Brait S.E Paying up for pep

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1 28th October 2014 Brait S.E Paying up for pep R76.10 Company Update; Sean Ashton / Tamzin Nel Investment thesis: Since Brait s transformational restructuring from predominantly a listed private equity fund operator to an investment holding company in 2011, investors have been very handsomely rewarded. As shown in figure 1, the share price has risen by more than four times since the rights issue to acquire Pepkor in May 2011 a compound annual gain of 52% over this time period. This has vastly outperformed broader JSE indices, even outperforming Mr Price (+40% compound annual gain over this period) which we regard as the closest comparable underlying asset for Brait s high-flying Pepkor subsidiary. This strong performance has been underpinned by significant growth in Brait s NAV (underlying value), partially assisted by gearing in the respective asset structures. Figure 2: Brait published NAV (directors valuation) +24% CAGR Figure 1: Brait share price performance versus the market and peers Source: Brait While this history of value creation and share price gains (well ahead of underlying NAV growth we may add) is no doubt impressive, what is more important to investors is the outlook for further gains from here. In this regard, while we believe the underlying assets principally Pepkor have strong growth prospects, we are concerned that this is fully reflected in the current share price. Source: iress data, Anchor Capital calculations Company stats While we regard the director s published NAV of R34.75 as fairly irrelevant (due to conservative multiples applied to the underlying assets), the share price does not represent attractive value at a 2.1% discount to our adjusted NAV of R77.70/share under what we regard as very bullish assumptions (detailed in this report). We rate Brait a HOLD, but prefer Woolworths on valuation grounds. Share price: 7610c Market cap: R37bn Net debt: R1.3bn Avg trade per month: R900mn 12-month low: 4365c 12-month high: 8298c Sales: R5.45bn Anchor Capital (Pty) Ltd, FSP number

2 Un-compelling share price discount to NAV Being an investment holding company with a portfolio comprising privately owned businesses in a range of industries looking at EPS is not too meaningful as it includes fair value gains on marking their gains to new director s valuations. Brait uses a very conservative valuation approach and according to director s valuations, the share was trading at a 21.3% premium to NAV at year end (31 March 2014) and is currently trading at a 116% premium. They are using 8x EV/ EBITDA for companies such as Pepkor where in reality their peers are trading at 10+ times multiples. Brait s directors valuation of the group of R34.75/share amounts to less than half the current share price, which clearly implies the market believes the directors valuations of the various underlying assets are too conservative. Management applies the following EV/EBITDA multiples to the underlying assets: Pepkor: 8x (Mr Price trades at 18x EV/EBITDA) Premier Foods: 7.5x (Pioneer Foods trades at 14x) Iceland Foods: 6.5x (Tesco trades at 7x) Clearly, the multiples of the first two assets utilised in management s estimates are too conservative when assessed relative to comparable listed assets. Nevertheless, even if we apply the same EV/EBITDA multiple Figure 3: Brait sum of the parts assuming peer group multiples for Mr Price and Pioneer Foods to Pepkor and Premier, respectively, there is still no material margin of safety built into the market price of Brait shares. The sum of the parts value then equates to R77.70 (see figure 3). So, one has to justify pretty heady valuations to even meet the current share price of R In this instance, investors have to be very confident that the quality of Pepkor in particular and its growth profile warrant such a valuation. Pepkor An alternative to Mr Price with limited visibility but performing well Pepkor is a leading retailer with its core businesses being two of the most recognised brands in SA, namely; Pep and Ackermans, and is involved in apparel, footwear, homewares and cellular products in Southern Africa and Eastern Europe and comprises over 3,700 retail outlets. Pepkor contributes 71% to the value of Brait and as a result Brait should be viewed as a South African cash retail play, much like Mr Price. On a comparable basis, Brait trades at a higher valuation but based on the metrics that we have access to from Pepkor, the operational performance seems to justify this (see figures 5 and 6). 2

3 Figure 4: Underlying assumptions for SOTP valuation Figure 5: Pepkor vs Mr Price Sales Figure 6: Pepkor vs Mr Price Margins As an investee company of Brait which is non-controlled, we do not have access to full accounts for Pepkor and hence a proper analysis of its balance sheet and return metrics is not possible, but by all accounts this business is performing exceptionally well despite very tough conditions facing consumers in SA. The group s sale mix by geography and trading format is shown in figures 7 and 8. Virtually all of Pepkor s geographies and formats are performing very well: the core Pep chain (predominantly operating in SA) delivered 15.9% sales growth in FY14, with growth in trading space of 4.8% - like for like growth of more than 10% is very impressive in the current economic climate and indicative of a shift toward value-biased cash retail chains. Figure 7: Pepkor sales by geography 3

