HSP, CLR – Buy when others are fearful

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At first glance Clover (CLR) a producer and distributor of milk products and Holdsport (HSP) a sport and outdoor equipment retailer may have nothing in common.

However, on closer inspection, we find the following similarities:

  1. Exposed to the Consumer

HSP owns the Sportsman’s Warehouse and Outdoor Warehouse retail stores as well as the Capestorm clothing and equipment brand. As Southern Africa’s population gets richer, I am convinced they will increasingly use the fantastic weather and facilities available in their countries to engage in outdoor activities. The world is on a health, fitness and nature trend and will continue in this direction.

CLR produces milk products such as cheese and yoghurt. Importantly it has a huge network of trucks and distribution centres which ensure that the “cold chain” of uninterrupted refrigeration is maintained. They are looking to make acquisitions, such as the purchase of the excellent Frankie’s soft drinks, that can leverage off this existing infrastructure. Again the consumer, as he becomes more effluent, will naturally buy more dairy and chilled products.

  1. It is tough out there

Both companies recently published negative trading statements. CLR sees profits down over the festive period due to poor weather, higher input costs that could not be passed on to consumers and general lack in consumer demand. They expect half year earnings to be down by about 20%. HSP has provided a four months update that sees revenue up 5%, which at reported price inflation of 8.5% means that sales were down 3.5% in real terms. They do not provide any commentary, but given recent updates from the likes of Mr Price, we know that consumers are constrained by rising costs, stagnating wages and a general lack of income in the economy.

  1. The companies are relatively cheaply valued

Given these poor trading updates and the general market conditions, it is not a surprise that both companies are trading relatively cheaply. By my calculations, HSP is heading towards full year earnings of about 4.50, putting it on a forward PE of 13 and the dividend yield of 5.5% is likely to be sustained. Similarly, CLR is looking at a conservative FPE of about 11, with a healthy dividend yield of almost 4% also sustainable.

  1. Toes are being dipped into Southern Africa

Both companies are exploring expansion into Southern Africa. Holdsport has opened stores in Namibia and will likely look next into Botswana, Mozambique and Zambia. Clover has an established Southern African footprint. The lessons they learn from operating in other jurisdictions, will serve these companies well, when the other African markets inevitably mature sufficiently to support their businesses.

  1. Both companies are set to benefit from the long term demographic and socio-economic trend

Most importantly, both these businesses have good fundamentals. We should regard current consumer pressure as temporary and a buying opportunity. In the long term, growing demographics, will mean more consumers. And also more effluence amongst these consumers. They will consume more footballs, squash rackets, hiking boots, lemonade, yoghurt and all these other things that are required for a daily balanced and healthy life.

Warren Buffet is famously quotes as saying that we should “be fearful when others are greedy and be greedy when others are fearful.” In this context, it is an opportune time to use the temporary negativity surrounding these consumer orientated businesses to investment in cashflows that are underpinned by strong long term fundamentals and good valuations.

PHM – Why I will be following my rights

durbanjuly

Gambling is as old as time itself. Many people like to take a punt on uncertain outcomes, believing that they have some superior insight, or to be entertained, or hoping that they are just plain lucky. We have several (legal) ways to gamble in South Africa:

  1. The National Lottery

This is popular and profitable, but it is also a state monopoly and private individuals can therefore not participate.

  1. Casinos

Two big companies have locked down the Southern Africa casino market: Sun International and Tsogo Sun. Unfortunately for these businesses, I believe their future is uncertain. The reason is simply that my generation, the Millenials, does not go to casinos. We just don’t. Walk around Montecasino on a Friday night and I dare you to find any customers in the casino that are not either tourists or over 40. The youth simply does not view this a means of entertainment.

  1. Online casinos

The rise of poker has made these very popular and profitable. However, these businesses are headquartered in tax efficient island jurisdictions and JSE investors therefore have no access to these.

