TRADE OF THE MONTH

Tsogo needs people to spend more, and what can HCI sell to reduce its debt?

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This month IM looks at two related counters — gaming group Tsogo Sun and investment counter Hosken Consolidated Investments (HCI).

HCI is the biggest shareholder in Tsogo, and Tsogo is still the biggest listed investment owned by HCI.

Because of this, it could easily be argued that the share price of HCI and Tsogo should really move up in tandem. If investors follow the trading patterns since the onset of Covid, this notion would be reinforced. Tsogo is up 186% over a year, and HCI rose 255%.

It could be argued that there is a big difference between 186% and 255%. But both shares were priced for a worst-case scenario when Covid restrictions shut down casinos and gaming amenities. HCI, with a large chunks of debt at its centre, was obviously hardest hit — remembering the investment company would have needed to find further capital if Tsogo had needed a rights issue (like Sun International) to remain afloat during the pandemic shutdowns.

Fortunately, Tsogo did not need a capital infusion, and the pressure on HCI eased off (somewhat).

So far this year there has been a disconnect between the HCI and Tsogo share prices. Tsogo has found considerably more traction as its casinos and alternative gaming properties have reopened — albeit under trading density restrictions. The share has surged over 40%, which suggests the market expects a meaningful recovery in Tsogo’s larger casinos — such as Suncoast and Montecasino — and a sustained, robust performance from its limited payout machine and electronic bingo hub.

In the past financial year — the period before Covid infected businesses — Tsogo managed earnings of about 135c a share. One might argue that before the implications of Covid dawned on the market, Tsogo was trading around R12.

The current share price then, it might be argued, suggests the market expects it might be some time before earnings normalise. A key issue in the upcoming final results — which should be out just as this magazine hits the shelves — will be the margin of earnings before interest, taxes, depreciation, amortisation and restructuring/rent. The margin was 34.2% in the most recent financial year, and it will be interesting to see what margin was achieved in second-half trading as casinos started opening up again.

IM feels that Tsogo, notwithstanding some sterling efforts in cost containment, needs a healthier environment for consumers to unleash discretionary spending. Without top-line growth driven by its large casinos, Tsogo is going to grind along. Of course, it’s fair to point out that a dour short- to medium-term performance from Tsogo will surely drag on HCI.

Yes. But IM thinks HCI, like so many other investment firms (Zeder, PSG, Remgro, Sabvest and Long4Life), will need to revisit its structure and strategy sooner rather than later.

HCI still attracts a sizeable discount on its intrinsic NAV and has plenty of opportunity to unlock value by either disposing of noncore assets or unbundling assets for a separate listing.

In HCI’s most recent annual report CEO and significant shareholder Johnny Copelyn conceded that a key weakness was that the group had too much debt for its own longterm good.

HCI turned incredibly enthusiastic on its oil and gas exploration investments — pumping in significantly more than the R300m to R500m the group traditionally earmarked for new investments.

It is difficult to see what HCI could sell to cull debt. Perhaps its minority stake in the Karoshoek renewable energy project? Or part of its underappreciated property portfolio? Maybe the coal interests — though HCI seems more enamoured of these operations lately.

IM doubts very much any consideration will be given to selling the controlling stakes in cash-spinning Hosken Passenger Logistics & Rail or the potential upside in eMedia’s satellite television thrust.

The big “swing” at HCI may come from its holdings in two Toronto Stock Exchange-listed counters — its 31.6% holding in Platinum Group Metals (PGM) and its 509-million shares in Africa Energy.

The value of HCI’s Africa Energy shares have dribbled down over the past year, and now infer a value of C$60m, or about R700m.

HCI’s stake in PGM is worth about $100m or R1.4bn.

Both the energy exploration and PGM assets are volatile in valuation. But at the right time these both could be monetised, culling a chunk of HCI’s debt.

One suspects that with a more flexible gearing regime, HCI would not hesitate to buy back (more of) its own shares if the pesky discount remained.

IM sees more upside in potential debt culling actions at HCI than in the gradual and potentially prolonged recovery in Tsogo’s gaming businesses. ●

The big ‘swing’ at HCI may come from its holdings in two Toronto Stock Exchangelisted counters — its 31.6% holding in Platinum Group Metals (PGM) and its 509-million shares in Africa Energy