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Ghost Bites (Harmony Gold | Life Healthcare | Mpact vs. Caxton | Thungela)

The Finance Ghost
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Ghost Bites (Harmony Gold | Life Healthcare | Mpact vs. Caxton | Thungela)

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Harmony Gold, or Harmony Copper?

Harmony is acquiring an Australian copper project for up to R4.1 billion

If your gold operations have been giving you a hard time, then what do you do? Apparently, you buy copper.

This is a big one. I mean, “gold” is literally in Harmony’s full name. Despite this, the company is looking to diversify its revenue by moving into copper. To settle some jitters you might already have, the deal is being funded with existing cash resources and net debt : EBITDA remains below 1x even after this transaction.

There’s some gold involved here. The target is the Eva copper project in Australia, which adds 1.718 billion pounds of copper and 200,000 ounces of gold to Harmony’s mineral reserves.

Harmony will acquire Eva in full from Copper Mountain Mining corporation. The price is an upfront payment of R3 billion plus a contingent consideration of up to R1.1 billion. It seems as though the price is in US dollars, so there’s a good chance of the rand amounts fluctuating. The contingent payments will be based on the declaration of the copper resources and a share of net revenue.

The construction period for the project is two to three years, which is quick by mining standards. This is an open pit mine with a simple process plant and low overall execution risks. The estimated requirement for development capital is $597 million. The expected life of mine is 15 years.

Life Healthcare emerges from the pandemic

EBITDA is flat or slightly down, as Life isn’t quite like the other healthcare groups

Life Healthcare is the latest hospital group to give us an update on post-Covid trading conditions. In a trading update for the year ended September, the group has indicated a modest improvement in revenue and a decline in EBITDA. That’s not great.

When you see an unusual result like this, you always need to dig deeper to figure out if there’s really a problem or if there’s a good explanation for this. In this case, you’ll discover that the UK business was a major beneficiary of Covid, in stark contrast to most other hospital groups. As the pandemic has eased, this has negatively impacted Life’s earnings from Alliance Medical Group (AMG), which saw revenue growth of between 1% and 4% but a decline in EBITDA of between 10% and 13%. Leaving aside the Covid contracts, AMG’s scan volumes were higher in all three major geographies (the UK, Italy and Ireland).

The Southern African operations have produced the type of result one would expect to see in a post-Covid environment, with revenue growth of between 3% and 6% and normalised EBITDA growth of between 3% and 8%. This implies an EBITDA margin of 17% to 18% vs. 17.1% last year. Interestingly, acquisitions have been mainly in the imaging market (i.e. radiology).

The impact at group level is revenue growth of between 3% and 6%, with normalised EBITDA lower by between 0% and 3%. The numbers were also impacted by the introduction of an employee share scheme this year.

I’m always nervous of “adjusted earnings” as management tends to just paper over the cracks in the business. In this case, they note that EBITDA would be between 6% and 9% higher were it not for the share scheme and the ending of Covid contracts. Sounds good, except that number also conveniently forgets that Covid in the base was negative for the South African business and so the growth rate looks better locally.

There’s no way to truly strip Covid out of this result.

Net debt to normalised EBITDA has increased from 1.82x to 2x over the past year. That’s a number that I would keep an eye on.

The wrong kind of Mpact

The public feud between Mpact and Caxton is just warming up

Here’s the good news: Caxton is writing SENS announcements that sound like an adult was involved in them as opposed to an angry teenager.

Here’s the bad news: it’s also quite clear that a lawyer is involved.

Yes, the fight between Caxton and Mpact is far from over. It gets weirder with every announcement, with plenty of mud being slung in both directions.

I’m going to try hard to get this summary right:

  • Caxton wanted to file a Rule 28 merger application (a separate filing) which is the case when a joint filing is not possible, for example where there is a hostile takeover.
  • According to Caxton, the application was refused because Mpact claimed that a major customer would be lost if a merger application was lodged (a highly unusual “poison pill” in this particular deal – though such pills can take many forms).
  • Mpact’s largest customer is Golden Era, which also happens to have a 10% shareholding in Mpact – this is the customer that Mpact alleged would be lost (and Caxton notes that confidential submissions were made by Mpact and Golden Era in this regard). This is because Golden Era and Caxton are hardcore competitors.
  • Caxton is arguing that this flight risk (the possibility of losing Golden Era) is price sensitive information, which should be disclosed and which directors of Mpact were aware of when trading in shares. Caxton notes that Mpact “apparently” defends this position by saying that the flight risk isn’t certain, which Caxton argues isn’t in line with the filings at the Competition Commission.
  • Mpact also alleges that Caxton is seeking to disclose this information in an attempt to get the share price to drop. Caxton strongly denies this (though it doesn’t take a rocket scientist to understand that a heavily depressed Mpact share price makes it an easier takeover target for Caxton).

There are various other fights underway, not least of all Caxton’s opposition to remuneration being paid to non-executive board members of Mpact. In response, Mpact appointed the non-execs to the board of the operating company and is paying them there.

There are other little daggers in the announcement, like Caxton claiming that Golden Era buys nearly half of the carton board output of Mpact’s Springs mill, as well as tens of thousands of tons of corrugated board. There’s also a claim that “independent sources confirm that Golden Era is already seeking alternative imported carton board sources of supply” – something that won’t do the Mpact share price any favours (whether true or not).

It is worth noting that Mpact has previously admitted to cartel conduct with Golden Era and has received conditional corporate leniency from the Commission. Golden Era has denied its participation. If any cartel activity is continuing, Mpact could face a fine of up to 10% of its turnover.

As you can see, there’s a lot going on here. Caxton holds 34% in Mpact and whilst any short-term negative effect on Mpact’s share price would hit the value of that stake, it would also make the remaining 66% a lot cheaper. There are very serious accusations flying around from both parties and Competition Law is no joke whatsoever.

The most significant step would be a Rule 28 application and Caxton is hoping for a positive outcome based on the Tribunal’s reconsideration thereof. This would test the theory of whether Golden Era will find other suppliers.

Get the popcorn!

Thungela can mitigate the Transnet strike

This tells you how useless Transnet is at the best of times

Just when you thought Transnet couldn’t possibly do more harm to our local mining industry, there’s now a strike by the United National Transport Union. The good news is that because Transnet is so useless, Thungela has already implemented various risk mitigation strategies for the inconsistent rail service.

Although railing to the Richards Bay Coal Terminal is now interrupted, Thungela has high stockpile levels in its operations. The business can manage seven days of interruptions without a significant impact on production, which tells you everything about the usual level of service from Transnet. If the strike lasts for two weeks, Thungela will need to curtail production and this will hurt export volumes.

The trick here is that the coal terminal can keep loading vessels, so Thungela can survive off its stockpile that is already at the port.

In a final example of how “easy” it is to do business in South Africa, Thungela is working with Transnet to deploy additional security measures on the coal corridor. This includes helicopter surveillance, amongst other measures.

Maybe Tom Cruise should’ve stuck around longer in South Africa to shoot the next Mission Impossible movie.

