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Observations: SNV, BDM and PKH

This week has (and indeed the last couple weeks have) seen a splurge of news on the JSE from results to major moves.

African Bank (ABL) saw its share price collapse yesterday and, while it was down over 26% at one stage, it managed to recover somewhat to close only 17% down. ABIL has been sold off 40% in the last three months, but, perhaps more importantly, has dragged other related and unrelated counters down with its taint. Capitec (CPI), Lewis (LEW) and numerous other stocks saw themselves get sold off over the same time period that Nasper (NPN) and Richemont (CFR) have quite simply shot the lights out.

The divergence is just so dramatic.

But there are numerous shares just outside this predominantly Top 40 limelight where things are happening, but almost no one is noticing.

Santova (SNV) is really a niche logistics provider utilizing an integrated IT platform, OSCAR, for supply chain management, particularly and increasingly with an international flavour.

The Group has steadily performed over the last couple of years, weathering the volatile local and international trade as it established offices in Hong Kong, Australia, the United Kingdom and the Netherlands, as well strategic partners throughout the world.

This key move has obviously led the Group's International segment's revenues to rise to R49m (FY 12: R29m) driving Net Profit from these operations to R8.7m (FY 12: 4.5m). These numbers came out in the Group's recently reported FY 13 results that saw the Group grow turnover c.6% and via Operating Leverage lift HEPS 10% to 17.62cps (FY 12: 15.99cps).

What is not readily apparent by this fairly robust set of results is how tough the local market obviously is... Revenue in South African declined 6%, slumping Net Profit from this area down to R16.3m (FY 12: R18.8m).

There was an acquisition during the period and a post-balance sheet date event, but moving beyond this detail, Santova's prospects are probably best summed up by management's comment that "Whilst the outlook for world economies for the year ahead is relatively 'flat' to 'slightly optimistic', we are confident that not only will we be capable of meeting the challenges as they present themselves but will capitalise further on our entrepreneurial capability and the 'spirit' in which we engage such challenges."

Next up is the turnaround, Buildmax (BDM), that also reported its FY 13 results this week. In summary, Buildmax managed to lift HEPS to 28.6cps from HEPS from Continuing Operations the year before of only 13.72cps. Revenue was up 9% as operating profit remained flat.

Interestingly Depreciation dropped by almost 20% in FY 13, despite capex of R400m (FY 12: R415m) being spent and Property, Plant and Equipment on the balance sheet rising to R873m (FY 12: R712m).

This paradox only makes sense once you read the commentary pointing out how "management reviewed the current remaining economic useful lives and residual values of all items of property, plant and equipment. When determining these estimates, the company considered the following: replacement and market value, local and international demand, OEM support and their value perspective, reliable availability of spare parts, maintenance philosophy and history, operational application and value in use. This exercise, coupled with preferred brand purchases and balancing of applications, identified the need to expand the categories of plant in order to cater for the different economic useful lives of different brands. These revised estimates were implemented from March 2012 and resulted in a reduction in depreciation costs."

So, basically, management has adjusted their depreciation in FY 13, making it not very comparable to FY 12. Carefully of clever little tricks like this, they can sometimes make results look a lot better than they actually are.

Probably more reflective of the progress Buildmax has made in its turnaround is its cash flow statement. The Group generated 9% more cash from operations while a combination of degearing and capex saw it's cash balance slip a little to R66m by year end (FY 12: R109m).

Finally, another off-the-radar counter is Protech Khuthele (PKH) that is only ever seemingly mentioned when Eqstra (EQS) and the latter's bid for the former arises.

Protech Khuthele reported its FY 13 results this morning with revenue rose 6% to R1027m (FY 12: R965m) as EBITDA improved to R116m (FY 12: R63m). HEPS turned to a profit of 3.9cps (FY 12: Loss of 1.0cps).

Now roughly R20m of once-off costs were incurred in FY 13 relating to defending the Eqstra bid (c.R7.5m to R10m) and the new management’s due diligence of Protech (c.R9.5m to R10m) were incurred. If this amount is taken out of the Group’s financial results, we estimate that HEPS would be have been c.7.4cps or at an ROE of c.8.1%.

The Group’s Order Book is stated at R1013m with ‘Work to Be Completed’ at R463m, ‘New Work in Final Negotiation’ at R360m and assuming an R190m revenue pipeline for the Readymix segment.

