HLM – A bet with fantastic upside or a risk not worth taking?


Hulamin (HLM) is a business that has been in existence for 80 years, forms a mainstay of the KZN economy, employs just over 2000 people and has grown to become the largest semi-fabricator of aluminium in the world. The company takes molten aluminium from the Hillside and Bayside smelters in Richard’s Bay and converts this basic aluminium into saleable products at its facilities in Pietermaritzburg and Midrand. The products include packaging such as cans and rigid aluminium foil containers as used by caterers and in take away packaging; extrusion products such as windows and door frames, which are sold to the construction industry and developers such as Balwin; and rolled products such as sheets, coil and plates sold to the auto industry and exported to industrial customers globally.

The company has faced severe headwinds recently, which has seen its market cap reduced to R600m, with the share price of R1.80/share near 5-year lows, having been trading at almost R10 half a decade ago.

Hulamin sells products on every continent, with 59% exported, 25% of sales go North America, mostly the USA. With increasing protectionism in the USA, South Africa has been reclassified as a developed country by the US Department of Trade, leading to additional tariffs on SA products and putting Hulamin’s exports to this destination at risk.

Generally speaking, this is not a great business for the following reasons:

  • Over 50% of aluminium fabrication capacity is located in China, from where dumping to international markets occurs. The group is therefore constantly working against anti-dumping tariffs in its export destinations (see the USA example currently playing out above) and has to lobby its home government to forestall dumping at home.
  • Fabricated aluminium is a commodity and they are price takers in a bigger market. Margins are very low at 4% and ROE is 7%. This is with the scale affects of being the largest company in the business and extreme proximity to the smelters. The group has little control over these metrics.
  • The business is both directly energy intensive and is fully exposed to a single supplier, South32’s smelters, who is even more exposed to the price of electricity. In an environment of rising energy prices and ongoing load shedding in the medium term, this does not bode well for the group.

However, given the very depressed share price, these poor fundamentals may be priced into the business and the share may present an incredible value play at this level. In fact, this is exactly what Investec’s John Biccard believes and he is putting his money where his mouth is. The various funds that he manages have upped their stake in the business to 11%. In addition, he purchased almost 7% (or R50m) of the company in his personal capacity. Hulamin directors agree and the company has also repurchased 3% of its shares in the last few months, at an average price that is 30% higher than the current share price.

The thesis is that the company will return to historic profitability. Revenue of R11bn in the 2017 and 2018 financial years produced, HEPS of 95c and 91c in respectively. Free cash flow was R300m in 2017 and still R90m in 2018. Even with a poor 4% margin, operating profits on R11bn revenues could be R440m, almost 70% of the current market cap. Despite an impairment of R1.1bn in 2018 the group paid an 18c dividend and reported record sales and revenue.

The thesis changes though when looking at the interim results for H1 2019 where the group reported a loss of 23c. The loss included once off costs such as right sizing and retrenchments costs and losses incurred due to metal price lag, which will reverse in the long run. The price lag is likely to continue this year as the aluminium price has fallen further, but will eventually taper off. More worryingly, is a drop off in sales, in particular in North America. This led to a R400m build up of inventories, which are now R2.6bn and make up half of assets. We are likely to see more poor sales in H2, with the coronavirus annihilating Asian demand.

The build up of inventory has led to negative operating cash flow of R170m and suggests a scrapping of the dividend is on the cards, in fact it is surprising that the group strained cash resources with a share repurchase programme.

Management concludes the poor H1 2019 results with:

“Hulamin expects the turnaround actions to gain momentum in the second half, and these are forecast to start yielding ongoing benefits from 2020. “

This is precisely the bet made by Biccard. If earnings revert to R1/share, then shares could easily increase 5 fold for an exit PE multiple of 9. This is premised on a long term vision that an increased focus on recycling and the move away from plastics will underpin aluminium fundamentals. The business is also trading at less than 20% of NAV. The bet, however, needs two key outcomes:

  1. The group remains liquid with sufficient working capital whilst the US protectionism, coronavirus and Chinese dumping reduce sales and right sizing and further price lag increase costs. This will play out in the next 12-18 months.
  2. The Bayside and Hillside smelters remain in business. They are currently running on the last years of their notoriously beneficial supply contract with Eskom. Whether South32 (or a new owner) will be able to negotiate a power supply agreement that can keep an old fleet of smelters operating on expensive and dirty electricity remains to be observed in the next 3-5 years. The Industrial Development Corporation is a 30% shareholder in Hulamin and may target the preservation of jobs by getting directly involved in these smelters in the future.