Little Bites

  • Zeder released a trading statement that seems concerning unless you read carefully. As an investment holding company, the measure is net asset value (NAV) per share. This is expected to be between 41.7% and 42.8% lower than the prior year. There are two good reasons for this: Zeder unbundled the stake in Kaap Agri in April and paid a large special dividend in May. The group has become a lot smaller as a result of the value unlock strategy. To assess the total return to shareholders, one would need to include the value of the Kaap Agri stake and the special dividend. In a silly missed opportunity, the announcement doesn’t give that calculation.
  • If you are a shareholder in Novus, you will want to be aware that the company has released the circular for the proposed acquisition of Pearson South Africa. This publishing house has a focus on textbooks and achieved revenue of R960 million and operating profit of R368 million in the year ended December. I had no idea that margins like this are achieved by publishers! You’ll find the full circular at this link.
  • Sirius Real Estate has achieved the early refinancing of the company’s next major debt expiry (a €170 million facility) approximately a year ahead of schedule. The refinanced facility is the same value and is priced at 4.26% over a seven year term. At group level, the impact is that the weighted average debt expiry moves from 3.8 years to 5.0 years and the weighted average cost of debt moves from 1.4% to 1.9%.
  • Pan African Resources has closed the transaction to acquire the Mintails SA assets for R50 million. The assets were bought out of liquidation and have the potential to increase Pan African’s gold production by 25%. To fund the project, a debt package of $80 million has already been negotiated with RMB. Further capital will be needed and the company is considering various options.
  • Vunani has released results for the six months ended August. Although revenue and premiums were up by 17%, profit after tax was flat (and thus margins contracted). Headline earnings per share (HEPS) decreased from 21.7 cents to 20.3 cents. Despite this, the interim dividend has been increased from 6.5 cents per share to 9 cents per share. This is a highly illiquid stock that is currently trading (occasionally) at R2.97 per share.

Who’s doing what this week in the South African M&A space?

Marylou Greig
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Who’s doing what this week in the South African M&A space?

Exchange Listed Companies

Harmony Gold Mining has acquired Eva Copper Project and the surrounding exploration tenements in Australia from TSX-listed Copper Mountain Mining. The deal, which sees Harmony paying an upfront cash consideration of US$170 million (c.R3 billion) plus a contingent payment of up to a maximum of US$60 million (c.R1,1 billion), will lower the company’s risk profile. The acquisition will add 1.7818 billion pounds of copper and 260,000 ounces of gold to Harmony’s Mineral Reserves and will extend its diversification into copper – a future-facing metal critical to the energy transition.

Motus has released further details on the proposed acquisition by its UK-based subsidiary of family-owned business Motor Parts Direct for a purchase consideration of £182 million (R3,64 billion). The acquisition is aligned to Motus’ international growth strategy to reduce dependency on vehicle sales and strengthen its integrated business model by focusing on the aftermarket parts business.

Anglo American is to form a renewable energy partnership in South Africa with EDF Renewables, a subsidiary of the French utility group. The new jointly owned company, Envusa Energy, will develop a regional renewable energy ecosystem designed to meet Anglo’s operational power requirements in South Africa and support the country’s broader just energy transition.

Vunani Capital (Vunani) is to acquire a 50% stake in Verso Group, a financial services company specialising in wealth management and Section 13B retirement fund administration. Verso, predominantly Western Cape based, also has offices in Pretoria, Johannesburg, Gqeberha and East London. The acquisition is in line with Vunani’s strategy to expand its financial services activities, particularly in niche markets both in South Africa and across the continent.

Aveng has, via subsidiary Aveng Africa, disposed of Trident Steel to a consortium for R700 million. Trident Steel Africa, a vehicle established for the purpose of the acquisition is owned by consortium members Ambassador Enterprises, a US-based private equity firm, Joseph Investments, Arbor Capital Investments and Trident Steel management. Aveng will provide R210 million in the way of funding to a separate company in order to subscribe for 30% of the equity in the purchaser, thereby retaining a 30% stake in the business, which will be specifically reserved for B-BBEE participation for a period of one year post closing. The business was seen as falling outside the ambits of infrastructure development, resources and contract mining which, going forward will underpin Aveng’s long-term strategy.

+OneX (Reunert) has acquired South African Azure solutions provider EUCafrica as part of its strategy to build end-to-end digital transformation solutions for enterprise clients.

Consortium parties, Old Mutual Life and African Infrastructure Fund 4 (managed by Old Mutual’s African Infrastructure Investment Managers), Bauta Logistics and Mokobela Shakati are to acquire Oceana’s Commercial Cold Storage Group – trading as CCS Logistics. The purchase consideration payable for the Southern African cold storage provider is R760 million. The transaction will enable Oceana to allocate capital to opportunities aligned to its strategic objectives in the global fish protein sector.

Grand Parade Investments (GPI) has acquired and on sold two properties in relation to the settlement of a dispute with Gumboot Investments. The properties, based in Cape Town and Gauteng were acquired from Gumboot Investments for a transaction consideration of R66,5 million. These were on sold to Karez Trading for R44 million, generating a loss of R22,5 million for GPI – the cost attributed to the indemnity provided by GPI on behalf of its subsidiary Mac Brothers which was placed under voluntary liquidation in April 2022.

Europa Metals has announced the signing of a letter of intent for an option and joint venture arrangement with Denarius Metals, in terms of which, Denarius will have the right to acquire up to an 80% ownership interest in Europa Metals’ wholly owned Toral Zn-Pb-Ag Project in Leon Province in Northern Spain. The farm-in transaction involves the granting of a two-stage option (to acquire 51% and 29%) in return for funding of certain planned expenditure for an aggregate consideration of up to US$6 million.

Pan African Resources has announced the closing of the deal in which it acquired the Mogale Gold and Mintails SA Soweto Cluster assets out of provisional liquidation. The R50 million deal was first announced in November 2020.

Two companies reported the termination of deals announced

The US$4,7 billion deal announced in August 2021 between Prosus and Indian digital payment provider BillDesk failed to fulfil certain conditions precedent by the long stop date of 30th September 2022.

Conduit Capital’s intention to acquire 51,769,633 Trustco shares for N$93,7 million, first announce in August 2021, did not fulfil the conditions precedent resulting in the lapse of the share sale agreement.

Unlisted Companies

Cape Town-based venture capital firm HAVAÍC has concluded its third investment in Kenyan fintech company Tanda. The investment will enable Tanda to invest in key strategic partners, accelerate product development and scale in Kenya and East Africa over the next 15 months.

Cars.co.za, the local online car marketplace, has entered into agreement with Sun Exchange to buy into an off-grid solar power project providing off-grid solar power plus battery storage for Karoo Fresh, a commercial farm in SA’s Karoo district.

Talk360, an international voice calling app which is building a single payment platform to be launched in 2023 combining all local African currencies and payment methods, has raised a further US$3 million in seed round funding adding to the US$7 million raised in May 2022. Investors in the round include Allan Gray E2 Ventures, Kalon Venture Partners, E4E Africa, Endeavor and existing lead investor HAVAÍC.

