The world is entering an unprecedented time and there is no historical playbook for what happens next. While not our base case, calamity risk is increasing (mass infections across SA, with dire economic consequences), and nobody knows how to quantify this risk. We have many requests from clients asking for investment opportunities in this crash and we are happy to share our fundamental views. However, investors in any equities must bear in mind that, in the shorter term, cheap shares can get even cheaper and wild swings are likely. Our views are based on a 12-to 24-month timeline, with a base case scenario of the world normalising during this time period. So, risks have to be taken into account and any investment in equities should be considered in this context. Shares only become this cheap when risks are extremely high.
The past few weeks have seen global markets endure the most volatile period in history. The VIX, a US index tracking the stock market’s expectations for volatility over the next 30 days and derived from price inputs of S&P 500 Index options, hit all-time highs recently, surpassing the records it set during the 2008 GFC. This volatility was due to the rapid worldwide spread of COVID-19 and the draconian, albeit very much justified, measures taken by global governments to fight the pandemic. Entire economies are being shut down with people forced to stay at home and to enact social distancing. The ramifications which these measures will have on the global economy will be severe, but (and this is what is causing the market volatility) almost impossible to quantify.
Having said that, it is important to keep a clear mind when looking at the extreme share price movements on the JSE. While we might agree that earnings for many companies will be decimated in the next few months, as it is very difficult to sell your products/services when everybody is staying at home, the human race is also extremely resilient. Looking at how Asian economies have reacted; it would appear to us that economic activity will return to normal after about two to three months.
With this as our base case, we have decided to look for the opportunities currently being created in the SA market. Our criteria are simple – we are looking for quality, high-growth and high return on equity (ROE) companies with strong balance sheets that can withstand a short-term cash drain. Many of these companies have in the past appeared too expensive for us to stomach and this sell-off may provide an opportunity for investors to accumulate these compounders at very attractive entry points.
Tencent, Naspers’ most significant investment, reported very strong earnings during the week of 16 March (unfortunately, not the best week to report strong results). Revenue grew by 26% YoY and operating profit jumped by 35% YoY. But what was even more heartening was how well the company is progressing at diversifying its earnings base and setting itself up for more growth going
forward. Advertising, financial services and international gaming (outside of China) continue to contribute a greater proportion of revenue and management are guiding that this is set to continue. Tencent also continued to generate significant cash flow and, ironically, although management was reluctant to elaborate on this on the company’s investor conference call, the COVID-19 outbreak has resulted in a boost for its gaming segment and other online revenue.
Moving to Naspers, we note that holding company structures have come under pressure during this sell-off. Naspers is currently trading at a c. 50% discount to the value of its underlying investments or net asset value (NAV) and a 40% discount to the value of its investment in Tencent alone. This is the widest discount to NAV that we have ever witnessed for Naspers and the Group has, in its own right, established very attractive investment opportunities in the exciting spaces of online classifieds, food delivery and financial technology (fintech).
Naspers management have committed to try and close this discount and the company has sold some Prosus shares, which will potentially be used to buy back Naspers shares. At current levels, management are looking like geniuses, if they start buying now.
The wide discount to NAV, the attractive growth profiles of Tencent and the other investment companies and the additional optionality of management actively trying to close the discount, all combine to make this Naspers opportunity extremely attractive for investors.
Transaction Capital has been a great compounder over the past few years, even in the face of some dire local economic growth. Its SA Taxi financing business, which provides financing and other ancillary services (including insurance and buying groups for tyres and fuel) to mini-bus taxi operators, has continued to perform well as the mini-bus taxi industry established itself as the most effective public transport system in SA. The COVID-19 outbreak may cause some of these operators to come under pressure due to a lack of commuters, but this should be somewhat negated by a reduction in local fuel prices. Over the past few years, SA Taxi has also built a strong and widening competitive moat through its vertical integration and data collection on taxi routes.
