Partly fine, partly not; a solid long-term buy

Deneb Investments, which is controlled by investment giant Hosken Consolidated Investments (HCI), is the “sleeper” on the JSE’s industrial board.

Presumably HCI’s dominant shareholder precludes too many institutional investors seeking out large parcels of shares, and the Seardel legacy assets in the textile sector don’t exactly thrill punters. Any market interest in the share is mainly of the “deep value” variety — with Deneb’s share price offering a more than 50% discount on hard net asset value (NAV) of around 400c/share.

The NAV is underpinned by a property portfolio generating bigger rentals as real estate is gradually redeveloped. In the year to end March Deneb’s property portfolio rose 4% in value to R1.2bn with revenue up 10% to R150m (with rentals from external tenants representing 71% of this). Operating profit before finance costs, excluding property revaluations, increased 6% to R104m.

There is a refreshing sense of realism in CEO Stuart Queen’s commentary on the property segments prospects. He notes that though Deneb is still looking to grow its property portfolio, the company had actually been a net seller of real estate. “We seem to have a different view to other buyers as to what fair acquisition yields should be. However, rather than changing our expectations, we will continue to look for opportunities that fit our model even if it means being a bit more patient.”

It would be foolish to overlook Deneb’s industrial assets. However, at this juncture the segment is offering threadbare returns from a large operating asset base. There has been progress, but clearly a heap of work is still required.

In the year to end March turnover grew 7% to R2.9bn with operating profit before finance costs up 26% to R197m.

Queen categorises Deneb’s business into four main groups: good, solid businesses that continue to grow strongly; start-ups with profit potential; businesses with poor fundamental economics but strong management teams that ensure they “muddle through”, eking out small profits; and businesses that are unable to find profitable traction.

Queen reports the “strong businesses” have grown turnover on a compounding basis by 16% over five years and core operating profit by 22% per annum. They account for R1,9bn of turnover — which is heartening, as the net operating margins are better than 10% after accounting for all centralised head office costs.

The start-up businesses are mostly meeting expectations, and Queen believes they will join the “strong” business segment and become good contributors in time. The business-

es with poor fundamentals are marginally profitable and probably not likely to offer any great upside. But Queen stresses these business units don’t cost Deneb too much to maintain.

He notes: “We are working on opportunities to shift them into areas that would enable them to deliver better returns.”

The businesses sans profitable traction — “due to the economics in the industries they serve and our inability to strategically reposition them onto a more sustainable path” — might be on review. Queen concedes the state of the economy means Deneb might need to be “a bit more pragmatic in our outlook towards them”.

Effective plans to sort out the struggling operations could make a marked difference to Deneb’s operating margins and return on equity.

The X factor for Deneb is whether the company can make selective acquisitions that will enhance margins and bolster cash flows. The recent strategic investment in specialist building supplies firm Premier Rainwater Goods has shown initial promise.

At this juncture, IM reckons that Deneb is a solid long-term buy where further improvements in operating performance should narrow the discount to NAV markedly.