Bateleur Flexible Prescient Fund 2016 third quarter report back
01 Bateleur Flexible Prescient Fund ( the fund ) - 2016 third quarter report back The fund s unit price appreciated 2.1% in the third quarter of 2016 and has appreciated 1.0% YTD. As comparisons, the JSE All Share Index gained 0.5% (inclusive of dividends reinvested) for the third quarter and 4.8% YTD. A basket of SA government bonds (ALBI) returned 3.4% for the third quarter and 15.0% YTD; while cash (STeFI) returned 1.7% for the third quarter and 5.0% YTD. The fund was conservatively positioned throughout the review period with average equity exposure of 79%, the remaining 21% of the portfolio was held in cash which has benefitted from interest yields in excess of 7%. Risk levels of the fund remain significantly lower than for equities, the 30 day volatility for the fund since inception has averaged 7.3% versus the JSE All Share at 15.0%. A summary of the fund s return by strategy over the three month period (table 1) and the top contributors and detractors (table 2) are shown below. Table 1: Performance summary third quarter 2016 Table 2: Contributors and detractors third quarter 2016 Performance by strategy Contributors Detractors JSE listed equities 1.9% Naspers 0.6% Steinhoff -0.2% Foreign listed equities -0.1% KAP 0.3% Stenprop -0.2% Interest & costs 0.3% Famous Brands 0.3% Old Mutual -0.2% 2.1% Tsogo Sun 0.3% Reinet -0.2% Mondi 0.3% Capital & Regional -0.1% Source: Bateleur The fund has delivered a net compound annual return of 19.0% since inception (1 st July 2010) versus 15.1% for the JSE All Share Index (inclusive of dividends reinvested); at significantly lower levels of risk (chart 1). Chart 1: Bateleur Prescient Flexible Fund net return vs. JSE All Share Index (TR) July 2010 to September 2016 300 Bateleur (net) 19.0% 260 JSE All Share (TR) 15.1% 220 180 CPI Index +4% 9.5% 140 100 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13 Dec 13 Jun 14 Dec 14 Jun 15 Dec 15 Jun 16 Source: Bateleur, Bloomberg
02 Recent quarterly commentaries have centred on top down macroeconomic analysis and the associated impact this had on the fund s asset allocation and weightings assigned to different sectors of the SA equity market (such as resources). However, this recent emphasis on top down macro should in no way infer a diminished focus on the importance of fundamental stock picking. Individual stock selection has been the primary driver behind the fund s historic returns and remains the area where the majority of investment time is spent. In this regard, several of the fund s stock specific holdings registered strong share price gains in the September quarter. This was mainly due to these companies delivering solid reported results against a tough economic backdrop of low GDP growth, a volatile currency and continued policy uncertainty. Good results were reported by Italtile (Headline Earnings per Share HEPS growth of 21% for the year to June 2016), Super Group (HEPS growth of 10% for the year to June 2016), KAP Industrial Holdings (HEPS growth of 18% for the year to June 2016), EOH (HEPS growth of 25% for the year to July 2016), Adcock Ingram (Normalised HEPS growth of 20% for the year to June 2016) and Bidcorp (HEPS growth of 32% for the year to June 2016). In the commentary below we provide further insight into three of these holdings (Super Group, KAP and EOH); all of which are viewed as well managed and attractively priced relative to their expected growth outlook. Super Group Market Capitalisation R14.8bn Super Group is a diversified industrial company with operations in logistics, fleet management and vehicle dealerships across Africa, Australia and more recently Europe and the UK. Following a recapitalisation in 2008, Super Group was comprehensively restructured under new CEO Peter Mountford. The turnaround centred on the disposal of non-core assets and a refocus on the core business. Since 2010, the company has delivered an impressive six year CAGR in revenue of 20% (chart 2) and HEPS of 27% (chart 3), indicating an uplift to operating profit margins. The majority of the earnings growth emanated from existing businesses (through restructuring and organic growth) and balance sheet deleveraging as opposed to an over reliance on acquisitions. Super Group is highly cash generative (having delivered R1.6bn in free cash flow in financial year 2016) and the management team have a sound track record in allocating this capital. The company does not pay a dividend, preferring to re-invest cash flows into existing businesses or acquiring complementary businesses at accretive valuations. Chart 2: Super Group revenue (Rm) Chart 3: Super Group HEPS (R) 35,000 Supply Chain Fleet Solutions Dealerships 4.0 30,000 25,000 Revenue CAGR of 20% 2010-2016 3.5 3.0 HEPS CAGR of 27% 2010 2016 20,000 2.5 15,000 10,000 2.0 1.5 1.0 5,000 0.5 0 2010 2011 2012 2013 2014 2015 2016 2017e 2018e 0.0 2010 2011 2012 2013 2014 2015 2016 2017e 2018e Source: Company data, Bateleur