  1. Sport betting

Everyone has an opinion about their favorite sports team, and many are willing to put their money where their mouth is. Not surprisingly this is the fastest growing form of gambling and much more attractive to young people then casinos.

Phumelela Gaming and Leisure (PHM) is a big player in Southern Africa in the sports betting market. They offer fixed odds and totebetting through various outlets on sports such as rugby and football. Their primary focus, however, remains the hosting of horse races, the marketing, screening and distribution of these races and facilitation of betting on these races. They operate 8 race tracks in South Africa (including the iconic Turffontein and Kenilworth race courses) where 440 races are held annually on 364 days per year. This content is distributed all over the world and interested international fans diligently follow the South African horse racing scene.

PHM is profitable and good value at the current share price, offering a steady and rising dividend, with a current yield of 4.7%. They are in the process of undertaking a rights issue to fund the acquisition of 50% of Supabets. This deal has been more than a year in the making and in my opinion will add significant value to the company. I am following my rights and will support the deal for the following reasons:

  • Supabets will more than double the retail outlet footprint for PHM. They will be able to offer Supabets content in their existing outlets, whilst rolling out horse racing content into all Supabets outlets. The synergies are excellent.
  • The acquisition PE is 9.25 Earnings, whilst PHM trades at a PE of 13, meaning that the transaction will be immediately earnings enhancing.
  • By acquiring only 50% of the company, the founders and current owners remain interested in the business. The risk of “skeletons in the closet” appearing after the deal is also much lower.
  • The future of media and entertainment is increasingly moving towards live events and content generation. This is confirmed for instance in the mega-deal where At&T is paying in excess of $100bn for Time Warner, mostly to get access to content. Horse races at iconic race tracks are unique and sought-after content and live flagship horse races will become increasingly appealing.
  • Sport is the only reason many of my friends and I subscribe to Dstv. It is the future of entertainment of content and also the future of betting and gambling. I am convinced it will increasingly take market share from the casinos. Supabets and PHM are dominant in the Southern African market.
  • CEO WA du Plessis has just bought 100,000 shares on market at R2.2m, in time for the rights issue. In total directors and management hold 14% of the business, Markus Jooste (of Steinhoff fame) holds 3%
  • The Thoroughbred Racehorsing Trust is a non-profit organisation established to maintain and encourage horse racing in SA and own 35% of the company. They will ensure that the management continues to encourage horse racing, which I am confident will be PHM’s unique content differentiator from other sports betting businesses.

MFL – Boxes full of dividends

Polaroid

I love to see and use the products or services of the companies I own. Document management company Metrofile Holdings (MFL) is not a service that I subscribe to directly, but since I have become an investor in this cracking business about a year ago, I have increasingly seen boxes imprinted with their logo creep up in various homes and offices. Boxes is exactly what this company does. They take your documents, which you as a business (say a doctor, a lawyer, an engineering company or a financial institution) are legally bound to store for a number of years, put them in boxes, and then store them for you. They own the warehouse, they own the online platform, they own the boxes.

This type of business is incredibly profitable, as it takes time and scale to build warehouses, establish logistics chains and develop online platforms. It has very strong recurring earnings, as it is difficult to change providers, once established and businesses need to file their documents in good as well as bad years.

MFL is trading at a relatively rich PE of 16. However, if we remove the once off costs associated with a replacement of the CEO, this PE drops to 14.5. If we further consider that group has a dividend payout policy of 1.25-1.5 and management has temporarily increased this to 1.1 to increase gearing in the business, then the value at current share prices, becomes more apparent. The current dividend yield is 6.1%, essentially the same return as money in the bank, if the different tax treatment of dividends and interest are considered.

