We dig into the profit foun­da­tions

Financial Mail - Investors Monthly - - Front Page - Stafford Thomas

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.

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