Keith McLachlan (CA (SA)) has long been an equities analyst focusing on the JSE-listed small and mid caps stocks. His history ranges from founding www.SmallCaps.co.za in 2006, time spent working in the stock market at Standard Bank and, most recently, a number of years spent as a Senior Research Analyst at Thebe Stockbroking servicing most of the buy-side institutional clients and their businesses in South Africa.
His approach to analyzing stocks focuses on fundamental research backed up by robust valuations that necessitates a longer-term view of the stock market. While he tends to be style, industry and market agnostic, he does accept a strong value-bias in his preference for selecting attractive investments and believes that in the longer-term value investing out performs both growth and momentum investment strategies.
FY 21 Results: Smaller than Expected Preproduction Loss
Renergen’s operating loss was smaller than expected despite a small revenue miss as lost production (due to the lockdown) was offset costs.
The Group spent R125.7m on assets under construction, capitalized R21.5m intangible assets and made a second draw down on its US International Development Finance Corporation (DCF) loan to the tune of $12.5m. The Group’s short-term unencumbered cash reserves sit at R130m.
Progress Updates: Almost Entire Positive
The Group has concluded a partnership with Total SA as LNG distribution is set up down the key N1 route.
Drilling of P007 & MDR1 both reflect strong resource, flow & helium concentration data, highlighting potentially better-quality resources and/or lower capex intensity of Phase Two.
The Group has concluded its first helium sales agreement with a global tier-one automotive supplier for Phase Two.
Finally, The Group’s innovative cold chain storage solution (Cryo-Vacc™) made its first sale, moving post-revenue.
Forecast, Valuation and Implied Return: Appears Undervalued
Since our Initiation, our major assumptions remain the same, albeit we have updated our model for the latest spot prices that, in general, have moved in Renergen’s favour.
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 4149cps (previously 3539cps). After options for Evander and Cryo-Vacc are added, we see Renergen’s share as potentially worth 4978cps (previously 4247cps).
Rolled-forward by CoE, our 12m TP is 5850cps (previously 4977cps) or over double what the current share price is.
Business Overview: Leveraging Product, Route-to-Market & Returns
Trellidor’s traditional business of customized manufacturing of security gates for a national, African and export network of franchisees remains strong while management’s addition of innovative & complementary products (including Taylor blinds and shutters, and NMC) is logical and steadily gaining traction.
The Group is cash generative and management’s careful capital allocation into the acquisition of (some) the main regional franchisee, share buy-backs below fair value & degearing the Group’s balance sheet while paying dividends should all add to the Group’s financial performance and shareholder returns.
Macro Environment: Home Improvement Tailwinds
While high domestic real rates had depressed residential property and home improvement markets, the South African Reserve Bank’s strongly accommodative monetary response to COVID-19 has reversed this trend with exciting implications.
Building materials, home improvement sales and the residential property markets have all positively responded to this and, in many instances, are trading at-or-above their pre-COVID levels.
Despite numerous domestic & global macro risks remaining, Trellidor should be a beneficiary of these home improvement & residential property market tailwinds.
Forecast, Valuation and Implied Return: Undervalued & Yielding
Given a reasonableness check against our implied EV/EBITDA regression, our DCF Model indicates that Trellidor is worth c.442cps or a c.8.8x PE and c.4.4x EV/EBITDA against our expected FY 21E earnings. These valuation metrics appear quite undemanding of a Group with a 5-year average ROE of >20% and a Free Cash Flow/EV Yield just shy of 18%.
Rolling 442cps forward by our CoE, we arrive at a 12m TP of 532cps implying a 54% return from the current share price.
Even if the market never fully reflects this valuation, it is worth noting that the share’s attractive c.6.0~7.0% Dividend Yield also makes this compounder a good yield play.
Group & Portfolio Overview: Majority Unlisted Investments
Sabvest Capital offers a unique entry-point into a portfolio of majority unlisted investments that have demonstrated strong growth, dedicated management teams (often co-investors) and that are carried at reasonable valuations.
The Group’s three largest investments (all unlisted) are (1) DNI-4PL, a cash-generative last-mile telcos distribution group, (2) ITL Holdings, a global labelling & technology-enabled tagging business, & (3) SA Bias, an exporter of narrow textiles/strapping from South Africa and group offering process-critical fluid handling solutions in the United Kingdom.
Investment Case: Better than the Best (Fund Manager) & Cheaper
Management has grown Group NAV (+18.6% CAGR y/y for fifteen years, excluding dividends) faster than the best-of-the-best general equity fund managers across South Africa (even after including distributions) and management have done so at a lower cost-to-NAV than these leading unit trusts.
Finally, this performance is currently priced at a c.51% discount to NAV on the JSE (relative to our estimated fair discount of only c.19% and the peer-group average discount of 42% currently applied to listed HoldCo’s > R1bn market cap).
The key competitive advantages that have helped Sabvest generate this growth (permanent capital & alignment of interest/‘Partnership Principle’) remain intact and, thus, we see no non-macro factors why the Group could not continue performing as it has done in the past.
Valuation, 12m TP & Implied Return: Cheap Against All Measures
We have formed a view that the Group’s unlisted investments are reasonably valued. Importantly, most of them have seen trading recover strongly following the impact of COVID.
Furthermore, updating the Group’s NAV for the latest listed price, inserting post-period corporate actions and taking out our fairly-valued “HoldCo discount” of 19%, we arrive at defendable (post-discount) fair value for Sabvest Capital shares of 6402cps or +64% higher than the current share price.
Rolling this fair value forward at our Cost of Equity, we see the Group’s 12m TP as 7542cps with an implied return of +93%.
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.