DealMakers is SA’s M&A publication
www.dealmakerssouthafrica.com

Who’s doing what in the African M&A space?

Marylou Greig
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Who’s doing what in the African M&A space?

DealMakers AFRICA

Development Partners International (DPI) has, through its ADP II fund, exited from Egyptian retail group B.TECH. The 33.4% interest was sold for an undisclosed sum to the Saudi Egyptian Investment Company (SEIC), a wholly owned subsidiary of the Saudi Public Investment Fund. B.TECH represents the largest integrated omnichannel retailing and consumer finance platform in Egypt, selling consumer electronics and household appliances.

Access Holdings plc, via its Lagos-based subsidiary Access Bank, is to acquire a 51% stake in Finibanco Angola from Portuguese Montepio Holdings. The deal is in line with the bank’s strategy to be Africa’s payment gateway to the world.

Ascent Rift Valley Fund has exited its investment in Medpharm Holdings Africa, a provider of medical diagnostic laboratory services in Ethiopia. The stake was sold for an undisclosed sum to Cerba Lancet Africa, a network of clinical pathology and medical diagnosis sites in Africa.

Helios Investment Partners, a UK-based private equity fund, has sold back its 60% stake in Telkom Kenya to the Kenyan Government for Ksh6,09 billion.

Britannia Industries, a leading Indian food company, has acquired a 51% stake in Nairobi-based Kenafric Biscuits. In addition, Britannia Industries has acquired all the shares in Kenayan Catalyst Britania Brands.

Venture capital firm HAVAÍC has concluded its third investment in Kenyan fintech company Tanda. The investment will enable Tanda to invest in key strategic partners, accelerate product development and scale in Kenya and East Africa in the short term.

Easy Matatu, a Ugandan minibus ridesharing services platform, has received an undisclosed investment from the Renew Capital Angels. Funding will be used to expand Easy Matatu’s end-to-end technological platform, which will double its monthly trip capacity, and to expand the fleet of cars.

Cowtribe, a last-mile veterinary delivery company in Ghana coordinating deliveries of veterinary vaccines and other animal health products to rural and underserved communities, has received an investment and non-financial support from the Boehringer Ingelheim Social Engagement initiative.

Nigerian proptech startup Spleet, has raised US$2,6 million in a seed round led by MaC Venture Capital. Other investors included Noemis Ventures, Plug and Play Ventures, Metaprop VC among others. Funds will be used to expand its property management product offering and expand across Africa

CardoO an Egypt-based IoT devices manufacturer has raised US$660,000 in a seed funding round led by The Alexandria Angels with participation from Sofico Investments, the European Bank for Reconstruction and Development and angel investors. Funds will be used to improve products, enable local manufacturers to produce consumer electronics for IoT under the brand name CardoO.

DealMakers AFRICA is the Continent’s M&A publication
www.dealmakersafrica.com

Weekly corporate finance activity by SA exchange-listed companies

Marylou Greig
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Weekly corporate finance activity by SA exchange-listed companies

This week was all about the repurchase of shares on the open market

Argent Industrial has repurchased 37,000 ordinary shares representing 0.07% of the issued share capital. The shares were repurchased at R13.00 per share for an aggregate value of R481 million.

Glencore this week repurchased 8,759,982 shares for a total consideration of £42,80 million. The share purchases form part of the second part of the Company’s existing buy-back programme which is expected to be completed over the period from August 4, 2022, to February 14, 2023.

South32 has this week repurchased a further 2,744,745 shares at an aggregate cost of A$10,14 million.

Prosus continued with its open-ended share repurchase programme. This week the company announced the repurchase of 3,625,070 Prosus shares for an aggregate €196,88 million.

British American Tobacco repurchased a further 692,108 shares this week for a total of £22,53 million. Following the purchase of these shares, the company holds 212,015,769 of its shares in Treasury.

Investec ltd is to embark on a purchase programme as part of its capital optimisation strategy. Investec will conduct an on-market purchase of Investec plc ordinary shares to a maximum aggregate market value equivalent of R1,2 billion. The purchase programme commenced on 3rd October 2022 and will end on or before 17th November 2022.

Five companies issued or withdrew cautionary notices. The companies were: PSV Holdings, Nutritional Holdings, Telkom, Sebata Holdings and Aveng.

DealMakers is SA’s M&A publication
www.dealmakerssouthafrica.com

Thorts: Minority shareholders’ appraisal rights

Johan Coertze and Giscard Kotelo
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Thorts: Minority shareholders’ appraisal rights

An important consideration when implementing a repurchase of shares

The repurchase by a company of its own shares is allowed in terms of section 48(8) of the Companies Act 71 of 2008 (the “Act”) provided, inter alia, that the solvency and liquidity test is met. One of the other core restrictions, in terms of s48(8)(b), is that a decision by a company’s board to acquire its own shares is subject to the requirements of s114 and s115 of the Act where the transaction – in terms of which the shares are reacquired by the company, considered individually or as an integrated series of transactions – involves the acquisition by the company of more than 5% of its shares.

S115(8) expressly provides that any person who informed the company of their intention to vote against the special resolution approving a fundamental transaction – and, in fact, attends the relevant meeting and votes against such special resolution – is entitled to seek relief in terms of s164 of the Act.

S164 of the Act provides for dissenting shareholders’ appraisal rights. An appraisal right is best described as the right of a dissenting shareholder, who does not approve of a fundamental transaction, to have its shares bought out by the company in cash, at a price reflecting the fair value of the shares.

In the recent case of Capital Appreciation Ltd v First National Nominees (Pty) Ltd and Others1, the Supreme Court of Appeal (the “SCA”) was called upon to consider whether the reference to the requirements of s114 and s115 of the Act in s48(8)(b) means that the appraisal rights in s164 of the Act were triggered when a company proposed to repurchase more than 5% of its shares.

The facts can be summarised as follows: Capital Appreciation issued a circular to its shareholders in which it notified them of its intention to repurchase shares from specific shareholders, and that due to the number of such shares, the transaction was subject to s48, s114 and s164 of the Act. The special resolution for this transaction was passed by a large majority of shareholders.

The minority shareholders in Capital Appreciation approached the High Court, in terms of s164 of the Act, for an order that an appraiser be appointed to assist the court in determining a fair value of their shares in Capital Appreciation. The minority shareholders exercised their appraisal rights in terms of s164 due to the fact that Capital Appreciation proposed to repurchase specific shares from specific shareholders in terms of s48 – which repurchase met the requirements of s48(8)(b). Capital Appreciation changed tack and argued in court that s164 did not apply, with the result that First National Nominees (the minority shareholder) had no right to an appraisal of the fair value of its shares by the court.

Before the High Court, (which judgment became the subject of the appeal) Capital Appreciation argued that the repurchase of shares in terms of s48 does not qualify as a scheme of arrangement, as understood in the authorities related to the previous Companies Act and, accordingly, although s48(8)(b) incorporates the requirements of s114 and s115 into a transaction whereby more than 5% of a company’s shares will be repurchased, this is only a reference to the procedural requirements and not the appraisal rights in s164. Moreover, as s48(8)(b) does not reference s164, the legislature would have made reference thereto in s48 if its intention was that s164 would be triggered in the circumstances referred to in s48(8)(b). The High Court disagreed and held that the inclusion of the requirements of s114 and s115 in s48(8)(b) incorporated all the requirements of these sections into a repurchase in terms of s48(8)(b), including the appraisal rights in s164, irrespective of whether the transaction qualifies as a scheme of arrangement or not.

