is Tito Mboweni, another indication of the strength of management.

 

LHC – Why I decided not to invest

hilton-private-hospital-slide

Private hospitals are a phenomenal business. We all need them at some stage in our lives, and when we, or our loved ones, need them we are price takers. As health and life are unique and essential, we are price inelastic to these services. In fact, because of this imbalance between buyer and seller, the economic concepts of free will, of willing exchange of money for goods and services, of Adam Smith’s “invisible hand”, are compromised. Therefore, the ethics of paid hospitals are the topics of many essays and much political opinion. I personally think that hospitals should be run by a competent accountable government as a monopoly supplier.

However, decades of political legacies and infighting have created realities in South Africa and other emerging market economies that provide large opportunity for private health care providers. From an investor’s point of view, these are great businesses. Not only are demographic changes, such as ageing populations, and public health challenges, such as obesity, increasingly creating demand for these services, but life style procedures, such as elective surgery, are also supporting private hospitals and will do so increasingly. The particularly poor service delivery in South Africa, create significant demand from a growing middle class. Additionally, the weak Rand and relaxed visa regulations for other African countries, support medical tourism trends, which are likely to grow.

For these reasons, hospital groups have had strong growth in the last decade and the protected nature of their cashflows through business cycles has ensured that these businesses have traded at significant premiums. My interest was piqued, when the large pullback in prices, has suddenly moved these companies into reasonable valuation territory. I prefer Life Health Care Group (LHC), as unlike their peers Netcare and Mediclinic, they have resisted the temptation to expand into developed markets. I am convinced that the real value for these businesses remains in the developing world, where governments will remain incapable of providing these services for many decades.

LHC on paper is currently looking very attractively priced. A PE of 16.5, with a forward PE of 14 and, importantly a dividend yield of 5.2%. The stock is lower today than in mid-2012.

However, in mid-November the group announced a game-changing deal, that boggles the mind and completely changes the investment perspective of LHC:

  • They are acquiring the Alliance Medical Group in the UK for a consideration of R13.3bn. At the current market cap of R34bn, this immediately transfers approximate 25% of the LHC value into a developed country that has a saturated private market AND a moderately successful public system in the NHS.
  • The acquisition target has Total Assets of 276m Pounds, at a purchase price of 800m, this will result in significant goodwill on the LHC books.
  • Worse, Alliance Medical Group has Net Assets of 10m Pounds, essentially implying that the business is EXTREMELY geared and LHC are acquiring no net assets. When interest rates rise (and they are already rising in post-Brexit UK), this amount of debt will bite straight into cashflows.
  • Alliance Medical Group has net profit after tax of 9m pounds. What? This implies an acquisition PE of 100. How desperate is LHC management to move into the UK?

The deal appears to distract management from its emerging market growth destinations and – more importantly – appears to severely over price the Alliance Medical Group. If management is that desperate to make a deal in a developed country, it also shows that they have negative views of the Southern African market.

In conclusion, this is an excellent example of how one deal can change the investment fundamentals of a company. In my opinion, LHC has gone from a value business in a market with strong fundamentals and focussed management, to an overvalued business that lacks geographical focus or growth prospects.

MDP – Another great acquisition

mall-of-tete

Mara Delta Africa Property Holdings (MDP) announced on 6 December that they were engaging in another acquisition. With this, they are continuing to execute on their strategy, which was defined in their last annual report by Chairman Sandile Nomvete as:

In the short term we will continue to capitalise on our knowledge base and diversify our sectoral exposure by expanding in current jurisdictions such as Mauritius, Morocco and Mozambique.”

The target is the recently constructed Mall de Tete in Mozambique’s coal rich Tete province. The wording from the press release:

“The Property is in line with Mara Delta’s investment strategy to acquire rural retail centres in          under-serviced markets which meet the rigid investment criteria of strong counterparties,          underpinned by long-term dollar-based leases.”

Mall of Tete is in the largest town in a province that is not only growing rapidly economically, but whose population has not seen a Western- style Shopping centre on their doorstep before. This fits perfectly into the MDP investment fundamentals.

