AVOID FALLING INTO THE VALUE TRAP
The JSE offers plenty of bargains on paper. But cheap is often cheap for a good reason, writes Marc Hasenfuss
Every crisis brings opportunities, or so the cliché goes. There is no shortage of crises in South Africa. The economy is moribund, with the chances of growth reigniting dampened by successive interest rate hikes and inflationary pressures. Business confidence is low and investment sluggish, limited largely to niches such as fintech and selected mining activities. Government policy
across a number of business sectors remains uncertain if not plain incomprehensible and, worse, devoid of the necessary urgency to stave off impending disaster.
Politically there is an ominous fragmentation, with hastily cobbled alliances at local government level pointing to a desperate power struggle that, in some instances, has already ushered in a damaging dysfunctionality that has hurt businesses and entrepreneurs alike.
But local companies are a hardy bunch that are doing their level best to survive disruptive load-shedding. More recently, they fought their way through lockdowns, insurrection, floods and political jitters. Before that, they staved off the effects of several global economic crises and exchange rate collapses. A few even survived two world wars and pandemics more devastating, relatively speaking, than
Covid.
At face value the JSE might not necessarily reflect ongoing crises. The all share index (Alsi) is trading at an average earnings multiple of close to 12. Though this is below the 15 yardstick that investors
Look for pragmatism in the management team especially if the business is facing operational challenges
usually shake at JSE-listed company valuations, it seems a decent enough multiple considering the challenges local companies are facing across many fronts.
It could be argued that the average Alsi multiple is buoyed by rich multiples accorded to some of the JSE’s bigger dual-listed global counters — such as Richemont (trading on a 37 multiple), Prosus (36) and AB InBev (19). But stocks that might be better considered as proxies for the local economy show far more modest ratings — such as Standard Bank (7.9), industrial supplies conglomerate Hudaco (7.8), logistics giant Super Group (seven) and motor dealership group Motus (four).
Beyond these “betterknown” counters there is a surfeit of shares trading at low- to mid-single-digit earnings multiples, and some with dividend yields edging towards high single digits. Bargains on paper. But cheap is often cheap for a good reason.
In this regard IM was interested to note a recent article in Business Day, quoting Allan Gray chief investment officer Duncan Artus, around the dangers of springing “value traps” on the JSE.
By definition, a value trap is set off when investors are attracted to what is perceived to be a cheap asset — whether because of dismissively low earnings multiples or a sizeable discount to “hard” NAV. But investors subsequently suffer capital erosion as the share dwindles in line with deteriorating prospects for the company’s growth, or as value-unlocking efforts are stifled.
Artus is quoted as saying: “South Africa Inc looks really cheap, but the economy is not growing so investors don’t want to assign high valuations to domestically focused stocks like they used to.”
He adds: “Prices are low but perhaps they are low for a reason — you’ve got low growth combined with a high cost of capital, so many projects don’t happen, and investors aren’t willing to pay what they did in the past. My concern is that some domestic shares end up as value traps.”
There are a couple of tips to avoid getting snared in a painful and prolonged value trap.
First, make sure the company is operating in viable and sustainable niches and can adapt to changes that technology and changing consumer habits bring to these sectors. Think British
The outlook for local agriculture has changed for the worse with the advent of drier El Niño conditions
American Tobacco using its strong cash flows from its shrinking tobacco business to build a commanding presence in new-generation products such as vapes.
Second, try to assess whether there is an obvious trigger for a value unlock. This might be the presence of a new strategic shareholder, a subsidiary that could be sold off or listed separately via an unbundling, or an excess of cash that might be used for special dividends or meaningful share buybacks.
Third, look for pragmatism in the management team — especially if the business is facing operational challenges. By this, IM means executives taking tough decisions timeously around loss-making or unviable operations to protect shareholder value. Hopefully, managers also have skin in the game, and are not primarily salary earners.
One of the most famous value traps in recent memory was industrial group Dorbyl, which had the mighty Remgro as an anchor shareholder. Dorbyl, which was winding down its remaining operations, traded at a significant discount to its hard NAV — which included a large cash pile.
The value proposition, on paper, was enormous. But there was a snag. A remaining operation — Guestro Castings — was a difficult business to sell. It was also a difficult business to operate profitably, and much of the cash was funnelled into the business to keep operations going. The outcome for investors banking on a rich value unlock was disastrous, with NAV unceremoniously whittled away — and this was in spite of new shareholders emerging and takeover offers.
More recently there is the case of Premier Fishing & Brands, which is subject to a buyout offer that is well shy of NAV, and heavily discounts longer-term prospects. Premier had been firmly caught in a value trap over the past few years with uneven catch rates and the prolonged impasse over new long-term fishing rights. But the prevailing economic gloom makes it easy to convince minority shareholders to bail out — even if there is compelling evidence that the company is worth considerably more than the offer price.
Ellies, an electronics retailer and wholesaler, has also seen its NAV chipped away by poor trading conditions and an out-of-date business model that urgently needs to be revamped to be relevant. Consequently, losses for Ellies shareholders have been devastating over the past decade.
Agribusiness investor
Zeder is another case in point. Zeder — which is actively marketing the sale of its last two remaining assets, seed business Zaad and fruit group Capespan — is trading at a
33% discount to intrinsic NAV. The discount strongly suggests Zeder will struggle to sell its remaining assets at anything close to the inferred value — R2bn for Zaad and R1bn for Capespan.
Indeed, the outlook for local agriculture has changed for the worse with the advent of drier El Niño conditions.