The collection services business may struggle somewhat in the current environment but, as management highlighted, Transaction Capital purchased these collection books at very attractive prices. Thus, it should be able to weather the economic impact that may arise from the COVID-19 clampdowns.
At our last engagement with management following the COVID-19 outbreak, they maintained their guidance of 15% to 17% CAGR in earnings for the next three years, with some downside risk to this financial year (FY20). With a very strong balance sheet and trading at a historic PE ratio of c. 10x, we believe that this potential downside is more than accounted for at its current, very attractive, entry point.
A very experienced industrial analyst once said that BidCorp’s portfolio of assets is one of the most resilient and highest quality he has ever had the privilege to analyse, and he has covered many industrial companies globally. We tend to agree.
BidCorp has built a strong business network supplying food services to restaurants and hotels, community services (hospitals, prisons, etc.) and airlines. Over the years, the company has managed to acquire small independent food-services businesses and bring these under the BidCorp banner. This gave these entrepreneurs the stability of funding and infrastructure of a large corporate, but also provided them with the freedom to build and grow their businesses further. It was a formula that worked, and it helped BidCorp become a compounder of note, growing earnings every year by between 10% and 15%.
Unfortunately, the COVID-19 outbreak, and the subsequent clampdown, hit exactly those economies in which BidCorp operates and the market duly punished the share price. Nevertheless, we note that at our last engagement with management following the COVID-19 outbreak, they were surprisingly upbeat. According to them “… BidCorp is in the food business, people need to eat.” BidCorp also services all food delivery and many food-retail companies that are doing very well in the current environment. BidCorp is also seeing significant opportunities in these trying times as many entrepreneurs are engaging with it to enter the BidCorp family of companies. In addition, its strong balance sheet will allow the Group to take advantage of these opportunities.
At a historic PE ratio of 12x, we believe that this is a great opportunity to buy into a high-quality company.
Discovery is one of the few SA companies with a truly global mindset. The company’s concept of “shared values” (rewarding people who live healthier and who change their behaviour and using the data to price policies better and engage more effectively with customers) in insurance is truly a novel approach and it has a competitive advantage against its competitors, even on a global stage. One only has to look at how many competitors have tried (with limited success) to mimic the concept or how global giants such as Ping An, Apple, AIA, John Hancock, Generali and many more, have approached Discovery to collaborate with them, to see that its business model has value and significant opportunities to scale up.
Recently, Discovery has taken these same principles of “shared values” to short-term insurance and banking. The jury is still out as to whether it will be as successful in these market segments as it has been in life insurance, but the growth potential is huge. It is again interesting to note how competitors in both sectors immediately started to mimic this Discovery concept. These investments into new business segments in SA have, however, come at a cost. Despite this, we believe that over the next five years the cost of investment will start to decline and the operational leverage in these new ventures will cause a strong J-curve effect on the income statement.
Fears surrounding the negative impact of the COVID-19 on claims ratios and a weak balance sheet have caused the market to punish this share disproportionately over the past few months, in our view. Discovery is currently trading at prices last seen in 2014. We engaged with Discovery management during the past week and tested them on these two fears – we exited the meeting feeling even more confident that this is a great buying opportunity.
Management were adamant that Discovery’s balance sheet is healthy and that even in an extreme stress scenario the company will not need additional capital. One key point management highlighted was that Discovery’s greatest risk to requiring additional capital is if it exceeds its own growth expectations. Given the nature of a life insurer, and especially an early stage growth life insurer, the capital requirement is very severe upfront. If the value of new business was to reduce, the capital strain will actually decline and improve the firm’s own cash generation.
Discovery was also very fortunate, through its joint venture with Chinese financial services group, Ping An, to have experienced first-hand the consequences of the COVID-19 outbreak on everyday life in China and the subsequent impact of the virus on life- and medical insurers in that country (surprisingly, we note that the outbreak had a positive impact on premiums for these businesses). In the greater context, the mortality experience due to the outbreak was minimal vs expectations. In fact, companies had positive claims experience vs expectations, as people started to prioritise only going to a hospital in severe situations. Nobody is going to go to hospital for a toothache, while the world is on high alert due to a pandemic. Thus, insurers recorded a strong uptick in sales, as people became acutely aware of their own mortality and started to buy life insurance and medical cover.
