Pick of the week: Afrimat

A winner in the construction space but it’s still in buy territory for the brave.

Afrimat has seen a fivefold rally in its share price over the past five years at a time when the construction and materials index moved 32% in the opposite direction. The rally was backed by 15% compound annual growth in earnings. In full-year results released earlier this month both revenue and headline earnings per share surged 42%. Such numbers are very rare in a sector where profitability has been trending downwards.

The market has noticed its impressive performance but we think it’s still in buy territory for the brave. Using a discounted cash-flow model we obtained a 12-month upside potential in the region of 20%. This assumes a conservative 15% growth in earnings putting it on a forward price:earnings (PE) ratio of 11.

That looks like a bargain considering that the market PE is at 17. It also has a good history of dividends for those investors who would like income. In the most recent year it paid out 41c which puts it on a 3% yield.

Afrimat looks like a real winner in this construction space. But how did it manage to pull such good results and survive the implosion which saw many players going down? First, Afrimat is not itself involved in construction works but rather supplies goods to construction and mining companies as well as private developers.

Its traditional business has been quarrying and selling aggregates or processing them into concrete and ready-mix, but it has also moved into small-scale mining of industrial and agricultural minerals.

So, unlike the listed construction giants who need a critical mass to contract before it’s worth their while, Afrimat benefits from small projects as much as from bigger projects. In KwaZulu-Natal for instance the company reports that close to half of its bricks and blocks go to private buyers.

The second factor in favour of Afrimat’s prospects is its strategic positioning in relation to major projects around the country. Its management has demonstrated the ability to anticipate where major projects are going to be and positioning the firm in proximity to them. Aggregates are heavy so location is key in this business.

With more than 35 quarries and sand and gravel mines spread evenly across SA, Afrimat can produce and deliver at relatively lower transport costs than many other players. It has also introduced mobile equipment, which enables it to take advantage of opportunities as and where they arise. With the low-cost housing in KwaZulu-Natal tapering off it has acquired a mining permit in Mpumalanga, gearing itself for potential construction growth along the Nelspruit-Botswana corridor.

Afrimat’s success is also underpinned by the diversification strategy which it pursued post the 2008 global financial crisis. In 2010 it bought the Glen Douglas metallurgical dolomite mine for R35 million from Exxaro and a year later the little known Clinker Group for R124 million. Early last year it secured an 80% stake in fellow listed penny stock Infrasors, which was struggling at the time but has seemingly turned its fortunes around.

These acquisitions brought diversity to the group’s product offering and in most cases enhanced margins. It now has a vibrant division which supplies the industrial sector with metallurgical dolomite and quartzite (customers like ArcelorMittal), silica (glass makers), and ceramics. The recent financial statements indicate that these activities combined with aggregates contributed R1.3 billion – about 70% of group revenue – at an elevated operating margin of 14%.

There are downside factors to its operations. Its costs side is dictated by familiar energy and labour input cost issues. If you believe that the current low oil prices will persist then it’s a plus but the joy will be spoiled by Eskom’s planned tariff hikes. The industry, which is inherently labour intensive, is also very vulnerable to industrial action.

Afrimat’s prospects depend substantially on construction activity, ranging from roads and power stations to private development. Of course we’re pretty fatigued by government promises of major infrastructure spending, but if they do translate into real activity then Afrimat will be well positioned. In the meantime the company pins its hopes on small pockets of expenditure by government and private developments.

With the government putting more focus on expenditure on water systems, reservoirs and pipelines, especially in rural areas and townships, Afrimat is also well positioned to capture such spending. Management indicates that it wants to continue improving the company’s geographic and product diversification with possibilities of moving beyond SA’s borders.

These ambitions are backed by a solid balance sheet and operations that are strongly cash positive. We think it’s a solid company doing well in difficult circumstances. But if you’re an optimist who believes the economy is going to recover, labour problems are behind us and the much-publicised government’s multi-trillion-rand infrastructure programme is going to gain traction, then this stock could really fly. Its scrip is relatively liquid for a company of its size trading an average of R33 million worth of shares per month.

Analyst: Orin Tambo, CFA; Editor: Stuart Theobald, CFA

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, methodologies and definitions please click here.


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