APF, ILU – When Dividend Yield is too high to ignore

I first wrote about Accelerate Property Fund (APF) in December 2016, when the stock was trading at R6.50/share.

Much has happened since: The retail collapse has played out in slow motion, the severe mall oversupply in SA has started to reflect in rental vacancies and absent rental escalation, economic stagnation across the country and APF management has been embroiled in the Picvest scandal. (I highly recommend this excellent piece of investigative journalism by Ryk van Niekerk on Moneyweb.)

A combination of the above factors has resulted in the share now trading at R1.75/share. With the market cap reduced to a meagre R1.8bn. However, I have received dividends of more than R2.50, since I first purchased the share in 2015. Are the fundamentals that support the dividend yield still in place?

Fourways remains a good and growing node. Major “super regional” centres such as Fourways mall are in demand and continue to be so. The Eastern European hardware stores (Obi) also continue to do well and may actually represent one of the few successful offshore acquisitions undertaken by SA Inc in the last few years. The business’s property portfolio is valued at R12bn, resulting in a NAV of R7.77/share. Given the often aggressive rental assumptions used to calculate property values, it may be prudent to halve the NAV of the business to R4/share. Even then, the share is currently trading at 40% of NAV.

The dividend has come off somewhat with R0.58/share in 2016, 0.58/share in 2017, R0.51/share in 2018 and 0.16/share for H1 2019. Forecast for FY 2019 is 0.43/share, implying an H2 dividend of 0.26/share. Taking the management at their word, puts the company on a current dividend yield of 25%. Conservatively assuming that the dividend continues at the value of H1 2019, puts stock on a forward yield of 19%.

I made an investment case for Indluplace (ILU), first in March 2017 when it was trading at R11/share and again in March 2019, when it was trading at R7/share. Both investment cases were premised on good, low risk, repetitive dividend yields, which exceed yields of outright ownership of a buy-to-let property. As ILU has been caught up in the overall small cap and REIT sell off, the stock is now trading at R4/share.

The share price sell off can be partially explained by reducing dividends due to operational problems with payouts dropping from R1.05/share in 2017, R0.98/share in 2018 to only R0.78 share in 2019. Furthermore, the company forecasts that 2020 dividends will be 6-9% lower. Assuming a reduction of 10%, results in an expected dividend of R0.70/share in 2020.

Retrospectively, 2017 was not the right time to invest in this business. However, at current levels, the company is trading at 40% of its NAV of R9/share. The forward dividend yield is a whopping 18%. In an environment where Zimbabweans and refugees, immigrants and asylum seekers from other African countries continue to stream into South Africa, I am confident that an investment in low cost housing will prove to be resilient in the medium term. As the company works through its operational issues by strengthening the management team, dividend growth should also resume.

Both companies will also benefit from a reduction in interest rates. I expect the businesses to revalue to more realistic multiples of 90% of NAV and I am happy to collect ridiculously good dividend yields while I wait for the thesis to play out. Both stocks can double and still trade at a discount to NAV and a dividend yield of approximately 10%.

VLE – Offering great value

value

If you live anywhere in Gauteng, you cannot help but see the Value Group (VLE). Whether large trucks, medium size moving vans or canopied bakkies, Value branded vehicles are on the roads, near warehouses or busy resupplying your local supermarket. According to their latest annual report, they “specialise in providing a diversified range of supply chain services, which encompass distribution, transport, clearing and forwarding, warehousing, fleet management, materials handling and commercial vehicle rental and full maintenance leasing.”

The increasingly ubiquitous presence of the group indicates that business has grown significantly in the last decade, however the share price has not really moved, still trading at around R5/share, the same as 5 years ago, with a market cap of R850m.

Earnings in the full financial year 2019 were 89c. The earnings for the first half of the 2020 year came in at 30c, however, earnings are historically seasonal, with the second half coinciding with the peak Christmas trade period. In the words of the group, “… the board anticipates that … earnings will at least be maintained in the 2020 financial year.” This puts the group on a forward PE ratio of 5.5.

Strong earnings growth in the last two years has shown that the group has the capacity to grow in a difficult economy. This is not surprising, as in difficult times, people are more likely to hire their own moving van, then to go with a lumpsum service provider and business are more likely to subcontract logistics or lease vehicles than to incur capital expenditure to expand their own fleet. Therefore, I am confident that the group will continue to be a solid earner both in good and bad economic environments.

The group operates on an excellent gross profit margin of 30% and has cash conversion of around 100%. Cash from operations in FY 2019 was R320m or about one third of the market cap of the business. And the group is generously returning this to shareholders. Last year’s dividend was 40c, with H1 2019 coming in at a 23% increase. If last year’s dividend is maintained, then the yield is 8% and if final dividends are increased in line with the first half, the forward yield could be as high as 9.8%.

Management also recognises that shares are significantly undervalued and are therefore returning further cash to shareholders by means of a buyback programme. Last year R36m (or around 4% of the group) was repurchased at R4.74/share. In H1 2020, the buyback continued with a further R8m. Total debt of R600m is under control at 60% of equity.

I leave final words to management and support wholeheartedly that “the Group is well positioned to grow organically and by acquisition.”