03 Like many South African corporates, Super Group has diversified offshore to offset the slow domestic economy and increasing policy risks. In 2014 the group acquired UK motor dealership group Allan Ford (on a P/E multiple of 6.3 times). They added IN time in October 2015, a large German time critical delivery operator (vehicle components) on a P/E multiple of 8.4 times, and in November 2015 acquired NLC in Australia to cement their position as the largest novated lease provider in that country (P/E multiple of 11.7 times). These transactions have altered the geographic earnings base of Super Group, with the company generating close to 60% of operating profit outside of SA in the 2016 financial year (compared to 32% in 2010). Super Group s businesses have strong market positions within the industries and geographies they operate in. SG Fleet is the leading novated lease provider in Australia while IN time is the second largest time critical delivery provider in Germany. In SA, the company holds a top five position in the highly fragmented supply chain management market, while the vehicle dealerships have consistently outperformed the NAAMSA market sales figures. The benefits of the most recent acquisitions (chart 4) have yet to be fully realised with all projected to be earnings accretive, supporting an expected CAGR in HEPS of 15% over the next three years (2017-2019). Super Group is currently valued on a historic P/E multiple of 13.3 times and an expected forward P/E multiple to June 2017 of 11.3 times. If the market value of the Australian listed SG Fleet business is removed, then the remainder of Super Group is valued at a historic P/E multiple of 10.0 times and a forward P/E multiple to June 2017 of 9.2 times (chart 5) - an attractive rating for a well managed, geographically diverse business with sound prospects. Chart 4: Super Group EBIT split by geography (Rm) Chart 5: Super Group valuation excluding SG Fleet 3,000 2,500 2,000 1,500 1,000 500 0 100% of NLC (Australia) R2003m on 11.7x P/E 100% of Sandown Motors (SA) R500m on a 8.5x P/E 100% of Fleet Hire (UK) R352m on a 9.8x P/E 100% of Allen Ford (UK) R606m on a 6.3x P/E 75% of IN time (Germany) R1575m on a 8.4x P/E EBIT - Africa EBIT - Global 2010 2011 2012 2013 2014 2015 2016 2017e 2018e Valuation of SPG ex-sg Fleet SG Fleet Market Cap (AUS$) 1083 Super Group Holding 52.1% Super Group Share (AUS$) 564 ZAR/AUS Exchange Rate 10.61 Super Group Share (Rm) 5989 Super Group Market Cap (Rm) 14823 Implied Rump Value (Rm) 8834 2016a 2017e 2018e Earnings ex-sg Fleet (Rm) 888 964 1040 Implied Rump P/E 10.0x 9.2x 8.5x Source: Company information, Bateleur KAP Industrial Holdings Market Capitalisation R18.5bn KAP is an industrial holding company with two main operating divisions; diversified manufacturing (52% of group revenue) and diversified logistics (48% of group revenue). Steinhoff has a 43% shareholding in KAP. The company underwent a significant transformation in 2012 following the acquisition of Steinhoff Africa s industrial assets (comprising logistics business Unitrans, integrated timber manufacturer PG Bison and various Bedding businesses). Subsequently, KAP has made selective bolt on acquisitions (Autovest & Restonic) where synergies exist with existing operations, whilst also disposing of businesses that are non-core to the group (footwear operations, Bull Brand Foods and Brenner Mills).
04 The various operating divisions of KAP are shown below (table 3). Several of KAP s underlying businesses have large market shares (in some cases over 50% of the SA market e.g. Hosaf, PG Bison, Woodchem and Feltex); are vertically integrated (PG Bison, and the Bedding businesses); and have high barriers to entry (Hosaf, PG Bison, Woodchem, Unitrans specialist contract logistics, and Feltex). Table 3: KAP operating divisions Diversified Manufacturing (red) and Diversified Logistics (blue) Diversified Manufacturing: 52% of revenue Diversified Logistics: 48% of revenue Source: Bateleur Despite the low GDP growth environment in SA, KAP has delivered an impressive four year CAGR in revenue of 11% and HEPS of 19% (charts 6 and 7). Earnings growth has benefitted from efficiency improvements, a continuous investment into capacity expansion as well as through earnings enhancing acquisitions. Chart 6: KAP revenue (Rm) 2012-2016 Chart 7: KAP HEPS (R) 2012 2016 17,000 16,000 15,000 Revenue CAGR of 11% 2012-2016 0.5 HEPS CAGR of 19% 2012-2016 14,000 0.4 13,000 12,000 11,000 0.3 10,000 9,000 2012 2013 2014 2015 2016 0.2 2012 2013 2014 2015 2016 Source: Bloomberg, Company data, Bateleur