The SCA, in dismissing the appeal by Capital Appreciation and confirming the decision of the High Court, held that the reference to s114 and s115 in s48(8)(b) establishes a direct link between s48(8)(b) and s164. The SCA held that First National Nominees was, therefore, entitled to be paid the fair value of its shares by Capital Appreciation.

In so ruling, the SCA confirmed that a company wishing to repurchase more than 5% of its shares in terms of s48 of the Act must, in addition to complying with the procedural requirements of s114 and s115, comply with the requirements of s164, should a minority shareholder wish to exercise their appraisal rights. The possibility of a minority shareholder exercising their appraisal rights is, therefore, an important consideration when a company decides to implement a repurchase of shares in terms of s48 of the Act.

1Capital Appreciation Ltd v First National Nominees (Pty) Ltd and Others [2022] ZASCA 85 (8 June 2022).

Johan Coertze is an Associate and Giscard Kotelo a Candidate Attorney. Article overseen by Counsel Michael Van Vuren | Fasken.

This article first appeared in DealMakers, SA’s quarterly M&A publication

DealMakers is SA’s M&A publication
www.dealmakerssouthafrica.com

Ghost Bites (Alphamin | Ascendis | Equites | Grand Parade | Massmart)

The Finance Ghost
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Ghost Bites (Alphamin | Ascendis | Equites | Grand Parade | Massmart)

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Alphamin beats its production guidance

But a lower tin price means profits are way off the preceding quarter

Alphamin reminds us in every announcement that the company produces 4% of the world’s mined tin at its operations in the DRC.

Production in this quarter was 3,139 tonnes, a solid beat of the production guidance of 3,000 tonnes. The problem is that the average price per tonne has dropped from $35,345 to $22,011, a nasty 38% decrease in the space of just three months. This drop in the commodity price explains why the share price has lost 32% of its value this year.

The impact on EBITDA is substantial, down 55% from the preceding quarter to $30 million in this quarter.

The company believes that demand for tin is expected to increase over the next five years, with supply expected to remain constrained. Along with the Mpama South project (scheduled for commissioning in December 2023), this is the underpin for the investment thesis in this company.

The share price is back to where it was in May 2021. If you missed the uptick over the pandemic, there’s a chance here for another bite at the cherry if you like the fundamental story of the business and the tin market.

One step closer for Ascendis

The Austell offer has achieved Competition Commission approval

As regular readers know, Ascendis shareholders need to decide whether they like money or not. It’s really as simple as that, as there are two competing offers on the table and one is materially larger than the other.

As a reminder, the offer from the Pharma-Q / Imperial Logistics consortium is a base price of R375 million. Austell Pharmaceuticals has offered R432 million for the same assets. You don’t need to get the calculator out to choose a winner there.

Until the latest announcement, the material difference between the offers was that Pharma-Q / Imperial already had Competition Commission approval in place and Austell didn’t. Ascendis has announced that Austell has also received approval without conditions, so the difference between the offers is only the price.

Obviously, the board has given shareholders a clear recommendation to vote in favour of the Austell deal.

Equites is proof that the grass isn’t always greener

In the six months to August, the UK portfolio lost value and the SA portfolio moved higher

The annoying thing about markets is that they don’t always fit the popular narrative. For example, the SA-bashers tend to conveniently forget that other countries also have problems (though they do tend to have electricity at least).

There are issues in the UK at the moment and the property market there is under pressure. Goodness knows we have our problems in South Africa too, but markets are all about the reality vs. what was already priced in.

Despite load shedding and everything else, logistics property fund Equites is reporting record demand for warehouse development in South Africa. With a substantial amount of land in its portfolio, Equites is well positioned to take advantage of this.

Over this period, like-for-like valuations in South Africa are up 2% and the UK portfolio is 2.9% lower (in sterling). Now, before you point to the weakness in the rand, I must point out that in August 2021 the pound was actually slightly stronger than it is now against the rand. Both currencies have been slaughtered against the dollar.

The loan-to-value (LTV) ratio of 33.3% means that Equites has lower gearing than many other property funds. This conservative positioning isn’t a bad thing in this environment.

The net asset value (NAV) per share is 6.5% higher year-on-year and is up 0.8% since February. The interim gross dividend of 81.58013 cents per share is 4% higher than the interim dividend last year.

Mac Brothers continues to hurt Grand Parade Investments

The latest hit relates to a lease that was guaranteed by GPI

Grand Parade Investments (GPI) had an adventure in the food sector that won’t go down as one of South Africa’s finest success stories. After selling Burger King South Africa to close the curtain on that initiative, the voluntary liquidation of catering business Mac Brothers is going to leave a bitter taste for shareholders.

Back in 2016, Mac Brothers entered into a sale and leaseback transaction with Gumboot Investments. In these transactions, a company looks to raise capital by selling properties and immediately leasing them from the purchaser, thereby securing ongoing occupancy of the property. For the buyer, the appeal is that there is already a tenant in place for the property who clearly wants to be there. For the seller, capital is unlocked and there is no need to move to a new building (at least for the term of the lease).

Sadly, it can go wrong when the tenant goes bankrupt. In this case, GPI gave Gumboot a guarantee for the rental, so the liquidation of Mac Brothers triggers a claim from Gumboot under that guarantee.

To avoid a long and expensive fight in court, GPI has agreed to acquire the building from Gumboot at a premium price that reflects the higher-than-market rental that Mac Brothers was paying. GPI will pay R66.5 million for the properties and will immediately sell them for R44 million to unrelated third parties. This locks in a R22.5 million loss for GPI, which is much lower than the exposure under the guarantee that was estimated to be R46 million at the end of June.

Another major blow to Game

There were no buyers for the Game stores in East and West Africa

Anyone who has followed Massmart’s journey in recent years is well aware that Game is a major problem. The business model is struggling to achieve resonance with customers, having been disrupted by eCommerce and its own strategic mistakes.

With Walmart poised to take Massmart private assuming shareholders accept the offer, there will be some major changes required to make Massmart financially viable. Game is the obvious area of focus.

In yet another blow to the business, Massmart couldn’t find a buyer for the Game stores in East and West Africa. Considering that Game is the format that was supposed to win in Africa for Massmart, this is a disaster.

Massmart has started the process to close the Game stores in those regions. This raises yet more questions about the future of Game in South Africa.

