Turn­around can­di­dates may re­ward pain

Marc Hasenfuss sug­gests how to se­lect com­pa­nies of­fer­ing a chance of re­cov­ery and prof­itable re­turns

Financial Mail - Investors Monthly - - Front Page -

TH­ESE days in­vestors could be for­given for deem­ing turn­around sit­u­a­tions far too danger­ous to con­tem­plate as pos­si­ble port­fo­lio boost­ers.

In the past, turn­arounds — or more specif­i­cally a suite of re­cov­ery op­por­tu­ni­ties — could gar­ner an in­vestor some nifty re­turns as a com­pany doggedly dragged its prof­its back into the black or re­sumed nor­malised earn­ings pat­terns.

Su­per­mar­ket gi­ant Pick n Pay and con­sumer brands con­glom­er­ate Pi­o­neer Foods Group are great ex­am­ples, even though the re­spec­tive turn­around plans have not yet run their full course (op­er­a­tionally and strate­gi­cally speak­ing).

There have been more than a hand­ful of leg­endary turn­around sit­u­a­tions in re­cent years to en­hance the story of rich “re­cov­ery re­turns” — most no­tably Su­per Group (which man­aged not to be dragged down by a debt load), Hu­lamin (which took “leaner and meaner” to a new level) and Nam­pak (where a stodgy busi­ness was un­packed and re-po­si­tioned for op­er­a­tional ef­fi­ciency). The tra­jec­tory of the share prices of small caps like OneLogix, Fin­bond and San­tova over the last three years are also worth men­tion­ing, hardly of­fer­ing ev­i­dence that th­ese busi­ness were at one stage strug­gling for op­er­a­tional trac­tion.

Some turn­arounds are rel­a­tively rapid and pain­less af­fairs, like the re­shap­ing of the be­lea­guered SA French into the vi­brant Torre or af­ford­able hous­ing de­vel­oper Cal­gro M3’s quick bounce­back. But some ef­forts can drag on.

It took the best part of a decade for in­vestors to recog­nise the turn­around at Sekun­jalo, now in its new guise of AEEI (African Eq­uity Em­pow­er­ment In­vest­ments). Pur­ple Cap­i­tal, Sovereign Foods and Metro­file also en­dured lengthy stints in the re­cov­ery phase be­fore re­ward­ing pa­tient share­hold­ers.

Pipe­line spe­cial­ist Rare, build­ing sup­plies group WG Wearne and con­sumer prod­ucts man­u­fac­turer Beige are at the mo­ment en­dur­ing pro­longed turn­around ex­er­cises.

There’s lit­tle doubt that turn­around ef­forts, es­pe­cially those linked to the lo­cal econ­omy, are get­ting tougher to ex­e­cute suc­cess­fully. The con­sid­er­able ef­fort re­quired for a com­pany to undo strate­gic snarl-ups or to right-size op­er­a­tions to meet the chal­lenges of a chang­ing trad­ing en­vi­ron­ment is now com­pounded by fright­en­ing fac­tors well be­yond man­age­ment’s con­trol.

It seems above-in­fla­tion in­creases in the cost of labour is now non-ne­go­tiable, while Eskom’s elec­tric­ity tar­iff in­creases speak to the util­ity’s own brittle bal­ance sheet rather than the eco­nomic re­al­i­ties faced by lo­cal in­dus­try and com­merce. And then the volatil­ity of the rand against ma­jor cur­ren­cies whacks in­put costs, play­ing havoc with prod­uct pric­ing at a time when con­sumers are stretched rather thin. Eco­nomic pol­icy un­cer­tainty can also dog ef­forts to push busi­ness back into prof­its.

The hor­ror sto­ries have be­gun rolling in.

Those who be­lieved Evraz High­veld Steel & Vana­dium was too big, too well es­tab­lished and too strate­gi­cally im­por­tant to lo­cal in­dus­try to fail watched de­spair­ingly as the com­pany was ush­ered to­wards busi­ness res­cue.

Paint and coat­ings group Chem­Spec, once a poster child for the charms of small cap turn­around ef­forts, also re­cently headed for busi­ness res­cue. And this de­spite hav­ing some in­flu­en­tial back­ing as well as loads of fresh cap­i­tal gar­nered through suc­ces­sive rights is­sues.

