AFRIMAT VS PPC
We dig into the profit foundations
Afrimat and PPC are both companies linked closely to the infrastructure, building and construction sectors. The similarity begins and ends there.
Afrimat has in place a strategy delivering robust growth off an almost ungeared balance sheet. By contrast, strategic bungles have left PPC crippled by an overwhelming debt burden.
“We run the business for maximum cash flow, not maximum headline earnings,” says Afrimat CE Andries van Heerden. “Our cash conversion rate is 1.5 times. For every rand profit we generate R1.50 in cash.”
Share prices tell the story, PPC’s down by more than 70% since peaking in March 2013 and Afrimat’s up 130% over the same period. It is a diverging trend which appears to be far from over, making Afrimat the share to be long of and PPC the share to short.
Central to PPC’s woes is a strategy adopted in 2010 which set a target of generating 40% of profit from non-South African operations by 2017. It triggered heavy capital expenditure, much of it continuing in the Democratic Republic of Congo (US$280m), Ethiopia ($180m), Rwanda ($170m) and Zimbabwe ($85m).
PPC ended its year to September 2015 with debt of R8.2bn and a 237% net debt to equity ratio. It is not the end; PPC predicts debt will peak at R10bn-R12bn in 2017.
It has left PPC with a huge interest burden — R664m in its past financial year including R196m partially hidden from view by capitalising it to fixed assets. Reflecting the interest burden and intense price competition in SA’s cement market, PPC’s net profit in 2015 was a third lower than in 2009 and fell by another 15.9% in the six months to March.
It was all enough for Standard & Poor’s, which in late May slashed PPC’s long-term credit rating seven notches, well into junk status. It also placed PPC on a negative watch.
PPC is attempting damage control through a rights issue in which it plans to raise up to R4bn, a sum not far short of its R5.95bn market cap. It spells serious earnings dilution.
Another of PPC’s errors has been failure to diversify. It has left cement contributing 85% of operating profit, one of the highest levels of any major cement producer globally.
Afrimat did not make this error, setting out six years ago to reduce dependence on its traditional businesses: quarried aggregates, ready-mix concrete and concrete products.
Between 2010 and 2013 Afrimat made three acquisitions providing diversification into a range of industrial minerals. First came Glen Douglas (dolomite), which was followed in 2012 by Clinker Supplies (clinker) and in 2013 by Infrasors (dolomite, limestone and silica).
Acquisitions have transformed Afrimat, reducing its traditional businesses’ contribution to operating profit to 32% in its year to February. They have also provided a big boost to profit growth, which between 2009 and 2016 saw headline EPS rise by an average of 21.3%/year. Excluding acquisitions they would have grown at 5.8%/year.
This rapid growth reflects Afrimat’s ability to integrate and extract value from acquisitions. With Infrasors it also showed its ability to turn a troubled company around.
Another factor in Afrimat’s growth story is an ability to bring marketing expertise to bear. “Private owners do not optimise their businesses,” says Van Heerden. “They focus on operational issues but don’t think about marketing and pricing. It provides us with opportunities to boost margins and volumes.”
Epitomising this is the clinker division. “When we bought the business we found its former owner was selling at only R22/t. We are now selling at R87/t with no resistance from buyers.”
A waste product produced when coal is burnt in a boiler’s furnace, clinker is highly sought after as a brick and concrete aggregate. “Clinker’s density is half that of normal aggregates, which means far lower transport costs,” says Van Heerden. “It makes clinker a very profitable business for us.”
So profitable that the clinker division is Afrimat’s biggest money spinner, delivering 38% of group operating profit in its past financial year.
Afrimat remains on the hunt for acquisitions. It struck again in October with the acquisition of Cape Lime in a R276m cash deal closed on March 31.
“The business is well run and produces SA’s highest quality lime, but it does not even have a marketing department,” says Van Heerden. “It could be our next clinker.”
Likely to add 8%-10% initially to Afrimat’s operating profit, Cape Lime sets the scene for another year of solid growth.
Also pulling its weight is the construction aggregate quarrying division. Indeed, it is enjoying something of a boom.
“Our research shows government spending is at an all-time high on roads, low-cost housing and water projects,” says Van Heerden. “Our quarries in the Eastern Cape, KwaZulu Natal, the Free State and the Western Cape are flying.”
Right now Afrimat’s share price is not flying. It’s down almost a third from its record high reached in January. It makes Afrimat, on a 12.6 p:e, a sitter as a buy.