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Diamonds in the rough

The JSE-listed companies that are under-valued and unloved.

The JSE is trading on a price:earnings multiple of 19.6, well above its ten-year average of 16.2x. While valuations are still high, in many cases share prices have retreated slightly and for those prepared to do the legwork, value can be found.

The Moneyweb Investor invited suggestions from analysts on ‘diamonds in the rough’, shares they felt were over-looked and un-loved but which could reward patient investors over the next twelve to 36 months. We present the ten we found most interesting.

AngloGold Ashanti

ANG’s share price follows the gold price.  The share is down 9% this year but Lonwabo Maqubela of Perpetua Investment Managers believes this discounts the work that the management team has done in improving the business and capital structure.

He notes that South Africa now contributes only 25% of ANG’s production, which means it is not highly exposed to the SA environment.

Since 2012, ANG has reduced its all in costs of mining by some 40% and mines at  a cash cost $750/oz. Emerging market currencies and the low oil price  act to counter the falling gold price. As the company focuses on improving its safety record in South Africa there is scope to cut costs further. Furthermore ANG has reduced its debt over the past year. At marginally higher gold price we think the company can continue to cut debt.

ARB Holdings

This copper and lighting distributor is well managed and capitalised. However the company is ill served by the macro-environment which has seen most of its customers put the brakes on capital spending. This has harmed its lighting division, which generates the bulk of revenue. As a result the company is cutting costs internally, and focusing on winning maintenance business. With its strong balance sheet ARB is in a position to make some value-enhancing acquisitions. The share has lost 14% of its value over the last year and is now trading below NAV. When the economy lifts, this could be the horse to back.

Astrapak

This is a classic turnaround opportunity says Terence Craig of Element Investment Managers. The business has been under new management for two years; it is isposing of non-core businesses (at a premium to book value) and has consolidated its manufacturing base for optimal use. The company is conserving cash and improving balance sheet strength by reducing debt (it peaked at R500m+ in FY2012 and had reduced to R193m by FY15).

Despite these steps the share continues to trade at about a 50% discount to book value. Management warned that the turnaround would likely take five years with a tough initial two-year period as the business was restructured.

The share price has been weakened by forced selling by transition managers. It’s worth noting that the CEO has acquired over 500,000 shares over the last three years.

Actions taken by management should result in an improvement in earnings over the next three years, which should unlock material value in the Astrapak share price.

Conduit Capital

This company has two divisions: an insurance and risk business and an investment services business. Simon Brown, founder of justonelap.com describes the business as a mini Berkshire Hathaway in that CEO Sean Riskowitz is using the insurance arm to create float, which he then invests into other assets. The company is in the process of raising R150 million through a rights offer, which will be used to make further investments. While Brown is not in love with all the assets Riskowitz is buying, he has faith in the management team. 

Dawn

This building supplies company recently caught the public’s eye by announcing that management agreed to voluntarily pay back bonuses, a positive step demonstrating an alignment of management and shareholders interests.

However, with Dawn’s share price at R4.75, where it was ten years ago, more remedial action is needed to affect a lasting recovery, says Chris Logan of Opportune Investments. Encouragingly the board is talking about substantially reducing operating expenses to 15% of revenue. Costs have crept up to well over 20% of revenue, eroding the operating margin.

The board has also committed to further share buy-backs, which are value enhancing at current levels. Despite the tough local economy it looks as if Dawn could earn some 100cps of earnings in F2017 if positive momentum is maintained which should lead to a rerating.

It may be worth noting that the chairman has recently purchased 200 000 Dawn shares at R5.

Investec Australia Property Fund

This locally listed property fund is attractive for several reasons, says Michael Porter of Harvard House Investment Management. While it has 100% offshore exposure, it is a different geographic focus to other listed funds, which are mostly focused on Europe.

IAP is listed locally, offers exposure to a foreign market, has already built up a 2-3 year track record, has the experience and expertise of Investec behind it, and offers a compelling income yield of close to 7%, depending on your rand assumptions. Growth has been good and there is more to come as the fund grows and matures.

It is a small cap, but the downside is limited, there is a good income yield on offer, and the share is underappreciated, so room for a rerating.

Porter adds that the share is not very liquid, so tradability can be problematic. It also has a relatively small market cap of only R3bn.

Others may balk at Australian exposure given its commodity focus and similar currency woes however Harvard House believes this is compensated for by the yield.

Metrofile Holdings

Metrofile is a document storage and records management company. But can also be seen as a property company, says Asief Mohamed, CIO Aeon Investment Management. It charges companies a monthly storage fee for document storage, electronic storage and secure shredding. As it stacks the boxes on racking up to seven floors high it gets a very high rent per square metre relative to most other property companies. The growth in earnings is expected at a steady rate of about 10%/year. The bulk of its earnings will in the next few years be paid out as dividends as it is extremely cash generative with a dividend payout ratio more in line with other property companies in South Africa.

Stefanutti Stocks

Small cap construction company Stefanutti Stocks is trading at an all-time low of R3.38/share since it listed in 2007. This is a 43% discount to its tangible net asset value of 723cps.

Earnings have declined for the last six years. However, Vanessa van Vuuren, small cap analyst at Sanlam Investment Managers notes that despite the progressive earnings decline Stefstocks has remained profitable on the whole.

The company is well run with a well-capitalised balance sheet. Yet the market is pricing it as if it were verging on bankruptcy.

Earnings are expected to decline in this financial year ending 28 February 2016, but even if earnings halve, the company is valued on a 3x PE multiple. The inverse of the PE ratio is the earnings yield – and Stefstocks is offering an earnings yield of 34%! Compared to the paltry yields of cash, bonds and property, it is a compelling proposition and an investor entering at this level is being more than adequately compensated for equity risk.

Transaction Capital

Transaction Capital is a financial services group that provides asset-backed lending to the SA minibus taxi industry, among other credit management and collection services. According to Andrew Dittberner, CIO Cannon Asset Management, Transaction Capital is a defensive business that can withstand the difficult economic conditions.

In it latest results the business delivered organic headline earnings growth of 20% with a return on shareholders equity in excess of 16%. These are impressive numbers in the current climate. A business of this stature with the ability to grow earnings organically usually demands a very high rating.

While not a dripping roast, Transaction Capital affords investors the opportunity to invest in a very well run business with high quality earnings power at a reasonably attractive price.

The Jse

The JSE is highly cash generative and sits with net cash of R1.5bn (13% of market cap) on its balance sheet. Although, it is not glaringly cheap as it is on a high earnings base, continued market volatility bodes well for the share, which has little need for re-investment other than IT spend.

As a defensive measure the company has introduced new revenue streams that are less related to trading. These services (such as market data) now account for nearly half of the revenue.  Other products are planned that will help drive top-line growth.

The JSE has a monopolistic position but is behaving rationally to ensure the sustainability of its business model. Its margins have grown from 20% in 2006 to nearly 40% in 2014 but are lower than other global exchanges.

Overtime the JSE’s revenue should continue to grow faster than inflation and operating costs, supporting further margin growth.

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