Of course, the real risk is what will happen if the world falls into a deep recession due to the outbreak. This will be negative for earnings but allowing your life insurance and medical cover to lapse is nevertheless likely to be low on the list for most people.
Overall, we see the balance sheet and claims ratio spike risks as being overblown and we believe that Discovery can become a truly global player in the insurance space. The current market sell-off provides a great opportunity for investors to jump on for the ride.
Capitec has defied gravity for almost a decade, navigating through the African Bank crisis, weak economic growth and even an attack by short-seller, Viceroy Research, to compound its earnings by 27% p.a. for the past decade. Over the course of the decade, Capitec has also transformed from a pure unsecured credit provider to a far more diversified financial services Group. Net transactional fee income and funeral cover sales contribute 46% of its net income and covers 91% of operating expenses. The bank is also very conservatively capitalised, with ample liquidity coverage and a very low leverage ratio of only 5 times. The company targets a ROE of 25%, but it has achieved a ROE of 27% over the past few years.
The acquisition of Mercantile Bank has opened up exciting new growth avenues for Capitec. The small- to medium-sized enterprise market has been very underserviced by the big-four banks (ABSA, Standard Bank, Nedbank and FirstRand) and, in our view, Capitec’s simplistic and affordable product offering will be extremely attractive to these entrepreneurs. Capitec’s entry into business banking and the continued growth of its credit card book and funeral cover policies will allow Capitec to continue to grow at the high-teens to low-20% over the next three to five years.
Although we do believe that the next financial year (FY20) may be tough for Capitec, we also think that once the initial impact of the COVID-19 outbreak has passed, Capitec will resume on its high-growth path. We are mindful of the fact that Capitec is ensured by a third-party against defaults due to retrenchment and death on all of its products. The bank is also well-funded with its retail deposits exceeding its credit book.
We have always been reluctant to buy into Capitec, even considering the exciting growth prospects, because we believe that the market was pricing it for perfection at close to a 20x historic PE. However, at current valuation levels, the share provides a rare attractive entry point in a high-quality business.
Discretionary spending may not be a space you want to invest in when people are not leaving their homes but, sometimes, an investor has to look through one year of bad earnings and buy a quality company for the decades to come. We believe that Mr Price falls squarely into this category.
Running through our modelling and based on what we have learned thus far from European and Asian apparel retailers, Mr Price will likely see a decline in earnings of between 30% to 40% YoY. It will, however, recover reasonably strongly after that, in our view.
Sitting on a cash balance equal to c. 12% of the current market cap and still generating free cash flow of 7.7% going forward, the management team are in the fortunate position to take advantage of this difficult environment. Management have already dismissed expansion into new markets, so they may be looking at buying back shares at the current depressed share price levels.
Mr Price is a high-quality business generating ROEs in excess of 30% (including the cash drain) and is trading on a very attractive valuation of 10x historic earnings.
The global financial market has been in turmoil. Rumours of liquidity squeezes in the financial system have resulted in global banking counters being severely punished. Across the world, banking stocks are down by between 60% and 40%. And SA banks have not been spared!
Regulators globally have reacted by injecting liquidity into the system. We maintain that these measures should be enough, and we are not expecting (as things currently stand) to see any significant bank failures due to the COVID-19 outbreak.
As such, we believe that SA banking shares are providing some exceptional opportunities and we can probably have listed any of the big local banks here for a good opportunity to enter. However, in times of extreme dislocation the market provides the opportunity to buy an Audi at the price of a Fiat 500 and that is why we picked the gold standard of SA banking stocks – FirstRand.