Little Bites

  • Director dealings:
    • Des de Beer is back at it, buying shares in Lighthouse Properties for nearly R2.4 million. I just wish they would get their website fixed.
  • Anglo American has released the latest rough diamond sales figures for De Beers. The eighth sales cycle comes at a traditionally quieter time in the year for the industry, so the group is happy with sales of $500 million that it says were in line with expectations. The comparable cycle last year delivered $492 million in sales. The seventh cycle this year was larger at $638 million, so the impact of seasonality is clear.
  • Newpark REIT is a funny little property fund that owns just four properties. There are some iconic properties in the portfolio though, not least of all the JSE building in Sandton and the nearby mixed-use property 24 Central, where yours truly spent many Friday evenings as a young banker attempting to attract ghosts of the opposite sex. Nostalgia aside, the net asset value per share is down 4% year-on-year and the interim dividend per share is 15.4% higher at 25 cents. The loan-to-value (LTV) ratio is slightly lower at 33.1%.
  • Although Europa Metals jumped by over 47%, it’s worth noting that liquidity in the stock is incredibly thin. It doesn’t take much money in absolute terms to really move the price. The company announced a deal with Denarius Metals, a company that sounds like a Harry Potter character, which would see Denarius take up to an 80% interest in the Toral Project in Spain. Denarius has the option to do so rather than the obligation. The first tranche would be for a 51% interest, with the associated cash used to finalise a pre-feasibility study and pay for exploratory drilling. There are plenty of details in the announcement that give you insight into the financial structures used in junior mining, so read it if you are interested in this space.
  • Jasco Electronics released results for the year ended June 2022. It’s been a horrible year, with challenges ranging from civil unrest through to gross misconduct by the leadership team in one of the divisions (a business that Jasco has decided to exit). A rights issue in February raised R42.7 million net of costs. If you’re wondering why the capital raise was necessary, operating profit in this period of R3.2 million vs. net finance costs of R16.5 million should answer the question. The headline loss per share of 6.4 cents caps off another tough year for Jasco. The net closing cash balance at the end of June was R29.4 million.

Ghost Global (Bed, Bath & Beyond | Costco | Nike | Tesla)

Karel Zowitsky and Kreeti Panday
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Ghost Global (Bed, Bath & Beyond | Costco | Nike | Tesla)

In this week’s edition of Ghost Global, Ghost Grads Karel Zowitsky and Kreeti Panday bring us the latest on a variety of consumer facing stocks.

Beyond horrible

Bed, Bath & Beyond keeps capturing our imagination with awful numbers

Brace yourself. Bed, Bath & Beyond has reported a 400% worsening of its net loss, showing that things can always get worse even for listed companies. This was driven by a 28% drop in sales in the quarter ended August.

To compound internal struggles, the company is also subject to external pressures with supply chain costs negatively impacting gross margin by 380 basis points.

As we desperately look for any positives, it’s worth noting that this quarter saw the launch of the Welcome Rewards programme which is now at 6.3 million members. That gives an indication of the scale of the US consumer market. Another important point is that inventory has improved by double digits, thanks to “aggressive inventory optimisation actions” including markdowns and strategic promotions.

No matter how bad things get, the company somehow remains optimistic about the turnaround strategy. Much hope is being pinned on Buy Buy Baby, a chain of baby stores that the group believes can grow. To help with that growth, the company secured a $375 million loan in August. Improvements in the working capital situation also help with matters.

Still, this business is clearly in a world of hurt.

Costco feels the margin pinch

Inflationary pressures are clearly visible, yet Costco is delivering

In the quarter ended 28 August (the final quarter of the 2022 financial year), Costco has demonstrated what happens to retailers when inflation is higher. Typically, overall revenue improves and margin deteriorates based on changes in the underlying product mix.

Costco beat analyst expectations for revenue ($72.09 billion vs. $72.04 billion). In case you aren’t familiar with the model, $1.3 billion of that revenue is sourced from membership fees paid by Costco shoppers. This is a warehouse club model that offers great prices to members, so some of the gross margin is already locked in when subscriptions are paid.

Gross margin of 12% in this quarter is down from 12.9% in the comparable quarter, driven by a change in mix that has included higher fuel sales. Yes, one of Costco’s major selling points is that the retailer sells fuel (or “gas”) in the US, with that change in mix accounting for more than a 50 basis point decrease in the margin.

Despite the gross margin pressure, Costco managed to increase its earnings per share by 11.7%.

Costco normally increases its membership fees every five years. As a sign of the times, the company will hold off on those increases. As another sign of the times and as we look forward to the first post-Covid Christmas, Costco will be pulling out the tinsel and bringing in the holiday season early this year. This has less to do with holiday spirit and more to do with supply chain uncertainty.

If you’re interested in learning more about Costco, this company has been featured in Magic Markets Premium.

A tick on the shoes, a cross in the financials

Nike’s business model is coming under pressure and so is the share price

With a share price that has lost 46% of its value this year, Nike is proof that things can get ugly when bad multiples happen to good companies. With a macroeconomic environment that is presenting many challenges, Nike’s latest quarter is compared to a period last year when things were a lot easier.

An obvious pressure is on freight and logistic costs, with high fuel prices as a major challenge for any global supply chain. Speaking of supply chains and related volatility, Nike’s inventory levels have increased by a gigantic 44% to ensure that demand can be met. This isn’t great when demand is under pressure, as markdown sales can then lead to a lower gross profit margin.

Despite the strength of the direct-to-consumer model, the gross profit margin has fallen from 46.5% to 44.3%. The net impact is that gross profit itself has fallen by 1% to $5.615 billion. This isn’t good news when selling and administration costs are up by 10% and income taxes are up by 55%.

By the time you reach the bottom of the income statement, you find a net income number that is 22% lower year-on-year. Those who bought shares this year will wish they just hadn’t done it.

One small step for a robot, one giant leap for mankind?

For those who believe in the Tesla story, the future is now

Tesla held an AI Day last week Friday at which they unveiled their new prototype robot: Optimus.

The unveiling revealed how far Tesla has come with their design by showcasing a humanoid robot that can walk the stage and bust some dance moves – without any assistance. This is an interesting step for Tesla as it evolves from being just an electric vehicle manufacturer to something more.

The onboard computer is much the same as that used in the Tesla cars, so this is part of the broader push towards autonomous driving. These are the same cars that have allowed Tesla owners to send their dogs for a joy ride without actually needing to be in the car.

Trading on a P/E ratio of around 90x, which understandably is nauseatingly expensive for most investors, it cannot be denied that Tesla is an innovator. Whether that is a sustainable competitive advantage remains to be seen.

Elon Musk hopes to sell each Optimus robot for less than $20,000 as early as next year. Even the most dedicated Tesla fans must acknowledge that Musk is famously optimistic with his guidance of what they can achieve and by when. Time will tell on this one.

Costco, Nike and Tesla are included in the library of 50 research reports and podcasts produced by The Finance Ghost and Mohammed Nalla in Magic Markets Premium. For R99/month or R990/year, the full library is available, along with a new show each week.

Ghost Bites (Anglo American | Aveng | Capitec | Oceana | Transcend)

The Finance Ghost
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Ghost Bites (Anglo American | Aveng | Capitec | Oceana | Transcend)

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Anglo American is serious about renewables

A major joint venture will deliver 3 to 5 GW of renewable energy by 2030

Anglo American and EDF Renewables have announced a joint venture to develop a regional renewable energy ecosystem in South Afric.

