Business Overview: Near-term Helium & LNG Producer
Renergen owns an onshore petroleum production right to the “Virginia Gas Project” that is rich in methane (LNG) and helium and the Group is developing in a two-phased approach.
Renergen is in a formidable position to move up the value-curve as Phase One nears first-production.
Importantly, the Virginia’s Phase Two could be multiples the size of Phase One and unlock staggering value in the Group.
LNG & Helium Markets: Attractive Prospects
South Africa is an energy-scarce economic region with both a good potential LNG demand and a potential supply deficit of the gas in its near-future as some existing assets come offline.
The global helium market is opaquer, but the recent drop-off in USA supply and uncertainty around Russia’s planned supply growth combine to imply tight(er) helium supplies post-pandemic. Finally, the major consumers of helium (aerospace, semiconductors & MRIs) are all above-average growth vectors and cannot substitute helium for anything else.
Forecast, Valuation and Implied Return: Upside Apparent
Our DCF-driven sum-of-the-parts (SOTP) valuation for Renergen implies Phase One & Two—offset by central costs, debt and (potential) dilution—are worth 3539cps. After options for Evander and Cryo-Vacc are added, we see Renergen’s share as potentially worth c.4247cps.
Rolled-forward by CoE, our 12m TP is 4977cps.
Key Up- & Downside Risks: Lots of Moving Parts
Running a sensitivity analysis on our model highlights that Renergen’s valuation is more sensitive to helium than LNG, but both prices are ultimately sensitive to the USD/ZAR rate.
Inflation, production, and resource risks also exist here.
ARB Holdings published an excellent H1:21 result showing good revenue growth and particularly strong profit growth from key cost-savings measures annualizing across the period.
Revenue rose +5% y/y, Operating Profit shot up +59% y/y (thoroughly beating our expectations), & HEPS grew +26% to 41.1cps (H1:20 – 32.6cps).
For a Group that typically generates strong cash flows, cash generation was particularly strong over this period and the Group’s balance sheet remains very much ungeared.
Our Thoughts: Emerged Stronger
Management has built a superb Group over the years and, over the current pandemic, reacted swiftly in reigning back expenditure. Following from our previous results note, we believe that H1:21 has demonstrated that the Group has emerged stronger with more market share than at the beginning of this period. In the long-term, this can only be a good thing.
We expect dividends to resume with the full-year results and have maintained our revenue expectations while adjusting our margin assumptions to reflect the fantastic gains made by the Group in H1:21 annualizing even further into H2:21E.
Forecast, Valuation & Implied Return: EV/EBIDTA lining up with DCF
We see fair value as 631cps (previously: 464cps) on a Price Earnings (PE) of c.9.2x.
Interestingly, we have built a new EV/EBITDA Model for ARB against a hand-selected peer set and this model arrives at a fair value of 624cps, thus lending weight to our DCF fair value.
Our implied 12m TP of 737cps (previous 12m TP: 546cps) places the share on an Exit PE of 12.9x & implies a potential return of c.71%, albeit with typical macro-risks remaining present.
While “cheap” is not a defining characteristic of the current domestic small cap market, the combination of it with the high-quality of ARB’s track record and prospects makes it unique.
During a period deeply marked by the COVID-19-induced lockdown and a global recession, ARB’s FY 20 numbers are not particularly reflective of much other than its environment.
Revenue contracted -13%, margins improved as deep cost-cutting, rationalization of operations, retrenchments and management salary sacrifices all protected the Group, & a range of IFRS entries flowed through results distorting comparisons.
The Group ended up seeing HEPS rise +3.0% y/y to 59.96cps (FY 19 – 58.2cps), but, above all else, the Group appears to have protected its balance sheet (cash on hand of R152m), bolstered by operations generating R135m (FY 19 – R226m) cashflow.
Our Thoughts: Emerging Stronger
Near-term numbers (both historic & forecast) are somewhat meaningless in an environment of heightened chaos & uncertainty with major global variables playing out.
Despite this, ARB management has done all the right things and the Group is likely to emerge from this period stronger, if not absolutely then at least relatively speaking.
Key variables remain, though, from the global (pandemic & geopolitics) to domestic (infrastructure spend, public sector finances & Eskom) that imply both up- & downside risks.
Forecast, Valuation & Implied Return: Still Underrated
We see fair value as 464cps (previously: 562cps) on a Price Earnings (PE) of c.7.4x. This appears reasonable against the various comparatives in the market (average: 10.3x) despite the reliability of PE as a metric declining due to the abnormality of this period and the raft of IFRS non-operational entries flowing through both ARB’s & the rest of the market’s financial results.
Our implied 12m TP of 546cps (previous 12m TP: 659cps) places the share on an Exit PE of 8.8x & implying a return of c.56%.
While “cheap” is not a unique domestic small cap characteristic, the profitability, cash generation & robust balance sheet of ARB make it one of the higher-quality stocks in this universe.
While ARB missed out topline expectations,
management’s extraction of efficiencies across the Group saw a resilient profit
The disappointments were all in sales, as
Eskom/contractor volumes remained weak in the Electrical Division and
retailer/consumer markets stagnated.
The victories were all won in costs as the Radiant
acquisition begins to bed-down, an underperforming Electrical store was closed
and the Lord’s View DC began operations.