Interestingly (and backing up commentary from Afrimat and Stefanutti Stocks) the Group is seeing local construction work picking up into FY 14 (particularly in the public sector in South Africa), and is targeting c.30% of its revenue to come from public sector work. The Group is also targeting c.55% of its revenue coming from the mining sector (predominantly in South Africa, but also in Zambia, Zimbabwe and Mozambique).

Now, here is an interesting observations I have regarding Protech's NAV...

PriceWaterhouseCoopers (PwC) has valued PKH at between 79cps to 88cps and advised the Board that Eqstra’s 60cps bid for PKH is unfair and unreasonable. While this may be a fair point, PwC’s fair value range (with a high-end of only 88cps) implies that the Group’s balance sheet is overstated as PKH’s NAV is 94.5cps implying that some or all of the goodwill (R33m) and intangible assets (R3.5m) should perhaps be impaired?

The Group’s Tangible NAV is 84.2cps, though, versus the current share price of 53cps.

I really only see three scenarios playing out here with Protech:

Firstly, Eqstra’s 60cps bid appears opportunistic after PwC’s independent report speaks out against it. Despite that, the share price remains <60cps, implying that the market disagrees and there may well be a number of shareholder’s that accept the offer (our understanding is the offer is currently non-binding). [i.e. short-term upside.]

Alternatively, Eqstra may well also raise its offer to Protech minorities. In this event it will likely raise it to the low-band of PwC’s fair value range. This would also likely trigger a run on the share price. [i.e. short-term upside.]

Finally, Eqstra may also just pull its offer from the table. Given PKH’s PE based on FY 13 HEPS and our “Normalized” HEPS implies a range of between 7.2x to 13.5x, it is likely that the share price will not slide too far in the short-term based on this scenario. In the long-term, the turnaround appears to be gaining traction and to have significantly de-risked the Group, thus arguably implying healthy upside potential for the medium- to longer-term investors. [i.e. short-term downside, long-term upside.]

On a balance of probabilities across all these scenario’s I am starting to see limited downside in PKH’s share price with either short-term opportunistic or long-term turnaround-driven upside potential in the Group.
How Long Is Long?

Understanding your time horizon is both quite a personal process and quite an important aspect to either investing or trading.

In a way, it is your individual positions' aggregate time horizon that actually dictates whether you are a trader or an investor. If you're only holding positions for the short-term, you are a trader making trades and should be using the toolkit available to traders (technical analyst, etc). If you're holding positions for the long-term, you are an investor and should be using the toolkit available for investors (fundamental analysis, valuation, etc).

This is not a new point. I have made this point in numerous presentations, interviews and articles. I merely reiterate it here as a prologue to an interesting debate:

How long is long-term?

Before I answer this, let's step back a moment and look at the (theoretical) bigger picture.

A business is the interaction of people, processes and assets combining in a coordinated approach to creating economic value by satisfying some form of demand in the economy. A key ingredient in this mix is "people". Without people to use them, assets would sit around worthlessly. Without people to perform them, processes could not leave the very page they were written on.

Hence, people really are businesses. Management run people. And the CEO runs management.

Thus, when you invest in a listed business's shares for the long-term, after all the research and after all the valuations in the world, you are buying into the ability of the CEO to deliver.

In an interesting annual study done into CEO tenures in the States, the long-term trend is towards a shorter and shorter tenure. More pointedly, in 2012 the average tenure of a CEO in the States dropped to 8.4 years.

I would venture to say that our local market's average (and trend, particularly in mining CEOs!) is likely roughly in line with that length. But, don't forget, this average period of CEO tenure is just that: an average. I would go further to venture a guess that CEOs of successful companies stay in their positions longer than CEOs in unsuccessful companies. As Eric Schmidt, the former CEO (but not founder!) of Google, once said, "If you're offered a seat on a rocket ship, get on, don't ask what seat."

Now armed with these facts and insights, answering the question of how long is long-term becomes fairly obvious: currently is about 8.4 years.

Well, alright, this is a massive oversimplification, but it does serve to illustrate the point I am trying to make. While trading is worried with short-term stock movements, investing is more worried about long-term company direction. And, in the long-term, it is the CEO that should form the company strategy and guide the company's capital allocation decisions towards a better outcome.

So two thoughts come to mind at this junction.

