The share price of Ellies (ELI) started this year at 793cps, rallying all the way up to 1000cps before a strong sell-off over the latter half of this year has seen its fall to its current range around 600cps. And this movement is coming from a share price that three years ago was around 200cps.
So Ellies has been a volatile share in both directions, making it a topical stock for small cap investors with some quite vocal proponents for and against it.
So what are the arguments for and against Ellies investment case?
Ellies is really made up of two businesses: the Consumer Goods & Services (CGS) segment and the Infrastructure (Megatron) segment. CGS trades in electronics with a focus on audio-visual as highlighted by its core brand, Elsat, that supplies the majority of satellites in South Africa. Megatron really builds substation for the power infrastructural market in South African and across Africa.
In FY 13, Ellies' CGS won a large portion of Eskom's Residential Mass Roll-out (RMR) Phase 1 that saw it replacing old lights in buildings with energy efficient lights, thus saving the national grid a good amount of power. This contract was once-off, lumpy and quite substantially lifted Ellies' CGS profits during the period. Now CGS is about two thirds of the Group's profits, so this helped Ellies produce a strong FY 13.
The problem is that Eskom's RMR Phase 2 was pulled and its Phase 3 is now (by the sounds of it) off the table for good. So Ellies will have no RMR revenues flowing in FY 14. As RMR revenues flowed during H1:13, this will likely make H1:14 look significantly worse. Add to this that the local consumer is under pressure, therefore CGS's volumes to its predominantly retail client-base may be softer, and you get the argument for a bad FY 14 set of results coming through (or, at least, a bad H1:14).
But then again, if you're investing base only on the next six month's results, well...you're not actually investing, you're actually trading.
The bigger picture is that Ellies' FY 13 results actually saw a weak result from Megatron where its profits dropped 10% due to revenue timing issues. These revenues timing issues are likely to push the revenue to being booked in FY 14, thus this fact (as well as Megatron's strong order book at the end of FY 13) will likely lead to a strong FY 14 for Megatron.
So there are no RMR revenues during FY 14, but the CGS segment is so much more than just an ad hoc Eskom contract or two.
Ellies’ Consumer Goods & Services (CGS) segment is a fully-fledged supplier of select consumer electronics to the local (and some African) retail market(s). A steady expansion of product range has helped the business grow faster than its respective market, taking market share from other players. CGS's revenue has a CAGR of c.13.7% against the relevant retail sales data pointing to a market growth rate of c.1.9%.
OVHD was launched in South Africa during October and the units are sold at c.R1,000 per unit with the retailers able to place a discretionary mark-up thereafter. The take-up of OVHD has apparently been slower than usual, but an adapted marketing campaign is to be launched soon and management remain fairly confident that this will help lift volumes towards the expected 500,000 to 600,000 units per annum mark. Just a steady-state volume of OVHD at these anticipated volumes would add c.50% to Ellies' CGS revenues. And, even better than the once-off Eskom RMR revenues, these OVHD revenues are less lumpy and more annual or operational in nature.
Digital Terrestrial Television (DTT) is also an eventual reality. The world will not wait for South Africa and the 2015 deadline is fast approaching. Sure, so Ellies pre-stocked for DTT and is having to (successfully) move the DTT boxes into Africa to free up working capital. But DTT is not going away and sooner rather than later will be put out into the market. If just 500,000 OVHD units make this much different to Ellies, it is worth lingering on the estimated demand for DTT will be about 11,000,000 units.
And then there is the fact that Ellies's CGS segment has been steadily growing its range of products and, actually, has a very healthy position for the long-term with key relationships into all the big retailers and a comfortable distribution network (including effectively off-book installers who run themselves as SMMEs).
Getting back to what is likely to be a bit of an artificially weak H1:14, if you're investing base purely on the next six month's results, well...then you're not actually investing, you're just trading.
In the longer-term, a bigger risk to Ellies is not volumes or results, it is actually more likely to be financing. When you already have a stretched balance sheet trading in overdraft, how do you finance a working capital intensive business when all its blue sky cylinders all fire at the same time? There is so much blue sky tied up into some many initiatives in Ellies, that the concern of financing all of them is (in my mind) a much greater risk than some soft H1:14 results.