Slight “pre-Chinese New Year” overstocking across the
Group negatively impacted on cash flows but should serve the Group well given
the current Covid-19 (i.e. “Coronavirus”) disruption to global supply chains
and the coming likely stock shortages across global and domestic markets.
Thoughts: H2 to remain tough, but long-term positive
The Group remains ungeared, has positive cost-savings
that should annualize nicely going forward and is well-positioned to weather
the current macro-headwinds and capture any growth that may appear going
Unfortunately, H2 in South Africa and with growing
global risks is likely to remain a tight trading environment and one with a lot
of forecast risk (either upside or downside).
Forecast, Valuation & Implied Return: Still underrated
Our fair value for ARH is 562cps (previously: 576cps)
on an implied Price Earnings (PE) of 8.3x, indicating that the stock is c.39%
undervalued at its current share price.
Rolling our fair value forward at our CoE, we arrive
at a 12m TP of 659cps (previous 12m TP: 670cps) on an Exit PE of 13.2x.
ARB Holdings grew revenue +4.5% y/y, partially bolstered by Radiant, GMC and CraigCor acquisitions.
An anaemic domestic economy and construction sector, supply chain disruptions, competitor activity & a volatile currency all combined to put downward pressure on Group results, while the Group also began accounting for Radiant with restructuring once-offs costs, relocated operations in Gauteng and suffered some non-cash impairments and Put Option revaluations due to subsidiary results.
IFRS HEPS slipped -19% y/y to 58.2cps (FY 18: 71.7cps), but this materially beat our conservative expectations of 50.1cps. We see our calculated ‘Normalized’ earnings figure as c.-21% y/y.
The Group maintained its dividend at 25cps (FY 18: 25cps + 10cps special dividend) as cash flows remained strong.
Our Thoughts: Domestic versus Global – Eskom versus Trump
Globally, a red-flags are flashing as the US-China Trade War escalates and the global economy suffers.
Domestically, Brexit (as the UK is a large South African trading partner) and Eskom continue directly hurting our economy.
While these global and domestic risks are well-known, any positive resolutions to them would create macro-upside that should bolster prospects going forward.
Given the depth of discount the valuation of the domestic small cap sector currently trades at, we would argue that no positives anywhere have been priced in and therein lies the opportunity.
Forecast, Valuation & Implied Return: Still Quality & Still Value
Our fair value for ARH is 576cps (previously: 636cps) on an implied Price Earnings (PE) of 9.9x, indicating that the stock is c.42% undervalued at its current share price.
Rolling our fair value forward at our CoE, we arrive at a 12m TP of 670cps (previous 12m TP: 744cps) on an Exit PE of 12.6x.
ARB Holdings reported growth in FY 18 revenues and stable profits with consistently strong cash generation, generous dividends, and an opportunistic post-year-end acquisition.
FY 18 revenue came in per our expectations at R2.6bn (FY 17: R2.4bn), & HEPS rose +16% to 71.7cps (FY 17: 61.9cps), which is materially higher than our forecast of 65.6cps.
The Lighting segment disappointed but was actually slightly better than our downwardly-adjusted forecasts at H1:18. Inversely, the Electrical segment performed well but slightly below our half-year expectations.
Our Thoughts: Eskom & Radiant Key Variables
Post-year end, the Group concluded a conditional acquisition of the Radiant Group. This move consolidates the Group’s position in the lighting market while materially transforming the Group’s segmental exposures; post-consolidation of Radiant, Lighting may become similar in size to the Group’s cable exposure.
A slowdown in Eskom spending has prolonged the domestic malaise. Top-level Board and management changes in the utility have been positive, and supply chain audits and related reorganization (in an attempt to both eliminate corruption in the SOE and stabilize it) are likely to blame for this drop in spending.
Logically, the spending from Eskom should materially pick up after this internal process is completed (while Eskom will come out of it stronger for having gone through this period).
Thus, we remain positive on South Africa and the sector.
Forecast, Valuation & Implied Return: Still Quality & Still Value
We update our fair value for ARH to 714cps (previously: 777cps), implying a reasonable Price Earnings (PE) of 10.0x.
Rolling our fair value forward at our CoE, we arrive at a 12m TP of 838cps (previous 12m TP: 911cps), placing the share on a comfortable Exit PE of 11.4x, and implying a return of c.34%.
Key risks to the Group are unchanged from our original Initiation of Coverage, though note that we have not taken the Radiant acquisition into account in our forecasts or valuation.
ARB Holdings reported revenue +5% for H1:18 and operating profit growing +3%.
The mark-to-market fair value changes in the Put Option for Eurolux distorted the IFRS numbers by 5.9cps, but excluding this effect, the Group’s HEPS would have been +13% y/y to 31.72cps (H1:17 – 28.07cps). This is materially better than our bottom-line expectations for FY 18E.
One sore point in the Group’s results was its Lighting segment where revenue slipped and profits felt pressure as consumer destocking, technology and delays combined.
Post-reporting period, the Group acquired a 60% interest in Craigcor for a maximum consideration of R30m. The business is a process automation distributor for Rockwell Automation products.
Our Thoughts: Well-positioned for an ‘SA Inc’ Recovery
While risks remain and ‘big ticket’ infrastructure spend roll-out is always lagging, ARB Holdings is extremely well to benefit from the de-risking of South Africa, the recovering sentiment and the potential recovering domestic economic activity.
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%.