The casualty list among small cap turn­around ef­forts is omi­nously long — Ububele, Alert Steel, Bio­Science, Protech, AG In­dus­tries, Africa Cel­lu­lar Tow­ers, Faritec, Dor­byl, 1Time Hold­ings, Sal­lies and Er­ba­con.

So how does an in­vestor in this edgy eco­nomic cli­mate as­sess

Eco­nomic pol­icy un­cer­tainty can also dog ef­forts to push busi­ness back into prof­its

whether there is po­ten­tial for a turn­around op­por­tu­nity?

The tra­di­tional rules still ap­ply: make sure there is a tan­gi­ble net as­set value (NAV) un­der­pin, that (present and fu­ture) cash flows can sus­tain debt lev­els and that the man­age­ment team has skin in the game in the form of a de­cent shareholding in the busi­ness.

The NAV mea­sure should be ap­proached with some cir­cum­spec­tion, re­mem­ber­ing that the fig­ure is merely an as­sess­ment of value at a cer­tain point. Some com­pa­nies have shown that a grind­ing op­er­a­tional turn­around can erode NAV dras­ti­cally in just six months. In­vestors also need to be wary that cer­tain as­set val­ues, for in­stance in­vest­ment prop­er­ties, can be un­re­al­is­ti­cally stated.

Per­haps more im­por­tant th­ese days is the pres­ence of strong in­sti­tu­tional share­hold­ers who are will­ing to back the busi­ness if the re­cov­ery road proves bumpier or longer than ini­tially ex­pected.

The chances of a suc­cess­ful turn­around are also greatly en­hanced if a com­pany is pitch­ing for a sweet spot in the lo­cal econ­omy or off­shore mar­kets. For in­stance, com­pa­nies of­fer­ing se­cu­rity ser­vices, al­ter­na­tive en­ergy, me­dia/cel­lu­lar tech­nol­ogy, health care or wa­ter man­age­ment ap­pli­ca­tions might find busi­ness ac­tiv­ity a tad more vi­brant than some of the old smoke­stack com­pa­nies.

There are, per­haps un­der­stand­ably, a wide va­ri­ety of turn­around op­por­tu­ni­ties on the JSE, rang­ing from com­pa­nies that need only a bit of a tin­ker­ing to re­sume viability to those mak­ing a des­per­ate shot at sur­vival. Un­for­tu­nately, the chance of par­tic­i­pat­ing in some of the more in­trigu­ing turn­around op­por­tu­ni­ties can be snuffed out by well-timed, opportunistic buy­outs. Th­ese would in­clude poul­try group Coun­try Bird Hold­ings (which delisted from the JSE re­cently) as well as Met­mar and Mor­vest (which are both sub­ject to sep­a­rate buy­out of­fers).

IM has di­vided the turn­around op­por­tu­ni­ties that are avail­able into the two cat­e­gories: high-con­vic­tion come­backs and turn­ing-point temp­ta­tions.

HIGH-CON­VIC­TION TURN­AROUNDS

MA­ZOR:

This spe­cial­ist claddings busi­ness tends to gen­er­ate lumpy rev­enue, and how good a year it is de­pends on the num­ber of size­able build­ing projects it par­tic­i­pates in. But in­vestors might have learnt by now that CEO Ron­nie Ma­zor is not an ex­ec­u­tive who makes flip­pant com­ments about prospects. He is usu­ally bru­tally hon­est in as­sess­ing the busi­ness en­vi­ron­ment, whether it’s good or bad. Ma­zor re­cently re­ported poor re­sults for the year to endFe­bru­ary 2015 with earn­ings swing­ing from the pre­vi­ous fi­nan­cial year’s 24c/share to a loss of 33c/share. But the com­pany looks set for a much im­proved per­for­mance in the fi­nan­cial year ahead. Ma­zor notes that the con­struc­tion mar­ket, which af­fects the com­pany’s core steel and alu­minium di­vi­sions, was more buoy­ant, with prices ris­ing.

