Tag Archives: fundamental analysis

ARB Holdings – FY 19 – (Still) Awaiting Macro-Tailwinds

Share Code: ARH – Market Cap: R0.9bn – PE: 7.0x – DY: 6.2%

FY 19 – Macro-headwinds Remain Strong

  • 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.

See our methodology here and note our disclaimer here.

Wescoal Holdings – FY 14 Results Note – Positives Dampened by Eskom

FY 14 Results Note – Share Code: WSL – Market Cap: R374m – PE: 12.9x – DY: 1.3%

Download the full Wescoal Holdings FY 14 Results Note

FY 14 Results: Once-off Costs Create Earnings Miss

  • Wescoal reported its FY 14 results with revenue rising 70% to R1.1bn (FY 13: R0.7bn), largely driven by the H2:14 inclusion of the MacPhail acquisition into the Group’s Coal Trading segment.
  • Excluding the once-off profits on the sale of mineral assets during the period, the Group recorded an “Operational” EBITDA growth of 124% and HEPS rising to 15.7cps (FY 13: 12.4cps),
  • While the Group’s revenue slightly surpassed our forecast of R1.0bn, restructuring and relocation costs in the Coal Trading segment (R6m), intangibles amortisation (R2m), higher than expected costs and a more aggressive rehabilitation programme at Khanyisa and a general dip in Eskom-related volumes of coal collectively saw the Group miss our target HEPS of 21.2cps.

Our Thoughts: Uncontrollable Eskom and Spot Price Variables

  • The Group has identified mine extensions for Khanyisa and Intibane while Elandspruit is progressing well towards an expected first production during January 2015.
  • MacPhail is integrating well into the Group’s Coal Trading segment and the enlarged business’s prospect look positive.
  • Two key variables that will determine the Group’s short-term prospects are (1) Eskom-related coal volumes, and (2) the Rand-price of inland coal. Both variables were soft during FY 14E and—while hard to forecast—indications point to upside here.

Forecast, Valuation and Implied Return: Relatively Flat Update

  • We lower our fair value by 5% to 240cps (previous: 253cps), as the time value of money has been offset by a lower spot coal price and slightly lower Eskom volumes.
  • The implied PE of 15.3x is not very illustrative, though, as both Elandspruit and MacPhail are currently adding to our SOTP, but not yet (fully) contributing to the Group’s profits.
  • Based off this fair value, we marginally raise our 12m TP by 4% to 301cps (previous 12m TP: 287cps), implying a 48% return on an Exit PE of 12.2x (which still would not include a full year’s steady-state contribution from Elandspruit).

Download the full Wescoal Holdings FY 14 Results Note

What do you think of ARB Holding? Let us know…

See our methodology here and note our disclaimer here.

Five Things to Look for in a Turnaround

Turnarounds are risky, but if they work that can often create staggering investment returns as a deeply discounted share rebounds to fair value and, perhaps even, moves into a higher rating as a growth stock as the rest of the market grows in confidence.

But how do you know if a turnaround is going to work?

The short answer is that you don’t know. But, try focusing on the following aspects when analyzing a business for the potential of turnaround prospects:

1.) Solvency: The less debt you have, the more time for the turnaround you get

Debt is a time sensitive funding structure as interest is incurred over time and, particularly in structured debt, have set covenants, repayment schedules and/or redemption details and dates. This include net overdraft positions and even off balance sheet funding (via operating leases and other more “creative” structures).

In other words, the more debt a turnaround business has, the less time it often has to “get things right”. It may be half way to turning the business around when the debt suddenly falls due or the lender calls in its breach of debt covenants, and then–very quickly–the business can hit the wall.

Hence, the less debt a turnaround has, the more time it has to get things right. And the more time a turnaround has, the greater the odds that it will eventually come right.

2.) Liquidity: More cash coming in than going out keeps you in business

Even if a turnaround has no debt, if its operations year after year suck up cash and it never generates any free cash flows, eventually its resources will exhausted and it will need to borrow.

On the hand, the stronger the operating cash flows in a business, the more the business can use these cash resources to shore up other aspects of the business, service debt, payout retrenchments, and so on, in the steady progress towards sustainable profitability.

We would go so far as to say, no matter what IFRS profits are reported, if a company year in and year out produces large operating cash inflows, the business will continue to operate just fine. And, if a business can continue to operate, then it has more time to effect a turnaround and the odds increase that it will eventually come right.

3.) Profitability: Pricing power makes for easier turnarounds

Here is a published an article discussing the major difference between a business’s Gross Profit (GP) margin and its Operating Profit (OP) margin (Insight into Operating & Gross Margins).

In essence, a high GP margin implies a business that has a strong competitive advantage, particularly with regards to its pricing power in its good and/or service. OP margin is more a metric reflecting efficiency, returns to scale and/or “bloat” in a business’s operating structure.

We believe that it is always easier (i.e. improves the odds of successfully) turning around a business that has pricing power, rather than one that is a price taker.

4.) Turnaround plan: A bad plan is better than nothing, but a good plan is the best

Has the business even admitted that it is doing a turnaround? This may sound like a funny question to ask, but some business’s management are in such denial about what a bad business they are running that they cannot admit that they are trying a turnaround, and thus will likely fail. Avoid these.

Then next level is that, at least, management admits that it is performing a turnaround. That goes hand-in-hand with having a “Plan” for the turnaround.

Consider whether the Plan is a good one, though? Be particularly skeptical when it is the same management that originally ran the business into the ground that are suddenly offering this Plan as a solution… If they messed up once, the odds are increased that they will do so again in the future.

Does the Plan admit what went wrong? Does the Plan state what needs to be done to address what went wrong? Does the Plan cover all bases and does it sound reasonable to you?

Not all plans are good plans, but having a plan is better than nothing.

5.) Management: Are they committed and convinced?

This last point is actually tied into (4) above, as management are the ones who draft the Plan and have to execute the Plan.

Only with hindsight will we know if the execution of the Plan is actually good or not, as investing into a turnaround is investing before the Plan becomes reality. So, try to get a sense for whether management will execute the Plan well or not, but it will remain a guess at this stage.

Rather, consider if management are committed. Have they bought large amounts of their own stock? Are they large shareholders in their own turnaround? Have they underwritten their rights issues? Have they signed multi-year employment contracts?

If management has no skin in the game regarding the turnaround, the odds are that they are not convinced that it will succeed.

In conclusion, each turnaround really actually needs to be judged on a case by case basis. But, this list should at least give you a starting point from which to try gauge what the odds are for success. And, have no illusions, turnarounds are just like any other investment: they have odds that they will succeed, just as they have odds that they won’t.