Although we acknowledge that revenue growth will be lacklustre for the next few years and that bad debts may continue to tick up, FirstRand’s dividend yield should be sustainable as this environment will have a limited demand for capital. The bank is also diverse enough to absorb the uptick in bad debt and the management team has been extremely conservative on the lending front over the past few years, which should protect the bank from an extreme blowout in bad debts.
Generating a ROE of between 18% and 22% going forward and offering a dividend yield of 9% at current prices, we believe that this is a great opportunity to buy.
Bidvest’s stable earnings growth profile and its diversified income streams have ensured that the company has evolved into one of the cornerstone stocks in many SA portfolios. With a presence in freight, office management, trading and distribution as well as automotive dealerships, Bidvest’s presence in the domestic economy is indeed far and wide. Bidvest has also been one of the few local companies that has successfully expanded beyond our borders. It first started to venture into food services, building an attractive and scalable portfolio of assets, and later independently listed BidCorp. More recently, the firm ventured into office management and hygiene markets with the acquisition of Noonan in the UK and Ireland and PHS in England. These latest acquisitions are still in the bedding-down phase, but Bidvest’s management team has a very good track record of successfully incorporating new businesses under the Bidvest umbrella.
Several of Bidvest’s businesses are in the eye of the COVID-19 storm, which is both a positive and a negative for the company. Many of its aviation and travel-facing businesses will face tough times as the world goes into lockdown and global travel grinds to a halt. Management have guided that the company is working closely with its customers to ensure the viability of the industry going forward. Bidvest’s freight division is very reliant on export volumes of chrome and manganese to China. These volumes were significantly down while China was in lockdown but should recover as China starts to re-open its industries. In Bidvest’s automotive and trading divisions, the impact is still difficult to assess and also very fluid, but it will, in all likelihood, be a tough few month for those divisions. On the positive side, the heightened awareness of hygiene is proving to be a boon for the company’s office management and hygiene divisions.
Overall, we believe that Bidvest’s earnings will be under pressure in the short term, but then management are of the view that the Group’s well-diversified earnings stream and strong balance sheet will be able to absorb the economic shock.
In our view, the current valuation of 11x historic earnings provides an attractive entry point into a solid SA industrial company with the optionality of a successful global expansion almost for free. Given the success that Bidvest has had in building BidCorp this is a bet we will very happily take.
Since listing on the JSE in 2011, Curro has established itself as the largest private-education player in SA. From 4,200 learners in 2011, Curro has grown its learner base by 35% p.a. to 62,700 in 2020. These expansions have, of course, come at a cost with Curro spending significantly on new schools or upgrading older school to accommodate these new learners. Curro spent R1.3bn in 2019 alone, with plans to spend another R1bn in 2020. To December 2019, Curro has spent a cumulative R10.2bn in capital!
During the initial stages, Curro used the equity market to fund its expansion plans and it has successfully completed a number of capital raises from 2011 to 2015, which helped the company reach scale. From 2016, however, Curro started tapping debt markets to fund its capital requirements. With very strong and defensive cash flow generation, banks were more than willing to extend credit to Curro at very attractive interest rates. But even at these attractive rates, Curro’s interest expense started to increase aggressively, growing from R55mn in 2014 to R243mn in 2019 (by 35% p.a.). A lagging local economy resulted in Curro’s EBITDA underperforming its growth in interest expense (which advanced by 29% p.a.), and this dynamic combined with a higher depreciation and amortisation charge culminated in Curro reporting a 15% YoY decline in earnings (to ZAc51/share).
The market took these results very negatively and sold the share down aggressively. But, as always, the market tends to overreact and share prices very quickly swung from overvalued to undervalued. We believe that Curro is now pricing in a doomsday scenario, and that the market is placing too great a focus on earnings and ignoring the structural momentum which the company continues to maintain.
