Deep roots but not enough fertiliser

t York Timbers, the company’s history is almost as deep as the discount to NAV. Incorporated in 1916 and listed on the JSE since 1946, these trees have seen many things — including the erratic nature of York’s earnings.

If you are seeking a dependable cash-flow generator, York isn’t for you. It operates in a difficult industry with many exogenous factors and internal risks. Up more than 20% year to date and 60% since the start of 2020, the company has rewarded shareholders who recently went in search of deep value.

The key question is: are we now at the shallow end of the value pool?

At first glance, the stubborn discount to NAV of 76% suggests not (R9.14 NAV a share vs R2.20 share price).

Within York’s total assets of R4.7bn as at December 31 2020, the critical line is biological assets at R2.8bn. This represents the value of the plantations, calculated in a detailed fashion under international financial reporting standards rules. Many market yield curves and other techniques are applied in estimating future cash flows from the timber.

The discount rate applicable to these future cash flows should be referenced to financial markets. This is where the deep value thesis may be falling well short, as the market is screaming an answer by perpetually valuing York at a significant discount to NAV.

The 2020 financials went into the detailed calculation of the value of biological assets. The cash flows are discounted at a weighted average cost of

Acapital (WACC) assuming 25% debt:equity ratio and cost of equity of 16.2%, with beta of 1.2 and an equity risk premium of 6.2%. For those unfamiliar with the WACC calculation, an equity risk premium of 6.2% (above the long government bond return) reflects average risk of a company in the local equity market.

Is that high enough for York? The market doesn’t think so. We can back-solve for the discount implied by the York share price.

The 2020 annual report guided that every 25BPS increase in the rate would decrease the value of the assets by R60m. Closing the gap between R720m market cap and R2.9bn NAV requires R2.2bn in round numbers, or a 920BPS increase in the WACC.

The full effect must be in cost of equity rather than the cost of debt, which suggests that the equity risk premium must increase from 6.2% in the biological assets calculation to 16.4%. The cost of equity in the calculation would be 28%, which is a level applied in particularly risky private equity deals in SA.

Is the market getting this wrong, or is York equivalent to a risky private equity deal?

The risks are clear. Expropriation without compensation and political risk in general around land has been a concern. Wildcat strikes destroyed York’s profitability in 2019, as the company found itself at the centre of a power struggle between rival unions.

Even at the company’s peak in 2017, return on equity (ROE) was only 12.3%. In other recent years, it was frequently below 5%. The interim 2021 result suggests annualised ROE of just 2.7%. These are poor returns and provide further support for why the discount to NAV is structural rather than temporary.

There has clearly been a value unlock play over the past 12 months that astute investors have enjoyed. However, the current share price of about R2.20 is a consolidation level historically and York has not traded materially above these levels since early 2018.

With interim revenue only up 2% and no dividend declared despite a return to profitability, the bulk of the value unlock may have already taken place. Annualised diluted earnings suggest a forward p:e of 9.2 times, which isn’t a bargain for these inherent risks.

Liquidity is a further major issue. Just 4% of York’s shares in issue traded during 2020, as nearly 80% of the register is held by major shareholders. This severely limits price discovery and further institutional involvement. It also hampers York’s ability to execute share buybacks to improve the discount to NAV, because it cannot

“Liquidity is a further major issue. Just 4% of York’s shares in issue traded during 2020, as nearly 80% of the register is held by major shareholders

afford to reduce liquidity further.

Unless there is a strong catalyst to reduce the discount to NAV, York is likely to trade somewhat sideways from here. While there are various strategic initiatives under way to diversify away from timber and generate revenue from other sources, the underlying ROE speaks for itself.

The best outcome for shareholders may well be a buyout offer. Those interested in this space should also look at TWK, listed on ZARX. ●