The com­pany ex­pects an up-tick in vol­umes and, more im­por­tantly, mar­gins. En­cour­ag­ingly Ma­zor re­ported that ma­jor projects have al­ready been se­cured on the back of the mar­ket turn­around — “re­flect­ing in a healthy or­der book for alu­minium and steel”. The com­pany backed up this bullish fore­cast by buy­ing back shares on the open mar­ket — a sen­si­ble op­tion (in­stead of fork­ing out a div­i­dend from the cash pile) since the share price dis­counts tan­gi­ble NAV of 170c/share.

AS­TRA­PAK:

This pared-down pack­ag­ing con­glom­er­ate has done most of the hard yards in its stren­u­ous turn­around ef­fort. It has now been scaled back from 23 op­er­a­tions to just nine man­u­fac­tur­ing en­ti­ties spe­cial­is­ing in mould­ing and form­ing plas­tic pack­ag­ing tech­nolo­gies. The sales pro­ceeds in the last two fi­nan­cial years top R228m, with an­other R149m due in the fi­nan­cial year ahead. Con­se­quently, As­tra­pak’s debt:eq­uity ra­tio should no longer be any source of worry, hav­ing al­ready slipped be­low 20% in the last fi­nan­cial year. It seems rea­son­able to as­sume As­tra­pak will move back into the black this fi­nan­cial year af­ter head­line losses from con­tin­u­ing op­er­a­tions were slashed to 2,1c/share in the year to end Fe­bru­ary. Turnover from con­tin­u­ing op­er­a­tions was up 7% to R1,4bn. This is en­cour­ag­ing, be­cause CEO Robin Moore aims to fat­ten the Ebitda (earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion) mar­gin to 12%-15%. The com­pany’s in­vestor pre­sen­ta­tion tar­geted a re­turn on cap­i­tal em­ployed of 15%-20% through the busi­ness cy­cle.

As­tra­pak’s op­er­a­tional pro­file is also fairly de­fen­sive, with 35% of its sales in the food sec­tor, 26% in per­sonal care and 11% in bev­er­ages. The year to endFe­bru­ary state­ments showed that As­tra­pak man­aged an in­crease in av­er­age sell­ing prices of 5,4%. NAV is re­flected as 835c/share, hint­ing at the con­sid­er­able up­side should prof­its flow con­vinc­ingly in the next two fi­nan­cial years.

VALUE GROUP:

At the time of writ­ing the share price of this lo­gis­tics and truck­ing group was trundling close to its

The chance of par­tic­i­pat­ing in some of the more in­trigu­ing turn­around op­por­tu­ni­ties can be snuffed out by well-timed, opportunistic buy­outs

The chances of a suc­cess­ful turn­around are also greatly en­hanced if a com­pany is pitch­ing for a sweet spot in the lo­cal econ­omy or off­shore mar­kets

three-year low. It seems the mar­ket has missed a dis­tinct change in mo­men­tum in the sec­ond half of the year to end-Fe­bru­ary. At the in­terim stage Value’s earn­ings came in at just 4,9c/share, but the com­pany man­aged to fin­ish the full year with a re­spectable 42c/share at bot­tom line. Im­me­di­ate prospects are not ex­actly rosy, but Value’s solid long-term track record means the share of­fers great turn­around value on an earn­ings mul­ti­ple of un­der 10.

Even though Value has en­dured a tough patch, gear­ing re­mains com­fort­able at 39%, with op­er­a­tional cash flows still solid at R286m. The op­er­at­ing mar­gin held firm at 3,8% (drop­ping only slightly from 3,9% pre­vi­ously). This sug­gests that ef­forts to ter­mi­nate non­prof­itable con­tracts, the dis­posal of older ve­hi­cles and ac­qui­si­tion of a more fuel-ef­fi­cient fleet as well as tech­nol­ogy in­vest­ments in freight con­trol, plan­ning and rout­ing tools, are pay­ing off. A strong bal­ance sheet and re­as­sur­ing cash flows put Value in a great po­si­tion while the turn­around wheels are still in spin — the abil­ity to hitch onto ac­qui­si­tions and the re-pur­chas­ing of its own shares on the open mar­ket. It could be a tough de­ci­sion; buy­ing new op­er­a­tions in a stressed trad­ing en­vi­ron­ment or pick­ing up un­der­val­ued shares when sen­ti­ment for stocks linked to the econ­omy has all but leaked out. In March the com­pany snatched a ma­jor­ity stake in Nu­cleus Chain Stores, which spe­cialises in chain store and front door de­liv­er­ies, but it’s the share re-pur­chases — at cur­rent lev­els — that will prob­a­bly oc­cupy di­rec­tors’ minds in the months ahead.

