BWN – Blowing up the bears

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I have previously explained why I like Balwin Properties. They had a voluntary trading statement that was very much in line with my lofty expectations. Of course, companies only make voluntary trading statements, when the news are good, but this one really had the desired effect. The share price spiked by over 11% as people realised they might have this company wrong.

BWN did not, like many other companies, comment about pressurised consumers, difficult economies and political uncertainty. Rather they focussed on the solid demand for their developments and the success of their strategy, which has led them to start their first development in KZN, in Ballito.

I am convinced this company has plenty more steam and phenomenal long term fundamentals. At the earnings forecast in their trading statement, the company is trading at a PE of 6.3. With BWN’s stated strategy of distributing approximately 30% of earnings as dividends, the shareholder can currently expect a dividend yield of 4.7%. At these levels, I see at least an 80-100% upside in the share price and I am comfortable to collect the juicy dividends while I wait for this to materialise.

TAS – I believe management owes us an explanation

Taste Holdings (TAS) is an interesting combination of Jewellery and Watch retailer and fast food business. One third of sales are generated in the jewellery division, with the likes of NWJ, Arthur Kaplan and World’s Finest Watches, all stores that we come across in Gauteng’s shopping malls. Two thirds of Sales are from fast food franchises such as Maxi’s, Zebro’s Chicken and the Fish & Chip Company. Importantly, these also include Domino’s pizza in South Africa, which TAS are cleverly rolling out through the conversion of their Scooter’s and St Elmo’s stores and … of course … Starbucks.

Whilst the jewellery business delivers higher profit margins then food division, it is difficult to scale this business. The demographic that can purchase expensive jewellery will remain small in Southern Africa. The turnaround and medium term future of the business lies in the food segment. I am convinced that eating out is a growing trend globally and that Taste too, should benefit from it.

Management, who own a healthy 17% of the company, have a vision to grow both Domino’s and Starbucks into Southern Africa. Their challenge in the next two years will be to get both these strong international brands to scale, to ensure that the food business returns to profitability. It is with this overarching objective in mind that we should query their recent announcement:

TAS is buying 80% of 15 Domino’s stores for R6m from its CEO, at an effective price tag of R500,000/store. The reason given is that the deal is to remove a conflict of interest, whereby a director represents both the interests of a franchisee and the franchisor. At first glance this appears to be a logical explanation, particularly if the acquisition cost per stored is compared to the set-up cost of R2.3m/store posted in the Taste annual report.

However, with some closer inspection we discover that the NAV of the purchased stores is a negative R10m and that they produced an annual loss of R8m in the previous year. These stores must be extremely heavily geared and are clearly not running well. This acquisition should lead to a loss in the first year of R24m (R6m purchase price + R10m negative knock on the balance sheet + R8m loss), followed by subsequent losses of R8m per year. Or a loss of R0.08 per share or 4% of market cap. This is more than the 2015 profit made by the entire company.

It appears that we have a business buying worthless, loss making assets from its own CEO at a time when they should be knuckling down and delivering on their ambitious expansion programme. As a shareholder, I would certainly like an explanation.

GBI – How are they funding their acquisition spree?

Gold Brands Investment (GBI) is best known for the Chesanyama brand, with over 300 stores in South Africa. They also own the Hot Chicks, Wild Wings and rapidly growing BlackSteer brands.

In the last week, they have signed a deal with the Casual Dining Group (CDG), which operates 300 mid-market restaurants including Café Rouge, Bella Italia, Belgo and Las Iguanas in the UK, to roll out their restaurants on a franchise basis in South Africa. Less than a week later, and geographically bizarre, they have announced that they will acquire 50% of the Hot-Hot Burger Bar chain, which operates 15 American style diners in Greece and Cyprus.

Whilst I openly admit that other than Chesanyama, I have never heard of any of these restaurants, I believe that there is a huge and growing market in Southern Africa and globally for Eating Out. This is supported by several trends including:

  • Smaller apartments: As people live in smaller more centrally located apartments, they will be increasingly likely to entertain in restaurants rather than at home.
  • Increasing affluence: The middle class in Southern Africa is growing rapidly and this additional disposable income is often translated into “spoiling yourself” with meal away from home.
  • Economies of scale closing the price gap: As restaurant chains scale their supply chain and optimise their operations, their costs drop, which brings the costs of eating out closer to the costs of home cooking.
  • Time: Demanding jobs, gym time, dual job households and long commutes all contribute to less available time for the preparation of meals at home.
  • Less and later children: People with children are considerably less likely to eat out then those without kids. As people reconsider having children or have children later in life, demand for dining options increases.

For all these reasons, I am convinced that mid- and low priced restaurants represent a significant growth market in South Africa’s maturing middle class.

However, a specific investigation of GBI poses a weighty question, how are these deals being funded?

Their latest results paint a gloomy picture. Revenue was down 13% year on year, despite the opening of new franchises. Fortunately, costs were kept in check, but Trade and other Receivables have tripled in a year, from R11m to R38m, and now make up almost half of the company’s market cap. This means that reported profits did not translate into cashflow into the business. And cash flows were indeed negative to the tune of R8.5m in the previous 6 months.

The company was supported by the dilutive issue of 25m new shares. This has the effect that additional profit (up 16%) has translated into reduced earnings per share (down 10%). The share is trading at a modest PE of only 11, but that is only if you believe the receivables will materialise into actual cashflows in the future.

On 1 September 2016, cash on hand at the company was a mere R500k, a fraction of monthly operating costs. Worringly, the CDG deal requires approximately R1m in up front franchise fees and the additional large costs of opening-up the various restaurants (assume 5 restaurants at R1m apiece in the first year). The Hot-Hot Burger transaction comes at the hefty price tag of R11m. Therefore, while these new brands add “sex appeal” to the stable of restaurants, the costs in the short term are likely to be in the order of R17m or 20%-25% of market cap. Another dilutive rights issue is most definitely coming, and it is unlikely that this will lead to an increase in earnings.

I will stay far away from this company until cash flows are more established. It may be time to consider Taste Holdings or Famous Brands, which will make up the subject of future posts.