Ar­ti­fi­cially flavour­ing BEE stew?

Is there a huge down­side risk for empowerment fund?

Finweek English Edition - - Companies & Markets - MARc HASEN­FUSS

AT A TIME WHEN UNIT TRUSTS and shares are be­ing smacked silly by pre­vail­ing mar­ket volatil­ity, StratEquity’s Empowerment In­vest­ments (SEI) has only lost be­tween 5% and 7% of its value since launch­ing ear­lier this year. In May this year SEI shares were of­fered to the pub­lic at a net as­set value of 103c/share. Last week on “Black Mon­day” – when the mar­ket came off around 5% – the units were trad­ing at 96c/share.

That’s truly a re­mark­able achieve­ment con­sid­er­ing the JSE’s all-share in­dex over the same pe­riod has dropped by around 25% since mid-year.

One might sur­mise that, as a fund com­pris­ing mainly JSE-listed in­vest­ments, SEI boasts su­pe­rior as­set man­age­ment and hedg­ing skills.

Well that, in Fin­week’s opin­ion, may be stretch­ing mat­ters a bit far. In fact, we’re amazed SEI re­tained so much of its value when 22% of its com­pos­ite NAV is held in ex­change-traded funds.

As pointed out in an ear­lier Fin­week re­port (“More trans­parency, please,” 18 Septem­ber) the in­vest­ment ve­hi­cle’s other main con­stituents are cash (21% of NAV), un­spec­i­fied in­ter­est-bear­ing loans (11%), an in­vest­ment in marine trans­porta­tion (6%) as well as smaller in­vest­ments in Fin­bond and StratCorp (StratEquity’s listed par­ent).

But the bulk of its port­fo­lio value lies in re­cently listed meat pro­ducer Best Cut Hold­ings, rep­re­sent­ing a chunky 33% of the port­fo­lio. Now Best Cut is blessed with share illiq­uid­ity. That not only keeps an ar­ti­fi­cial bear­ing on the com­pany’s share price but also sta­bilises SEI dur­ing this volatile pe­riod.

A key con­sid­er­a­tion for in­vestors buy­ing into the empowerment fund’s sec­ond tranche share of­fer is de­ter­min­ing what Best Cut is re­ally worth. The rul­ing price for Best Cut on the JSE was 75c/share on Wed­nes­day last week. That’s pre­sum­ably the mark-to-mar­ket value that StratEquity ap­plies when valu­ing Best Cut.

But – and this is a big BUT – there are no bid­ders (ie, buy­ers) for Best Cut’s shares on the JSE. In fact, it would not be amiss to de­clare there’s no cur­rent mar­ket in­ter­est in Best Cut. That lack of trad­ing has cer­tainly helped Best Cut – which listed in Jan­uary

– re­tain a value close to its pre-list­ing place­ment val­ues of 80c/share. By com­par­i­son, the val­ues of other new list­ings – even those that have per­formed strongly – have been ham­mered over the past six months.

At the rul­ing 75c/share Best Cut is worth nearly R90m – a huge pre­mium on the group’s tan­gi­ble NAV of 17,4/share stated as at end-June this year. With earn­ings of 2,99c/share for the year to end-June, the share is “trad­ing” at an earn­ings mul­ti­ple of more than 25 times – a heady rat­ing by any stan­dards.

How Best Cut has main­tained its value while its fel­low new­com­ers have swooned un­der tense JSE trad­ing is quite baf­fling. We say that be­cause since list­ing Best Cut has seen the res­ig­na­tion of its CEO (Nick Ser­fontein) and group op­er­a­tions MD and founder (Alexis Steenkamp) af­ter the release of the group’s in­terim re­sults – events that would usu­ally spook sen­ti­ment.

It would be nat­u­ral to view those res­ig­na­tions with some sus­pi­cion when con­sid­er­ing that re­cently re­leased re­sults for the year to end-June showed Best Cut fall­ing short of its pre-list­ing earn­ings fore­cast by around 70%.

As pointed out on our Fin24 web­site last week, it would ap­pear Best Cut ac­tu­ally ran at a loss in the sec­ond half of the fi­nan­cial year. It seems cash flow was also staunched, with full-year cash flow re­flected as only R6,8m com­pared to R9m at the in­terim stage.

The key ques­tion for par­tic­i­pants in SEI’s ve­hi­cle is whether they’re buy­ing in at a price that doesn’t re­al­is­ti­cally re­flect the risks in the big­gest com­po­nent of the fund’s NAV. Of course, you can’t pre-judge what could tran­spire at Best Cut. But it may be worth high­light­ing that much of Best Cut’s “go for­ward” is based on ex­pand­ing op­er­a­tions out of KwaZulu-Natal. The group has taken a tilt at the Gaut­eng mar­ket and now wants to find points of pres­ence in the East­ern and West­ern Cape.

It would be rea­son­able to ask whether it’s an ap­pro­pri­ate time to be ex­pand­ing – what with in­put costs eat­ing into mar­gins and con­sumer spending be­ing reined in?

Ex­pan­sion ef­forts could cost Best Cut if suf­fi­cient cash flows aren’t gen­er­ated to sus­tain ag­gres­sive ef­forts to broaden its op­er­at­ing base. Al­ready the group has seen gear­ing ratch­eted up, with bor­row­ings in­creas­ing R28m dur­ing the year.

Fin­week rec­om­mends in­vestors make sure they can stom­ach the risks as­so­ci­ated with Best Cut be­fore pitch­ing into StratEquity’s “re­silient” empowerment in­vest­ment ve­hi­cle.

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