A de­pend­able busi­ness that has scope to ex­pand

Financial Mail - Investors Monthly - - Analysis - In­vestors Monthly In­vestors Monthly Marc Hasenfuss

How many years of solid profit gen­er­a­tion does a small-cap com­pany need un­der its belt be­fore the mar­ket will start tak­ing it se­ri­ously?

A cut­ting-edge tech­nol­ogy ven­ture, es­pe­cially one that is blessed with a CEO with the gift of the gab, may not need to pro­duce any sig­nif­i­cant profits be­fore the mar­ket starts to grope madly for scrip.

How­ever, if you are a hum­ble man­u­fac­tur­ing con­cern — even with a dash of en­tre­pre­neur­ial flair and man­age­ment dis­ci­pline — it will prob­a­bly take sev­eral years of de­cent profits backed by cash flow and a rather gen­er­ous div­i­dend pol­icy be­fore pun­ters give even a side­ways glance.

Spe­cial­ist pack­ag­ing group Bowler Met­calf is prob­a­bly a prime ex­am­ple, hav­ing pro­duced mean­ing­ful earn­ings and div­i­dends for nearly 30 years, and still not get­ting the mar­ket rat­ing that it de­serves.

Wood pan­els man­u­fac­turer and dis­trib­u­tor KayDav does not have as long (or, in­deed, nearly as im­pres­sive) a track record on the JSE as Bow­calf. How­ever, the com­pany has man­aged, un­der try­ing cir­cum­stances, to churn solid earn­ings and div­i­dends for the past five years.

Clearly there is scant in­ter­est in KayDav, with the share price at 121c — which is not that far from an an­nual low. Trad­ing vol­umes are piti­ful, too.

At the rul­ing price KayDav is trad­ing on an earn­ings mul­ti­ple of just 6,5 and of­fers a rather hand­some historic div­i­dend yield of 4,55%. It could be ar­gued that this mod­est mar­ket rat­ing be­fits a counter that is linked largely to the slug­gish lo­cal econ­omy and, com­pared with other spe­cialised light in­dus­tries, boasts no rand hedge at­tributes.

But holds that KayDav is a well-man­aged lit­tle busi­ness ca­pa­ble of gen­er­at­ing de­cent re­turns in the longer term. It’s by no means in­sti­tu­tional fod­der, but it is a value-laden mi­cro-cap share that can be tucked away by pa­tient small in­vestors.

Of course, prospec­tive in­vestors need to get their minds around the fact that KayDav sup­plies wood pan­els mainly to the con­struc­tion, fur­ni­ture man­u­fac­tur­ing and shop­fit­ting in­dus­tries. These are not ex­actly eco­nomic sweet spots. But man­age­ment ap­pears ca­pa­ble of run­ning a very tight ship.

What stands out in the re­sults to the year to end De­cem­ber is that while the gross mar­gin crimped ever so slightly to 28% (29% pre­vi­ously), the op­er­at­ing mar­gin shifted to close to 6% from around 5,6%.

Rev­enue was up a sprightly 13% to R865, helped by the ac­qui­si­tion of a small spe­cial­ist pack­ag­ing firm last year. But the core board divi­sion showed top-line growth of 9%, which should douse any scep­ti­cal con­tentions that the pack­ag­ing ac­qui­si­tion was done merely to prop up top-line growth.

For the record, the new pack­ag­ing as­sets chipped in R50m to the rev­enue line, and ac­counted for a chunky R5,4m of op­er­at­ing profit.

The big sell­ing point at KayDav is its po­ten­tial to pay size­able div­i­dends. The most re­cent dis­tri­bu­tion — a cap­i­tal re­duc­tion, to be pre­cise — was cov­ered more than three times by earn­ings. Op­er­at­ing cash flows were down markedly in the most re­cent fi­nan­cial year, but KayDav re­mains lightly geared, with a gear­ing at 27% and a cur­rent ra­tio of 1,7 times.

In­ter­est­ingly, KayDav has sig­nalled that the pack­ag­ing seg­ment pro­vides the most im­me­di­ate op­por­tu­nity for growth. The com­pany is ex­pand­ing its Gaut­eng oper­a­tion and push­ing new prod­uct lines. Se­lected ac­qui­si­tions — per­haps cash-starved op­er­a­tions too small for the larger listed pack­ag­ing con­tenders — might not be en­tirely out of the ques­tion.

The core board op­er­a­tions will no doubt keep push­ing for prof­itable mar­ket shares.

Ad­mit­tedly KayDav is not the most ex­cit­ing in­vest­ment op­por­tu­nity on the JSE. But it is a de­pend­able, div­i­dend-pay­ing busi­ness — with the scope to ex­pand prof­itably with­out strain­ing the bal­ance sheet.

thinks KayDav of­fers good old-fash­ioned fun­da­men­tal value up to 130c, es­pe­cially at a time when sen­ti­ment in the main­stream mar­ket is in­creas­ingly fickle.

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