The key stat that we focus on is learner growth. Curro has continued to grow this measure at a robust rate, albeit at a slightly slower pace than the company would have liked. Curro’s pricing has remained strong and it has been able to maintain fee growth at a higher rate than inflation. We still expect turnover growth in excess of 15% YoY for 2020 and, in the current local economic environment, that is very strong. Earnings will continue to be depressed due to higher interest expense and depreciation charges, but we believe that Curro is past its peak in terms of capital expenditure requirements and it now just needs to fill excess capacity.
Education remains a defensive sector. People want to get the best education for their children and, even in a COVID-19 shock, people will continue to try and find a way to provide their children with high-quality education. The current poor economic conditions may place a brake on Curro’s growth ambitions, but we still think that the market is completely overpricing the counter’s downside risk. It is important to remember that Curro’s debt profile is due to its expansion and the firm can choose to slow that down if it believes it to be prudent, which will change the profile significantly for the better.
Trading at an enterprise value less than 70% of its cumulative capital expenditure over the past 7 years, provides a fantastic opportunity to enter a high-quality company.
In times of extreme market volatility (and corrections), it is often unnecessary for investors to look far down the quality curve to find attractive opportunities that will generate significant returns in future. This is oftentimes the correct strategy as those economic uncertainties causing market volatility can have far more dire consequences for lower-quality businesses. This can make a company look inexpensive on the surface, but the upside might be limited as the business first has to struggle through an earnings trough, or raise equity to shore up its balance sheet which will, in turn, dilute current shareholder returns.
However, sometimes it is worth taking the risk. During market corrections, fundamentals are often ignored, and some market participants will sell a share at any price. It is at these prices where, we believe, the risk-return profile is so attractive that these counters deserve a small allocation in a diversified portfolio. These calculated risks may just turn out to be some of the best performers in an investor’s portfolio.
With that as background, we have scoured the SA market for some very exciting investment opportunities. We concede that these opportunities do come with some risks, whether it be debt, currency, regulation, liquidity or, in some cases, a combination of these factors, associated with them. Nevertheless, we believe that, at current valuation levels, the investor is more than compensated for such risks. So, put your hard hat on and prepare for some volatility although, at the end of the day, we are confident that a portfolio of these shares will reward investors handsomely.
If one were to draw up a list of countries where it is notoriously difficult to do business, and that also have extremely volatile regulatory and economic environments, the chances are that a large number of these nations will be among the 21 countries in which MTN operates. Initially, with major global mobile operators reluctant to enter these markets and regulations being fairly light, these countries held the appeal of attractive EM growth potential, with limited competition, for MTN.
While this worked well in the beginning, over recent years MTN has appeared to stumble from one exogenous shock to the next – wars, extreme currency volatility, sanctions, exorbitant regulatory penalties and various lawsuits – but the company has weathered all these setbacks. MTN’s vulnerability to these exogenous events means that it is typically sold off, particularly aggressively during periods of risk aversion. This time around, the market sell-off was amplified by the collapse in the oil price, to which a number of MTN’s markets are vulnerable (especially Nigeria).
With MTN’s share price falling to below the R40/share level in early March, the counter had at that stage declined >85% from its 2014 peak. It has since posted some gains but is still trading at levels last seen in 2005 and thus we see definite upside to the current share price.
In an industry where scale is critical, the significance of MTN being a top-two market share operator across all the markets in which it operates should not be underestimated. Where the telecommunications sector globally has largely been consigned by investors to the status of an ex-growth utility, MTN stands apart for several reasons. First, many of the Group’s markets still have further opportunities to increase penetration of mobile
telecommunications and the potential to migrate those users to smart devices and drive data adoption. Second, while most DM operators are confined to the provision of commoditised voice and data services, MTN is capitalising on opportunities to also add digital and mobile financial services.
Although MTN CEO, Rob Shuter has announced that he will be leaving the company at the end of his contract in one year’s time, he assembled a very competent management team during his tenure. Shuter has set the Group on a self-correction course. This includes the disposal of non-core assets, with proceeds being used to pay down debt (R14bn in sales were raised in the first year, with guidance of a further R25bn to be realised over the next few years) and paying particular attention to turning around some of the Group’s underperforming business units.
