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Rolfes: My chemical romance

The business is nicely diversified on a product basis.

The wordplay proved irresistible, but nonetheless it courts danger to form an attachment to the shares in ones portfolio on any other basis than fundamental value, however slippery that notion may be in practice. I am still of the opinion that the probability is high that Rolfes (RLF) will reward buyers handsomely over the short to medium term (12 to 36 months) at a current share price of R5.40 per share. The rest of this short update is an argument in support of this claim. But first things first… 

I wanted to thank Michael Dale of St John’s Capital (a corporate finance house among others) for his invaluable comments and suggestions regarding a misunderstanding I had in my treatment of corporate tax in the valuation formula employed in the CIL article. The faulty formula used had the following form: 

V = Ebit2017 (1 – g/ROCE)/(WACC – g) 

But it should rather have been the following: 

V = (1-t){(Ebit2017)(1-g/ROCE)/(WACC-g)} 

This change in formula has the rather unfortunate effect of largely erasing the margin of safety I thought CIL had. This changes my recommendation on CIL from a buy to a hold (given CIL’s current share price of R19.10). The updated intrinsic values range from a low of about R15.72 to R19.57 (as you can see, a significant difference from the R21.85 and R27.17 calculated with the faulty formula!). 

Rolfes operates in the industrial, agricultural, food, and water segments of the specialty chemicals sector in South Africa, Africa, Europe, and North America. However, most of the businesses’ revenue (90%) as of December 31 2016 (interims) was generated in South Africa. Rolfes is thus predominantly a domestic play at present, which does not seem a particularly enticing economic place to be, given the current and expected medium-term dynamics we are experiencing and expect to confront in SA on a number of fronts. 

Countering these macro headwinds is the fact that RLF is still small and well capitalised (reasonable balance sheet), which provides room for growth even in lean economic times. More particularly, Rolfes prudently managed its currency risk in the short term (a biggie for any business significantly reliant on imports or exports) by forward covering its USD exposure at a level of around R12.60/$ for the next three months. I expect this to provide a nice currency kicker for the financial year ending June 30, given the rand’s recent depreciation.

As I alluded to in a recent podcast with Warren Thompson, I think that a number of small caps are a lot less economically risky than what many suppose them to be. Rolfes sells many different high margin/low volume (specialty) chemicals to hundreds of different customers, none of which individually has a significant impact on RLF’s top line. True, we categorise the collective product basket of RLF as chemicals, but to my mind it seems highly likely that the likes of red paint, plant chemical feed, hydrocarbon-based solvents, and the chemical ingredients used in a birthday cake to name a few, are not highly correlated economically. In other words, this company sells many products that will most likely not all do well or badly at the same time. In addition, they sell to very many different people, largely in SA at present, but soon enough to a much greater degree in the rest of Africa (especially Zambia) and in the longer term Europe and North America are expected to feature more prominently as well. 

In summary: This business is nicely diversified on a product basis, and in the medium term it will de-risk significantly on a geographic basis as well. Due to its relatively small size, RLF has plenty of room for growth, even in tough economic times. In addition, it has the balance sheet and BEE credentials to do so. 

There is one other extremely important question concerning risk a prospective investor needs to consider: “Will I pay too much for this business at current levels?” Let’s see. 

Rolfes financials and valuation – postcard-style 

To my mind there is much to be said for doing a first past valuation of a company that could fit on a postcard. The value of a prospective investment should be clear as day – if this value is not salient when introducing a few high-level numbers like revenue, margins, and return on capital – then I’m not sure it will magically result from a complex bells-and-whistles-spreadsheet-exercise. 

