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Ghost Bites (Merafe | Nampak | Omnia)

The Finance Ghost
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Ghost Bites (Merafe | Nampak | Omnia)

Merafe releases a production update

Guess what? Load shedding doesn’t help.

Mining is the toughest game on the planet, yet in some ways the simplest as well. You need to produce a commodity and you need to sell it based on an observable market price. Production is in your control and the pricing isn’t.

It all comes down to operational efficiencies and reliability, something that Eskom really doesn’t assist with. In the quarter ended December, Merafe’s attributable ferrochrome production fell by 5% year-on-year. Despite this, the full-year production number is 1.3% higher than last year.

Merafe’s share price has been on a wild ride over the past year, something that mining investors are only too accustomed to. The 52-week high is R1.96 and the 52-week low is R1.03!

Investing in South African mining will either give you a strong stomach or a heart attack.

What is being packaged at Nampak?

An adjournment of the extraordinary general meeting means that something is brewing

For a clue as to what might be happening at Nampak, we can look back to an announcement on 11 January regarding an acquisition of shares by Peresec, taking them to a holding of 6.12%.

Unless the stockbrokers at Peresec are planning to learn a lot about bottles and cans, I suspect that they are holding those shares for someone else. The obvious candidate is A2 Investment Partners, the activist investment group that enjoys running into a burning corporate building to see if it can be saved.

This is all just speculation, of course.

For now, the official word from Nampak is that a motion will be proposed at the meeting on 18 January to postpone it to 8 March.

Having lost two-thirds of its value in the past year, Nampak’s investment story is broken and so is the balance sheet. There’s clearly a strategic investor poking around the place, so we will have to wait and see what happens.

The share price only closed 2.4% higher on this news.

Omnia exits Umongo

The call option for the remaining 9% has been exercised

There are all kinds of tricks and mechanisms that find their way into deal structures. Call options are a great example. A call option is an agreement that gives the holder the right (but not the obligation) to buy a particular asset at a predetermined price.

This is a nifty thing, which is why the party that writes the option (grants it to the holder) doesn’t do so lightly.

As part of the disposal of 81% in Umongo Petroleum, Omnia granted a call option relating to the remaining 9% that it held in the company. This option has now been executed and Omnia has received R93 million in cash, which the company says is at the top end of the purchase price that was payable. This is because some call options have a price calculation mechanism rather than a set price.

Little Bites:

  • Director dealings:
    • The company secretary of Investec has sold shares worth R691k
  • Buffalo Coal has announced the final discharge of the Investec loan, with a payment of around R32.6 million and a royalty payment of R2.5 million.
  • Sable Exploration and Mining has announced a delay in the release of the circular for the PBNJ Trading and Consulting offer. An extension has been granted until the end of January due to delays in receiving approval from the South African Reserve Bank.
  • Acsion Limited has renewed the cautionary announcement related to a potential cash offer and delisting of the company.
  • In case you are still holding your breath for the release of financial statements by Oando PLC, the company hopes to release its 2020 financials (not a typo) by 28th February. It will take until August for the reporting to be fully caught up (in theory).

Ghost Stories #4: An in-depth trading experience (Travis Robson, CEO Trive South Africa)

The Finance Ghost
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Ghost Stories #4: An in-depth trading experience (Travis Robson, CEO Trive South Africa)

Trive South Africa offers a gateway to the JSE and global markets.

Providing an in-depth online trading experience, Trive exists to empower progression. You can simply and securely trade and invest in JSE and US stocks and leveraged products, or invest in tax free savings accounts.

In this episode of Ghost Stories with Trive South Africa CEO Travis Robson, we cover:

  • An overview of Trive’s global business and the international perspective that the group is bringing to South Africa.
  • The extent of the group’s investment in South Africa and the significant team that has been built in Trive South Africa, a show of faith in our economy and the strength of our financial markets.
  • The focus on both technology and customer service to provide more sophisticated traders and investors with the potential to take their wealth beyond its current levels, particularly by finding the right mix.
  • A discussion on the broker landscape in South Africa and what is needed to attract, retain and develop retail stockbroking clients.
  • The unplanned creation of the Trust Trive with Travis hashtag – a tongue-in-cheek response to a business that genuinely wants to create a trusted brand in the market.
  • Lessons learnt while building a startup within an international organisation.
  • The benefits of bringing different cultures and backgrounds to a business.
  • The concept of a “Trive Tribe” and the trading and investment community being built around the business, combining the best of Trive’s trading technology and its telephone broking / research offering.
  • The reasons why people trade and invest, which often go beyond the financial incentivisation – for so many, the markets are a hobby and a great love, confirmed by Travis’ extensive research in our local market.
  • The risk of gamification in trading platforms.