This is a pipeline of more than 600 MW of wind and solar projects in South Africa, the first step towards an ecosystem that can generate between 3 and 5 GW of renewable energy by 2030.

This is a major step for all involved and adds to the almost 1 GW that EDF Renewables will be building or operating in the country by 2023.

In a particularly good example of achieving a full renewable solution, this ecosystem will serve as a clean energy source for the production of green hydrogen for the nuGen Zero Emission Haulage Solution that Anglo American has invested in:

Aveng gets a great price for Trident Steel

The purchase price is well above the net asset value

Aveng has only been trading under cautionary since June, so this has been a relatively speedy negotiation as corporate deals go. The business of Trident Steel is being sold as a going concern for R700 million, plus an amount of R264 million for the net cash portion of the business. There’s also a ticking fee – more on that later!

In this type of deal structure, the buyer acquires the individual assets and liabilities rather than the shares in the company. This avoids any skeletons in the closet, which isn’t to say that there are any such skeletons to worry about. It just means that the buyer wasn’t prepared to take the risk.

Speaking of the buyers, the consortium includes local and US-based private equity investors, as well as the Trident management team. It is typical for the management team to be included in the equity layer in a private equity deal, as incentivisation is key. I’ve only had limited experience in deals with US-based funds, but I do remember a strong preference to de-risk the deal and buy the business rather than the shares. This seems to tie up with the Aveng structure.

The really interesting point is that Aveng is going to provide R210 million in funding to the company that will be acquiring the business. This will give Aveng a 30% stake in that company on a temporary basis, as that stake is reserved for a B-BBEE investor. The holding period will be up to a year and there is a call option in favour of the consortium for R210 million plus interest, which means they can get Aveng out of the structure at any stage after closing. This tells me that they want to get on with closing the deal even though a B-BBEE investor hasn’t been finalised.

With Trident’s primary business being the supply of steel products to the automotive, rail and mining industries, it’s not hard to see why a strong B-BBEE score is important.

There’s always something new to learn in these deals. In this case, there is a “locked box” mechanism, which means the purchase price is fixed based on the balance sheet at a particular date. The alternative is to use “completion accounts” – a method that considers the balance sheet on the closing date and adjusts the price accordingly.

An additional nuance is the “ticking fee” (in this case R7.45 million per month), which incentivises a faster closing of the transaction. The seller receives a higher fee if the deal takes longer to close.

The net assets at 30 June were valued at R409 million, so the purchase price is well above that level. Operating profit for the year was R220 million and profit after tax was R81 million. I’m no expert in this industry, but it looks like Aveng secured a great offer price here.

As this is a Category 1 transaction, shareholders will be asked to give their views on the price in the form of a vote to approve the transaction.

Capitec rallies after announcing a life insurance licence

Capitec will underwrite its own credit life and funeral policies

With strong growth in the number of insured clients, Capitec has taken the significant step of obtaining its own life insurance licence. Capitec Life (a subsidiary of Capitec) will in due course replace the current cell captive insurers as the underwriters of the credit life and funeral policies.

The bank also highlights proposed changes to the third-party cell captive regulations as a driver of this decision.

In simple terms, this means that Capitec is taking on more risk. Rather than giving away profits to other insurance companies and passing on the credit and mortality risks, Capitec has decided to take those risks and retain the related revenue.

Whether or not this will be beneficial in terms of net profit remains to be seen. The market liked it, with the share price closing 5.4% higher on a day when the ALSI closed 3.25% higher.

There were also major purchases of Capitec shares by directors, which are covered in the Little Bites section.

Oceana sells Commercial Cold Storage Group

Oceana is set to receive R760 million from the deal

The sale of this business, known as CCS Logistics, has achieved an enterprise value of R895 million. The amount of R760 million due to Oceana is after adjusting for minority interests. The net assets on the balance sheet are worth R156.8 million and normalised profit after tax is R48.6 million.

The purchasers are the IDEAS Fund and the AIIF4 Fund, both managed by African Infrastructure Investment Managers. Other partners include Bauta Logistics (a food logistics business focusing on the Middle East – Africa region) and Mokobela Shakati as the strategic investment and empowerment partner.

The CCS business has six cold storage facilities with capacity of around 100,000 pallets across South Africa and Namibia.

There’s yet another locked box mechanism at play here, accompanied by “ordinary course leakage provisions” – the announcement doesn’t go into detail on those. What we do know is that Oceana will use the proceeds to reduce debt.

This is a Category 2 deal under JSE rules, so shareholders won’t be asked to vote on the deal.

Unfair and unreasonable

The board of Transcend Residential Property Fund isn’t impressed with the Emira offer

In times of difficulty, it’s not uncommon to see opportunistic transactions on the market. A great example is Emira’s offer to acquire all the remaining shares in Transcend Residential Property Fund.

I’ve seen many deals that are determined by the independent expert to be unfair but reasonable, reflecting a situation where the offer price is lower than the fair value per share and higher than the traded market price. This is especially the case for small caps that tend to trade at eternally frustrating multiples.

This one is unusual, as Deloitte has opined that the offer is unfair and unreasonable to shareholders. The independent board has agreed with that assessment and has recommended that shareholders reject the offer.

The opinion and the report are contained in the response circular and make for interesting reading. The fair value range for the shares is between R6.00 and R6.60. The offer price is R5.38 per share. The independent board takes it a step further, noting that a liquidation of the fund would realise R11.46 per share.

Of course, if the board was actually asked to achieve an order wind-down of the company and return that value to shareholders, we can only speculate what the answer might be.

Notwithstanding this recommendation, the Public Sector Pension Investment Board and the Development Bank of Southern Africa have already agreed to sell their shares. This represents 22.8% of the company and 38.5% of the shares not already held by Emira.

This is a general offer rather than a scheme, so any number of shareholders can accept the offer. There’s no requirement here for a 75% approval.