The main reasons why I think this is such a great acquisition, is how it is financed. I have simplified things slightly to the main points and numbers:

  • The purchase price is $25m, with a Gross Rental of approx.. $2.4m/annum, resulting in a gross yield of 9.5%
  • 95% of the rentals are denominated in US$ and 29% is underpinned by one tenant, Shoprite
  • As the rental contract with Shoprite is still being negotiated, there is some risk associated with the Shoprite rental yield. The conditions of sale therefore stipulate that if the desired rental terms are not achieved the Seller will reduce the purchase price, so that the yield to MDP is brought back to expectations
  • Half of the purchase price is settled by a loan from the Bank of China. The interest rate is not given, but it is likely to be far below the yield of 9.5% and more in line with MDP’s average cost of debt, which is about 6.2%.
  • The other half of the purchase price is settled with new shares in MDP, which are issued at a price of R22.60/share, significantly above the current share price of R18.50. This enhances shareholder value and once again implies the inherent undervaluation in the company. It also reduces the risk that there are “skeletons in the closet” for the buyer, as the seller remains invested in the business.

The structure of this deal significantly de-risks the acquisition for MDP shareholders, whilst leveraging of their Mozambican and African Retail experience. A phenomenal fit for this undervalued company.

MDP – A Pan-African Property Champion in the Making

mda

When I first invested in Mara Delta Africa Properties (MDP), it owned just two properties, a Shopping Mall in Cassablanca and an Office Building in Maputo, but it had big ambitions to grow into a larger Africa focussed property fund. Importantly, this excludes the saturated South African market.

Under the leadership of Bronwyn Corbett and her impressive and aggressive management team, they are executing on exactly this strategy. They have acquired Shopping Malls in Zambia and Kenya, Office Buildings in Mozambique and Mauritius, and Logistics and Residential Compounds – also in Mozambique. I could show pie charts of their geographical breakdown or the property market segments, but the company has further acquisitions in the pipeline, which would change the entire picture. After the release of their last annual results, they are finalising the acquisition of two large hotel resorts in Mauritius and a logistics centre in Nairobi.  This will further enlarge their property portfolio from the current US$350m.

Management has the stated vision to grow the value of the property portfolio to $1bn in the next 3 to 5 years by growing in existing jurisdictions and the high growth East Africa region.

Fundamentals and long term trends

Opinions about the property business vary fundamentally. It is true that the property business and the unique opportunity for gearing that it offers has made many people fabulously wealthy. It is also true that margins and growth are limited and often property offers predictable cashflows without delivering large growth. In addition, in an increasingly digitising world, it is likely that demand for property is likely to decrease. A move towards online retailing, will reduce the value of Shopping Malls as much as increased virtual and online entertainment will reduce the need for large housing, hotels and resorts or Digital Offices will replace the need for large collective office space.

However, these trends are opposed in Africa by several factors:

  • Growing demographics: Populations in Africa are growing faster than anywhere else in the world. Nigeria’s population alone is set to double in the next 50 years and it will have overtaken the USA by 2050. More people will need more space to eat, sleep, entertain and work.
  • Economic Growth: Africa is growing of a low base and has far to go in the next few decades. Of course, resource based economies have slumped in the last year, but we should regard this as an opportune time to buy property in these countries, an opportunity that MDP is seizing with both hands.
  • Poverty: It is easy to argue that you will go on virtual holidays, shop and work all from the comforts of your apartment, if you have a comfortable apartment. However, if you live in a shambolic hut, you will do everything to escape to a good, clean, “Western” office or mall or hotel. This more than any other trend is a visible manifestation of the need for quality property in Africa.

For these reasons, I am of the opinion, that property is an excellent low-risk means of benefiting from demographic and economic growth trends on the African in the decades to come.

Valuation

MDP, like most property companies is a solid dividend payer. They bring a Rand hedge component, as the dividend is dominated in US$. Last year’s annual dividend was US$11.75c, which at the current exchange rate and share price equates to a dividend yield of 8.6%. Whilst, it is difficult to judge the sustainable cashflows of a company that is growing rapidly and acquisitively, it appears that the dividends are covered with funds from operations.

