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.
H1:16 – Better Than Expected Results Despite Macro Pressure
ARB produced excellent H1:16 results with revenue rising 12% to R1.2bn (H1:15 – R1.1bn), comfortably beating our FY 16E full year expectation of 4% y/y, though the Gross Profit (GP) margin slimmed to 22.4% (H1:15 – 22.5%).
The Group’s Operating Profit followed revenue upwards by 11% as overheads were kept incrementally in line with revenues and resulting in HEPS growth of 12% to 27.8cps (H1:15 – 24.8cps).
While all segments saw growth in revenues and profits, the Lighting Segment (Eurolux) produced the majority of the growth as market share, customer and product gains all lifted its Profits before Interest and Tax (PBIT) grew by 27% y/y in another excellent period’s performance.
Cash generation remains exceptionally strong, the Group net ungeared and the underlying property portfolio’s valuation flat at R181m (FY 15: R181m).
Our Thoughts: Management Transition Complete
An experienced Financial Director being appointed to ARB’s Board implies that the Group’s management transition is now complete.
This period’s strong organic growth indicates the operational competency of the management team, but they are cognisant of their need to execute on the Group’s acquisitive intentions.
Forecast, Valuation & Implied Return: Overlooked by Market
We view ARB as worth c.520cps (previously: 613cps) on an implied Price Earnings (PE) of 9.8x (previously: 12.3x). The de-rating in our fair value has to do with the rise in South Africa’s risk-free rate impacting on our Discounted Free Cash Flow (DCF) valuation, rather than any major variables relating to ARB itself.
Rolling our fair value forward at our CoE we arrive at a 12m TP of 609cps (previous 12m TP: 712cps). A 12m TO of 609cps places the share on a comfortable Exit PE of 10.4x, implying a 12m return of c.15%.
Key risks to the Group are unchanged from our original Initiation of Coverage. In fact, the macro risks remain even more pertinent in the current environment.
Business Overview: A Group of attractive businesses
Floorworx is the most significant player in the South African resilient flooring market and stands to gain from the National Healthcare Insurance (NHI) driving hospital refurbishments and expansion. In the long term it should benefit from the eventual roll-out of the pent-up infrastructure spend in South Africa.
Safic is an industrial chemical business in the fast-growing chemicals market with strong linkage into and synergies with Floorworx.
Ion Exchange Safic is 40%-held, early-stage (but extremely promising) water treatment solutions business with key backing by its large Indian-listed parent, Ion Exchange India Ltd.
Accéntuate has de-risked its balance sheet, streamlined its various businesses and now begun to focus on growth. NHI spend should help near-term revenues, public sector infrastructure roll-out should drive medium-term revenues and Ion Exchange Safic offers long-term blue sky optionality.
Key Issues: Macro-economic uncertainty
Despite the promising businesses in Accéntuate’s stable, the Group’s prospects rely very much on the activity, timing and quantum of a recovery in the local construction and infrastructure markets. While the long-term prospects of these sectors remain positive, there remains significant short-term macro-economic uncertainty.
Forecast, Valuation and Implied Return: Appears very inexpensive
We have pegged our valuation to our segmentally-driven SOTP DCF model, implying that ACE has a fair value of 114cps. This would put the share on a comfortable 10.6x PE and also implies that the current share price of 85cps undervalues Accéntuate by c.35%.
Rolling forward our fair value, we arrive at a 12m TP of 132cps with an Exit PE of 11.0x, which is slightly elevated due to Ion Exchange Safic adding to our valuation but its operations not yet adding to the Group’s profits.
Our 12m TP implies an attractive c.56% return.
Finally, even if Ion Exchange Safic is excluded from our valuation (assumed to be of nil value), the share’s fair value still appears between 90cps to 100cps, thus lending some comfort to our view that the share is currently undervalued.