The following is an excerpt from a June 2019 letter to investors, in which Keith McLachlan provides high-level commentary around AlphaWealth’s prime small and mid cap fund.
Datatec’s turnaround of its Westcon International continues to gain traction in what we believe is the build-up to the final sale of this subsidiary. In the background and equally important, its Logicalis continues to grow as a global ICT services group.
The share’s uplift is being generated independently of South Africa and local politics, Eskom or macro-data. If anything, a weaker local currency creates more upside in this hard currency play. Read more here.
Hosken Consolidated Investments
Trading at around 30% discount to its listed sum-of-the-parts, HCI continues to steadily unlock value across its diverse portfolio. The recent unbundling of its hotels business from the casino business (Tsogo Sun Hotels from Tsogo Sun Gaming) is yet another step in the right direction.
The group’s unlisted investments – particularly in Impact Oil & Gas – are becoming increasingly valuable while management’s capital allocation track record provides further comfort.
In a way, HCI offers the blue-sky upside of any return to growth in SA while giving us the margin of safety by investing in this exposure through a holding company discount and in a relatively diverse manner. Read more here.
Coronation Fund Managers
With a share price trading on a historical and, likely, forward dividend yield that is above cash (i.e. > c.5.75%), Coronation offers a high returning (its return on equity is over 50%) option on either a recovery in emerging markets and/or a recovery specifically in SA. Preferably both.
Given the share’s current below-mean valuation against its Assets Under Management and the relative transparency with which we can track its performance (i.e. via its underlying funds), we are being paid to wait in this investment and are getting any recovery for free.
Adcock Ingram Holdings
Adcock Ingram has a defensive, high-margin underlying with a winning public sector underpin and an ungeared balance sheet offering acquisition, dividend and/or share buy-back optionality.
More recently, the fast-approaching BEE deal unwind should shift Bidvest into a controlling position at the group. This may precede an offer to minorities (at an attractive premium; we estimate a low-end price of c.7500cps) and the ultimate delisting of the stock. Read more here.
Stor-Age Property Reit
The self-storage property sector offers diversified income (lots of small tenants) with real asset underpin (if a tenant does not pay, their stored property can be sold) that is defensive in nature (consumers tend to cling to possessions).
Any investment in self-storage has high barriers to entry given that the properties cannot secure pre-tenants and new properties carry speculative risk until enough tenants have been signed to reach break-even.
Stor-Age holds its own against the few global peers that exist on profitability, gearing, qualitative (e.g. internal ManCo) and valuation metrics. This provides the basis for our investment in a Reit currently offering a 7.4% dividend yield. Read more here.
Master Drilling is not a South African business. Rather, we view it as a global, industrial technology play leading in the field of hard rock and commodity drilling services that should diversify across territories and commodities, drilling services and even industries.
Master Drilling should not be trading on such a low price-to-earnings (PE) of 7.4x. The risk is that management and/or private capital agrees with this view and delists the stock. Sure, this will likely be at a premium to its current share price, but it will mean that AlphaWealth won’t participate in the group’s future. Read more here.
Sabvest is currently trading at a discount to its largely unlisted and seemingly conservatively-valued investment portfolio. We expect the collapse of the -N- and Ord structure into a single share class to boost liquidity and further lower this discount. Indeed, management incentives now include the share’s discount to its own net asset value.
The group’s unlisted portfolio holds appealing rand hedge protection. Even after a large investment holding discount and a non-controlling discount (due to the -N- shares), we still estimate that Sabvest -N- shares are trading on a c.37% discount to their fair value. Read more here.
Sirius Real Estate
Sharing some of the same characteristics as Stor-Age Reit, Sirius plays exclusively in the German property space. While the group does have some long-lease, single-tenant properties, its real edge comes from buying industrial parks with vacant space that is unlikely to ever be tenanted, and hence is not charged for in a property transaction.
It then develops smart space (office, industrial, logistics or storage) that it tenants efficiently. The uplift in both rental and value of the property is potentially material while the in-house platform managing the tenanting and leases captures material margin.
At Wescoal’s current free cash flow yield of c.33%, we are paying for about three years of mine life. Once you work through the detail, though, Wescoal shows a current average six-year mine life and several of its longer-life green and brownfields projects should add materially to this.
There is also a profitable coal trading business. However, Eskom’s sustainability and the general pressure to ‘go green’ remain risks to the longer-term group. Given the valuation, we are not paying for this longer term. Anything beyond ‘Year 3’ is a bonus at this valuation.
An argument may be against the group’s capital allocation, its capex requirements or its rehabilitation provision. But current cash flows are quite real as is management’s intention to launch a material share buy-back programme to return surplus cash flows to shareholders. Read more here.
Super Group recently acquired a local, asset-intensive logistics business on a forward PE of 8.1x. This acquisition is roughly the same size as Santova’s market cap. As opposed the 2/3PL business that Super Group acquired, Santova is a 4PL non-asset based, globally-trading (c.60% of earnings outside of South Africa) logistics provider. And is currently trading on a historical PE of only 5.8x. Why? For no reason that we can see.
The risk is that companies like Super Group realise this and end up delisting. Yes, we will get a short-term payout from such an action, but we will lose the option on long-term growth that such a business can deliver. Read more here.
Keith McLachlan is a fund manager at AlphaWealth.
This article was originally published on SmallCaps.co.za here.