So, what does the value of RLF appear to be from such a perspective? Rolfes made R862 million revenue for the six months ended December 31, 2016. Assuming that the business will repeat this performance for the six months ending June 30, 2017, implies that the total revenue should be somewhere in the vicinity of R1.72 billion. On interim revenues of R862 million RLF made R97.4 million in operating profit (Ebit) and R61.5 million profit after tax (PAT). Assuming that RLF will maintain steady operating and net profit margins for the year ended June 30, 2017, implies that the business will generate approximately R195 million in Ebit and R123 million in PAT. But, are these assumptions of a repeat of the last interim results justified? Not quite, but it’s a good place to start. Rolfes requires a bit more nuance in analysis as it has varying degrees of cyclicality in demand for the products it sells in some of its underlying operations. Hence, it’s a good idea to delve into the various business segments to consider their results on an interim basis.

Agricultural segment 

The drought that affected the top line of the segment during 2015 and much of 2016 has largely lifted. All else equal, this will probably result in a revenue performance for the year ended June 30, 2017, that is at least what was seen for the comparable period ended June 30, 2016. 

But, it should be noted that the performance of the business varies between the first half of the year (H1) and H2 as shown by the following simple observations: Revenue for the year ended June 30 2016 was R268.5 million. If we disaggregate this top line into its H1 and H2 components, we see that the revenue for the six months ended December 31 2015 (H1) was R142.6 million, while it was R125.9 million in H2, which is significantly different. This implies that we cannot simply double the revenue figure for H1 2016 to arrive at a forecast for H2. What we could safely do to maintain an adequate margin of safety in our estimates here is to suppose that the revenue in H2 of the 2016/2017 financial year will at least equal that achieved in H2 (R125.9 million) of 2015/2016 and thus pencil in a total revenue of R281.9 million (H1 R156 million + H2 R125.9 million). I think the actual result will probably turn out to be better than this, but if I am going to be wrong, it seems better to undershoot with a forecast rather than the converse.  

Turning our attention to the Ebit margins in this business we observe that it has traditionally done worse during the second half (H2) of the financial year when compared to the first (H1), and as such we need to adjust our forecast downwards here as well from a simple H2-will-equal-H1 scenario. For example, the Ebit margin for the year ended June 30 2016 was 13.9%, significantly less than the H1 Ebit of that same year (17.36%). To be conservative I will pencil in an expected Ebit margin of (13.9%) for the year ending June 30 2017, which matches that achieved to June 30 2015, even though H1 2016/2017 (18.67%) has started off better than H1 2015/2016 (17.36%). 

Conjoining the first pass revenue forecast with the Ebit margin forecast implies that the agricultural segment should generate around R17.5 million Ebit in H2 and therefore R46.6 million Ebit for the year ending June 30 2017 (H1 Ebit + expected H2 Ebit).

Food segment 

The food segment, in the form of Bragan, has been a truly outstanding contributor to RLF group results since its acquisition in the latter part of 2015. Bragan generated R397.1 million in revenue for the six months ended December 31 2016 (H1). In the comparable interim period for the year ended December 31 2015, the top line was R161.5 million, but one must remember that Bragan only contributed to the group for three months of that six-month period (Bragan was acquired in the middle of H1 2015). In effect, Bragan would probably have contributed somewhere in the region of R320 million in revenue if it was acquired at the start of the new financial year in July 2015. Hence, the top line growth from H1 2015 to H1 2016 was approximately 24%. The revenue in H2 of 2016 was R306 million, which shows that this business also has a bit of seasonality associated with the demand for its products. IF we pencil in a very conservative R306 million for H2 of 2017 it will imply that the total revenue from the food segment for the year ending June 30 2017 should be at least R703 million, and probably much closer to R800 million if you ask me. 

The Ebit margins of this business has ranged from a low of 10.8% for the interim period ended December 31 2015 to 12.7% for the interim period ended December 31 2016. The full year Ebit margin was 11.2% in June 2015 and 12.1% in June 2016. Given the seemingly low volatility of this business’s Ebit margins, at least during the last 18 months, I expect the Ebit margin to be somewhere in the vicinity of 12%. 