Little Bites

  • Director dealings:
    • Capitec’s directors didn’t hold back when it came to their latest purchases, with more than R21 million in aggregate purchases by several directors.
  • Equites Property Fund is in dispute with Promontoria Logistics, the company buying land from Equites that is subject to the approval of a planning application. The initial application was refused and the purchaser wants to cancel the deal based on a claim that certain notification requirements were not met. Equites is disputing this attempted cancellation and is moving forward with an appeal to secure the planning approval. Talk about an awkward relationship.
  • Sirius Real Estate has acquired three properties in Germany for €44.6 million. They were predominantly funded with capital from three disposals in Germany and the UK for a combined €33.6 million. The disposals were all above book value and the acquisitions have an occupancy rate of just 54%, so there is a significant opportunity for Sirius to create value here. Right at the end of the announcement, Sirius notes that the uncertainty in the market is leading to a slower acquisition pipeline.
  • You may recall that Gold Fields is busy with a blockbuster deal that would see the company acquire Yamana Gold. In an update on timing, Gold Fields announced that Yamana shareholders will meet on 21 November and Gold Fields shareholders will meet the following day. It will be fascinating to see what happens here.
  • Newpark REIT released a trading statement noting that distributable earnings per share for the six months to August are 43.9% higher than in the prior period. The company intends to declare a dividend of R0.25 per share.
  • Telkom has renewed the cautionary related to discussions with MTN, noting that the MTN proposal is still under consideration by both parties.
  • Aspen released its annual financial statements and there’s something unusual about them: a change to the reviewed provisional results that were released in August. R1.3 billion worth of liabilities were reclassified from non-current to current, which is a material change. This relates to an amount due by 1 July 2023. The group is in the process of refinancing a much larger amount of R8.4 billion in bank debt, which it expects to have in a new facility before the end of November.
  • Sappi has announced a cash tender offer for 3.125% Senior Notes due in 2026, as issued by one of the group’s European subsidiaries. This simply means that the company wants to settle some of its debt. The notes have an outstanding principal amount of €443 million and the target acceptance amount is €150 million. Holders of notes who wish to be paid out would need to follow the tender offer process, with a deadline of 10 October.
  • Sebata Holdings has renewed the cautionary announcement related to the potential disposal of one or more of Sebata’s businesses.
  • The latest news from the Nutritional Holdings circus is that the court has held the deferral of the liquidation, with a new court date of 20 January 2023. The termination of the listing is under “advanced consideration” by he JSE which doesn’t sound good. In the meantime, the company is looking to finalise historical financial information and proceed with the audit.

Ghost Bites (Motus | Pick n Pay | Prosus | Sibanye-Stillwater)

The Finance Ghost
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Ghost Bites (Motus | Pick n Pay | Prosus | Sibanye-Stillwater)

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Motus finally spills the beans (well, mostly)

The target acquisition has a name: Motor Parts Direct (UK)

Regular readers would’ve seen the weirdness around Motus withdrawing a cautionary announcement regarding this acquisition and then announcing extensive sales of shares by certain directors. In a clarification announcement that I’m certain was due to pressure placed on them in Ghost Mail, Motus confirmed that the sales were part of an incentive scheme and happened automatically as part of the scheme.

Leaving all of that aside, the company has now announced the full details of the transaction. Motus will be acquiring 100% of Motor Parts Direct in the UK for R3.64 billion. This is a family-owned business that has been around 1999. There are 175 branches that that sell vehicle parts to workshops in and around the UK.

Based on a quick look at the website, it looks a lot like the UK equivalent of Midas.

There are 14,000 customers and 1,700 employees, so this is a business of scale. It does move the dial for Motus in reducing the group’s reliance on car sales.

The sustainable EBITDA of the business is R580 million. Irritatingly, the announcement doesn’t confirm whether there is any debt in the company. If there is no debt or excess cash (i.e. the purchase price is equal to the enterprise value), then the EV/EBITDA multiple is around 6.3x.

But, hang on a second.

When they withdrew the cautionary, Motus said that the deal multiple is between 6.5x and 6.9x. This means that there must be debt in Motor Parts Direct. The announcement just doesn’t bother telling us how much debt and also doesn’t confirm the multiple.

Based on the recent quality of disclosure by this company, could I really have expected anything better?

Pick n Pay maintains strong momentum

The share price closed 6.8% higher in a nod to great performance

In a trading update covering the 26 weeks to 28 August 2022, Pick n Pay reported sales growth of 11.5% without adjusting for the riots and liquor restrictions. Here’s the impressive part: if you strip out those issues, normalised sales growth for the period is 8.2%.

Selling price inflation for the period was 7.2%, a depressing reality for the many South Africans who were already struggling to put food on the table. Literally.

The cadence is even more worrying, with CPI Food inflation at 11.3% in August vs. 8.6% in June.

The group acknowledges that a strong performance in Boxer helped drive this result, with the upgraded Pick n Pay stores performing well but remaining a small contributor to group revenue. As more stores are upgraded to the new format, the impact on group level numbers will become more significant.

Of course, with sales growth like this vs. such a soft base, it’s not surprising that headline earnings per share (HEPS) growth is through the roof. Even if you exclude the impact of business interruption insurance proceeds in this period and the effect of hyperinflation in Zimbabwe, HEPS is between 20% and 30% higher. This is a range of 85.01 to 92.10 cents per share.

Finally, the group notes that this includes R83.7 million worth of restructuring costs related to the Ekuseni strategic plan, which includes the repositioning of some stores under the QualiSave banner (which I still think is an awful name).

Prosus pulls out of BillDesk deal

This is another example of how tight things are getting in the world of venture capital

Venture capital investors are focused on stories and strategies rather than profits and dividends. They invest in companies that have exciting growth runways ahead, which is a nice way of saying companies that “invest through the income statement” – a wonderful term that Prosus previously used to describe a scenario where startups incur operating losses while building important assets.

Of course, this assumes that the assets are valuable at some point, which is by no means guaranteed.

An environment of low yields is favourable for venture capital, as money is “cheap” and plentiful. When the holding cost of capital is low, you can afford to take long-term bets on companies. When inflation and interest rates are biting, then the pressure is on to earn dividends.

With a major deterioration in macroeconomic conditions this year, the wheels came off for tech companies that relied on multiple funding rounds just to stay afloat. There have been many casualties along the way, ranging from layoffs of staff through to closures of companies.

Against this backdrop, Prosus has walked away from the BillDesk transaction. This was a $4.7 billion deal that would’ve cemented the market position in India alongside existing subsidiary PayU. Prosus has invested close to $6 billion in India since 2005, so this deal would’ve been a major further investment.

Prosus walked away despite the Competition Commission of India granting approval on 5 September. There were other conditions that needed to be met by 30 September that were not met, giving Prosus an escape hatch for the deal. The announcement doesn’t disclose which conditions those were.

In my opinion, Prosus is no longer comfortable with the terms of the deal (probably including the valuation) based on pressure from shareholders. When a company is keen to do a deal, they extend the deadlines for conditions to be met. At the very least, they make a lower offer based on the conditions not being met in time.

In this case, there’s no indication of that happening. The announcement simply states that the deal won’t be happening.

Spare a thought for the founders of BillDesk. I hope they didn’t already order their yachts.

Sibanye-Stillwater invests further in green metals

In a world far away from local labour issues, Sibanye is looking at European battery demand

Through a series of transactions, Sibanye now holds 84.96% in Keliber, a lithium group located in Finland. When Sibanye first announced its interest in Keliber earlier this year, it noted that the group is aiming to be the first fully integrated lithium producer in Europe.

This is strategically important because Europe is obviously a major manufacturing hub for electric vehicles.

The other shareholders are Finnish Minerals Group (13.9%) and various minority shareholders with a total of 1.14%.

The next step is an equity capital raise by Keliber that would require Sibanye to inject another €104 million. The company is also raising debt to at least match the €250 million equity on the balance sheet.