05 Operating profit margins are expected to improve from the current 12.1% (chart 8) over the next three years as capacity utilisation increases. The main contributors to expected margin improvement are Hosaf (through operating leverage), Bedding (through efficiencies and automation), PG Bison (through sales mix shift) and Autovest (through cost savings and business reorganisation). Chart 8: KAP operating profit (Rm) & margin (%) Chart 9: KAP net debt/ebitda & interest cover 2,200 2,000 KAP operating profit (LHS) Margin (RHS) 12.5% 12.0% 11.5% 2.5 2.0 Net Debt/EBITDA (LHS) Interest cover (RHS) 9.00 8.00 1,800 1,600 1,400 11.0% 10.5% 10.0% 9.5% 1.5 1.0 7.00 6.00 5.00 1,200 9.0% 8.5% 0.5 4.00 1,000 2012 2013 2014 2015 2016 8.0% 0.0 2012 2013 2014 2015 2016 3.00 Source: Company data, Bateleur KAP recently (August 2016) announced the proposed acquisition of chemical business Safripol for R4.1bn (on a historic P/E multiple of 8.4 times). If concluded, the Safripol transaction will further enhance KAP s vertical integration strategy (through the provision of feedstock into Hosaf and Feltex) as well as opening up new market opportunities. KAP trades on a estimated forward P/E multiple of 14.0 times. HEPS are forecast to grow at a CAGR of 15% over the next three years, and this excludes any accretive benefits from the proposed Safripol transaction. KAP is considered an attractive investment in light of the sound growth prospects and current valuation. EOH Holdings Market Capitalisation R23.5bn EOH is the largest listed information technology (IT) company in SA with a market capitalisation of R23.5bn. The company estimates that the addressable IT market size in SA is R220bn growing at 8% per annum.* Group revenue amounted to R12.8bn in 2016, (less than 6% of the addressable market) highlighting the fragmented nature of the IT market and EOH s relatively small market share. What started as a company installing third party SAP and Oracle systems has grown into a substantial business offering a diverse range of products and services including data centres, call centres, installation and management of networks, big data analysis, point of sales solutions and more recently software development. The company has successfully managed to cross-sell these products and services across a wide range of industries from mining and construction, to retail, telecoms, finance and the public sector. Under the capable leadership of CEO Asher Bohbot, EOH has grown revenue at a compound annual growth rate of 37% (chart 10) since 2004 and earnings per share at a compound annual growth rate of 25% (chart 11) over the same period. With a wide services offering and a track record of adapting to a continually evolving market, EOH has sufficient opportunities for continued growth. *Source: EOH integrated annual report 2015
06 Chart 10: EOH revenue (Rm) Chart 11: EOH HEPS (R) & margin (%) 20,000 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Revenue CAGR of 37% 2004-2016 2004 2006 2008 2010 2012 2014 2016 2018e 12.0 10.0 8.0 6.0 4.0 2.0 0.0 EOH HEPS (LHS) HEPS CAGR of 25% 2004-2016 EOH operating margin (RHS) 2004 2006 2008 2010 2012 2014 2016 2018e 14% 12% 10% 8% 6% Source: Bloomberg, Bateleur Historic earnings growth has been supported by acquisitions, with each year, approximately half the growth being attributed to bolt on acquisitions. EOH has to date executed well on integrating acquisitions, although there is a risk that this acquisition strategy is not sustainable, especially as increasingly larger acquisitions will be required to make a material difference to the bottom line. Excluding any acquisitions, EOH is forecast to grow both revenue and operating profit at 14% per annum for the next three years as underlying IT demand remains strong, while there could be a further positive influence from the progression of cloud computing and big data. With the company being tightly integrated into its client processes, there is a high annuity element to EOH s revenue base. The cash generative qualities of EOH are also notable, with cash earnings exceeding accounting earnings in most years (chart 12). Chart 12: EOH cash vs. accounting HEPS (R) Chart 13: EOH share price (R) 9.0 8.0 7.0 EOH cash earnings closely match accounting earnings. 200 180 Bateleur average entry price of R141 6.0 5.0 4.0 3.0 HEPS Cash HEPS Cash HEPS CAGR of 25% 2004 2016 160 140 2.0 120 1.0 0.0 2004 2006 2008 2010 2012 2014 2016 100 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Source: Bloomberg, Bateleur EOH trades on an estimated forward P/E multiple to July 2017 of 18.9 times, well priced relative to its growth prospects, impressive track record, stable and regarded management team and strong underlying dynamics in the SA IT sector.
07 A summary of the fund s current positioning is shown in table 4. Table 4: Current fund positioning Strategy JSE listed equities 59% Foreign listed eqities 18% Total equities 77% Cash 23% During the period the fund increased its exposure to EOH, KAP, Oceana, Omnia, Spar and Super Group amongst others; while holdings in AVI, Bidcorp, Famous Brands, Reinet, Standard Bank & Tsogo Sun were reduced. Conclusion We anticipate the challenging investment environment to continue. However, we remain confident in our ability to deliver on the fund s investment objectives. Kevin Williams Fund Manager James Easterbrook Head: Distribution
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