Hudaco: operating leverage that works

Hudaco has released results for the six months ended May 2022 and they look juicy, with revenue up 11.8% and HEPS up by a substantial 25.1%.

It’s great to see the short-form announcement include a comparison of key financial line items to pre-Covid numbers. For example, revenue is 19.1% higher than the comparable period in 2019 and operating profit is 52.2% higher, so there’s through-the-cycle operating leverage here that shouldn’t be ignored. In other words, revenue grew faster than costs.

In case you aren’t familiar with Hudaco, this is a South African group that imports and distributes automotive, industrial and electronic consumable products. There are parts of the business that would compete with Invicta, for example. There are also consumer-facing parts of Hudaco, like recently-acquired CADAC (yes, the gas braai company – although many would argue that “gas braai” is an oxymoron).

I’ve written many times this year about how supply chain pressures are driving inflated balance sheets. In other words, more investment in inventory is needed. This either drives demand for debt from banks (which has not been as high as I expected) or a decision to retain more cash rather than pay higher dividends, which is the route most companies have taken. I guess they are nervous of banks after some of them behaved like such pigs in the pandemic (I’ve heard some frightening stories of opportunistic behaviour).

Hudaco has gone the route of adding debt, with bank borrowings up R266 million to R860 million. There’s plenty of internal reinvestment as well, with cash from trading of R558 million supporting a R459 million reinvestment in working capital.

Hudaco’s business model is hungry for working capital, not for fixed assets. This gives the group a lot of flexibility, as the balance sheet can shrink or grow in response to market trends and levels of demand.

With headline earnings per share (HEPS) of 857 cents, Wednesday’s closing price of R149 is a Price/Earnings multiple of 8.7x on an annualised basis i.e. by doubling the interim earnings. That’s a really quick-and-dirty approach, usually only useful in deciding whether to scratch deeper into a potential investment.

With a share price up more than 16% this year, that’s probably all the evidence you need to justify doing more research into Hudaco and forming a view.