IF my revenue and Ebit margin expectations materialise, then the total revenue from the food segment should be at least R703 million and the commensurate Ebit at least R84.3 million for the year ending June 30 2017. I expect this forecast to be on the low side for two reasons. Firstly, the Gauteng market, where RLF has a 50% market share, is growing at 6%. Secondly, RLF has quite a bit of room to grow in Durban and Cape Town, where their market share in the food chemicals space is still reasonably small. 

Water segment 

The water space is the one disappointing element of the greater RLF whole. For purposes of this simple valuation exercise I will assume that this business manages to cover RLF head office costs. There are some plans on the go for this part of the group. Top management has recently reorganised the business (installing a new CEO) and has stated that they aim to compete for larger projects in the water space in future. Time will tell if anything comes of these plans. For now, I am taking a wait-and-see attitude. 

Industrial segment

The industrial chemicals segment is the traditional heart of the RLF business (started in 1924). This business has shed some excess fat in recent times (lead chrome plant for example) and hence its top line actually decreased for the six months ending December 2016 as compared to the same period in 2015 (R221.2 million vs R260.1 million). This part of the business is very well diversified and sells everything from solvents to paint to chemicals used in leather tanning. 

It is not a shoot-the-lights-out sort of operation but it did generate a fair Ebit of R21.2 million at an Ebit margin of 9.6% for the 6 months ended December 31 2016. This Ebit and Ebit margin performance was significantly better than what was achieved in the comparable period to December 31 2015 (R14.2 million Ebit at a margin of 5.5%). The full-year Ebit and Ebit margin for this business was R42.7 million at a margin of 8.3% for the year ended June 30 2016.

It doesn’t appear that there is a great deal of seasonality in the demand for the goods of this business and as such I don’t think its completely wrong to expect this business to do pretty much as it has done for the last 18 months (given the subdued macro economic backdrop during this period and the expectation that it will not change for the better anytime soon). IF an H1=H2 assumption pans out for this segment then we should see it generate about R440 million in revenue at a margin of about 8%, which implies an Ebit of R35.2 million for the year ending June 30 2017. According to management, the business should probably do closer to a 10% Ebit margin but lets keep a prudent margin of safety given SA’s deteriorating macro environment.

The value of RLF: putting the pieces together

To get to the value of the company we need to put these four different pieces together and subtract some head office costs. As mentioned earlier, and to keep things simple, I will assume that the water segment pays all the head office bills. I’ve seen the head office, and believe me, Lizette Lynch (RLF CEO) does not appear to be in the habit of opening the company purse strings for unnecessary adornments, if at all.

I expect the total Ebit for the financial year ending June 30 2017 to be at least R166.1 million (R35.2 million + R84.3 million + R46.6 million).

The valuation formula is:

V = (1-t){Ebit2017(1 – g/ROCE)/(WACC – g)}

We have the tax rate (t), we have the expected Ebit2017, but we still require estimates for ROCE, WACC, and g.

This is getting to be an awfully large postcard (A3 I suppose), but hang in there for another paragraph or two.

The return on capital employed (ROCE) for 2016 was:

ROCE = Ebit/(Capital Employed) = (R 137.1 million/R 822.8 million) = 16.6%

In my opinion post-Bragan RLF is not really fruitfully comparable from an ROCE perspective to Pre-Bragan RLF, and as such the 2017 ROCE should not be too far off from 16.6% (both include Bragan). More specifically, IF my estimates for the forthcoming June 2017 results are correct, the floor as far as the ROCE is concerned is roughly 16.7% (R 166.1 million/R 989 million).

IF we assume a cost of equity of 16.25% and note that RLF’s cost of debt is roughly the prime rate, we arrive at a WACC of 13.07%.