If these two trends play out, they will certainly generate significant value for people willing to take a bet at these prices. However, I chose to pass on this bet because:

  • As per my Investment Philosophy, I don’t trade or bet, but choose to invest in long term, boring, cash generative businesses. This Hulamin bet is simply not boring enough.
  • Aluminium has strong fundamentals and prospects, but I am unconvinced that South Africa is the right location to process it. Iceland, Canada, Norway have abundant geothermal and hydro-electric energy sources and should be global sites for aluminium smelting, while Guinea and Australia are hosts to excellent bauxite deposits. Dirty, expensive coal power and no good local sources of bauxite make SA uniquely unattractive for this business.
  • I find I have a better play into South African packaging through boring old Bowcalf.

WSL – Tons of cash flow


The last financial year was tough for Wescoal (WSL), with disruptions to production as a result of labour unrest and poor weather conditions. Nevertheless, the group produced 5.9 Mt of coal. This compares to a production of 6.8Mt in the prior year and targeted production of 8Mt for the 2020 financial year.

Given the supply disruptions, the generally poor sentiment surrounding South African small cap stocks and the huge concerns at Wescoal’s largest offtaker, Eskom, it is not surprising that the company’s share price has been decimated. The share is hovering at approximately R1.20 or a market cap of R520m. In my opinion, these depressed levels offer an extremely cheap entry point into a business that has demonstrated its ability to act as a consolidator of smaller coal assets within the known coal districts of the country.

Keith McLachlan made an excellent case for an investment in Wescoal by pointing out that the business is trading at a free cashflow (FCF) yield of over 30%. This in a period where production was severely affected by external once-off factors. Management in their 2019 annual report goes as far as to claim a FCF yield of 74%, but this does not allow for replacement and growth capex, which are required to be reinvested into the business. The business also trades at around 50% of its NAV of R2.53/share.

In early November it was announced that Black Royalty Minerals (BRM) are acquiring the Gupta tainted Koornfontein assets for R 300 million. Resource and reserves were not clear from the announcement and media reports, but the assets consist of an open pit and two underground mines and a total capacity of approximately 3.5Mtpa.

The R300m appears to be a bargain basement price, after the preferred bidder, Lurco, failed to raise the initially agreed purchase price of R500m. At the Lurco price, Koornfontein would change hands at R142 per ton of annual production, at the bargain BRM price, the deal is at R86 per ton of annual production. Wescoal is currently trading at R65 per ton of forecast 2020 production. The trading business is included as a free extra in this assessment.

Furthermore, in February 2020 ASX-listed TerraCom made an offer for Universal Coal that values the company at R1.7bn. They forecast their production for 2020 at 8.4Mtpa, valuing Universal’s South African mines at R200/ton of annual production or roughly three times the value attributed to Wescoal’s production.

In July and August management repurchased 17m shares or 4% of the outstanding shares of the company at an average price of R1.58 per share reflecting their own conviction that the company is undervalued at current prices. With the current share price 25% below this last repurchase price and the significant cash generation, we can expect management to continue share repurchases in the foreseeable future. Management is also eating their own cooking with director Muthanyi Ramaite buying shares at current prices since December 2019.

Unfortunately, a trading statement in November 2019, showed that production problems continue into the 2020 financial year, with H1 production only at 2.7Mt. Most of these problems appear to be temporary, and a production rate of 0.65Mt per month from Elandspruit, Khanyisa and Vanggatfontein should be possible in the medium term. This lower production will result in a loss per share for the first half, but EBITDA of R140m will be maintained. This means that even in this terrible production period, the company is operating an annualised cashflow yield of around 45%.

With the reality of climate change, coal is no longer a sexy investment. In fact, investors are justifiably concerned about coal’s long term viability. In the department of energy’s latest Integrated Resource Plan (IRP) published earlier in 2019, coal is expected to continue to make up almost 60% of the country’s energy mix in 2030. Much of the coal mining capacity to support this blend still needs to be constructed. Even, if international pressure and the increasing competitive nature of renewals force an accelerated reduction of the coal mix in South Africa’s grid, the most optimistic transition is expected to take several decades. In order to keep the lights on in the interim, coal will need to be burned in Mpumalanga’s power stations and Wescoal will be able to snatch up cheap, highly cash generating assets.

