TRADE OF THE MONTH

The selection for September is to go long on AVI and short on RCL Foods

“There are suggestions that RCL’s glaring underperformance will see controlling shareholder Remgro demanding more radical action to restore or unlock value

Calling a long/short on the JSE’s food sector is a stomach-churning task. IM has retained a certain craving for the food sector, as can probably be seen by our extensive coverage of these consumerfocused stocks in this edition.

The mainstays of the JSE’s food sector — and that includes more recent listings like Rhodes Food Group, Sea Harvest and Libstar as well as Brait’s exposure to Premier Group — are, for the most part, a pretty solid bunch.

The large listed companies all hold strong brands that can command fat margins even in competitive niches. In bad times, most brands are defensive, and this was largely borne out during the Covid-19 lockdown when consumers were restricted to essential purchases only.

Most listed food businesses are well capitalised and capably managed, and most have scope to make acquisitions.

The recent buyout of Pioneer Foods by US consumer brands conglomerate PepsiCo was a timely reminder of the value some local food counters have built over the past few decades. Pioneer was a dominant player in staples such as cereals and bread, as well as a big player in the fruit juice sector. Tiger Brands even managed to offload its controversy-laced Enterprise processed meats business to a surprisingly enthusiastic Country Bird Holdings. IM’s selection for September is to go long on AVI and short on RCL Foods.

The choice of RCL Foods may surprise some, mainly because the share price is close to a multiyear low.

There are suggestions that RCL’s glaring underperformance will see controlling shareholder Remgro (which must still rue the day it bought the old Rainbow Chicken business) demanding more radical action to restore or unlock value.

With Remgro already speaking for the bulk of the issued shares, there have been increasingly audible arguments that RCL will be subject to an offer to minority shareholders and delisted. This would make sense, and would also allow Remgro some privacy in merging its Siqala spreads business (acquired from Unilever) and possibly other small assets like BOS Brands into RCL.

But history shows that the wheels turn slowly at Remgro.

IM suspects any corporate actions at RCL might only be considered when the business is on a sounder footing.

The drawback at RCL, for IM, is a structural one. The group still holds a large slug of commodity-type businesses in the form of its sprawling poultry and sugar operations, which does leave prospects hinging heavily on sometimes tricky trading cycles.

RCL’s higher-margin grocery business has some attractive brands — Nola mayonnaise, Yum Yum peanut butter, Ouma rusks and Sunbake bread, as well as pet food brands including Bobtail and Epol. But this portfolio — supplemented by the redoubtable Vector Logistics business — needs to be fattened markedly to flatten out the effect of the cyclical commodity businesses.

With the poultry business likely to endure a tough period in the foreseeable future and consumer demand compromised after the lockdown, it seems unlikely there will be much impetus at RCL’s bottom line.

IM does not expect the share to weaken dramatically from the current position. But there might not be much appetite in the market for buying into the stock’s recovery.

AVI is trading back at levels last seen in 2015, though it still commands a premium market rating with a trailing earnings multiple of over 15 times.

IM sees a meaningful shortterm recovery to R85, with AVI’s recent results to end-June showing that management still has the knack of balancing pricing power with market share gains.

This is particularly true in the key brands in tea and biscuits/snacks.

AVI should also feel the benefit of improved sales in its “fashion” segment — which includes footwear and cosmetics — as the effects of the pandemic dissipate. The same goes for fishing business I&J, which took some strain during the stricter lockdown phases.

AVI also has the luxury of a muscular balance sheet, which gives directors some leeway in deciding around distributions and share buybacks.

AVI certainly has the capacity to make a sizable acquisition — though CEO Simon Crutchley has made it plain that any opportunities would need to be “credible” and add high-quality brands.

IM reckons AVI has, over the years, proved capable of adapting to a changing macro environment. This means some reliance can be placed on management’s efforts to protect both margin and market share as well as to leverage the brand portfolio to make sure there is a high return on capital employed.

Reassuringly, AVI has also indicated that it is still targeting earnings growth, and will maintain its normal dividend payout ratio of 80% of cash earnings. ●

AVI VS RCL FOODS