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

Financial Mail - Investors Monthly - - Analysis - Marc Hasen­fuss * The writer holds shares in this com­pany

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.

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