Since many of MTN’s new revenue streams do not require significant capital investment and are delivered through over-the-top platforms already in place, it has enabled the company to provide guidance of low double-digit revenue growth, margin expansion and relatively flat capital expenditure over the next 3-5 years. With the strong double-digit growth in free cash generation that this guidance implies, MTN is targeting annual dividend growth of 10%-20%.
Even at the bottom of the dividend guidance range, the prospective dividend yield is 15%, while the price as a multiple of expected earnings in 12 months’ time is 5x. No doubt, Brent Crude oil at below $30/bbl poses risk in the short term of foreign exchange availability and currency devaluation in Nigeria (MTN’s largest profit generator in FY19, accounting for c. 40% of group EBITDA). However, we are mindful of the oil industry saying, “the best cure for low oil prices, is low oil prices” and it is unlikely that the current situation will be sustained long term. At current levels, we believe there is now enough of a margin of safety in MTN’s share price to compensate for the risks it presents, with the potential for a strong recovery as current headwinds abate.
Over the past four decades, Stephen Koseff and Bernard Kantor created an institution. Built on the foundation of entrepreneurship and being agile and nimble to service its customers, the distinctive zebra logo became one of the most widely recognised symbols in SA financial markets.
In the early 2000s, Investec started to expand offshore with the UK being a key target market. Unfortunately, the UK’s highly competitive banking environment, ever more draconian and complex regulation and a GFC that hit just as Investec started to expand aggressively in the UK, made the experience far more lacklustre than the firm’s local successes. However, the company stayed the course, and, over time, Investec has built a strong UK presence.
Nevertheless, the UK remains a considerable drag on the Group’s profitability and ROE. Since the disastrous acquisition of Kensington in 2007 and the harsher regulatory environment post the 2008 GFC, Investec’s UK division has struggled to achieve a ROE greater than its cost of capital. This has resulted in Investec rightfully trading at a discount to its book value for significant periods since the GFC.
This discount to book value reached extremely low levels during the current sell-off, trading at close to 0.3x book. In addition, it coincides with some real positive changes taking root at Investec. The old guard has moved on and the new management team have taken decisive steps to improve the profitability of the bank.
Management unbundled the asset management division to make the structure less complex, committed to improving the cost-to-income ratio in the UK and promised that there were no sacrosanct segments of the business that will not be cut in the event of underperformance. We are still at the initial stages of the new regime and it will be interesting to see whether management can indeed improve the UK division’s ROE.
Although we acknowledge that Investec is not the highest-quality bank in the world and its earnings growth and ROE profile are far more volatile than its SA peers, we believe that the current share price provides an opportunity to enter at depressed multiples that more than sufficiently reflect the lower quality. And, the investor may yet benefit from an improvement in operating metrics as the new management team start their work.
The platinum group metals (PGM) miners were the talking point of 2019. After being priced for bankruptcy in 2018, the price of the PGM basket recovered in 2019 resulting in the share prices of these miners rallying by 250% or more. The higher basket price helped these miners reduce their leverage with some of the mining companies going into a net cash position. It was a remarkable turnaround and highlighted just how cyclical the fortunes of these businesses are. Which begs the question, do you want to buy into such a cyclical industry in these uncertain times?
It is a fair question, and the answer very much depends on the risk tolerance of the investor. The reason why we are comfortable with a small position in Northam is due to the precarious demand-supply balance which the industry faced going into the COVID-19 crisis.
Prior to 2019, the threat of electric vehicles (EVs) caused the PGM basket price to remain below the breakeven price for mining companies and they battled to survive. Capital expenditure was cut across the board, with mining firms struggling to pay for maintenance capex, not to even mention expansionary capex.
