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Santova: A share you ought to own

Addendum:
I am very sorry, but I have made a mistake in the valuation calculation for Santova. The share is not “worth” R660 million because the R100 million profit after tax in five years time is worth R660 million IN FIVE YEARS TIME. In other words, I forgot to discount that R660 million to the PRESENT day. Additionally, I assume Santova will have no REAL growth in earnings, but grow earnings NOMINALLY in the 6% percent range (SA inflation and international ZAR depreciation against other major currencies assumed). When you do THAT calculation the value of Santova is R368 million (V = E(1 – g/ROE)/(k-g) = 100(1 – 0.06/0.18)/0.15-0.06). But one still needs to include the individual cash flows (Profit after tax from year 1 to 5) in the TOTAL present value. That calculation adds R250 million to the R368 million for a total present value of R618 million (R3.93 per share) at a discount rate of 15%. 

 

This article on Santova was included in my letter to investors of the Futurewealth Portfolio.

Santova is in the logistics business. However, Santova is not your run of the mill logistical operator. It does not own any of its own ships, trucks, trains, or airplanes. Neither does it own any warehouses or distribution centers. What it does own is a very smart software system and a number of offices in geographically significant locations in Asia, Australia, Africa, and Europe. It employs people to serve the supply chain needs of its customers by using proprietary software. In effect, Santova is an information services company specializing in global trade and supply chain management where it helps its clients to get what they want, when they want it, where they want it, within the budget they require.

By not having to use its own trucks, trains, airplanes, or ships, it is able to use the best combination of these modes of transport in any given situation. For example, if DHL provides the best airfreight rates between London and Cape Town, then Santova uses DHL for this route, and if Maersk provides the best shipping container rates, then Santova uses Maersk Shipping.

By being modal agnostic, Santova decreases its business model risk. Owning your own fleet of ships, trucks, or planes allows you to make boatloads of money if the going is good, but if demand for your services dries up unexpectedly (as it usually does), the cost burden of maintaining your fleet, paying salaries, and other necessary expenses can prove fatal to your business.

Santova Financial Performance 

The value of a company or any asset is the present value of all the cash flows the asset is expected to generate from the present day until the end of its useful life, which may be many decades in the future. The present value (PV) of a R100 is its value today. The present value of a R100 in a year’s time is less than the PV of the R100 I have in my hand now. Why? Because I can invest my R100 in the bank today, keep it there for a year, and receive R106 or R107 next year (assuming the bank pays 6% or 7% interest on savings). In other words, R106 or R107 in a year’s time is worth R100 today.

The concept and process of determining the value of money at different points in time using interest rates is called the time value of money and the twin processes are compounding (if we move forward in time) and discounting (if we move backward in time) respectively. For example, a R100 compounded at an interest rate of 7% is worth R107 in a year’s time. And a R107 at the end of the year is worth R100 at the beginning of that same year discounted at 7%.

Valuing a company, and its shares, is essentially using your best guesses of what the company will make in all future periods of its existence, and then discounting all those expected cash flows to the present using a discount rate that is high enough to reward you for risking your money in a business whose future earnings performance is uncertain. In other words, when I want to calculate a value for Santova, I need to do the following: 

  • I need to “guess” the cash flows that Santova will generate in its remaining life. Maybe the company will only be around for another year, maybe it will last another 50 years.
  • I need to determine an appropriate interest rate (discount rate) to bring all those future cash flows to the present point in time. Why? Because we want to know what the business is worth today in order to decide if we want to buy or sell its shares.

Step 1: “Guessing” the future cash flows of Santova

Guessing has a bit of a negative connotation in the minds of most people; especially when you are supposed to be doing something serious like investing money in shares. In reality, all human activity related to the future has an element of guessing at its core. For example, planning a December holiday is fraught with “guesses (assumptions)” that the future will be very much like the past. Are you not assuming that you will be healthy in December, that you will not have an unexpected cash flow problem due to a loss of employment perhaps, that the country will not be at war, that the earth will still be rotating on its axis? Bottom line: Nothing about the future is known with certainty, except its uncertainty.

Knowing that the future is uncertain, and knowing that business is one of the more volatile activities we human beings engage in, I have decided to limit the impact of the future on my investment decisions by prioritizing one element of the investment process above all others. Do not overpay. The lower the price you pay for an asset in the present, the less the future has to be good to great for your investment to pay off.  