Listen to the discussion below:

For more information on Trive South Africa, visit the website at www.trive.co.za or check out their social media pages (@trive_sa).

Trive South Africa (Pty) Ltd is an Authorised Financial Services Provider, FSP number 27231.

The resilience of SA retailers

Chris Gilmour
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The resilience of SA retailers

In a market that is ultimately a hybrid of emerging and developed characteristics, South African retailers continue to demonstrate resilience in the face of huge challenges. Chris Gilmour explains.

January has started off well for the JSE All Share Index (ALSI), reaching an all-time high last week, mainly on the back of higher commodity prices.

This underlines the view that the South African equity market is still predominantly driven by commodities, even though the mining industry itself is a relatively small contributor to GDP. The rest of the market outside of mining stocks hasn’t really moved much, though this is to be expected, given that household consumption expenditure (HCE) is in the doldrums and that is by far the biggest GDP contributor at over 60%.

And with HCE and GDP generally not forecast to do very much this year, there seems little reason to get excited about consumer stocks generally and retail stocks in particular. But as with everything in life, the devil is in the detail and there may be some surprises from the strangest of places as 2023 unfolds.

Much of the rationale behind South African retailing’s place on the global retailing map redounds to South Africa’s perceived position as somewhere between an emerging and a developed economy. In 1990, as Nelson Mandela was released, the ANC and other liberation movements were unbanned and the first tentative moves toward democracy were made, there was understandable impatience among local investors. Many were firmly of the opinion that foreign money would come flowing in almost immediately to the JSE and when that didn’t happen, they were crestfallen.

It took quite a few years post-1990 before foreigners starting eyeing up SA as an emerging market destination and even then, it was only pocket money that came our way. The big money was going into countries in eastern Europe, South America and Turkey and of course emerging Asia.

Are we really an emerging market?

I had the privilege of taking a veteran US emerging markets specialist called Joe Williams of Batterymarch (Now Legg Mason) around Cape Town in the mid-90s, meeting the CEOs of companies such as Rembrandt Group (now Remgro), Pepkor and Pick n Pay. He and his sidekick Cam Huey were suitably impressed with these companies and at the end of the trip as I was driving Joe back to the airport to catch a plane back to the US, I innocently asked how he thought SA stacked up in comparison with other emerging markets.

He let out a huge belly-laugh and said “Chris, South Africa is NOT an emerging market; it’s a developed economy with high unemployment!”

I was a bit non-plussed by that remark, but it has stayed with me all these years. And on reflection he was absolutely correct. SA rarely if ever managed to squeeze any decent growth out of its economy, even before Eskom went into terminal decline. And South African institutions – be they banks or accounting bodies, or the JSE, or industrial companies or retailers-are world class and have been for decades. They are not emerging, they are right up there with the world’s best.

A year of so later at an investment seminar I asked Mark Mobius of Templeton the same question. He phrased his response differently, saying that SA was a hybrid between developed and emerging. Very diplomatic and in its own way, equally true.

What does this have to do with retailers?

So, what does this have to do with the outlook for retail stocks in the current years and beyond? Well, South African retailers have first world management but the ambient economy mimics emerging market conditions because of the chronically high rate of unemployment. Self-service checkouts, a feature of many British, American and European supermarkets, are not used in South Africa because of the fear of union resistance, not because of technological incapability. South African food retailers are among the most efficient in the world and that is reflected in their paper-thin operating margins.

It’s difficult to see how the retailing industry can get much more efficient in 2023 and beyond.

In food and drug retailing, the emphasis is going to be on price. And this is where the unlisted retailers may do better than the listed ones. Unlisted banner groups such as EST Africa support a broad range of independent FMCG and hardware retailers all round the country and their hefty buying power allows them to compete head-on with the listed giants. But they have a much lower overhead structure, which allows them to be able to sell their products at keener prices than the listed FMCG players.