GML – A gemstone at bargain prices

Gemfields (GML) is a unique business globally and we are fortunate to have the opportunity to have it listed on the JSE. The company developed out of the Pallinghurst stable of companies. Pallinghurst is a mining investment vehicle set up by former Billiton chief and mining deal legend Brian Gilbertson. His son, Sean, is CEO of Gemfields. What makes the business unique is its exclusive focus on coloured gemstones. Primary mining assets and cash generators are the Kagem Emerald Mine in Zambia and the Montepuez Ruby Mine in Mozambique.

The real value creation is that they have invented and implemented an auction system (probably borrowed from the De Beers business of the 80’s), which has ensured that they are not simply price takers at the mercy of the gemstone traders and dealers. Rather by controlling a large portion of supply and by creating additional demand through the Faberge brand, they have ensured that they can somewhat control the price received for their stones. In the group’s own words: “[The Faberge brand] promotes the positioning and perception of precious coloured gemstones by producing jewellery, timepieces and objects.”

The company has developed this system through trial and error and they appear to have settled on three separate auctions, each taking place twice per year. The Singapore Ruby Auction averages revenue $60m on sales of around 600,000-900,000 carats. The Lusaka Emerald Auction focuses on lower quality stones and averages sales of $13m on around 3m carats. The Singapore Emerald Auction focuses on higher quality Emeralds and nets an average revenue of $25m on sales of 300,000 carats. In total the auction system yields annual revenues of around $200m.

Free cash flows for the 2018 FY were $27m (profits were impacted by the revaluation and impairment of certain mining assets). In H1 2019, free cash flows were reduced to $10m, however, the group reported paying export duties of $5m on Zambian emeralds. In December 2019 it was announced that the Zambian government had suspended this tax. This increases Zambian profits by $10m/year and would put the group back on annual free cash flows of around $30m.

The company is trading at around R1.80/share or a market cap of R2.5bn ($170m). This puts the business on a 6 times free cash flow multiple.

In April, the company sold a non-core stake in manganese producer Jupiter mines for $31m. Further assets by the group are a 6.5% stake in Sedibelo Platinum platinum mine, which produces around 150koz/year, and gemstone and gold exploration activities in Mozambique, Madagascar and Ethiopia. The exploration activities provide upside and a pipeline for the gemstone core business, while the minor stake in the platinum mine is clearly non-core and is likely to be sold at the right price, similar to the Jupiter mines stake.

Major shareholders are Christo Wiese with 12.6% and several fund managers (Fidelity, Oasis, Investec Asset Management, Old Mutual). Management holds a few percent and in May, former chairman Brian Gilbertson purchased another R2m of shares at current depressed prices.

The group holds 7.6% of its own shares and voted in a December 2019 EGM to cancel these treasury shares. In fact, given the large amounts of cash on hand and the significant discount to NAV, the group is continuing with an aggressive buyback program, which was first announced in June 2019. In September they announced a successful repurchase of 10% of the issued share capital of the company at R1.50/share. Further repurchases were approved in the recent EGM and the company will continue to reduce the number of shares in issue at these depressed prices.

I believe that the group represents a compelling investment at the current price and have added the stock to my portfolio. The following factors present significant value upside in the medium term:

  • Gemstones, like diamonds, represent discretionary expenditure, incured mostly by the very rich. This is the layer of the population that is most protected from economic downturns. The people forking out $100,000 on a jewel encrusted iPhone cover or a Faberge egg will continue to do so, no matter what the economic climate.
  • Gemstones are gaining popularity when compared to diamonds. Increasingly, people in my circle of friends are choosing coloured stone engagement rings and the Faberge brand is helping in strengthening this trend.
  • Gemstones are also less at risk of substitution from lab grown varients, as they are less expensive in $/carat then gem quality diamonds, thus providing less incentive for creating alternatives.
  • I like the capital allocation approach developed by the group. Over the last year they have have disposed of most of their non-core assets. This has resulted in very low debt levels and a large cash pile which is being put to specific use in a Distribution fund. At current low share prices, I agree with management that repurchase of shares is the best way to deploy this cash horde.
  • The disposal of the non-core assets has ensured that management focus on the core business, which is creating a market for and then selling coloured gemstones. The two existing mines are long life, large, high quality assets and other assets may complement this in the future. This may be through exploration (in Ethiopia and Madagascar) or through acquisition.
  • Suspension of the Zambian export duty, is likely to significantly increase cash flows. In fact, the group is trading at less than 6 times free cash flow.
  • The group has stated its intention to sell its stake in Sedibelo Platinum. The asset has a carrying value of $50m (around 30% of the GML market cap). However, with palladium prices notching up record highs, the asset may well be worth significantly more. As a comparison, Northam Platinum produces 520koz/annum of 4PGE and carries a market cap of $4.4bn. This implies a valuation of $80m for the Sedibelo stake. The value of this holding does not appear to be considered at all in the market cap of the group and has the potential to release significant cash. It is not surprising that the group is trading at only 30% of NAV.
  • If we exclude the Sedibelo stake, the company is trading at a free cash flow multiple of only 4 times.
  • As all sales are in US$, the group functions as an effective Rand hedge. Any devaluation in the ZAR should increase the share price.
  • Management is eating their own cooking with recent purchases at the current share price.