By: Marc Hasenfuss Source: FinancialMail
Pricing discrepancies offer those who want to take advantage of them abundant opportunities to pursue on the JSE
An increased number of buyouts and more evidence of feisty profit performances are not stopping the ongoing derating of small-cap stocks on the JSE.
Research by the team of alternative investment house Westbrooke’s Special Opportunities Fund shows a drastic and intriguing fall in valuations of small-and mid-cap counters from about November.
In the third quarter of 2018 the average p:e of listed companies with a market capitalisation below R10bn was nine and that of those with a capitalisation below R2bn was about seven.
By the end of January that gap had widened significantly. The valuations on larger stocks had remained more or less the same, but for smaller-cap counters below R2bn the rating had slunk down to just 5.5.
It is clear that political uncertainty — especially in the wake of reckless rhetoric ahead of the election — has spooked investors about prospects for domestically focused counters.
No surprise, then, that the JSE’s solid performance has been driven by global groups like Naspers and the large mining conglomerates, as well as the “bounce” in large dual-listings such as AB InBev, Richemont and British American Tobacco.
Westbrooke also says a lack of capital and research has resulted in valuation multiples among the JSE’s small-cap counters declining to lower than historical norms and equivalent private-company valuations.
The latter part of this contention is interesting. Westbrooke’s analysis of merger & acquisition transactions indicate that private companies are valued at a 40%-50% premium to similar listed companies.
When it comes to listed investment companies — especially those holding smaller unlisted companies in their portfolios, such as EPE Capital Partners, Sabvest, RECM & Calibre, Trematon and African Rainbow Capital — the market is discounting the multiples applied to the valuation of underlying holdings.
Most investment holding companies on the JSE are trading at deep discounts, well above the traditional 15%-20% applied to such counters when assets are considered to be of reasonable quality and management is well regarded in terms of capital deployment.
In the rather bizarre case of Stellar Capital Partners, three large investments – Torre Industries, financial services group Prescient and security technology firm Amecor — were sold off at prices well ahead of market expectations. Stellar’s shares rallied on news of these corporate actions, but have since drifted back to offer a 45% discount on the latest sum-of-the-parts valuation of 120c a share. The market doubts there will be a large cash disbursement to shareholders any time soon.
Westbrooke has built a significant stake in Stellar. Westbrooke executive Jarred Winer tells the FM that he has engaged with management about the cash-deployment strategy to unlock shareholder value.
The key reference points for valuing small-cap counters have obviously been the recent handful of takeover and minority-shareholder buyout pitches – all of which, save the dismal Distribution & Warehousing Network, were executed at substantial premiums to the 30-day volume weighted average price (VWAP).
Intriguingly, three of these deals — Clover, Interwaste and Howden Africa — involved foreign suitors, which might suggest local investors are too jaundiced in their valuation outlook.
For the record, the Howden buyout by the company’s American parent was executed at a more than 20% premium to VWAP, Interwaste at closer to 50% and Clover at a hefty 70%.
Before the takeover bids, Howden and Interwaste, as well as other “take-outs” like Cargo Carriers and Verimark, were trading on a trailing earnings multiple of low single digits, and the same would go for Clover based on a forward earnings multiple applied retrospectively to the pre-offer share price.
Details of private equity transactions are a little more difficult to obtain.
But Westbrooke’s estimate is that such transactions below R2bn averaged at between five and eight times EV/ebitda (enterprise value divided by earnings before interest, tax, depreciation and amortisation) multiples, which is a significant premium to the five times EV multiple the sector trades at. For transactions above R2bn the average was between seven and nine times.
Listed private equity investor EPE Capital Partners disclosed in its recent interim results that its average earnings/ebitda multiple applied to investments was around 7.6.
For investors hoping to take advantage of such a pricing discrepancy, there is an abundance of opportunities to pursue on the JSE.
The FM recommends looking for neglected companies with a potential break-up value well in excess of the share price, as well as counters where an extended earnings track record or the potential of respective trading niches is being overlooked.
The FM suggests investors take a closer look at these five counters:
• CSG Holdings: This services company still carries the taint of “labour broking” despite its well-documented exertions in building a services bouquet, especially in the high-demand security services segment. The share trades on a trailing earnings multiple of three, and just over four on a forward basis.
With a market capitalisation shy of R320m, CSG is not exactly going to stretch the balance sheet of any meaningful player in the services sector.
• Nu-World Holdings: There’s probably no other counter on the JSE that can boast such a consistent record of profitability over 32 years as this humble assembler and distributor of an array of household and consumer goods.
• Nu-World trades at a discount to NAV and on a desultory five times historical earnings multiple (with a +7% yield thrown in for good measure). Surely the time is nigh for strategic shareholder Wild Rose Capital to pitch a premium buyout offer to the Goldberg family (which still manages the business) and minorities?
• Argent Industrial: This mini-industrial conglomerate has finally started working determinedly towards narrowing the gap on its NAV, selling surplus properties and embarking on share buyback exercises. Last-stated NAV was R11.97 a share, with interim earnings to end-September of 50c a share suggesting a forward earnings multiple of less than five.
The FM estimates tangible NAV at R10.43 a share, which is still roughly double the ruling share price. Break-up value abounds, should executives be that way inclined.
• enX Group: This recently assembled industrial products and services conglomerate has already signalled that it is willing to review (in other words, sell off, partially sell off or merge) certain of its key operational assets. Considering the strong services element in enX’s businesses, this share should probably not be trading close to tangible NAV. If a deal is clinched to sell all or part of the fleet management business, the transaction price could offer meaningful value guidance in future.
• Grand Parade Investments (GPI): With Value Capital Partners emerging as the shareholder of reference and the influence of founder and executive chair Hassen Adams waning, this empowerment counter looks poised to unlock considerable value.
The gaming assets, most notably the stakes in GrandWest and the Sun Slots limited payout machine operation, are worth the price of admission alone. The tricky bit is whether GPI should bank on its Burger King venture eventually dishing up profits, or cut its losses and hand the business over to an experienced fast-food brands operator.