And in discretionary retailing, too, the emphasis will be on price. But it will be increasingly difficult to increase volumes in a high interest rate environment. Those discretionary retailers that have elected to adopt an aggressive expansionary through-the-cycle approach, such as Mr Price and TFG, will show growth, but it will be largely acquisition-driven.

Another feature that may aid discretionary sales is enhanced use of credit. This is a very sensitive subject and banks and retailers are keen to ensure that their credit books stay in good health and don’t deteriorate while at the same time looking for ways to increase turnover. Already a number of clothing and furniture retailers have exhibited enhanced cash:credit sales ratios in their recent trading updates, a marked divergence from trend.

This is happening at a time when rejection rates for credit applications are rising:

Source: www.ncr.gov.za, Gilmour Research

As the next graph illustrates, household debt/household income has been declining for a number of years. Recent surveys by FNB/BER suggest that consumer confidence is improving and that consumers are more inclined to spend again. If this is the case and higher degrees of credit can be advanced in a responsible manner, discretionary consumer spending may be aided to an extent:

The unknown factor is the extent to which rotational power cuts (load shedding in Eskom-speak) will impede retail sales this year and next. The really scary aspect of all of this is that there is no plan to reduce load shedding from government. It appears to be impotent, as the utility lurches from one crisis to another.

At the time of writing, Eskom had applied a continuous stage 6 and there were rumours that stage 8 was being contemplated. Some of the discretionary retailers such as Mr Price and TFG have installed some serious battery backup capability and by financial year end will have 70% of their stores “immune” to the impact of load shedding. But food retailers require far greater power input for refrigerators for example and only a few of them are adequately prepared for a prolonged escalation in power cuts.

So, one can add another string to the bow of SA retailers: world’s most resilient. One can only imagine how brilliantly these retailers would perform under more “normal” economic conditions with a stable power supply.

But that’s another story for another time.

This article reflects the independent views and opinions of Chris Gilmour, which are not necessarily the same as The Finance Ghost’s opinions on these stocks. For equity research on South African retail and other stocks, go to www.gilmour-research.co.za.

Ghost Wrap #7 (Steinhoff | Mondi | Telkom | MTN | Tharisa | Murray & Roberts)

The Finance Ghost
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Ghost Wrap #7 (Steinhoff | Mondi | Telkom | MTN | Tharisa | Murray & Roberts)

Welcome to Ghost Wrap. It’s fast. It’s fun. It’s informative.

In this week’s episode of Ghost Wrap, we cover:

  • Steinhoff’s updates on Mattress Firm and Pepco
  • Mondi closing the acquisition of the Duino mill in Italy
  • Telkom and rain deciding to walk away from a potential day
  • MTN received a very ugly letter from tax authorities in Ghana, which is definitely not going to be good news for the share price
  • Tharisa dealing with high levels of rainfall that have negatively impacted production
  • Murray & Roberts releasing the circular for the sale of the stake in Bombela Concession Company

The Ghost Wrap podcast is proudly brought to you by Mazars, a leading international audit, tax and advisory firm with a national footprint within South Africa. Visit the Mazars website for more information.

Listen to the podcast below:

Ghost Bites (MTN | Murray & Roberts)

The Finance Ghost
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Ghost Bites (MTN | Murray & Roberts)

Another African nightmare for MTN?

There’s never a dull moment when doing business in Africa

There are three certainties in life: death, taxes and African governments trying to fleece multinational organisations for money. We are used to this in Nigeria, a country in which MTN has a long and often painful history. Just when we thought the troubles were behind MTN, the FOMO has become too much for Ghana and that government has decided to have a go.

This isn’t a small issue, either. MTN’s subsidiary in Ghana has been issued with a tax assessment which infers that MTN under declared revenue by around 30% over the period of 2014 to 2018. It seems outrageous that this could be true. Unsurprisingly, MTN Ghana “strongly disputes” the assessment, which was based on methodologies like call data records, recharges and other data.

How much are we looking at here? Well, the Ghanaian government has issued an assessment for $773 million. That’s a lot of money.