Then, in 2019, the combination of a greater focus on carbon emission worldwide, the more enhanced testing after the VW scandal and the lack of R&D in combustion engines over the preceding few years forced vehicle manufacturers to just add more and more PGMs in their respective catalytic converters as emission standards became more onerous. With the costs of PGMs a small fraction of the total vehicle production cost, they had the luxury to do this. Demand for these metals surged and the miners were not in a position to increase supply. This caused PGM prices to rally, with rhodium and palladium hitting all-time highs.
In our view, this situation will not change in the short- to medium-term, despite the COVID-19 outbreak and the subsequent decline in global vehicle sales. We expect demand to remain strong due to higher emission standards. Importantly, the threat of EVs, which are expected to be close to 50% of global vehicle sales by 2030, will prevent PGM miners from investing in new mines, thus keeping a constraint on the supply response.
Northam is one of the few PGM miners that will see strong volume growth over the next few years. Due to some tough decisions taken by management during the lean years, the company was able to shore up its balance sheet and it continued to invest in operations. As a result, we expect Northam’s annual production volumes to increase from c. 600k ounces this year to 1mn ounces over the next few years. Northam’s mines are also of a very high quality, operating at very low operating costs due to mechanisation. Trading at very attractive valuations and offering significant earnings (at spot PGM prices) and production growth, Northam is a high-quality operator in a very cyclical industry.
Alviva Holdings is not an exciting company! But it is one of the Africa’s largest providers of information and communication technology (ICT) products and services. The Group has three business segments – ICT Distribution, which imports ICT hardware and software and sells it into sub-Saharan Africa via resellers, Services and Solutions, which provides system integration and ICT solution services, and Financial Services, which provides leasing finance to small-, medium- and micro-sized enterprises (SMMEs) for their ICT products.
The risks to this business are real. It is difficult to see Alviva continuing to operate in the same verticals and products as it is currently working, in five years’ time. This is due to the ever-changing industry in which it operates. For example, cloud storage and processing will, likely, fundamentally change the role ICT service providers play in the lives of their customers. To survive, ICT service providers will have to adapt their business models quickly and also ensure that they have a balance sheet strong enough to absorb any shocks.
We believe that Alviva has both these traits. It has a very experienced and conservative management team, which have navigated through some very turbulent times in the past and we maintain that management should be able to continue to do so in future. In addition, management have also been conserving cash. Over the past few years, they have adopted a very conservative dividend policy, paying out only 10% of earnings in dividends.
At our last engagement with management, they conceded that the operating environment is very tough at the moment, adding that they were very disappointed in the company’s performance but that it should improve in the second half. Management have guided that they will first look to retire around R400mn in preference shares, after which they will engage with shareholders regarding potential share buybacks. Admittedly, this was before the COVID-19 outbreak.
However, Alviva’s valuation is ridiculous – it is currently trading at a historic PE ratio of c. 2x and a normalised free cash flow yield of 50% (and we believe that we are being conservative here), so the risk-reward profile for investors is very much skewed to the upside. Liquidity is a concern and we highlight that investors should be patient if investing in this counter.
In recent years, many SA (and global) conservative investors squirrelled their savings away in property shares to earn an attractive, growing income. This bubble burst over the last few months and even the highest quality property companies have seen their value decimated.
As discussed in the previous section, we believe that, in a base-case scenario, the adjusted book value of the SA listed property companies will be well below current book values, but higher than the prevailing share prices. We calculate that many property companies are fundamentally worth 50% to 100% more than current share prices (unless Armageddon prevails!). But there is a high risk of shareholders not getting dividends for one, or even two, years. The share prices are factoring in a far worse scenario than our base case. Investors should, however, focus on the balance sheet and track closely the progress the various firms make in degearing.
There is a long road ahead but, in our view, in the end, we will look back at this as a great opportunity to buy property shares. For the more conservative investor Growthpoint, with its lower LTV and diversified portfolio, is the most appropriate entry into the sector and for the more risk-tolerant investor, we believe that Redefine is offering significant value, but it comes with some real risks that should not be ignored.