Firstly, it makes sense to always re-evaluate a stock you are holding once there is a CEO change. Will the new CEO change the strategy? How? If not, why not? While a change in CEO may not dictate a change in investment decision, it certainly should trigger an evaluation thereof.

Secondly, perhaps it is not a CEO that makes a company, but a CEO that picks a company. The underlying truth of what Schmidt said about accepting a seat on a rocket is that Schmidt did not actually build Google (nor probable add much lasting value to the business beyond "investor confidence" in a legit CEO), but he did pick the right company to jump on board as a CEO.

As much as I have lyrically waxed on about CEOs earlier in this article, I do think that some CEOs view their careers in the same way as we view our investments: pick a winning company and then back the winning company. It is not so much that the company picks the right CEO, but the CEO picks the right company to be associated with. If in the process they just happen to look good and get a load of bonuses and share options, well then they surely can't be blamed...

This has been a bit of an abstract article, but I do hope its stimulating some thoughts. Before I end the article, though, I want to make one last point.

I find the cliche perspective that the time horizon for long-term is "forever" quite misleading. This appears largely built on the over-quoted Warren Buffet saying how his "...favorite holding period is forever." I absolutely disagree. In fact, I find this a oversimplification perhaps only for the purpose of getting quoted (much like the Internet has "link bait", I see a lot of "quote bait" in what Buffet says).

As time goes on, staff in a company retire and get replaced with new staff with new agendas and new ideas. This includes management and, certainly, the CEO. Also, markets change and technology leapfrogs in unexpected directions creating new business models and, certainly, killing old ones.

An excellent business today will be a completely different animal (for better or worse) in fifty years time. If it even exists then. A succession of CEOs would have left differing legacies by then, as the natural staff turnover implies that you have a brand new workforce and the dynamics of the (global) markets means that the world is simply a different place.

Logically, should you not keep re-evaluating your investment? And, logically, this could lead to you exiting it.
Update on Calgro M3

Calgro M3 (CGR) released its FY 13 results with revenue rising by 55% to R798m (FY 12: 515m). The Group's GP margin widened to 18.53% (FY 12: 15.44%) lifting HEPS up by 40% to 71.84cps (FY 12: 51.44cps). ROE rose to 32.41% (FY 12: 31.81%) as the cash generation remained healthy for a fast growing business and its balance sheet’s gearing remained arguably low.

Download the FY 13 results presentation here.

Calgro's low income project pipeline is c.40,000 units with an estimated project revenue of c.R10bn over an approximate time horizon 6 years (actually closer to R11.6bn over 6 years, weighted towards the nearest 3 to 4 years). The Group’s Mid-to-High (c.R0.8m to R1.8m market price per unit) project pipeline is worth a further R1bn in revenues.

Now South Africa’s demand for housing is quite simply huge. As a major player in the market, Calgro M3 estimates it only addresses c.3% of the market needs.

Thus, the Group finds that the major risk facing it as a business is “uncontrolled growth”. Management constantly undertake a careful process of building capacity, managing cash flows and handling liquidity to ensure the growth trajectory is sustainable.

In FY 13, management estimate that Calgro's revenue could have been as high as 50% more had they cast the risk of uncontrolled growth to the wind and simply chased growth! But, beyond even the question of funding this scenario's level of growth, the reality is that the quality of delivery would likely have dropped and thus begun to risk the business’s sustainability via reputational risk.

Despite this endless demand for local housing, the reality is that the Group does operate in a fairly cyclical industry. Thus the Group only employs 93 permanent staff and management assert that they can "flip the switch" at any time on its cost base. Specifically, management say that they can wind down 50% of the Group’s cost-base within 60 days of deciding to do so (i.e. a huge portion of costs are variable in nature) and can expand or contract depending on the project pipeline.

Playing around with a rough DCF, I still get a fair value of around R10 per CGR share... See my previous article on Calgro M3 here: Calgro M3 - Rough Valuation.

Overall, Calgro M3 continues to be one of the most exciting small caps I see in our market.
Construction Sector Graphs

Following Stefanutti Stocks (SSK) results earlier this week (Cadiz and Chemspec Updates and Coronation Results), I have begun to notice what may be the end of the margin crunch being felt by this sector.

The local construction sector's recent margin crunch has really been driven by excess construction sector capacity following the 2010 World Cup boom. This capacity has either gone belly-up, moved into Africa or been consolidated by now, thus leaving the industry where it is now (or, at least, where it will be soon).