The announcement came out after the market closed on Friday, so I’m expecting some pain in the share price when it opens on Monday. I still believe in what MTN is doing in Africa and I’m a shareholder. Sadly, these sorts of issues are a reality when operating in high growth, risky markets.

Before you are tempted to suggest that MTN should pack it in and focus on South Africa, I would remind you that our cellphone towers currently stop working after about 2.5 hours of load shedding and our economy’s growth rate is slower than the annual egg-and-spoon race at your local frail care centre.

This isn’t an easy industry.

Murray & Roberts releases the Bombela circular

The embattled construction company is selling the Bombela Concession stake to Intertoll International

At the beginning of December, Murray & Roberts gave the market a glimmer of hope by announcing the sale of the stake in Bombela Concession Company for up to R1.386 billion. The purchaser is Intertoll International, a leading European investor in motorway concessions and related operations.

Nevermind a toll on the roads or railways – the economy has taken its toll on Murray & Roberts, with the company facing a liquidity crunch that needs to be dealt with urgently. The proceeds from this deal (assuming shareholders approve it) will be used to reduce debt and improve the state of the balance sheet in general.

Going forward and with Clough in Australia now placed into voluntary administration after a deal to try and sell that company fell through, Murray & Roberts will have two business platforms: Mining (a global business) and Power, Industrial & Water (focused on sub-Saharan Africa).

Murray & Roberts hopes to be able to deliver earnings growth from FY24 onwards, with the company acknowledging that this would be off a low base.

Here’s an ugly share price chart to make you feel better about your bad choices in tech stocks:

Little Bites:

  • Director dealings:
    • The CEO of Stor-Age has sold shares worth over R2.75 million, with the proceeds used to settle loan obligations to Stor-Age in terms of the old share purchase and option scheme for executives of the company
    • The financial director of Zeda (the mobility group unbundled by Barloworld) has acquired shares in Zeda worth over R150k
    • An associate of a director of Huge Group has acquired shares worth just over R20k

Ghost Bites (Mondi | Steinhoff – Pepco)

The Finance Ghost
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Ghost Bites (Mondi | Steinhoff – Pepco)

Mondi completes the Duino mill deal

The deal was first announced in August 2022

Mondi is a good example of a JSE-listed company that has a significant international footprint. This footprint is growing, with the acquisition of the Duino mill in Italy now completed.

The total deal consideration was €40 million, so this is a very small deal in the context of Mondi’s market cap of over R146 billion.

This is a strategic deal for Mondi’s efforts in Central Europe and Turkey, as the mill is close to two important export harbours. There will be many changes at this mill, with plans to convert the existing paper machine to produce high quality recycled containerboard.

The estimated investment required for this project is €200 million, which is 5x the size of the acquisition price. This is a solid example of a company buying a base to work from.

Pepco: a window into Europe

The latest quarter is a reminder of what Steinhoff could’ve been

Pepco is owned by Steinhoff. It’s a great business. Sadly, it sits far down in the group structure, with a ton of debt sitting above it at group level. For that reason, the creditors are rubbing their hands in glee about this business, with shareholders set to be squeezed out.

Nevertheless, Pepco is a really useful barometer for the state of play in Europe, particularly in value retail. This means retail formats aimed at lower income shoppers who are highly price sensitive. In other words: most people.

In the three months ended December (the first quarter of this financial year), revenue was up 27% on a constant currency basis and 24% as reported. There’s a major effort underway to increase the store footprint, evidenced by like-for-like growth coming in at only 13%, well below the total growth (but still impressive). The difference between reported growth and like-for-like growth is the new stores that were added in the past year.

The excitement is firmly in the Pepco format, with growth up 19.7% on a like-for-like basis vs. only 4.4% at Poundland Group.

The growth in the footprint isn’t slowing down. There are currently 4,066 stores in the group and the rollout plan is for 550 net new stores in this financial year (including those opened in the quarter just reported on).

When growing quickly, the challenge is always (1) not going bankrupt from running out of cash and (2) maintaining margins. Holding company Steinhoff has already nearly achieved the first outcome, so hopefully lightning won’t strike twice. This leaves us with margins, which need to be watched closely. It takes a while for new stores to ramp up to the desired level of profitability, hence why EBITDA is only up “mid-teens” at a time when revenue is growing in the mid-20s, a clear example of margin contraction.