4 Figure 8: Pepkor sales by trading format Source: Company data Perhaps the most exciting aspect of this business is the group s Pepco chain in Poland, with a non-food discount chain retail footprint that is currently the largest in the region and rapidly growing. Pepco currently has 553 retail outlets in Poland, Slovakia and Czech Republic up from just 116 outlets in 2008 (+27% p.a) and still growing by 100 stores annually and a further two countries are currently under evaluation. In addition to this rapid store roll-out profile, same-store sales growth remains exceptionally robust at 20% (in underlying currencies). Management remains fairly confident that the current store roll-out trajectory can be sustained, which if coupled with continued same store sales growth seems to suggest that the Eastern European unit can continue to grow by ~30% p.a for some time. Assuming Pepkor s remaining business units can continue sustaining low teen turnover growth, the well above average trend growth in Eastern Europe should continue to drive mid teen top-line growth for the group as a whole: Figure 9: Pepkor potential sales growth impact of Pepco s strong growth profile in Eastern Europe Premier Foods: FMCG acquisitions Premier Foods, which contributes 20.4% to the value of Brait, is a leading South African staple foods producer comprising consumer brands with a strong heritage (Snowflake, Iwisa, Blue Ribbon, Lil-lets, Manhattan and Super C). Premier traded well for FY14 with net revenue and operating profit up 24% and 30% respectively, although this did include non-organic growth. Cash from operations was up 32% as a result of increased profitability and FY14 acquisitions too; Lil-Lets, Star Bakeries and the milling assets from Ngwane Mills. Premier is delivering on its strategy of operational efficiencies and consistent quality, enhancing margins on its core staples business. Premier s operating profit margin, at 5.7%, is much lower than its peers (Pioneer has an EBIT margin of 10.3%) but all the FY14 acquisitions have been integrated and the business is well placed in FY15 to leverage these higher margin products across its deep distribution platform. EBITDA margin expansion is on track to reach management s target of 10% (the current EBITDA margin is 7.4%). We expect this to be achieved within the next three to five years and if we assume revenue growth of 10% per year, this will translate into operating profit CAGR of 21%. Since 2012 Premier has used 78% of the approved R850 million long term capex budget to expand its milling and baking asset base. As part of Premier s rebranding process from a staple foods producer to a fast moving consumer goods company businesses more acquisitions in this space can be expected. Iceland: Market leading frozen foods Iceland Foods, contributing 5.7% to Brait s value, is a UK based national food retailer focused on frozen food with a defensive 13.8% market share in this category. The environment is a tough one in which to operate which sales growth of 3.2% reflects but overall UK retail foods sales were up 2.8%. The UK grocery market remains extremely competitive and challenging with prices being driven down by the discounters (such as Aldi and Lidl). Although the discounters have a very small market share (<10%), their actions are disruptive as the majors react; driving down overall food inflation. Although changes in the market do offer opportunities for Iceland, short term performance is adversely affected by intensified competition and the need to cling onto market share. In addition to their extensive store portfolio (836 stores in convenient high street locations across the UK), 4

5 they have launched a few concept stores offering bulk buying, a wider product selection and more brands. In addition they have rolled out their online shopping service offering free delivery to customers spending at least 35 (average basket spend is 53) which are all considered strong competitive differences. Iceland is better positioned and should show stronger growth than the gorilla Tesco given the price points of Iceland which is why we believe we have applied an appropriate 8x EV/EBITDA multiple to Iceland in our SOTP valuation whereas Tesco trades at a 7x EV/EBITDA multiple. Although, we are not convinced that there will be any material NAV growth in Iceland in the next couple of months due to our expectation that the UK food retail space will remain under pressure; keeping margins down and resultant muted profit growth. Conclusion Brait is a highly cash generative and defensive business with a growing geographic spread and an ungeared balance sheet. With R2.8 billion in cash and undrawn facilities available for investment and the fact that the counter is currently trading under cautionary, we speculate that an acquisition will be made under the Premier brand. Management have expressed a clear strategy to target businesses in a wide range of food and FMCG categories in which Premier do not currently have an offering. We rate the share a HOLD due to the un-compelling discount to the sum of the parts value but we would be buyers into weakness given the quality of the underlying businesses. 5