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.
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.
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).