Turnaround candidates may reward pain
Marc Hasenfuss suggests how to select companies offering a chance of recovery and profitable returns
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.
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.
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.
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.
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.
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.
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.
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.
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.