I have a proposition for you. I am willing to wager R100 that Rolfes (RLF) will outperform any other share on the JSE (you will have to choose 1 to “compete” against Rolfes) for the period July 15 2016 (opening price) to the close of trade on the last day of trading for 2017 (closing price).
I always take my bets seriously, and therefore I am only taking the first 1 000 bets. Email me (firstname.lastname@example.org) with your name and the share that you think is going to edge out Rolfes. I will post an article on Moneyweb with the shares in “play” so to speak. I am looking forward to hearing from you. My case for Rolfes is briefly presented below.
Rolfes is a specialty chemicals company that sells niche chemical products (higher priced/lower volume) into four major market segments; food, industrial, agricultural, and water chemicals. Rolfes is still small, with lots of room for growth. Their future growth prospects are supported by the fact that they have chosen to operate in industries where I believe demand will be strong for many decades to come. This good for the revenue side of the profit equation. Remember that Profit = Total Revenue – Total Costs which implies that to increase profits you need to increase revenues, decrease costs, or do both. But costs can theoretically only go to zero while revenue may increase by many factors of its current value. For this reason I love businesses that can increase their revenues sustainably and like businesses that are very cost conscious. And if a business can do both, I am in a state of mind that is best described with words not fit for publication. Rolfes may very well turn out to be such a business.
The markets that Rolfes plays in will be with us for many centuries to come. We need to eat, which requires food and agricultural chemicals, and we need to drink and manufacture, which requires water and industrial chemicals and services. The revenue side is covered. New management is very much on the ball with regards to being motivated to manage Rolfes well, and we will have to wait and see if this fervor translates into sustainable cost discipline. I believe so.
Without boring you with too much detail, what would you “get” if you became the sole proprietor of Rolfes?
In short: If you were the sole proprietor of Rolfes, you would own a company that sells R1.25 billion worth of chemicals a year, and makes about R90 million in net profit after tax.
What would you be willing to pay to own a company such as this?
At the moment (as of July 15 2016) the price tag of the entire business is R500 million. Does the price seem like a good deal to you? Consider the following; Imagine that this business needs to spend another R20 million per year to maintain its current profitability into the future, which means that the R90 million net profit would actually be R70 million. What does that mean? It means that you, as the sole owner of Rolfes, would be able to put R70 million in your pocket every year for as long as the business is sustainable. (I am assuming all amounts grow at the rate of the economy so that the R70 million you receive will keep up with inflation). What would you be willing to pay for such an “income” stream?
The stock market is not a casino, but neither is it your mattress or the local bank. It needs to be a place where you could potentially make a lot of money to make up for the fact that it is a place where you could definitely lose a lot of it. Lets suppose that you require any money that you invest in the stock market to double every five years (15% per year) to compensate you for the very real possibility of financial loss. If we approach the question of Rolfe’s value with our required return, what would be a fair price to pay for the business?
Ignore the mathematical details, but when we do this calculation (R70 million/(0.15-0.06) we see that the answer is equal to R 777 million, or about R277 million more than its current price tag. In other words, assuming that Rolfes continues to churn out the same real income (R70 million per year growing at the rate of inflation), we can expect to earn more than 15%/year on our investment in Rolfes if we are willing to pay R500 million for the right to the earnings stream of Rolfes.
I believe that I have been conservative in estimating what the future of Rolfes holds. I am confident that Rolfes can grow the R70 million income stream at a pace higher than inflation for a number of years before it hits industry demand constraints. But it’s good to be conservative as any surprises that the future is bound to reveal will be of the positive sort. Bottom line: I think anybody who invests in Rolfes at this price (R3.09) is going double their money in the next five years, and if they are lucky, perhaps as soon as the next three.