TRADE of the MONTH

Fol­low the money when de­cid­ing be­tween value-laden and prof­itable in­dus­trial coun­ters Transpaco and How­den

Financial Mail - Investors Monthly - - Opening Bell - Marc Hasenfuss

Though op­er­at­ing in dif­fer­ent sec­tors of the econ­omy, there are a num­ber of sim­i­lar­i­ties be­tween pack­ag­ing com­pany Transpaco and in­dus­trial ser­vices group How­den Africa.

Both are more prof­itable than their peers in tough eco­nomic seg­ments. Both are highly cash gen­er­a­tive with strong bal­ance sheets to boot. The re­spec­tive man­age­ment teams are con­ser­va­tive, but seem­ingly will­ing to look se­lec­tively at ac­qui­si­tion op­por­tu­ni­ties.

In short these are spe­cialised busi­nesses that are manag­ing to main­tain thick(ish) op­er­at­ing mar­gins in lean trad­ing times by en­forc­ing a lean and mean op­er­at­ing cul­ture.

There is, how­ever, one ma­jor de­par­ture point … and one that is crit­i­cal in as­sess­ing the short to medium-term out­look for both com­pa­nies.

Transpaco is pay­ing a fairly gen­er­ous div­i­dend while still main­tain­ing a well for­ti­fied bal­ance sheet, while How­den has not paid a div­i­dend since mid-2013 de­spite hav­ing a bal­ance sheet that is re­in­forced by a net cash bal­ance of R764m.

Transpaco has shrugged off mori­bund eco­nomic con­di­tions to post a 38% gain in bot­tom line in the year to end June — a per­for­mance that leaves its more il­lus­tri­ous (and larger) coun­ter­parts such as Nam­pak and As­tra­pak in the shade. Es­sen­tially, Transpaco has stuck to its vi­able niches in plas­tics as well as board and pa­per pack­ag­ing in SA — no wild ef­forts to di­ver­sify op­er­a­tions and no growth-at-all-costs for­ays into African mar­kets.

What re­ally stood out in Transpaco’s re­sults was that thicker mar­gin of 9.2% (pre­vi­ously 8.1%) — which was es­tab­lished de­spite higher labour, en­ergy and raw ma­te­ri­als costs.

Transpaco CEO Phil Abel­heim also seems to have the knack of ek­ing out great re­turns from op­er­at­ing as­sets dis­carded by Nam­pak and As­tra­pak. With this in mind, in­vestors should not ig­nore Transpaco’s com­ments that Transpaco would pur­sue “ap­pro­pri­ate ac­qui­si­tions”.

Transpaco’s core plas­tics di­vi­sion, now bol­stered by for­mer As­tra­pak oper­a­tion East Rand Plas­tics, man­aged to hike top line 37% to R1.23bn with op­er­at­ing profit rac­ing up 76% to R100m.

Transpaco’s head­line earn­ings of 330c/share were un­der­pinned by strong cash flows from op­er­a­tions at R139m. Net cash flow came in around R52m — or 157c/share, un­der­pin­ning the full-year div­i­dend dis­tri­bu­tion of 150c/share — 40% more than the pre­vi­ous year.

The div­i­dend was cov­ered a gen­er­ous 2,2 times by head­line earn­ings. Transpaco has now in­creased div­i­dends by a com­pound an­nual growth rate of al­most 16% over the past five years — mak­ing for a com­pelling story for value in­clined yield seek­ing in­vestors.

How­den stands in stark con­trast.

The com­pany — which built a rep­u­ta­tion for con­sis­tent div­i­dend flows — has now skipped pay­ing a div­i­dend for six con­sec­u­tive re­port­ing pe­ri­ods. Dis­tri­bu­tions were ini­tially out on hold for a new em­pow­er­ment trans­ac­tion. But that has not come to pass, and cash starved share­hold­ers are un­der­stand­ably start­ing to spout con­spir­acy the­o­ries.

At last count, How­den’s cash pile had reached R764m. This equates roughly to R11.50/share, which is close to 40% of the com­pany’s share price.

It’s not un­com­mon for com­pa­nies — es­pe­cially those ply­ing their trades in the in­dus­trial seg­ment — to shore up bal­ance sheets with cash. But in the case of How­den, the cash buf­fer seems ex­ces­sive — even if the com­pany is con­tem­plat­ing bolt-on ac­qui­si­tions or share buy-backs (nei­ther of which have been sig­nalled by the com­pany of late).

The telling statis­tic is that since the last div­i­dend pay­ment (cov­er­ing the six months to end June 2013), How­den has ac­cu­mu­lated earn­ings of R12.50/share.

It is baf­fling that How­den di­rec­tors — or, more ac­cu­rately, par­ent com­pany Col­fax (a US-based in­dus­trial con­glom­er­ate) — have not seen fit to de­clare even the most nom­i­nal pay­out.

Of course, the fact that How­den is com­mu­ni­cat­ing coyly around its div­i­dend strat­egy might be in­ter­preted by some quar­ters that di­rec­tors may well sur­prise share­hold­ers with a bumper spe­cial div­i­dend.

For IM there re­mains too much un­cer­tainty around the re­sump­tion of div­i­dends in any form to rush into How­den at this del­i­cate junc­ture. IM would pre­fer to be short How­den — even though we ac­knowl­edge the com­pany holds a ro­bust ser­vice of­fer­ing and is well man­aged.

Transpaco, on the other hand, of­fers a de­pend­able busi­ness model cou­pled to an owner/man­ager that grasps the im­por­tance of cash re­turns to share­hold­ers. IM would be happy to be long here.

It’s not un­com­mon for com­pa­nies — es­pe­cially those ply­ing their trades in the in­dus­trial seg­ment — to shore up bal­ance sheets with cash. But in the case of How­den, the cash buf­fer seems ex­ces­sive

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