Little Bites

  • Director dealings:
    • Des de Beer is still putting serious money into Lighthouse Properties, with the latest investment worth R3.3 million (and no, I didn’t forget to hyperlink the name – the website is under maintenance!)
    • In good news for those with hospitality shares, the CEO of Southern Sun Limited has bought shares worth over R1.3 million.
    • A director of a subsidiary of Vodacom has sold shares in the company worth R3.76 million.
    • In a strange turn of events, an associate of a director of Thungela seems to have dealt in shares in numerous transactions this year without alerting the director. It’s actually the director’s wife who traded in the shares, so perhaps they are taking “no work at the dinner table” a little bit too far.
  • Etion has implemented the deal to sell Etion Create to Reunert for just under R202 million and has received the cash.
  • Schroder European Real Estate has confirmed that its net asset value per share at 30 June 2022 was 147.9 euro cents. This represents an 0.6% return for the quarter and 8% over a 12-month period.
  • Vunani will subscribe for a 50% stake in the Verso Group, a wealth management and fund administration group that has its own umbrella fund solution. If you know anything about the Vunani group, you’ll immediately recognise that this seems like a good strategic fit. As this is a small transaction, Vunani isn’t required to announce the purchase price.
  • Aveng has made further progress in improving its balance sheet. External debt was reduced by R75 million to R406 million on 30 September 2022. Performance guarantees were reduced by 45% to R191 million. The share price closed 3.7% higher on this news.
  • Merafe has announced that the ferrochrome price for the fourth quarter of 2022 is 17.2% lower than the third quarter. Although the share price is only down 5.9% this year, the chart is wild. It has lost over 41% in the past six months!
  • Investec has announced a programme to purchase Investec PLC shares with a value of up to R1.2 billion. Investec has a complicated dual-listed structure. In practice, this is same as the company announcing a normal share buyback strategy.

A check-in on the hotel sector

Chris Gilmour
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A check-in on the hotel sector

Until the Covid-19 pandemic, most experts were of the opinion that tourism was the world’s largest industry (based on percentage of global GDP) – bigger than oil and agriculture! Chris Gilmour unpacks the industry and takes a deeper look at City Lodge.

Tourism was a growing industry until the pandemic. It had special relevance to less developed countries, where it made a disproportionately large contribution to GDP. Sadly, the pandemic (with enforced lockdowns) changed everything. Travel and tourism as a sector was hit harder than most and has taken longer to recover.

Only now is the aviation industry at last managing to see the light at the end of the tunnel as more and more tourists make up for lost time during the pandemic. And hotel chains, too, are starting to get back to pre-pandemic occupancies and room rates.

Can a recession derail this story?

But times remain tough. A global recession is looming on the not too far horizon and that must surely put a dampener on travel and tourism. But having said that, the latest surveys from the UN World Tourism Organisation (UNWTO) suggest that the improvements seen in in 2022 will carry through to 2023 and beyond.

Source: UNWTO Tourism Barometer

They (almost) all survived

Locally, the hospitality (accommodation and restaurant) groups in South Africa, such as City Lodge, Famous Brands, Spur, Southern Sun and Sun International all suffered especially badly during lockdown and it is frankly miraculous that they have all survived.

Of course, the big listed casualty was Comair, which went into business rescue almost immediately when the pandemic struck and which looked like it might survive in unlisted form as lockdown restrictions eased. But it wasn’t to be and it eventually it went bust in June this year.

Checking in at City Lodge

City Lodge released its full year results to end June on 23 September. They were slightly better than expected, with full-year EPS being slightly positive at 14c but HEPS still slightly negative at -8.6c. But average occupancies were above breakeven for the first time in two years and all the hotels were open from about March this year.

The east African hotels were sold off and the proceeds received in July. The funds were used to pay down debt, which now stands at around R250 million.

The graph of average occupancies masks the harsh reality of what occurred at the deepest part of lockdown restrictions in 2020. In those days, the only City Lodge hotels permitted to remain open were so-called “quarantine hotels” that housed repatriated South Africans. Average occupancies plummeted to around 4% at one point during the darkest days of lockdown.

City Lodge also had to contend with a massive rights issue to fund its BBBEE programme. This was highly dilutive.

A shift in the model

The basic philosophy of City Lodge has always been to offer a quality room at a relatively low price without much in the way of food and beverage choice. Basically, that meant bed and breakfast. Discounting of room rates was never a big deal apart from promotions such as “Spouse on the House” and “Bid2Stay” for example. The target market was predominantly the corporate sector.

With the onset of the pandemic, that has all changed. A full repertoire of food is now offered at most hotels now, though without going totally overboard in terms of choice. So for example, tasty items such as pizza, burgers and shisa nyama are offered. This type of food undoubtedly appeals to both corporate and leisure travellers who often don’t want to venture out at night due to drinking and driving considerations or general safety concerns.   

Discounting takes place on weekends, with weekend special rates as well as a discounted Friday rate once a month at month-end called Woza Friday. Average room rates are moving up nicely and are not far off where they were pre-pandemic. Before getting excited, it’s worth remembering that City Lodge has effectively endured four years of inflationary cost growth and will only now be recouping a full room rate.

As with most global hotel chains, City Lodge makes extensive use of artificial intelligence when calculating room rates and this has helped to recoup better room rates in recent times.

A lower breakeven

Unlike most hotel chains, City Lodge doesn’t employ the services of a hotel management company, so there is a huge cost saving involved here. This is reflected in the much lower than average breakeven occupancy rate. Breakeven occupancy level for a chain such as City Lodge, with its predominantly three and four-star properties, would typically be in the high 50%’s / low 60%’s. However, thanks to its very low-cost structure, absence of a management company and the fact that it owns most of its properties, City Lodge’s breakeven occupancy level is nearer 38%.

Analysis of hotels primarily revolves around occupancy levels and is a classic case of marginal cost analysis. In other words, beyond breakeven occupancy level, operating profit falls almost unhindered (apart from tax) to the bottom line. This is due to the heavy capital nature of hotel construction and is especially relevant in City Lodge’s example, where most of its properties are owned.

The new financial year has started off well for City Lodge, with occupancies in September hitting a high of 58% after achieving 52% in July and 56% in August. The inbound foreign tourist season begins this month and runs all the way through to at least March next year and indications are that it is going to be substantially better than last year’s very low base of comparison. A number of new airline routes have either opened up already or will be opening up by year end, including Air Belgium from Brussels, United from Washington and Delta to Cape Town from Atlanta. Additionally, BA and Virgin Atlantic will be adding an extra 25 fights per week at the height of the holiday season.

And all the while, corporate travel is slowly but measurably improving as office workers return to their desks.

There are some options for investors, but not many

There aren’t too many options available on the JSE for investing in the hotel business: City Lodge, Southern Sun Hotels and Sun International.

Sun International is predominantly a gaming operation and the hotel side is mainly an interesting add-on in my opinion.

Southern Sun is by far the largest hotel chain in the country and the one with the longest pedigree. It is a quality operation but it lacks the elegant simplicity of City Lodge, with its 15 different brands, its multitude of hotel management agreements and its higher breakeven occupancy level.

So, the bottom line is that the worst now appears to be over for City Lodge and investors can reasonably look forward to a gradual improvement in earnings. Having said that, dividends may still be a while away.

For equity research on South African retail and other stocks, go to www.gilmour-research.co.za.

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