TURN­ING-POINT TEMP­TA­TIONS

EL­LIES:

For nearly two years this tech­nol­ogy hy­brid has been per­sis­tently punted as a great re­cov­ery story. Yet the share con­tin­ues to weaken (un­der 100c at the time of writ­ing) with the mar­ket be­gin­ning to grasp that plenty of cap­i­tal might be needed to float it out of its cur­rent op­er­a­tional mire.

There’s cer­tainly value and loads of profit po­ten­tial in El­lies and its mooted off­shoot Me­ga­tron, but there’s no rea­son to rush into the share just yet.

CADIZ:

This as­set manager and fi­nan­cial ser­vices com­pany is not in a happy place. Un­der­per­for­mance in the as­set man­age­ment di­vi­sion has brought about wor­ry­ing client out­flows, caus­ing what some ob­servers be­lieve to be ir­repara­ble brand dam­age. In­vest­ment com­pany Black­star made a start in build­ing a new cost-con­scious cul­ture, only to be re­placed by Stel­lar Cap­i­tal as the new an­chor share­holder. Stel­lar — which has links with re­tail ty­coon and se­rial risk taker Christo Wiese — is likely to em­bark on some form of cor­po­rate ac­tion to bulk up and di­ver­sify the busi­ness.

But it’s prob­a­bly pru­dent to wait for signs that client out­flows have been reversed be­fore pitch­ing into Cadiz.

REX TRUE­FORM:

This lit­tle fash­ion re­tailer has suf­fered lately as com­pe­ti­tion in­ten­si­fied. An ar­ti­fi­cial con­trol struc­ture which en­sures that fam­ily share­hold­ers re­tain out­right con­trol is prob­a­bly a hin­drance in terms of pur­su­ing a more ad­ven­tur­ous strat­egy to un­lock value. The re­tail side ur­gently needs crit­i­cal mass to com­pete prof­itably. How­ever, there could be a sig­nif­i­cant slab of value in ef­forts to re-de­velop the com­pany’s prop­er­ties in hip old Salt River. Col­laps­ing the pyra­mid con­trol struc­ture and re­mov­ing the low-vot­ing share ar­range­ment might be the real turn­around sig­nal.

AR­GENT:

This steel-based en­gi­neer­ing con­glom­er­ate might have been bent and buck­led by the lo­cal econ­omy, but, to its credit, it has traded mostly prof­itably, and main­tained div­i­dend pay­ments. The is­sue at Ar­gent is that the com­pany’s shares hugely dis­count the in­trin­sic value — a fact that, un­til re­cently, hardly seemed to per­turb man­age­ment. But non­core as­sets are now on the block and di­rec­tors have com­mit­ted to a long over­due share buy-back pro­gramme. So far the mar­ket has re­mained unim­pressed, and per­haps it is only man­age­ment’s vigour in con­tin­u­ing to cull non­per­form­ing and non­core as­sets that might swing sen­ti­ment.

POYNTING:

PSG Pri­vate Eq­uity is now steer­ing the turn­around at this sup­plier of an­ten­nae and broad­cast­ing ser­vices tech­nolo­gies. Poynting has un­der­gone an op­er­a­tional re­struc­tur­ing re­cently, and the medium-term goal ap­pears to be garner­ing a more con­sis­tent flow of prof­its. There also ap­pears to be a de­ter­mi­na­tion to build a mean­ing­ful off­shore pres­ence. It could be a bumpy ride in the next two years, though.

Pic­ture: THINKSTOCK

Pic­ture: THINKSTOCK

Pic­ture: THINKSTOCK

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