The gearing is very low, with long term debt at less than 10% of assets. In fact, management has stated its intention to increase gearing. They are not doing this by means of senseless expansions or acquisitions, but rather by increasing the dividend payout, thereby allowing the shareholder to re-allocate this cash. I think that a moderate increase in the debt is justified, given the low level of risk in MFL’s business model due to the recurring nature of the earnings. The company’s continuous cash flows are recession proof and supported by regulation in many of its jurisdictions. In fact, regulation, something that is abundant in Africa, is one of MFL’s strongest moats, and in my opinion this is unlikely to disappear in the coming decades.

South Africa’s specific regulatory requirements, namely BEE, are well addressed by the anchor shareholder, the MIC – Mineworkers Investment Company. They have recently increased their shareholding to just under 36% by subscribing to an additional 8m MFL shares, re-affirming their commitment to this strategic investment. The total Black shareholding in the business is at 55%.

However, the real growth and future of MFL lies outside RSA, in other African and emerging market economies, where cashflows are in US$, regulation is strict and quality document management services are yet to be stablished. It is with great pleasure that I read in MFL’s results that they operate in locations in Botswana, Mozambique, Nigeria, Zambia, the United Arab Emirates, Qatar and Oman.

Amid these healthy cashflows, solid business fundamentals and African and Middle-Eastern  expansions, the group is very positive about its growth prospects. The Management Outlook is that of a group that is confident that it can leverage its infrastructure and location advantages:

“Metrofile anticipates continued growth in the challenging economic and business environments, both locally and on the African continent. The group will continue to seek growth opportunities across all business units, both locally and internationally, in cradle to grave document management solutions. “

This strategy is already being executed, with various acquisitions in Southern Africa and the Middle East growing its strong foothold in these areas.

“At this stage, Metrofile expects to resume its historic earnings growth profile in the forthcoming financial year.”

Rarely, have I read a more confident statement by management. I for one am happy to share in their confidence, and receive boxes full of dividends, while I wait for the growth that is certain to come.

ARH – Boring, gloriously boring growth

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ARB Holdings supplies electrical products out of 20 wholesale branches across South Africa’s nine provinces. They supply SABS approved instrumentation equipment, overhead line and conductor equipment and low-voltage products. Through Eurolux, which you may have seen at the nearest Builder’s Warehouse, they supply LED’s and fluorescent lamps. I am an engineer and even I admit that this is an extremely boring business.

However, Vestact, in their excellent daily newsletter have pointed out that this boring business has made the chairman and founder a very wealthy man. Electrician Alan R Burke (who the business is named after) founded it in 1980 with one bakkie and one container. Since then, boring growth over 36 years has made his 54% stake in the R1.5bn company worth a cool R800m.

I have been a shareholder in ARH since 2011 and have recently increased my shareholding. In this time, the company has continued on a steady, boring path of continuous growth. Turnover and earnings per share have doubled, the profit margin has increased by 4 percentage points to 22%, the share price has doubled and the dividend (including special dividend) has increased from 12c/share to 33c/share. ARH is trading at a PE of 10 and a healthy dividend yield of 5%. The company has no debt and cash on hand of R240m, or R1/share, 17% of the market cap.

From the recent 2016 annual report there are several signs that show that there is no reason to expect this growth trajectory to stop:

  • “ ‘On ground’ presence established in Zambia.”

Africa’s population is growing and maturing and expecting increasing electrification. Positioning in Africa will be essential for a South African business in coming decades.

  • “…the board continues to evaluate potential acquisitions to further diversify the business”

Industrial companies are showing good value at the moment, as negativity around infrastructure investment continues. An ungeared company sitting on a cash pile is perfectly positioned to make an acquisition at the bottom of the market. The world is undergoing a green energy revolution in the next decade and Africa will be at the forefront of this. Diversification into Green Energy tech or smart grid equipment will be ideal for ARH.

  • “I am confident that ARB has positioned itself in its various markets to continue to gain market share and grow its customer base.”

These are words from the pen of the Chairman, who has built the business. He would not utter these comments lightly.

In conclusion, the company remains relatively small and nimble and is operating in a world with strong fundamentals for boring steady growth to continue for decades.