By Chantal Marx, Pritu Makan, Sithembile Bopela, Jalpa Bhoolia, Zimele Mbanjwa & Hashmeel Suka
GNU your SA Inc stocks
The results of the 2024 general elections surprised many. Prior to the election, the fall in support suffered by the ruling party was largely considered a "tail risk" event. This means that analysts regarded such an outcome as carrying a very low probability, but that it could possibly have a very large impact on the political order and by extension, capital markets.
The maturity with which the situation was handled, the formation of a government of national unity (GNU), and key portfolios (the presidency and finance) remaining under the same leadership, saw a sense of calm return to markets, and with it some optimism.
Since the announcement of the GNU on 14 June, the JSE All Share Index has returned 5.6% in rand terms and 8.3% in US dollar terms, comfortably outperforming the S&P 500, the MSCI World Index and our emerging market peers. The MidCap Index has returned 7.0% and the Small Cap Index 8.1% - highlighting an even stronger performance by the so-called "SA Inc" basket of shares. Certain SA Inc shares have been notable outperformers since the announcement, namely Stefanutti (+149.6%); Nampak (+70.2%); ArcelorMittal (+36.0%); and Raubex (+27.0%), prompting us to have a look at where we still see decent value as a play on the theme.
Afrimat (AFT)
Since its inception, Afrimat has applied a diversification strategy that has seen it grow through acquisitions and evolve into a multi-commodity, mid-tier mining and materials company. It has a wide range of offerings including Construction Materials (aggregates, bricks, blocks, pavers, ready-mix concrete and more recently cement), Industrial Minerals (lime and lime products), and Bulk Commodities (iron ore, anthracite and manganese). Its end market is both local and international.
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The strategy to diversify between commodities and revenue streams, coupled with stringent capital allocation, has enabled the group to weather economic and commodity shocks.
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Afrimat's agile nature allows it to service major infrastructure and construction projects for public sector and government-owned enterprises, as well as small private sector contracts.
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Afrimat boasts an exceptionally experienced executive and operational management team that has a superb track record in acquiring, assimilating, and then growing businesses.
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The most recent acquisition of Lafarge, a leading provider of construction materials, is set to create value for Afrimat through the significant operational synergies of its construction materials business with the well-established operations and product offerings of Lafarge. The group will benefit from increased national market share, operational efficiencies, and increased product volumes.
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An exacting focus on capital allocation and cash conversion has ensured the group's ability to be a consistent dividend payer over the years.
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Afrimat recently reported solid FY24 results with revenue increasing 23.9%, while headline earnings per share (HEPS) increased 24%. Bulk Commodities outperformed (~83% of the group's operating profits), buoyed by a strong performance by the Nkomati anthracite mine, and a strong uptick in local iron ore sales. Construction Materials also had a strong showing, and with the Lafarge integration underway, the near- to medium-term prospects for this division are encouraging. Group operating profits also accelerated.
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The balance sheet remains strong, with cash and cash equivalents at the end of the year of R504.7 million (+80.7%) y/y. The debt-to-equity ratio was at 1.4% (4.5% in FY23).
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We see upside in the construction materials business if gross fixed-capital formation locally picks up locally and the infrastructure backlog receives priority. Additionally, closer public - private sector collaboration in the repair, maintenance, and expansion of South Africa's logistics, electrical and water infrastructure (e.g., Operation Vulidlela) should be a major medium- to long-term driver. Lower cost of capital once interest rates start to go down may also bode well for the company as more leveraged construction projects pick up pace.
Afrimat is trading on a 12-month forward PE of 8.6 times, which seems compelling given its expected growth trajectory and optionality related to the Lefarge acquisition. Relative to its peers, it trades at a sizable discount.
Bidvest (BVT)
Bidvest is a service, trading, and distribution company operating mainly in South Africa. The company specialises in services including cleaning, security, landscaping, indoor plants and flowers, travel, banking, and foreign exchange; Private sector freight management; Commercial, which involves the manufacturing and distribution of electrical products, office stationery, office furniture, packaging closures and catering equipment; and Automotive retail, among others.
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This well-run business has a solid track record with a committed and highly regarded management team.
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The group is not asset intensive and is mostly services driven, with a strong track record of efficient capital allocation.
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The company is well diversified across a variety of sectors - both cyclical and non-cyclical, with no one segment contributing more than 25% to profit.
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The balance sheet remains robust and cash generation is strong, which should result in lower gearing going forward.
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In terms of recent results, the group released a relatively resilient half-year performance (headline earnings: +6.9%, revenue: +8.8%) against tough market conditions. Better-than-expected margin gains on strong expense control culminated in double-digit trading profit growth (ahead of expectations, with five out of the seven divisions reporting double-digit growth). Higher interest costs weighed on the bottom-line performance but was still ahead of expectations.
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Bidvest will benefit from an improved macroeconomic outlook, with structural improvements being complemented by cyclical tailwinds from lower interest rates and lower inflation.
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The group also has a pipeline of reasonably sized acquisitions that are being considered, which could compliment the organic growth profile. The balance sheet is also reasonably healthy, which means that funding growth is not a concern.
