Spot­ting a bar­gain on the JSE is not so easy

The Star Early Edition - - OPINION & ANALYSIS - Amelia Mor­gen­rood Amelia Mor­gen­rood is a port­fo­lio man­ager at PSG.

IDEN­TI­FY­ING the good com­pa­nies on the JSE is very easy. We all know which ones are suc­cess­ful and grow­ing above av­er­age over the long term. The prob­lem with these com­pa­nies are that they are al­ways quite ex­pen­sive and you are al­ways hes­i­tant to buy them at hefty val­u­a­tion lev­els.

Oc­ca­sion­ally they en­counter a head­wind and you get an op­por­tu­nity to buy. Then you are once again hes­i­tant be­cause you don’t know whether it is a per­ma­nent head­wind.

Fa­mous Brands is cur­rently in such a sit­u­a­tion. They ex­pe­ri­enced spec­tac­u­lar growth for many years, but this year it is dif­fer­ent and there are a few changes.

They have taken on huge debt, cut the div­i­dend and they have a new chief ex­ec­u­tive. The share price dropped 27 per­cent from R172 in Oc­to­ber 2016 to R125 this week.

Tak­ing a closer look at the rea­son for the de­crease in head­line earn­ings, it is a cur­rency ad­just­ment due to the fluc­tu­a­tions of the Bri­tish pound.

Growth com­pany

Fa­mous Brands (FBR) ac­quired seven busi­nesses in the fi­nan­cial year, in­clud­ing a UK busi­ness, their big­gest ac­qui­si­tion ever, in­creas­ing their debt-to-eq­uity ra­tio to 165 per­cent.

At the re­sults pre­sen­ta­tion this week, new chief ex­ec­u­tive Dar­ren Hele em­pha­sised that Fa­mous Brands is a growth com­pany and there­fore de­cided not to pay a div­i­dend, the first time in 13 years.

The groups’ in­ter­est ex­pense shot up to R132 mil­lion from the pre­vi­ous year’s R7m. This is mostly due to the loan of R2.4m to ac­quire Bri­tish group Gourmet Burger Kitchen (GBK) with around 80 res­tau­rants.

Ac­cord­ing to Hele, the tim­ing of this ac­qui­si­tion was not ideal, since the trans­ac­tion was con­cluded at an ex­change rate of R17.54/£ and the rand sub­se­quently ap­pre­ci­ated to a level of 15.19/£. Is the busi­ness still healthy? Strip­ping out non-op­er­a­tional items, it went very well with FBR. Op­er­at­ing profit grew by 18 per­cent. They ac­quired seven busi­nesses in the last year, and this is where the changes are com­ing in. So far FBR was a fran­chise busi­ness, play­ing the role of the fran­chisor.

Trans­formed busi­ness

The most re­cent ac­qui­si­tion of GBK trans­formed the busi­ness into a phys­i­cal restau­rant owner. What else was there for FBR? Since the fran­chise mar­ket in South Africa seems quite ma­ture, and they al­ready own the ma­jor­ity of the big chains. The ques­tion is whether they can suc­cess­fully do this trans­for­ma­tion?

Hele al­ways made a good im­pres­sion, shar­ing the same vi­sion and bring­ing it across in the same im­pres­sive way as his pre­de­ces­sor Kevin Hed­der­wick.

Bring­ing FBR skills to the newly ac­quired busi­nesses can bring more ef­fi­cien­cies and prof­itabil­ity.

De­spite dif­fi­cult trad­ing con­di­tions the South African busi­nesses did ex­tremely well, grow­ing by 18 per­cent. 192 new res­tau­rants opened, while 220 were up­graded.

Hele said he was not com­fort­able with the high lev­els of debt and said plans were afoot to re­duce the gear­ing (net debt to eq­uity), and hinted that a rights is­sue might be on the cards.

Like all en­tre­pre­neur­ial and re­spectable com­pa­nies FBR have pur­sued global food brands to buf­fer against local head­winds.

Mov­ing from be­ing mostly a pure South African play, Fa­mous Brands shelled out R2.1 bil­lion for GBK.


To sim­plify their val­u­a­tion: if they just re­sume their earn­ings from Fe­bru­ary 2016 (541c per share), the for­ward price/earn­ings (p/e) ra­tio is 24, and if the earn­ings is only 10 per­cent higher, the for­ward p/e is 22.

I am happy to buy a com­pany with an ex­cep­tional busi­ness model and growth po­ten­tial at such a rat­ing. They have now di­ver­si­fied prop­erly by adding the UK busi­nesses to their port­fo­lio, and with our cur­rency that will prob­a­bly keep on de­pre­ci­at­ing over the long term, it will add to their pros­per­ity.

At the cur­rent level of R133 you can con­sider buying at least half of your Fa­mous Brands hold­ing, wait and see if there will be a rights is­sue and the share go­ing back to the R120s, and then buy more.

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