Investors (also known as the people Steinhoff owes money to) will be looking for margin expansion to come through as the store rollout matures.

Little Bites:

  • Andrew Waller (a name you may recognise from Grindrod) has bought shares worth R1.68 million in Spar. He is a non-executive director of the retailer.
  • York Timbers has clarified the extent of the shareholding of A2 Investment Partners. The activist investment group owns 11.12% in the company directly and controls a further 20.2% via Peresec.

Ghost Bites (Steinhoff | Tharisa | Telkom)

The Finance Ghost
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Ghost Bites (Steinhoff | Tharisa | Telkom)

Why isn’t Steinhoff worthless yet?

There’s more bad news for shareholders

It really is beyond me why Steinhoff isn’t trading at zero. The creditors are essentially in the process of getting the keys to the castle, with shareholders likely to hold unlisted instruments as a best-case outcome. Yet, it’s trading at R0.53 per share, which is precisely 53 cents more than I would pay for it.

To reinforce my view that this is a donut (i.e. worthless), the latest news is that Steinhoff portfolio company Mattress Firm is no longer going to list in the US. It has withdrawn its registration statement with the US Securities and Exchange Commission (SEC), citing ongoing volatility in the IPO market.

As evidenced by layoffs at Goldman Sachs, this isn’t the time to be listing in the US market (or anywhere else, really).

It hardly matters, as the creditors will be patient and will wait for the next cycle. The brave few who plan to hold unlisted shares will be following the same thesis. The difference is that the creditors get to eat dinner first, with the shareholders lucky to get crumbs that fall off the table.

Tharisa was on the wrong side of the weather

“Unprecedented rainfall” (an annualised increase of 27%) has impacted production

In a quarterly production report dealing with the three months to December, Tharisa took a knock to both PGM and chrome output. There’s still plenty of cash on the balance sheet (net cash of over $101 million), so this was just a bump in the road.

There is some good news, like production guidance surprisingly being maintained for both PGMs and chrome. The other good news is that PGM and chrome prices have been holding up, which is obviously critical for miners.

The Vulcan Plant is on track for increased production and ground has been broken at the Karo Platinum Mine in Zimbabwe, after $31.8 million was raised for the project on the Victoria Falls Stock Exchange. And there you were, thinking that the Cape Town Stock Exchange is the most exotic place to raise capital. Trust me, there are many exchanges out there.

Drilling down into the numbers, quarter-on-quarter production fell 5.7% for 6E PGMs and 8.0% for chrome concentrates. Prices for the PGM basket and metallurgical grade chrome fell by 1.7% and 1.3% respectively on a quarter-on-quarter basis (i.e. vs. the three months ended September 2022).

Telkom and Rain have terminated discussions

Will Telkom ever find someone to dance with?

If you miss the existence of Ratanga Junction or the thrill of going to Gold Reef City in your holidays, you could always buy shares in Telkom. Take a look at this wild ride over the past year:

First, MTN was sniffing around a deal with Telkom. That eventually fell over, leaving space for Rain to get involved and irritate the Takeover Regulation Panel (TRP) in the process with poor behaviour. Having clearly hired better lawyers, things went quiet for a while.

After initial discussions but prior to any due diligence work, the parties decided to walk away from a potential deal at the moment. No further details were given.

The market seemed to like this, sending Telkom 9.3% higher on the day. With two major potential parties having walked away (for now at least), Telkom needs to find another potential way to unlock value.

Little Bites:

  • Director dealings:
    • Following the rights issue by York Timber, Peresec Prime Brokers now holds a 29.28% interest in the company. The value unlock story continues…in theory.
    • A director of Argent Industrial has sold shares worth R190k – it’s always dangerous to read too much into these trades, but load shedding must be biting these companies.
  • For those suffering from a December hangover and related memory loss, Impala Platinum released an announcement reminding the market that the only remaining condition precedent to the offer for Royal Bafokeng Platinum is the Takeover Regulation Panel (TRP) Compliance Certificate. Implats is still fighting with Northam Platinum at the TRP, helping several legal teams afford better holidays this year.
  • Labat Africa has issued more shares, this time a tranche representing 3.33% of shares in issue when the general authority to issue shares was granted. The funds are being used to expand the cannabis healthcare business and for general working capital purposes.
  • Having now appointed a Nominated Adviser (NOMAD), Kibo Energy has resumed trading on the AIM market in London.