Bidvest is trading on a forward PE of 13.1 times, in-line with average levels historically, but we see scope for an improvement in current forward-looking earnings estimates that could see this rating unwind quite quickly.
City Lodge (CLH)
City Lodge owns and operates high-quality, affordable hotels targeted at business and leisure travellers. Their offering includes hotels under four brands, namely City Lodge, Courtyard Hotels, Road Lodge and Town Lodge, offering ~7 600 rooms across South Africa, with smaller operations in the rest of Africa.
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City Lodge is well-placed in the value-for-money business in the accommodation sector. The group holds a solid track record of identifying, purchasing and developing new sites.
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Occupancies have been well supported by the post-pandemic travel rebound, and corporates returning to offices with an emphasis on building relationships and strategic planning. Domestic leisure travel continued to flourish and has been boosted by an enhanced food and beverage offering.
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A strong balance sheet position (the company is in a net cash position) will allow the group to continue focusing on its capital investment programme, which will improve the quality of its rooms on offer. This, together with the increased focus on food and beverage, may see the company's properties continue to become more attractive as a leisure destination rather than its pre-Covid positioning as mainly a business travel play.
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The outlook of the local hospitality sector has garnered fresh appeal as the newly appointed GNU seems driven to remove bottle necks to growth and sectoral development, including in tourism. A focus on refining the current visa regime could help improve international tourist arrivals and complementing this, improving macroeconomic conditions (structural and cyclical) could also aide domestic travel.
The stock has performed poorly over one year and on a year-to-date basis, down over 10% on both accounts. By our calculations, City Lodge is trading on a forward PE of 6.7 times, which still seems attractive against a very attractive medium-term earnings growth profile.
Hudaco (HDC)
Hudaco is a South African-based industrial and engineering supplies group, specialising in the sourcing, importing and distribution of various electrical and mechanical products. Essentially, the company serves as a "middleman" between leading international manufacturers and local retailers (as well as end-users) of industrial materials and consumables:
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Operating more than 30 distinct businesses throughout the country, Hudaco services more than 30 000 active customers across various sectors including mining, manufacturing, agriculture, construction, renewable energy, and the automotive industry. Products are sold through an extensive network of independent distributors and specialised stores.
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The company stocks a large and diverse catalogue of quality products with brands such as Bosch, Cadac, Makita and Kenwood. Given a strong focus on efficient inventory management, the company ensures that products are always available to customers as required. Additionally, the company offers various after-sales services including expert advice, technical training, as well as maintenance and repair solutions.
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Hudaco enjoys a strong market share position in South Africa, benefitting from exclusive distribution rights with major international suppliers as well as long-standing relationships with customers. The group has very few competitors or threats locally.
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Recent results for the group were a bit soft - during a cyclically weaker 1H24, revenue decreased 6.3%, operating profit was down 11% and HEPS dropped 15.4%. This was mainly due to a substantial decline in the Consumer-related Products vertical (-15.7%), impacted by weaker demand across certain businesses. Nevertheless, the group is set to make a strong recovery during 2H24, considering improving business conditions in SA, the mitigation of prior operational challenges, as well as the impact of a more favourable base.
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The near-term outlook is positive, with Hudaco well-positioned to benefit from a revival in the local economy. Recent political developments are particularly encouraging as they relate to improved infrastructure development in the country, which is supportive of demand (and hence growth) across the various end-markets. A stronger rand is also supportive, given that product imports (which are a main component of the company's operations) would be cheaper. Additionally, the group stands to benefit from easing macroeconomic pressure overall, in the form of lower interest rates and inflation.
The SA Banks
Despite solid returns since the GNU announcement, in line with increased appetite for SA Inc, the banks could still see further upside. A more favourable SA environment could be reflected in an improvement in consumer and business confidence from current subdued levels. This could, in turn, spur higher spending on big ticket items like homes (mortgage loans), cars (vehicle financing), and other assets including working capital or capital expansion (business banking solutions).
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Renewed loan growth and increased transactional activity may provide upside earnings potential for banks, which will likely respond by loosening credit granting criteria and increase origination/extension in response to an improvement in long-term macroeconomic growth expectations.
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Depending on banks' risk appetite and borrowers' demand for credit, we expect a noteworthy improvement in advances growth over the next three years.
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Credit loss ratios have been more resilient than expected through the hiking cycle. A possible convergence of an uplift in macro forecasts with the onset of the rate-cutting cycle, is particularly positive for lower credit costs.
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Local banks remain well capitalised, with capacity to drive robust investment spend and in turn, economic growth. An improvement in infrastructure and policy decision-making could yield more favourable capital markets or appetite for deal-making.
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To a lesser extent, the financial relief from the implementation of the two-pot retirement system could provide an uptick in debt reduction and spending/transactional activity given the withdrawal allowance, at least in the short term.
While we view the GNU as generally beneficial for SA's banks, we highlight key risks related to its stability, its capacity to actually enhance economic growth, and an extended delay between policy shifts and actual economic improvement. More so, rate cuts are anticipated to only occur later than originally anticipated, and the cutting cycle is expected to be flatter than previously assumed. Nonetheless, returns metrics have been stable and slowly expanding, and while banks have re-rated from a valuations perspective, the long-term fundamentals remain compelling.