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


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.


MFL, RLF – A buyer’s market

2019 has seen buy-out offers for three of my core holdings, namely Metrofile (MFL), Rolfes (RLF) and Clover (CLR). This number of take outs is unprecedented and the trend is further supported by other JSE-listed small and medium caps such as Interwaste and Pioneer Foods going through similar processes this year. There is much common ground between these transactions, all of them showing just how cheap small cap shares are in the South African market at the moment.


In February beverage and dairy group Clover announced that Milco, headed by CBC, a bottling and beverage business based in Israel will delist the company for R25/share or R4.8bn. This represents a 35% premium to the trading price of around R18/share prior to the deal, but three years prior, the group had traded at R25/share. The deal closed in October 2019. The acquisition was at a PE of 13.5 and at around 8.5 times 2017 EBITDA.


In October chemical group Rolfes announced that Phatisa, a Mauritian domiciled private equity fund, would delist the company for R3/share or R480m. This represents a premium of 33%, as the company was trading at around R2.30/share, however, as recently 30 months ago the company was trading at R6/share. The deal is expected to close in early 2020. Phatisa is acquiring RLF at bottom of the cycle earnings of 27c or a PE of 10. EBITDA was R92m, so the acquisition is 5.5 times EBITDA.


Yesterday document management company Metrofile announced that Housatonic Partners, a US based private equity firm, intends to acquire and delist the company at R3.30/share or R1.4bn. This represents a premium of 126%, as the company was trading around R1.50/share, but around 30 months ago, the share was at R5/share. The deal is expected to close around Q2 2020. Housatonic is paying a for 20c of earnings or a PE of 16. EBITDA was R225m, so the acquisition is 6.5 times EBITDA.

The following trends are apparent from these three deals:

  • Whilst the acquisitions are at significant and fair premiums to the recent share prices just prior to the announcement of the deals, in two cases they represent large discount to the price of the business a mere 2.5 years ago. This shows just how much these smaller companies have fallen out of favour in the last few years and how this is being recognised by private companies.
  • The acquisitions are all undertaken by non-South African players, who are seeing the value in Africa’s most mature economy. With global valuations stretched, South African businesses remain very cheap and outsiders are not blinded by the general negativity pervasive in South Africa at the moment.
  • All three companies are strongly cash generative in a tough economy. The average EBITDA multiple of these transactions is 7, around half of global businesses (prior to any control premiums).
  • The average PE ratio of 13 is equally undemanding, in particular, if we consider that earnings are at the very bottom of a cycle in a local recession.
  • All three acquired companies did not have a major founding shareholder with a large controlling stake. It is unlikely that a founder would have excepted a take out at these low valuations.
  • All three companies are too small to be included in the Top 40 index or any other index tracker. In fact, most equity funds would also consider these businesses too small to hold.

The streak of buy outs on the JSE clearly reflects that small caps and, in particular South African small caps are extremely out of favour and are therefore trading at valuations that make them attractive targets for private buyers. The premium paid to suffering investors offers small consolation, as minority shareholders with a long term focus cannot participate in the upside that is sure to materialise when the economy and sentiment turn.

So what can we small investors do?

We can either look for similar cash generative undervalued and under appreciated businesses in the hope of another buyout. For me these could be Value (VLE), Indluplace (ILU) or Santova (SNV).

Or we can invest in businesses that share the same characteristics but that are unlikely to be sold at current bargain prices due to the presence of strong founder shareholders. These businesses may not benefit from a short term acquisition premium, but they are likely to benefit all shareholders in the long term. These are companies such as ARB Holdings (ARH), Balwin (BWN), Masterdrilling (MDI), Bowler Metcalf (BCF) or Nuworld Holdings (NWL).



GRT – My favourite REIT keeps on giving


Watershed Piazza in Mahalapye owned by LLR Properties

I first decided to be a shareholder in Grit Realty (GRT), when they were still known as Delta Africa and controlled only three properties: A mall in Morocco (which has since been renovated), a building in Mauritius and an office block in Maputo. I spent a long weekend in Maputo in 2015 and the energy, vibrancy and potential of the city was palpable. The country is on a path to becoming a major gas exporter and the capital city’s infrastructure is woefully under equipped to deal with the expected influx of people, business and wealth.