The appetite of international agribusiness investors might also be fading with additional challenges presented by loadshedding and logistical logjams.
Well-known heavy industrial counters Hulamin and ArcelorMittal trade at dismissive earnings multiples and deep discounts to NAV. Both are cyclical businesses with erratic performance profiles, and both still have a long way to go to convince the market that their respective strategies have been properly overhauled for sustained growth.
South Ocean Holdings, the cabling group, as well as agribusiness plays Quantum Foods and Crookes Brothers, are also often cited as deepvalue opportunities. The value trap might not be fully sprung here, but all three have been snared by regular setbacks that disrupt consistent profit performances. At the time of writing, Quantum had issued a dire trading statement and warned of an outbreak of the dreaded avian flu.
Transpaco — a redoubtable profit performer and dividend payer that trades on a lowsingle-digit forward earnings multiple — would probably also rank as a counter whose value is underappreciated. The share, though, trades at a premium to NAV — which might be an affront to the deep-value acolytes. But IM reckons that Transpaco offers decent upside on its growth prospects — and is a great place to park for punters seeking an above-average yield.
Still, profit performances don’t always snap open the value trap. At the time of writing, food group RFG issued a tasty trading statement (earnings up 25% to 40%), but the share still seems to badly lag what shareholders might consider reasonable value for the business. RFG’s forward multiple is just five and hard NAV more than 900c a share — which clearly illustrates the market’s current distaste for the broader food segment on the JSE.
Then again, counters that were firmly stuck in a value trap have made remarkable escapes. Printing and
packaging group Novus was helped by an influential new shareholder, while gaming group Grand Parade Investments looks like getting a second lease of life also courtesy of a new influential shareholder. Both required serious restructuring, involving the sale of key assets.
But sometimes even large asset sales don’t break the value trap. Construction group Aveng’s finalisation of its sale of Trident Steel — where the proceeds matched the market capitalisation — has done little to bring the share closer to its NAV of R30 a share. Ditto Brait’s sale of UK grocery business Iceland and its listing of Premier Group on the JSE.
IM reckons there a handful of compelling deep-value situations on the JSE that won’t trap investors in a position of prolonged pain. Two are included in this issue — Nu-World Holdings and Combined Motor Holdings.
Here are another two opportunities:
CAXTON & CTP: It’s probably best to start with breaking down the sum-ofthe-parts value at Caxton. First, the printing, publishing and packaging group holds listed investments worth about R1.58bn — the bulk of which is a 34% stake in packaging giant Mpact. At current prices the Mpact stake alone is worth R1.36bn — about 36% of Caxton’s market value, or 377c a share. Then Caxton has cash and cash equivalents worth nearly R1.4bn — or roughly 388c a share.
Cash and the Mpact stake are collectively worth about 765c a share — more than three-quarters of Caxton’s market value. Put another way, the market is valuing Caxton’s printing, publishing and packaging operations at about R700m. That would mean the market values these perennially profitable operations — which generated bottom-line profits of R544m in the year to end-June 2022 and R404m in the half-year to end-December — on an effective earnings multiple of 1.6 historically and not much more than one on a forward basis.
Now, it’s easy to argue printing and publishing is a dying business. But Caxton is still commanding some viable niches — as can be seen from the stout R267m generated in interim operating profit from almost R2bn in turnover. The packaging segment, where Caxton has been steadily expanding, is now almost as big the printing and publishing division, with interim turnover creeping close to R1.85bn. The difference is a fatter margin, with the packaging segment’s profits close to R300m in the interim period.
Given just half the market ratings accorded to packaging listings Bowler Metcalf and Transpaco, then a value of between R1.5bn and R2bn could conservatively be slapped on Caxton’s operational core. Looking forward, investors could reasonably expect more strong cash flows from
Caxton (and a good annual dividend), as well as more selective acquisitions in the packaging space and more activism with the Mpact investment. Hardly the stuff of a value trap.
ARGENT INDUSTRIAL: Not too many years ago Argent would have been considered a classic value trap, with its sprawling portfolio of mostly small steel-based operations bending and buckling to stay viable in a tough local economy. The group handled its predicament deftly, gradually selling off noncore and less viable operations and then using proceeds to reinforce its balance sheet.
A stronger balance sheet allowed Argent to buy back heaps of its own shares and —
perhaps more importantly —
make selective acquisitions in niche engineering businesses in the UK.
At this juncture, Argent —
which has started paying dividends again — still lags its last stated NAV of R24 a share by close to 40%. IM estimates Argent’s tangible NAV at about R20 a share, which means the share offers a discount on this “harder value” measure of 27.5%. Such a wide discount would suggest that Argent is an ex-growth counter. Far from it.
In the interim period to end-September, Argent saw vibrant performances across numerous subsidiaries locally and abroad — most notably
Pro Crane and Hendor.
One development to note is that while South Africa still provides the bulk of Argent’s revenue (R821m out of
R1.2bn), the offshore operations are now the biggest contributor to profits. The offshore operations generated R78m in pre-tax profits from revenue of
R382m — a stout pre-tax margin of 20% vs 7% for the local operations.
Argent indicated that order books were brimming for the UK operations — highlighting that fuel equipment supply business Fluid Transfer, acquired for a nominal £1, had exceeded its budget tenfold.
If the second half matches the first-half trading, Argent could deliver about 360c a share — putting the share on a lowly earnings multiple of four. But that might be conservative, with CEO Treve Hendry reporting that Argent’s businesses were positioned for another incredibly good year.
Over and above organic growth, is it too early to start fantasising about Argent splitting off its local and offshore segments?