THE PPC INVESTMENT CASE
Competition and excess supply help make it hard to judge whether PPC is a buy
The promise of a quickly growing international business was, until September last year, propping up PPC’s shares despite a weak South African market.
But the stock’s gains were whittled away during a four-month boardroom drama, which was finally resolved in late January after the board was reconstituted at the company’s AGM, and new CEO Darryll Castle was given a vote of confidence by shareholders.
In early February, the cement company’s shares were worth a third less than at a peak in September, prior to Ketso Gordhan’s acrimonious exit as CEO. With a new CEO and board now in place, the question to ask is whether or not the PPC share is a buy at these depressed levels. The stock traded at a price:earnings ratio of below 12 in early February — a less demanding premium than before.
PPC’s shares had not been that low since mid-2005. Since that time, it has made serious progress in its international strategy, and looks on track to generate just over 40% of sales from outside SA by 2017. But its sizeable funding needs, as it completes projects in Rwanda, Ethiopia, the Democratic Republic of the Congo and Zimbabwe, mean PPC last year had to water down its policy on dividend payments, which had been a drawcard for investors.
PPC will benefit in some ways from the oil price slump of the second half of 2014, since diesel accounts for about 10% of its cost of sales. But input cost pressure remains a feature in an industry where demand is floundering and profits are cyclical.
Referring to two newcomers in the industry, Sephaku Cement and Mamba Cement, Kagiso Asset Management investment analyst Victor Seanie says that in a cyclical commodity industry like cement, the entry of a competitor is usually “a dangerous development, especially when demand is growing slowly”.
“Sephaku has been cutting prices to gain market share, and Mamba will do the same, which will reduce PPC’s profit margins.
“The investment case for PPC rests to a large extent on its ability to make profits on the continent beyond SA’s borders,” Seanie says, adding that a close eye needs to be kept on PPC’s ability to manage debt as it spends on projects.
He sees Castle’s experience in Africa and the “newly stabilised” executive makeup as positive, but says “managerial [expertise] may be stretched thin across all of PPC’s now far-flung operations”.
Seanie says that if PPC decides to accept rival Afrisam’s offer to merge, the subsequent industry consolidation would help raise local cement prices. Imara SP Reid analyst Sibonginkosi Nyanga agrees. He says PPC’s shares warrant a “fully valued recommendation” because of the changed dividend policy, unless the company gets a kicker in the form of a merger with Afrisam. The PPC-Afrisam deal put on the table by Afrisam in December would help the combined group close less efficient plants and eliminate overlaps, he says.
“We advise caution until we hear more and maintain our ‘hold’ recommendation with the speculation that the competition commission will approve the Afrisam deal.” If the companies decide to pursue a tie-up, they would need to negotiate on their relative valuations. AfriSam’s initial proposal suggested a merger ratio of 55%-65% in favour of PPC and 35%-45% in favour of AfriSam.
Rhynhardt Roodt, portfolio manager of Investec Asset Management’s Investec Equity Fund, says: “We would not be buying PPC shares just yet. The domestic operating environment remains weak, with volume growth firmly in negative territory. The local market is oversupplied and at this stage it is difficult to see any improvement in local infrastructure spending.”
As competition and excess supply builds in SA, pricing power will be difficult to come by and Roodt expects PPC’s domestic profitability to remain under pressure throughout 2015.
PPC’s headline earnings per share will fall by 25%-45% for the six months ending March 31, the company said in January, owing to a weaker trading environment, a previous one-off tax credit, and an increase in finance costs.
Roodt says PPC’s “aggressive” international growth in recent years “might prove to be the correct strategy for the group over the long term… the new management team will have to deliver on ambitious growth targets”. But he says “we think investors might be disappointed and lower their future earnings expectations for the group”.
However, JP Morgan sees PPC’s shares, at their price of R20,45 in late January, as oversold. “We think the expected earnings weakness in 2015-17 and delays in the DRC and Ethiopian projects have been priced in and we see value in the stock.
“It is trading at a forward enterprise value/earnings before interest, taxes, depreciation and amortisation of 8,9 times versus its historical average of 9,5 times, and a global cement peer average of 10,2 times.”
JP Morgan said in a note to clients it expected Castle’s appointment to bring stability to the company