The NAV per share is reported to be R22/share, which at the current share price of R18.50/share puts the company on a 19% discount. However, new shares issued for acquisitions have been issued at slight premiums to the NAV, implying that major shareholders have been buying shares throughout the year at a 20%+ premium.

Barriers to Entry

Operating in Africa is far from easy, as has been evidenced by many South African businesses burning their fingers on the continent. Partially, this results from a failure to differentiate between the over 50 individual countries in Africa, each with its own cultural, political, fiscal and logistical challenges. MDP has built up operational experience in Morocco, Mozambique, Kenya, Zambia and Mauritius, with a management and operational team that has now learned from the challenges in North, East and Southern Africa.

Whilst it may be argued that property is a relatively easy business to operate – and it is certainly less challenging then retail in the same location – MDP will still reap the benefits of first mover advantage on the continent. They will be ahead of other players in discovering the unique security, tax, utilities, customer and fund repatriation challenges of their various jurisdictions.

In my various travels in Africa I have often encountered hotel, retail or office properties that were clearly inefficiently used. Often space was poorly managed, maintenance apparently non-existent, operational staff untrained and many opportunities for monetisation of the property were foregone. As MDP continue to acquire additional properties, the company will build up scale, which allows it to keep costs low, but maintain and build a team of experts that can maximise the value of each individual property in the portfolio. I have no doubt that with a South African trained team of experts, significant value can be extracted from almost any property in Africa.

Major Shareholders

According to their latest Annual Report, Directors and Associates control just over 9% of the company. This is a sizable amount and ensures that the chairman and CEO are well aligned with shareholder interests. There are also two key shareholders. The Delta Property Fund owns 24% of the company, a legacy shareholding from when the company was created as a spin off from its parent, and the Government Employees Pension Fund, as a 28% cornerstone shareholder.

Conclusion

MDP represents a phenomenal opportunity to participate in the expected African growth over the next few decades through a low risk property vehicle. The company is growing rapidly and intelligently, looking to leverage their built-up knowledge in several jurisdictions. I for one am happy to sit on my healthy US$ denominated dividend yield, while I wait for this growth story to play out on a continent with a population that is desperate for quality property.

Rolfes – Firing on all cylinders

agchem-logo

 

Rolfes (RLF) is a chemicals business with a Market Capitalisation of R650m. Today they released a voluntary trading statement and operational update. Typically, a company would only do this, if management has excellent news to share with the market, and it is therefore no surprise to see the Share Price up 10% on the day.

Fundamentals and long term trends   

They have recently restructured their business into four divisions: Agriculture, Food, Industrial and Water. The Industrial division aside, these divisions reflect trends that are growing strongly and have excellent long term fundamentals in South Africa and Africa overall. Excess to clean water, optimising agricultural efficiency and feeding the population will remain major African areas of focus in the decades to come. The chemicals that Rolfes produces will therefore be sold into these growing sectors, which in turn need to consume increasing amounts of chemicals, as they are trying to increase efficiency and productivity from increasingly scarce resources.

Valuation

The growth in the demand for Rolfes’ chemicals is reflected in their excellent growth in earnings, which are at the heart of this trading statement. They anticipate half-yearly EPS to be at least 25% higher than the prior period. This is on the back of a 39% increase in EPS for the previous full year.

This strong earnings growth, however, comes with an undemanding valuation. Doubling the forecast 35c EPS for the full year, put Rolfes on an incredibly cheap Forward PE of 6.3. If we compare to this to the larger competitors in the chemicals sector, Omnia with a Forward PE of 16 and Afrox with 12, it becomes clear just how cheap this little business is at the moment.

Despite this rally in the share price, Rolfes trades at a moderate premium of only 1.3 to its NAV, while its larger competitors both trade at around 1.7.

Conclusion

Rolfes is a phenomenal business with excellent long term fundamentals, that is looking extremely cheap at current levels.