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The Investor: A rosy outlook in a gloomy sector

Clever acquisitions and shrewd management deliver for Afrimat.

After growing headline earnings at a compounded annual rate of 21% since 2010, Afrimat looks like a clear winner in the under-pressure construction sector. Its diversification drive post the 2008 global financial crisis has proven to be a reliable weapon in the trying operating environment.

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In 2010 it bought the Glen Douglas metallurgical dolomite mine from Exxaro and two years later the little-known Clinker Group. These acquisitions brought diversity to the group’s product offering and margin expansion. In the same vein the group also acquired a majority stake in the listed Infrasors (effective 2013), which was struggling at the time but has seemingly turned its fortunes around.

The market has noticed Afrimat’s impressive run but we think it’s still in buy territory. Intellidex’s discounted cash-flow model reflects 12-month upside potential of 20.3%. This assumes conservative 17% growth in earnings, putting it on a forward price:earnings (PE) ratio of 12. Compared to the all-share index with a price earnings multiple of 19, Afrimat shares looks cheap. It also comes with a good history of dividends. In the current year it paid out 50c/share which puts it on a 3% yield.

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In its recently released results for the year to end-February, management says it focused on reducing sales of low-margin products and increasing sales of higher-margin products. Because of this, revenue growth was pedestrian at 5% to R2bn (2014: R1.9bn), but the bias towards higher-margin products helped headline earnings jump an impressive 24% to 135c/share (2014: 109c)

Despite pressure from additional costs incurred on the start-up operations in mining & aggregates in Mozambique, the operating margin expanded to 14% (2014: 12.01%). The margin benefited from a solid performance in the clinker and industrial mineral operations as well as reduced raw material cost in concrete-based products.

As much as Afrimat’s prospects depend on construction activity where the outlook is not rosy at all, we think the group is capable of sustaining the current growth numbers. Afrimat has a unique advantage in that its not directly involved in construction works but rather supplies goods to construction and mining companies as well as private developers. This ensures that it captures sales from all kinds of construction activity on the market .

Additionally, unlike the listed construction giants that need critical mass to a contract before it is worth their while, Afrimat benefits from small-sized projects as much as from bigger projects. So in the short to medium term when larger construction projects are hard to come by, Afrimat’s order book will likely be dominated by smaller projects from government and private developments. Government is putting more focus on expenditure on water systems, reservoirs and pipelines, especially in rural areas and townships, Afrimat is also well positioned to capture such spending.

Diversification will also continue to play a pivotal role for the group and given the focus more on the higher-margin mining and aggregates products, we expect further margin enhancements.

Afrimat also benefits from its strategic positioning in relation to major projects around the country. Aggregates are heavy so location is key in this business. With more than 35 open-cast mines spread evenly across SA, Afrimat can produce and deliver at relatively lower transport costs than many other players. It has also introduced mobile equipment which enables it to take advantage of opportunities as and where they arise

There are downside factors to its operations though. Its costs side is dictated by familiar energy and labour input cost issues. The industry, which is inherently labour intensive, is also vulnerable to industrial action.

Overall, we think Afrimat is a solid company doing well in difficult circumstances. It has a solid balance sheet with net debt at only 5% of equity. Its operations are strongly cash positive. Based on our estimates, we maintain our previous buy recommendation on the stock. Its scrip is relatively liquid for a company of its size trading an average of R37m worth of shares per month.

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Bull Factors 

  • Diversification into the previously untapped market of industrial minerals
  • Products with scarcity value can sustain earnings in the depressed environment
  • Strategically positioned on major project pipeline
  • Healthy cash flow and strong balance sheet 

Bear Factors 

  • Earnings are largely transactional in nature and vulnerable to cyclical nature of markets
  • Suffers familiar energy and labour input cost issues
  • Labour-intensive industry vulnerable to industrial action

Nature of business: Afrimat is an open-pit mining company for industrial minerals. It supplies a broad range of construction materials ranging from aggregates and concrete products to ready mix and industrial minerals. It also provides drilling and blasting solutions for the construction and junior mining industries.

DisclosuresThe analyst has no financial exposure to the instrument discussed. The opinion represents his true view.

For Intellidex’s full disclaimer, methodologies and definitions please click here.

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