Too much stock!

The Finance Ghost
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Too much stock!

Margins are under considerable pressure at retailers who are now dealing with a fundamental swing in supply-demand dynamics

Turnover for show, margins for dough.

I’m borrowing liberally from golf folklore to bring you that catchy intro. If you’ve played golf, you’ll know how tough it is. If you’ve been reading any retail earnings releases in recent months, you’ll also know how tough that is.

A swing in supply and demand

Towards the end of 2022, the world found itself in an environment of high consumer demand and very limited supply. As consumers were flush with cash thanks to the Fed, demand for products in a gradually reopening economy was huge. Supply chains were a nightmare thanks to congestion at ports and ongoing lockdowns in China, creating a recipe for inflation and unsustainably high margins for retailers.

The supply – demand dynamics have swung wildly over the past twelve months, with the latest Black Friday and festive season shopping trends showing that retailers are having to sacrifice margin to achieve turnover growth. Everyone has stock (and usually too much of it), an issue compounded by a fall in consumer demand as stimulus waned and energy costs put pressure on household budgets across the world.

In recent Magic Markets Premium reports, we’ve looked at Lululemon, Levi’s and Nike. These global apparel giants operate in totally different product categories, yet the theme across the board is clear: margins are under significant pressure.

Where did the margins go?

I’ve lifted this chart from our latest Magic Markets Premium report on Nike:

Source: Magic Markets Premium, company filings

Other than some seasonality in the numbers, you can see that revenue isn’t a huge issue for Nike. The company is posting reasonable top-line growth on a year-on-year basis (the right metric in a seasonal business). Sadly, gross margin appears to have bought a one-way ticket to hell, with a recent trend that you don’t need a finance degree to understand. That yellow worm is headed firmly in the wrong direction.

There is simply too much inventory in the system, which means an environment of markdowns and SALE signs across the front of every shop. Another major contributor is the return of the wholesale channel, which Nike starved of stock (their exact wording) during the pandemic. Wholesale margins will always be lower than direct-to-consumer margins that capture the full value chain, so a swing back towards wholesale creates a mix effect that is negative for margins.

This isn’t just an issue for Nike. Most retailers are experiencing either pressure on gross margin (because of markdowns to compete) or operating margin (because they have lost market share while raising prices to protect gross margins).

Many are taking pain on both levels, which is why share prices have come under pressure in this sector, particularly for companies that have been trading at clearly elevated multiples.

Lululemon is particularly interesting

Lululemon is credited with inventing the athleisure category, taking yoga pants from the studio to the local coffee shop and charging a delicious premium along the way.

It’s been fascinating to see how the recent strategy has differed to the likes of Levi’s, which focused on hiking prices to protect gross margins. One would assume that Lululemon would have more pricing power, yet the company has chosen to chase volumes and give up margins along the way.

The net profit number is all that matters of course, which is a function of revenue and margins. Hot off the pressure is updated guidance from the company on its fourth quarter numbers, which will see revenue increase by 25% – 27% on a year-on-year basis. This is ahead of previous guidance.

Sadly, diluted earnings per share is expected to be similar to previous guidance, which means that margin contraction has offset any benefit of revenue being higher than expected. Indeed, gross margin is expected to decline by 90 – 110 basis points, a huge swing from previous guidance of an increase of 10 – 20 basis points.

Lululemon has done a great job of managing costs, with selling, general and administrative (SG&A) expenses growing below gross profit growth. This has offset some (but not all) of the margin pressure.

Chasing revenue has worked for Lululemon because the company still has incredible growth potential. For a business like Nike that is already a mature business in most key markets, margins are more important than top-line growth.

We are in a tough environment for apparel retailers. Tread carefully.

If you enjoyed this, you’ll love Magic Markets Premium!

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Russia – Ukraine at an impasse

Chris Gilmour
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Russia – Ukraine at an impasse

To kick off 2023, Chris Gilmour delves into arguably the most important geopolitical situation in the world today.

The Russia – Ukraine war has reached the type of impasse that is unlikely to change until at least the northern hemisphere spring.