The growth rate in Ebit to perpetuity is anybody’s guess, but we know it cannot be too far off the long-run growth rate of the SA economy. I expect that we will see good growth from management efforts in the rest of Africa, where RLF has already established a beachhead. It must be noted that the effects from these strategic efforts will initially be relatively small in the larger RLF group scheme of things as exports only make up roughly 10% of revenue at present. But it should fill in a bit of growth weakness that SA will probably experience over the medium term. Bragan is growing very nicely into new geographies within SA, where there is a number of low hanging fruit to be picked (for e.g. R600 million a year CPT market), although it has slowed to about 6% in the mature Gauteng region. In short, I think a 6% rate of growth (nominal inflation in SA) is probably not the worst forecast we can make.

Inserting all these variables into the valuation equation we see that the enterprise value of RLF is:

V = (1-0.28){(166.1)(1-0.06/0.167)(0.1307-0.06) = R1083.8 million

The equity value of RLF is therefore:

Vequity = R1083.8 million – R284.6 million (debt) + R56 million (cash) = R855.2 million or considering that there are 161.3 million shares outstanding the calculated value per share would then be R5.30. 

I consider R5.30 to be close to a sell-the-house, the car, and the mother-in-law price in order to acquire RLF shares given the current state of the business.

As you may have noticed, I was very conservative in the estimates I used for this valuation exercise. What happens when one is more realistic (move more towards the median of the expected distribution of returns)? Well, to make a long story short, this is what I expect:

  • The agricultural segment will do probably do better than R125.9 million but not quite get to R142.6 million in H2 2016/2017. (I pencil in R135 million here). This will imply an Ebit of R40.4 million.
  • The food segment will continue to do very well over the short term and will probably get close to matching the 2016/2017 H1 performance of R397 million (I pencil in R390 million). This will imply an Ebit of R97.5 million.
  • The industrial segment will probably manage a 10% Ebit margin and thus make about R44 million Ebit.

Inserting these estimates into the valuation equation we see that:

V = (1-0.28){(181.9(1 – 0.06/0.167)(0.1307-0.06)} = R1.186.9 billion

Which means that the equity value is:

Vequity = R1.186.9 Billion – R284.6 million + R56 million = R958.3 million or R5.88 per share 

As somebody put it rather well once, “the problem with these sorts of valuation exercises is that changing the inputs slightly puts you in a different universe”. Just under R6 per share is my best margin-of-safety-preserving guess regarding the fundamental value of RLF shares. IF it turns out that I am wrong on things like the cost of equity or the growth rate or the expected ROCE, this guess might not even be worth the few bits required to store it on the Moneyweb site.

I have tried to be conservative – to underestimate – the relevant values so that there are more ways for the world to turn out such that it contains a substantially higher RLF share price as opposed to one that will disappoint buyers at the current price. Thus, my chemical romance continues for the time being….


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Wish I knew some brand names associated with Rolfes products. When I look at their AR, I just see broad industry talk. If I can’t see how they make money in specifics, investing in them feels like a leap of faith in a good sounding play. The birthday cake example helps slightly. With so many independent companies involved in chemicals and imports, I wonder if Rolfes has long term advantages?

Rolfes shares falling sharply: what’s going on? Any news?

Really? This romance may be ending. Like many SA smallcaps, Rolfes is getting creamed at the moment.

Rolfes finally admitted the problem: Their results to June 2016 were wrong as were the Dec 2016 results! Wow, and they only found out now! I would like to know who has been selling shares in recent months…. mmmm I wonder? Is this what is referred to as “a real KPMG”!

And in May ’17 the Group FD left in a hurry. Those in the know sell their shares and minorities get screwed. Perhaps someone should introduce the Board to the King Code of Corporate Governance.

I consider R5.30 to be close to a sell-the-house, the car, and the mother-in-law price in order to acquire RLF shares given the current state of the business.

I hope you did not sell your house and car . The only good thing maybe be the mother-in-law sell off. But in any case . You can sell her now for double the units. What a score ( in your mind !!!! ) But wait , there’s more: wait for the the Junk status , maybe you can do even better !


End of comments.



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