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.
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).
H1:14 Results: Tough Trading Period, Hampered by Weak Rand & December
Accéntuate reported disappointing H1:14 results that saw sales rise 7% to R157m (H1:13 – R146m), but margins compress and Operating Expenses rise by c.13%. The rise in opex was partly due to Suntups duplicate leasing costs (eventually this business will moved into existing Group premises) and distribution costs being passed onto the Group by the higher diesel price.
This culminated in profit attributable to shareholders falling c.49%, HEPS being reported below our expectations at 2.81cps (H1:14 – 6.01cps).
Two small acquisitions were made during the period, being Suntups (wooden flooring) and Degrachem (metal treatment chemicals).
Our Thoughts: Promising Start to H2:14E
Floorworx saw a particularly tough December 2013 that appears to have reversed during January 2014, but the volatile Rand has affected most its businesses units negatively in the short-term.
In the long-term, though, the weak Rand creates a massive competitive advantage for the Group’s East London manufacturing asset (key in Floorworx) that positions the business well for the (very) slow recovery in some key indicators in the local construction and infrastructure market continues.
The South African elections (coming early May) create some short-term downside risk, as we believe that public sector spend is likely to be interrupted before, during and after this period.
Forecast, Valuation and Implied Return: Underpinned by Tangible NAV of c.90cps
We lower our fair value to 86cps (previously: 122cps), which is underpinned by ACE’s current TNAV of c.90cps and arrive at a 12m TP of 100cps (previously: 142cps), on an Exit PE of 11.0 (which is arguably inflated due to the trough earnings the Group is trading through currently as well as the fact that Ion Exchange Safic adds to our DCF SOTP but doesn’t add to the Group’s profits at this point).
Our 12m TP of 100cps (previously: 142) implies an attractive 73% return, but note the risks to our view later in this report.
FY 13 Results: Inland Market Tough in H2:13; Acquisitions Made
Accéntuate experienced a much tougher H2:13 than we had expected. FY 13 revenue flattened to R284m (FY 12: R283m), c.4% shy of our expected turnover mark.
This soft performance during H2:13 comes from Floorworx where particularly the inland market struggled. Safic and Ion Exchange Safic performed in line with our expectations as the former grows its market exposures and the latter continues to build traction in the local market.
The Group’s FY 13 EPS rose 17% to 8.4cps (FY 12: 7.2cps), but critically the HEPS from Continuing Operations slipped 11% to 8.4cps (FY 12: 9.5cps).
Some of this balance sheet was employed post-results to cleverly acquire two small complementary businesses, both paid out in script and to be incorporated from 1 September 2013 (i.e. ten of the twelve months of FY 14E).
Our Thoughts: “When”, Not So Much “If”…
Disappointing results and acquisitions aside, Accéntuate still remains well positioned to benefit from the pent-up public sector infrastructure spend. That said, the 2014 elections potentially create downside risk regarding the timing thereof.
In the meantime, management has been driving growth initiatives into other markets and product lines, and seeking strategic acquisitions.
Forecast, Valuation and Implied Return: Small Upgrade
We raise our fair value for Accéntuate to 122cps (previously: 114cps), which implies a PE of 14.6x. This compares reasonably attractively to two listed comparatives, Distribution and Warehousing Network Ltd (Share code: DAW – PE of 15.3x) and Afrimat Ltd (Share code: AFT – PE of 14.8x).
Rolling our fair value forward by the Cost of Equity (CoE), we arrive at a 12m TP of 142cps (previously: 132cps), implying an Exit PE of 13.8x and an attractive implied return of 54%.
The key risks we see in our valuation of Accéntuate remain macro.
* Note that the Group remains under cautionary announcement pending the release of pro-forma financial results relating to the Suntups acquisition. This results note does not take into account any material information following the resolution of this cautionary announcement.