Ukraine is a small country (relative to Russia), but it has serious backing in the form of NATO and/or the US. That backing is likely to be sustained provided a) the resolve of the Europeans remains largely intact and b) President Joe Biden’s US administration manages to keep getting large aid packages to Ukraine passed by the US Congress.

If these two factors remain in place, Ukraine should continue to punch well above its weight, as its people are highly motivated and cannot be intimidated by Russia’s terrorist tactics.

Conversely, the Russian troops really don’t want to be in Ukraine. They are fighting a war that their political masters have set for them and they don’t have anything like the motivation of the Ukrainians. Many of the troops are part of Yevgeny Prigozhin’s Wagner Group, a shadowy paramilitary force. It is widely believed that Prigozhin recruits soldiers for the Wagner Group from Russian prisons, offering inmates reduced sentences or even freedom in return for fighting in Ukraine and elsewhere.  

Common sense tells a rational fighter when to give up and surrender. But Russia is not following a rational process in Ukraine. As mentioned in this column some time ago, Vladimir Putin is attempting to plug another “gap” in Russia’s natural defences. He will not be satisfied until Ukraine is wiped off the map and re-incorporated into a greater Russia.

But he has badly miscalculated a number of factors in this war, the end result being a gradual emasculation of the Russian state.

Sanctions: slow and steady

The first point to note is that sanctions are working, albeit extremely slowly, and the Russian economy is being very slowly strangled. That process will continue, provided the resolve of the Europeans in particular doesn’t falter in 2023 and beyond. However, as demonstrated by London sanctions watchdog Moral Ratings Agency (MRA), a large number of very high profile international sanctions busting firms are still doing business with Russia.

The worst offender, according to MRA is US drugs and healthcare giant J&J, but the list also includes HSBC, Goldman Sachs, Unilever and Procter and Gamble. If past history is anything to go by, most if not all of these companies will eventually be forced to pull out properly, unable to resist the welter of moral outrage against their continued presence in Russia.

But there’s a long way to go, as demonstrated in MRA’s graphic below:

Source MoralRatingAgency.org

It’s perfectly understandable from a narrow, purely profit-motivated perspective why many of these companies persist with their Russian presence. Doing business for western firms in Russia has always been immensely profitable and a lot of companies are loathe to give this up. But the same argument could have been applied in the case of western companies operating in apartheid South Africa up until the 1980s, when most companies eventually cut ties.

If the war in Ukraine carries on long enough, a parallel commercial war of attrition will eventually force most if not all western companies out of Russia.

Military performance: poor

The second point to note is Russia’s pathetic performance on the battlefield.

At the start of this conflict, western military commanders could scarcely conceal their excitement when it became clear that the Russian army was seriously bogged down logistically in its initial attempts to take the Ukrainian capital city Kyiv. That excitement quickly turned to cautious re-evaluation, however, when they realised that a humiliating conventional defeat for Putin in Ukraine could quite easily degenerate into some sort of nuclear conflict.

There is no doubt that if properly armed with long-range rockets for their HIMARS MLRS, the Ukrainians could wipe out any Russian positions in Crimea and elsewhere. And the Ukrainians are champing at the bit for such an outcome. But the Americans are being typically cautious about supplying such long-range ordnance for fear of some degree of nuclear reprisal. Just to dimension this, if the Ukrainians possessed rockets that had even a slightly greater range, they could completely destroy the Kerch Bridge that links Crimea to Russia. By then cutting off Crimea’s water supply from near the recently re-captured city of Kherson, the Ukrainians could effectively turn Crimea into semi-desert and there’s nothing the Russians could do about it.

Where will the gas go?

Lastly, there’s the question of Russian oil and gas supplies to Europe this year and beyond. Europe currently has plenty of gas in storage to see it through this winter, but if no Russian energy makes its way to Europe this year, next winter could be problematic.

But of course, it must be remembered that Russian gas in particular is not going anywhere if it doesn’t go to Europe.

Constructing very long gas pipelines to China and India will take many years and enhanced shipments of liquefied natural gas (LNG) to these countries require port facilities in Russia that don’t currently exist. And all the while, Russia is losing valuable billions of dollars (or roubles) worth of exports that aren’t going to be made up any other way.

Outcome: a protracted negotiation?

