ARB Holdings maintained its revenue during a tough period that included political upheaval in South Africa, SOE paralysis, sour consumer sentiment, a sovereign downgrade and a technical recession (not officially over at the date of publishing).
The Group reported +4% y/y growth in HEPS to 61.9cps (FY 16: 59.7cps), beating our previous forecast of 61.4cps.
The Group continued to generate strong cash flow with well-managed working capital whilst adding to its store and product footprint.
Management remains committed to the organic and acquisitive growth of existing operations.
Our Thoughts: Resilience & Upside
Solid results year-after-year continue to build the Group’s track record for resilience while management put in place longer-term initiatives for growth that looks
We do note the various changing dynamics in the cabling supply market as a risk while the currently exercisable put option by Eurolux is actually a good opportunity (in our opinion).
Forecast, Valuation & Implied Return: Still Undervalued
We raise our estimated fair value for ARH to 687ps (previously: 664cps), which puts the stock on an implied Price Earnings (PE) of 11.1x.
In our opinion, this PE does not appear unreasonable against either ARH’s own history or the various comparatives in the market.
Rolling our fair value forward at our CoE we arrive at a 12m TP of 809cps (previous 12m TP: 779cps).
A 12m TP of 809cps places the share on a comfortable Exit PE of 12.9x.
ARB Holding’s revenue rose by 3% to R1.27bn (H1:16 – R1.23bn) with Lighting leading the growth while soft municipal spend dampening Electrical’s contribution during the period.
HEPS rose 1% to 28.07cps (H1:16 – 27.79cps) while cash flow generation remained good and the balance sheet ungeared with R175m of net cash on hand.
Although in the ARB’s results are a bit below our expectations, the Group continues to steadfastly execute their strategy of geographic, product and customer expansion with cabling dropping from >50% of the Group’s turnover seven years ago to c.37% of it in these results.
Our Thoughts: Stagnation in the Base, Upside in the Future
While we may be premature in this call, we believe that we are currently in the trough in both South Africa (2016/17) and in ARB’s market (FY 17E and, perhaps, FY 18E).
SA’s Leading Indicator and as well as many global indicators everywhere are, at worst, not falling anymore and, at best, starting to rise.
That said, we do not expect a sudden recovery and would not be surprised if this trough stretched out (i.e. flat growth) into 2018.
We lift our fair value for ARH to 664ps (previously: 650cps) on an implied Price Earnings (PE) of 11.1x. This PE does not appear unreasonable against either ARH’s own history or the various comparatives in the market.
Rolling this fair value forward at our CoE we arrive at a 12m TP of 779cps (previous 12m TP: 762cps), which places the share on a comfortable Exit PE of 11.4x.
This 12m TP also implies a reasonably attractive return of c.23%.
ARB Holding’s revenue grew by 16% to R2.49bn (FY 15: R2.15bn) while Gross Profit (GP) Margin compression in the Electrical Division from 24.1% in FY 15 to 22.0% was offset by Group efficiencies and led the Group to beat our HEPS expectation of 53.6cps by 11% to reach 59.7cps (FY 15: 51.7cps).
This reflected 15% y/y HEPS growth and was matched by an equal hike in the dividends to 23.1cps (FY 15: 20.1cps).
Another 10cps special dividend (FY 15: 10cps) was declared with further special dividends likely in the coming year or two.
Our Thoughts: Tough Trading Environment Unlikely to Abate
We have marginally raised our expected FY 17E revenues for ARB Holdings to R2.8bn (previous forecast: R2.7bn).
Despite this, we have lowered previously noted margin assumptions and see this margin squeeze continuing into at least FY 18E.
Therefore we forecast FY 17E HEPS growth of 10% to 65.4cpscps (previously forecast: 64.9cps), though we note the high degree of forecast risk in the present economic environment (both to the downside due to the economy and the upside due to management initiatives and the potential for acquisitive activity).
We raise our fair value for ARH to 650ps (previously: 520cps) on an implied Price Earnings (PE) of 10.9x, which appears unreasonable against either ARH’s own history or the various comparatives in the market.
Rolling our fair value forward at our CoE we arrive at a 12m TP of 762cps (previous 12m TP: 609cps), on a comfortable Exit PE of 11.6x, implying a 27% return.
ARB Holdings reported their FY 14 results with revenue growing by 14% to R2,2bn (FY 13: R1,9bn) versus our forecasts of R2,3bn.
The Group achieved better margins than we had expected due to both a rising contribution from the higher margin Lighting segment and from the Group driving purchasing savings across its business in H2:14, which saw HEPS rising nicely by 27% to 50.3cps (FY 13: 39.6cps) versus our expectation of 52.1cps.
The Group remains highly cash generative and declared both a dividend of 20.1cps (FY 13: 16.2cps) and a special dividend of 10cps (FY 13: 10cps), yet remained ungeared (R197m net cash).
While cognisant of the tough trading environment, management remain focussed on both organic growth and, potentially, adding the elusive “third pillar” (acquisition) to the Group.
Our Thoughts: High Quality Group, High Quality Share
ARB has proven itself a remarkably high quality group in some very tough trading conditions as it successfully executes on its communicated strategies of expanding product lines, geographies and markets (both organically and acquisitively).
While our valuation metrics indicate the share is fully valued, the “quality” quotient is a hard one to quantify and likely to prove very valuable for the long-term investor.
Forecast, Valuation and Implied Return: Attractively Priced
Our fair value for ARH is 715cps on a PE of 14.2x (previously 622cps). Rolling this forward at our Cost of Equity (CoE), we arrive at a 12m TP of 836cps (previous 12m TP: 727cps) on an Exit PE of 14.7x implying a total return of c.7%.
The key risks stated in this report remain the same from our Initiation of Coverage on the Group. Also note the newly added risk relating to the phasing out of incandescent lamps in South Africa and the uncertainty it creates in the Lighting segment.
Business Overview: Market, Store and Product Expansion
ARB has built a scalable electrical products distribution and wholesaling business off the back of a core cable product supply with key growth drivers being the expansion in product lines, movement into new territories, markets and industries and selected strategic bolt-on acquisitions.
The Electrical Division is predominantly a wholesaler of cables, overhead lines and related electrical components in Southern Africa.
In mid-FY 12 ARB Holdings acquired a 60%-stake in Eurolux (Pty) Ltd, a fast growing importer and distributor of light fittings, lamps and ancillary electrical products.
The Group Services segment includes the strategic and operational activities as well as holding the underlying property portfolio of the Group with a book value of R163m.
Key Issues: Macro-economic Variables Worrying
With many frothy indicators, the construction, building and related market in South Africa has many short-term downside risks including the current labour environment, the rising interest rate cycle and the upcoming elections.
Despite this, South Africa’s infrastructure needs are significant as encapsulated in the National Development Plan (budgeted c.R827bn spend) and the building materials market stands to benefit handsomely from this (eventual) roll-out.
Forecast, Valuation and Implied Return: Attractively Priced
Our fair value for ARH is 622cps on a PE of 13.5x. Rolling this forward at our Cost of Equity (CoE), we arrive at a 12 month Target Price (TP) of 727cps on an Exit PE of 12.7x implying a return of 21% from the current levels.
The two key risks to our above valuation methodologies are (1) the major macro-economic variables in South Africa (noted above), and (2) the timing and successful implementation of ARB’s product, store and market expansion drive (including any potential future acquisitions).