Grit is a way to benefit from growth in demand for quality property in dynamic African destinations and I have been accumulating shares in the group since that first experience in Maputo. The business has grown to encompass 24 assets in 7 countries across Africa. Whether it is office building in fast growing business friendly cities, logistics warehouses, housing for expats, hotel properties, that benefit equally from a growing European travel market and an increasing African traveller, or malls for the rising middle class, Grit is diversified to benefit from all these trends.

This rapid growth has been supported by strong discipline. In an environment where “shady” counter parties and local currency fluctuations are the norm, Grit has acquired only assets with solid international tenants in US$ or EUR denominated leases. Often they ensure that the seller maintains “skin in the game” by partially paying for assets with Grit stock. I have previously commented on an acquisition of a Mozambican mall and in November they announced another deal that perfectly reflects the investment discipline shown by this team.

Letlole La Rona Ltd (LLR) is a property holding company in Botswana, a country with enviable growth and stability in Southern Africa. Grit already held around 6% of LLR and in November 2019 they announced the acquisition of a further 23.75%. LLR has an NAV of $70m, but Grit are paying US$13.8m a discount of 20% to the NAV of their stake. Furthermore, they are paying for this stake by issuing Grit shares at NAV of $1.40/share. In South Africa, these shares currently trade at R16.50 or a further 20% discount to NAV. This means that JSE shareholders are actually receiving the LLR assets at a 40% discount to NAV at their current prices. LLR made $5m in profits last, year implying that the Grit acquisition is at a PE of around 10, but this assumes that no additional leverage will be introduced into the properties.

It is this type of deal discipline that has ensured that, despite the rapid growth in asset base, the dividend has grown steadily in US$ terms. In 2019 a dividend of US$12.20c or R1.75 was paid. At current prices, this puts the stock on a dividend yield of 10.7% in US$ with no exposure to South Africa. Even better, Grit is not actually a REIT on the JSE. They do not require this status as all property income is outside South Africa. Practically, this means that dividends are taxed at the dividend withholding tax rate of 20% for private investors and not at the personal income tax rate.

The growth and discipline has attracted new investors, with a listing on the LSE completed in 2017. This brought several institutional, yield driven shareholders to the registry.

I happened to be in Mauritius last week, so I decided to attend the Grit AGM at their offices in la Croisette shopping centre in Grand Baie. Imagine Melrose Arch in the middle of a northern Natal sugar cane field at the height of summer and you may be able to visualise la Croisette. The Grit team is striking in its youth. CEO, Bronwyn Corbett is in her late 30’s and the CFO is just over 40. I met other senior staff, all young, dynamic South Africans, eagerly hinting that there were more exiting deals in the pipeline.

Given the recent developments at Nampak, I asked how management ensure that they can repatriate cash from countries that may impose currency controls in the future. Grit has full cash repatriation insurance, covered by Lloyd’s. Whilst this insurance is not cheap, I am happy that this is a further safeguard to maintain the dividend in the long term.

In summary, Grit remains my favorite REIT. The dividend yield is in US$, not subject to marginal tax rate and not exposed to the South African economy. The management team is young and dynamic and has a proven record to execute disciplined and conservative growth via acquisitions. They are growing with quality properties in a continent that has the highest global population growth and may well be at the forefront of global economic growth in the coming decades. While I wait for the thesis to play out, I am happy to collect my dividend of just under 11%.

Nampak vs Bowler Metcalf – The lopsided battle of the packaging companies

Everything we buy, whether groceries, consumer goods, household consumables, drinks or take aways, it’s wrapped in plastics. Not surprisingly, global consumption has grown at 4% per annum since 2009 and this is unlikely to change, particularly in the developing world, as ever more people purchase fast moving consumer goods. Actually any goods. In this post, I will analyse two JSE listed packaging businesses that may stand to benefit from this trend.

