This article was first published in Moneyweb Investor. To read the magazine click here.
Since our last review of Invicta in July its fundamentals have deteriorated further largely because of South Africa’s poor economy and the weak rand. The latter is particularly worrisome for the company given its reliance on imports. Furthermore, some of its customers are in the mining and agriculture sectors which are being undermined by falling commodity prices and drought respectively. However, we think the market has overly pummeled the counter given its potential cash-generation capacity and relative valuation.
Its interim results to end-September have somewhat mimicked the country’s economic performance and its share price has lost almost half its value since July.
It is trading at a price:earnings ratio of 5.3 compared with an average of 11 between 2010 and 2014. Its industry is trading at 12.7 times, with an average of 11.8 between 2010 and 2014. We have used very conservative growth and cost of capital assumptions in our discounted cash-flow model and it points to significant upside potential. However, the share has become more volatile since June and there is a high degree of risk given the market conditions and its high gearing. We issue a speculative buy for those prepared to take on the risk.
Invicta share price performance
Group revenue edged up 1% to R5.3 billion while operating profit rose 7% to R457 million, helped by profit from an asset sale. The operating margin improved to 8.6% from 8.1%. If we exclude profit from the disposed asset, operating income actually fell 6%. Pre-tax profit was beefed up by a 4% reduction in net finance costs and rose 10% to R385 million. The acquisition of minorities in one of the group’s subsidiaries increased the income flow to attributable earnings, which gained 17% to R253 million.
However, as a result of an additional 33-million shares issued during the year, headline earnings fell 34% to 193c/share. The board declared an interim dividend of 67c/share (1H15: 84c/share).
It is worth noting that some executive and non-executive directors have been accumulating the stock since July with the exception of those who sold to meet some derivative contract requirements. We read this as a bullish signal because directors are usually in a good position to ascertain a company’s economic prospects
The markets that drive Invicta’s performance – mining, industrial, agriculture, building and construction – remain depressed and competitive. However, the management team has a decent track record and we think that will help the company navigate this difficult patch. The need to diversify earnings by geography has never been more important and management is pursuing this. It has also raised the possibility of a secondary listing though it hasn’t specified where.
Management says it will continue to seek growth through market share gains, growth into Africa and selected strategic acquisitions. It will also remain focused on margins and expense management, working capital control and cash generation.
The group is expanding and restructuring the BMG supply chain and all BMG businesses have been consolidated and migrated onto a new BMG IT platform. This is expected to improve efficiencies.
The engineering division is focusing on further reductions in stock and costs to adjust to the difficult trading conditions. It targets an operating margin of 10% in the short term and 12% in the medium term. The building supplies segment is targeting an operating margin of 6% in the short term and 8% in the medium term.
Furthermore, Invicta recently concluded three small bolt-on acquisitions within the engineering consumables segment. These are expected to have a positive impact on 2H16 earnings and also confirm management’s stance on acquisitive growth.
- Good management track record
- Cost-containment strategies paying off
- Possibility of a secondary listing coupled with a strategic acquisition
- Attractive valuation supported by directors taking long positions in the stock
- Low level of cash holdings amid high debt levels
- Weak local and global commodity outlook
- Limited capital spend by businesses
- El Nino weather conditions and drought will negatively affect agriculture-related business
Nature of business: Invicta Holdings is an investment holding company with three main subsidiaries: Bearing Man Group (BMG), Capital Equipment Group (CEG) and Building Supply Group (BSG). These operate more than a dozen divisions involved in importing and distributing engineering consumables, capital equipment and building materials. In 2013 Invicta acquired Singapore’s Kian Ann Engineering to lead the company’s expansion in southeast Asia.
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.