Altron gets a grip

Changes instituted as revenue plummets.

Numerous challenges, including a poor operating environment and restructuring costs, have restricted Altron’s top line and turned its bottom line into a loss. This may have been the nudge needed to re-evaluate its business strategy. The group is disposing of or closing assets with permanently impaired income streams – these have since been classified as discontinued operations.

Altron (AEL) (AEN – Altron prefs) did report improved business in some of its continuing operations – specifically the IT division – as well as some customer gains outside South Africa for its cables division. However, together with other industry players with big exposures to Eskom such as Ellies, ARB, and Reunert, Altron has suffered marked revenue declines as the monopoly power utility battles a barrage of its own challenges.

Now Altron is finalising the disposal of Powertech Transformers (Eskom dependent) and the Altech Autopage subscriber base (a similar move was undertaken by rival Reunert). Autopage is reeling from reduced mobile termination rates. It has also discontinued Altech Node, its video-on-demand offering, due to poor product take-up.

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Revenue retreated 6.5% to R13.29 billion, with 21% of the income coming from operations to be discontinued. Revenue from continued operations fell 8%, more than the fall in group revenue, a testament to the difficult trading conditions. Group operating profit tumbled 181% due to impairment charges and associated business restructuring costs, with continuing operations contributing a loss of R67 million. The effective tax rate was abnormally high at 129% due to unrecoverable deferred tax assets. That culminated in an unprecedented headline loss of 64c/share (1H15: profit of 72c).

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One might say the company needs a fresh set of ideas. This has been a closely family-run business, reflected in its sub-optimal shareholding voting rights structure. However, the board, in what seems the right call, is moving to a more independent management team – Craig Venter, son of company founder Bill, has been let off both his operational and director responsibilities. As part of the restructuring exercise, Altron is also downsizing its head office to create a leaner management structure.

The group’s gearing has increased at a time when sales are struggling, which is quite worrying. It now has a net debt:equity ratio of 50% from a debt-free position previously. However, management has shown commitment to reducing debt. It says proceeds from the disposal of the Altech Autopage subscribers, as well as other potential disposals, will be used to reduce debt. Although the increased financial leverage has reduced its weighted average cost of capital with the effect of improving its discounted cash-flow (DCF) valuation, we are concerned that its risk profile has been elevated, especially in light of its deteriorating income-generating power.

Altron is a cyclical business with most of its transactional-type revenue linked to the general economy’s performance. It relies heavily on capital expenditure and has high customer concentration risk. Until the economy recovers, it is difficult to build high hopes for this company.

The counter has taken a beating with 60% of its value wiped off since the beginning of the year. It is now valued below its book value. We believe the restructuring exercise will lower overheads while disposing of the poor performing businesses will help margins. However, given the elevated debt levels coupled with falling revenue, our discounted cash-flow model implies it is trading close to its intrinsic value.

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Bull Factors

  • Restructuring to reduce fixed costs and working capital requirements bodes well for a better valuation in the medium term.
  • Growth experienced outside South Africa reduces reliance on Eskom business and elevates earnings as the rand continue to lose value.

Bear Factors

  • High customer concentration adds to business risk.
  • High gearing characterised by negative income growth increases risk profile.

Allied Electronics Corporation Ltd [JSE : AEN]

2015A

2016E

2017E

2018E

Revenue (R’m)

    21 732.0

    19 993.4

    21 592.9

    22 888.5

EBITDA (R’m)

           769.0

           370.5

           638.6

           905.0

PBT (R’m)

           310.0

           124.0

           248.0

           372.0

Headline Earnings (R’m)

             54.8

             85.6

           171.1

           256.7

Headline Earnings Per Share (cents)

             94.0

             23.2

             46.5

             69.7

PER (times)

                 7.8

             31.3

             15.7

             10.4

Nature of business: Allied Electronics Corporation (Altron) is an investment holding company with two main operations: Altron TMT (combination of Altech and Bytes) and Altron Power, with interests in the telecommunications, multi-media, information technology and power electronics industries.

Disclosures: The analyst Phibion Makuwerere has no financial exposure to the instrument discussed. The opinion represents his true view.

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