The price of Santova shares is currently around R4 per share. This means that the person who wants to own the entire company (buy all the shares) will have to cough up around R630 million. Suppose you purchase Santova, what will you receive for your R630 million?

As of 2016: 

1. You will own a company with around 20 offices worldwide, operating in Australia, Asia, Africa, Europe, and Great Britain.

2. You will own a company that generates about 55% of its profit after tax (PAT) from sources outside the republic of South Africa.

3. You will ultimately be in control of a company that has almost doubled its revenue (1.87 times) and has more than doubled its profit after tax (2.20 times) during the last 5 years. What is more, it has done this largely from internally generated profits (it hasn’t asked you to invest a lot more money in the business to achieve what it has). This is shown by the fact that their number of shares outstanding has only grown from 134 million to 157.5 million during the same 5-year period (1.17 times). What is more, they haven’t grown their revenues and profits by using more debt, which would have been very risky. Their level of gearing (a measure of the percentage of debt used in the financing of the business has actually decreased during the last 5 years). 

4. You will own a company that made R48.7 million as of the end of the 2016 financial year (Feb), which is 26% more than what the company made in 2015 (in a very weak global trade environment).

5. The efficiency with which the company has managed this profit performance (R48.7 million) is a key consideration in determining how good a business is. Santova employed net assets (Assets – Liabilities) of about R308.5 million to generate the profits, which implies it made a 15.8% return on equity (ROE). This is lower than I would like it to be, but can be explained by the fact that only 3 months’ worth of the profits of their latest, and largest, acquisition is included in the 2016 results. If this acquisition is able to extend its 3 month results to a 12-month period, then we should see a couple of percentage points uptick in the ROE.

Santova Valuation

Very simply, we partly own (through our shares), a company that generates about R50 million in profits. Assuming its depreciation (maintenance cost of assets) is calculated correctly, what would you be willing to pay to own such a business?

The profits are not as secure as a bond, which promises to pay the same interest (profits) over its lifetime of 10, 20, or 30 years. That means that we would need to earn a higher interest rate from Santova than we do from a vanilla-type bond of the SA government. These bonds will pay you around 9% at present. So at most, we should be willing to pay around R550 million (R50 million/0.09) for our stake in Santova, given that it will continue to earn R50 million for the next couple of decades. We should probably be willing to pay a lot less, because the R50 million is surely in greater doubt than the SA government’s ability to pay (perhaps not nowadays!).

I would only buy such a business if I can make at least 15% on my money. This means that Santova would only be worth R330 million (R50 million/0.15) if it is not going to grow the R50 million and the sustainability of its profitability is uncertain. At the current share price of R4 a share the business is selling for R630 million. This means that we have seriously overpaid if the business is not going to make more money than R50 million in the future. But is it going to? And how much more should it be making for us to make at least 15% going forward (our goal remember) on our shares of R4 each?

I have already said a great deal, and if you have managed to read this sentence, I congratulate you. Have a cup of coffee and let’s do a few more paragraphs. Santova has more than doubled (2.20 times) its profits over the last 5 years. This is equal to a growth rate of a bit over 15% per year on average. This growth has happened during some of the most turbulent (negative) periods for shipping and trade in living memory. What is more, the business is still very small, which means there will probably be many opportunities to buy smaller logistics businesses that are struggling on their own, which they have been doing successfully for many years. 

Let’s assume that Santova is able to repeat its historical 5-year growth performance and grow at 15% on average for the next 5 years and then cease growing. In other words, Santova will grow profits after tax to R100 million over the next 5 years and then keep profits at that level for the next few decades. I do not think this is overly optimistic as Santova has only recently entered the German market, the largest in Europe, and it is busy establishing offices on the east and west coasts of Africa, connecting these to Europe, Asia, and South Africa. As it adds offices to its current network, the network will increase in value as Santova will be able to offer customized services (higher margins?) incorporating the new nodes (offices) to current clients. Additionally, they will be able to offer an enhanced offer in marketing efforts to new clients due to the increased scope and reach of the network. When we do the calculation, assuming 5-year growth at 15% and then stable earnings, we find that Santova is worth about R660 million, or just over R4 a share. In other words, a great little company at a fair price.

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