Bowler Metcalf Limited (BCF) is a medium sized plastic business with 800 employees and operations exclusively in the plastics in South Africa. They are well entrenched into the supply change of producers of personal care, chemical and food packaging items. After the huge windfall from the sale of the Softbev business last year, they paid an approximately 30% special dividend, handsomely rewarding patient shareholders. In the 30 June 2019 Annual Results they reported earnings and revenue that were operationally steady. These results should be regarded as a win in an environment that was hampered by violent strike action, load shedding and a depressed market reflective of the overall economy.

At a share price of R7.20, or a market cap of R650m, earnings of 88c reflect a PE of 9 and dividends of 40c yield just over 5%. Importantly, BCF is essentially ungeared, so earnings are also reflective of the return on equity, which is sitting at just over 10%.  However, the company has a cash pile R380m and if we strip out the cash and the interest income from this cash, the plastic operation is currently trading at a PE of approximately 6.5 and a higher ROE.

Management recognises the undervalued nature of the business and is utilising at least some of the cash hoard by progressing a share buyback program of around R40m or 6% of the outstanding shares.

Management is well invested to share in the future prospects of the business with a holding of around 26%. The CEO, Paul Sass, in particular, controls in excess of 20% of the company and has recently increased this stake at the current share price.

Nampak Limited (NPK) is Africa’s largest packaging group with a leadership position in beverage cans and some involvement in metal, plastic, liquid carton and paper packaging with presence in 13 countries including SA, Angola, Nigeria, Zimbabwe and the UK. The groups 49 manufacturing operations and 5600 employees outsize BCF significantly and hence the group trades at a market capitalisation of approximately 8 times BCF, at R5bn.

A decade ago, they were almost 100 times the size. Several overaggressive expansions, troubles in some very difficult African jurisdictions, an overall Africa sell off and high leverage have decimated the share over the last decade.

The contrarian value investor in me immediately springs to attention at the face of such share price devaluation. Perhaps, this is the perfect cheap entry point into business with a plethora of African operations, including Malawi, Ethiopia, Nigeria and Angola, consumer markets that are set to grow very rapidly in the coming decades? This might be a value play that beats boring old South Africa focussed BCF’s pure plastic business.

As a result of the many moving parts in Nampak, it is difficult to find sustainable earnings estimates. EPS stood at R1.69 for the 2018 Financial Year. This included “abnormal items” of R450m. Abnormal items in the previous year (2017) were R490m. How many years of abnormal items does it take, before they become normal to the cost of business in Africa? We should therefore assume that these “once offs” are set to continue.

In stark contrast to BCF, Nampak is heavily geared with R12bn in debt more than twice their market cap, resulting in interest payments of close to R500m per annum. Of even more concern is their cash flow, with cash of R3.5bn held in Zimbabwe and Angola, countries with notoriously difficult repatriation of forex. If we include Nigeria, the cash “stuck” in dodgy destinations is approximately R4bn; 80% of the market capitalisation of the business or around three years’ worth of profit. If they fail to recover even some of this cash, liquidly will be severely impaired. Not surprisingly, given the cash flow constraints, the company has not paid a dividend in years.

Results for the 2019 financial year end were announced on 26 November 2019 and contained many of the expected surprises. Huge currency write downs in Zimbabwe and further “abnormal items” of R270m brought earnings down to 54c. Even if we are generous and add back the currency losses from Zimbabwe, the business made around R1.40 for 2019. At a share price of R6.5, this puts them on PE of approximately 5, only slightly lower than the BCF operation.

Three Nampak executive directors were paid R35m in 2018. In comparison, the two BCF executive directors took home R9m. Unfortunately, Nampak does not disclose management shareholding or any shareholder information for that matter. However, it is safe to assume that management does not have the same amount of skin in the game that their BCF counterparts share with shareholders. To add to the worries for Nampak shareholders, CEO Andre de Ruyter will leave on relatively short notice to try and fix Eskom. This means they are on the hunt for a new CEO in the middle of a debt crisis.

In summary, in BCF we have a small steady operation that is sitting on huge cash pile, no debt, pays a handsome dividend, has a history of shareholder wealth creation and has a management team that is aligned with shareholder interest. In Nampak, we have a large multi-country, multi-asset operation that is well positioned across the continent, profitable and cheap, but that is struggling with cash held in questionable jurisdictions, a huge debt load and upheaval within the management team.

I remain a happy shareholder in BCF and will give Nampak stock a hard pass.

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.”