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.

HSP, CLR – Buy when others are fearful

Healthy lifestyle.jpg

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

arb

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.

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.