THE PPC IN­VEST­MENT CASE

Com­pe­ti­tion and ex­cess sup­ply help make it hard to judge whether PPC is a buy

Financial Mail - Investors Monthly - - Front Page - NICK HED­LEY

The prom­ise of a quickly grow­ing in­ter­na­tional busi­ness was, un­til Septem­ber last year, prop­ping up PPC’s shares de­spite a weak South African mar­ket.

But the stock’s gains were whit­tled away dur­ing a four-month board­room drama, which was fi­nally re­solved in late Jan­uary af­ter the board was re­con­sti­tuted at the com­pany’s AGM, and new CEO Dar­ryll Cas­tle was given a vote of con­fi­dence by share­hold­ers.

In early Fe­bru­ary, the ce­ment com­pany’s shares were worth a third less than at a peak in Septem­ber, prior to Ketso Gord­han’s ac­ri­mo­nious exit as CEO. With a new CEO and board now in place, the ques­tion to ask is whether or not the PPC share is a buy at these de­pressed lev­els. The stock traded at a price:earn­ings ra­tio of be­low 12 in early Fe­bru­ary — a less de­mand­ing pre­mium than be­fore.

PPC’s shares had not been that low since mid-2005. Since that time, it has made se­ri­ous progress in its in­ter­na­tional strat­egy, and looks on track to gen­er­ate just over 40% of sales from out­side SA by 2017. But its size­able fund­ing needs, as it com­pletes projects in Rwanda, Ethiopia, the Demo­cratic Repub­lic of the Congo and Zim­babwe, mean PPC last year had to wa­ter down its pol­icy on div­i­dend pay­ments, which had been a draw­card for in­vestors.

PPC will ben­e­fit in some ways from the oil price slump of the sec­ond half of 2014, since diesel ac­counts for about 10% of its cost of sales. But in­put cost pres­sure re­mains a fea­ture in an in­dus­try where de­mand is floun­der­ing and prof­its are cycli­cal.

Re­fer­ring to two new­com­ers in the in­dus­try, Sephaku Ce­ment and Mamba Ce­ment, Kag­iso As­set Man­age­ment in­vest­ment an­a­lyst Vic­tor Seanie says that in a cycli­cal com­mod­ity in­dus­try like ce­ment, the en­try of a com­peti­tor is usu­ally “a dan­ger­ous de­vel­op­ment, es­pe­cially when de­mand is grow­ing slowly”.

“Sephaku has been cut­ting prices to gain mar­ket share, and Mamba will do the same, which will re­duce PPC’s profit mar­gins.

“The in­vest­ment case for PPC rests to a large ex­tent on its abil­ity to make prof­its on the con­ti­nent be­yond SA’s borders,” Seanie says, adding that a close eye needs to be kept on PPC’s abil­ity to man­age debt as it spends on projects.

He sees Cas­tle’s ex­pe­ri­ence in Africa and the “newly sta­bilised” ex­ec­u­tive makeup as pos­i­tive, but says “man­age­rial [ex­per­tise] may be stretched thin across all of PPC’s now far-flung op­er­a­tions”.

Seanie says that if PPC de­cides to ac­cept ri­val Afrisam’s of­fer to merge, the sub­se­quent in­dus­try con­sol­i­da­tion would help raise lo­cal ce­ment prices. Imara SP Reid an­a­lyst Si­bonginkosi Nyanga agrees. He says PPC’s shares war­rant a “fully val­ued rec­om­men­da­tion” be­cause of the changed div­i­dend pol­icy, un­less the com­pany gets a kicker in the form of a merger with Afrisam. The PPC-Afrisam deal put on the ta­ble by Afrisam in De­cem­ber would help the com­bined group close less ef­fi­cient plants and elim­i­nate over­laps, he says.

“We ad­vise cau­tion un­til we hear more and main­tain our ‘hold’ rec­om­men­da­tion with the spec­u­la­tion that the com­pe­ti­tion com­mis­sion will ap­prove the Afrisam deal.” If the com­pa­nies de­cide to pur­sue a tie-up, they would need to ne­go­ti­ate on their relative val­u­a­tions. AfriSam’s ini­tial pro­posal sug­gested a merger ra­tio of 55%-65% in favour of PPC and 35%-45% in favour of AfriSam.

Rhyn­hardt Roodt, port­fo­lio man­ager of In­vestec As­set Man­age­ment’s In­vestec Equity Fund, says: “We would not be buy­ing PPC shares just yet. The do­mes­tic op­er­at­ing en­vi­ron­ment re­mains weak, with vol­ume growth firmly in neg­a­tive ter­ri­tory. The lo­cal mar­ket is over­sup­plied and at this stage it is dif­fi­cult to see any im­prove­ment in lo­cal in­fra­struc­ture spend­ing.”

As com­pe­ti­tion and ex­cess sup­ply builds in SA, pric­ing power will be dif­fi­cult to come by and Roodt ex­pects PPC’s do­mes­tic prof­itabil­ity to re­main un­der pres­sure through­out 2015.

PPC’s head­line earn­ings per share will fall by 25%-45% for the six months end­ing March 31, the com­pany said in Jan­uary, ow­ing to a weaker trad­ing en­vi­ron­ment, a pre­vi­ous one-off tax credit, and an in­crease in fi­nance costs.

Roodt says PPC’s “ag­gres­sive” in­ter­na­tional growth in re­cent years “might prove to be the cor­rect strat­egy for the group over the long term… the new man­age­ment team will have to de­liver on am­bi­tious growth tar­gets”. But he says “we think in­vestors might be dis­ap­pointed and lower their fu­ture earn­ings ex­pec­ta­tions for the group”.

How­ever, JP Mor­gan sees PPC’s shares, at their price of R20,45 in late Jan­uary, as over­sold. “We think the ex­pected earn­ings weak­ness in 2015-17 and de­lays in the DRC and Ethiopian projects have been priced in and we see value in the stock.

“It is trad­ing at a for­ward en­ter­prise value/earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion and amor­ti­sa­tion of 8,9 times ver­sus its his­tor­i­cal av­er­age of 9,5 times, and a global ce­ment peer av­er­age of 10,2 times.”

JP Mor­gan said in a note to clients it ex­pected Cas­tle’s ap­point­ment to bring sta­bil­ity to the com­pany

Pic­ture: THINKSTOCK

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