So, a couple aspects of the Stefanutti results perked my interest. Thus I've spent some time building a series of graphs attempting to find leading indicators (of various sorts) for where the local construction industry may be heading over the next 1 to 3 years.

(Click on the image below to see an enlarged version in a new window.)

Sources: I-Net Bridge; Workings

I think the graphs say more than I could...
Cadiz and Chemspec Updates and Coronation Results

Cadiz (CDZ) has been through a terrible couple of years as its been desperately seeking the way forward. As a niche financial services and investment management group, this stands in stark contrast with the great success of Coronation (CML) over the same period.

Going slightly off topic, but this serves as an excellent example of what I absolutely disagree with those people that use a "top down" approach to investing. They invest in grand themes and stories and sectors, but often skimp on the actually company-specific research. If you had invested in "local asset managers and small cap financials" as a theme, you may have picked Cadiz over Coronation a couple years ago...

Just food for thought.

Now, getting back to Cadiz, the Group released an positive trading update indicating that FY 13 HEPS is expected to be greater than 1.5pcs. The Group gives no upper limit, but at least the Group is now profitable. Unfortunately, at 1.5cps HEPS the share is on a PE of > 90.0x!

I guess we will have to wait and see for the full results to be released on or about 27 May 2013.

Contrasting with Cadiz turnaround, Coronation Fund Managers (CML) has been an astounding success story. Coronation also just released another fantastic set of results this morning and hosted an interesting conference call.

Regarding the Group's results, Assets Under Management (AUM) rise 21% to R409bn helping drive revenues from fund management up 62% and lift HEPS by 89%. The Group's BEE scheme has been flipped up to Group-level, thus the shares in issue expanded by 11%, but Cost-to-Income dropped o 48% from 51%.

The Group continues absorbing good local AUM inflows, with aggregate AUM predominantly still lying in the local equity markets (c.54.4%) and local fixed interest (c.26.8%). The blue sky, though, is Coronation's drive with its Global Emerging Markets (GEMs) funds into Africa and its international expansion strategy still bringing in strong new funds to management.

Coronation's share price, though, is up almost 100% in the last year and the question bouncing around the market remains: how much more?

It is always easier to manage AUM inflows than to manage AUM outflows. Coronation is yet to really test its expertise when redemptions drive mass liquidations of positions and both have the snowball effect on returns (and thus performance fees). Perhaps it will never come to this, but AUM is fickle and flows where the sentiment points.

Moving from financials to industrials, Chemical Specialities (CSP) or Chemspec has been attempting a multi-period turnaround. The Group really manages a key paint manufacturing plant in KZN that produces its own range of branded paints as well as some contract manufacturing for other branded paints.

The Group announced yesterday that "...for the year ended 31 March 2013, ChemSpec expects that the headline loss will be between 2.75cps and 3.16cps compared to the headline loss of 2.06cps reported in the previous corresponding period. Loss per share is expected to be between 2.70cps and 3.12cps compared to the loss of 2.13cps as reported in the previous corresponding period."

So the turnaround is not going so well.

Interestingly (or sadly, depending on which way you view this piece of "PR"), Chemspec goes on to say that "...while this is disappointing shareholders should bear in mind that the group has gone through major restructure and turnaround over the last two years which management and the board are confident will bear fruit in the coming financial year. The company is well capitalized, has a strong executive team in place and continues to experience market share growth particularly in the South African market. While we had hoped a return to profit had been earlier we still remain confident of rewarding patient medium to long term investors and we would hope that shareholders see this loss as a base setter for a prosperous future rather than as a negative."

So the loss is a good thing?

While I respect the management involved in Chemspec's turnaround, this is a very weak statement from them.

The reality is the paint is just a commodity. What brand paint are on the walls around you right now? What brand paint do you have on the walls at home? Aaaah, you have no idea. Neither do I. No one knows, and no one really cares about paint brands. Hence, paint is a commodity and has no pricing power. All you have is a low-cost advantage and a route-to-market advantage. Scale is key here too.

I suspect this lack of pricing power is the real challenge in a business model like Chemspec's that has large operating leverage and is operating in a soft market, no matter how spectacular management is.

Still, management does have a great track record and perhaps they can pull a rabbit out of the hat here? Time will tell...