Putin realises that he’s in a hole and would love an escape route, an offramp.

The West mustn’t lose its nerve and attempt to persuade Ukraine to accept a badly-negotiated deal with Russia. To date, the Ukrainians have recaptured 54% of the land occupied by Russia since the invasion almost a year ago. Ukrainian president Volodymyr Zelenskyy has made it abundantly clear that any peace deal will, of necessity, require a return to pre-2014 boundaries. In other words, Russia must vacate Crimea and the Luhansk region of east Ukraine. The Russians will likely stick to an old-style Soviet script of negotiation that involved demands and threats but little in the way of actual substance. Just when their opponents have been worn down mentally and psychologically, the Russians will offer a meaningless morsel that will be grabbed by a desperate West.

That type of scenario must be avoided at all costs.

However, what this means in practical terms is that the conflict will likely drag on for years until the Russian economy can no longer prosecute such an expensive exercise and will have to accept unconditional surrender, with all that this entails.

At this point, the humiliation of Russia will be complete.

This article reflects the independent views and opinions of Chris Gilmour, which are not necessarily the same as The Finance Ghost’s opinions on these stocks. For equity research on South African retail and other stocks, go to www.gilmour-research.co.za.

Ghost Bites (AYO | BHP | MAS | NEPI Rockcastle | Premier Fishing | Schroder | Transnet)

The Finance Ghost
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Ghost Bites (AYO | BHP | MAS | NEPI Rockcastle | Premier Fishing | Schroder | Transnet)

AYO gets fined again

The share price fell over 20% in response to a JSE censure and fine

The JSE has investigated a number of transactions between 2017 and 2019 that it believes have breached JSE Listings Requirements. In particular, the aggregation of related party transactions is an issue here, as the rule is that transactions with the same party must be added up and treated as one deal. This is for the purposes of assessing whether they breach the threshold for a small related party deal.

When it comes to deals, the categorisation of deals (e.g. Category 1 / Category 2) is based on a calculation that expresses the deal as a percentage of the size of the company. For related party deals, the threshold is much smaller as shareholders need to know that the terms of deals with related parties are fair.

In relation to various transactions that the JSE is unhappy with, a fine of R1.5 million and a censure have been imposed on AYO Technology.

AYO is upset about this, as the JSE previously fined the company an amount of R6.5 million for similar contraventions of the JSE Listings Requirements. More importantly for the company, a reconsideration application had been underway before the Financial Services Tribunal (FST). The company is irritated that it wasn’t given a chance to respond to the FST ruling to dismiss AYO’s application before the JSE announced this censure.

Either way, they aren’t on each other’s Christmas card lists. The right way for AYO to avoid this issue would’ve been to comply with the JSE Listings Requirements in the first place.

BHP concludes a scheme implementation deed with OZ Minerals

A four-week due diligence period has led to the desired outcome

BHP Group has moved quickly here, with the non-binding indicative proposal announcement having been released on 18 November. Approximately one month later, the due diligence has been concluded and the offer price of A$28.25 per share for OZ Minerals has been confirmed.

This puts an enterprise value of A$9.6 billion on the company and represents a 59.8% premium to the 30-day VWAP leading up to 5 August, which was when BHP’s first proposal was made.

The OZ Minerals board has unanimously recommended that shareholders vote in favour of the scheme, in absence of a superior proposal. As we’ve seen in some recent deals (like Gold Fields – Yamana), one can never ignore the risk of a bigger offer coming through.

It’s going to take a while for the deal to go through, with a deadline to satisfy conditions precedent of 31 August 2023.

There’s a substantial break fee of A$95 million payable by either side if they walk away from the deal, so there’s some degree of commitment that the deal will happen. Again, a break fee wasn’t enough to save the Gold Fields deal!

MAS’ pre-close update for six months to December

The fund’s largest market (Romania) is still attractive

With Europe expected to enter a technical recession in the first half of 2023, Romania’s real GDP is still expected to grow next year. Average wages in the country are largely tracking inflation, which is supportive for retail assets in the region.

MAS also has exposure to Bulgaria and Poland, so this is another great example of a Central and Eastern European property fund right here on the JSE.

Much like NEPI Rockcastle (see below), MAS has enjoyed strong trading in these regions in the first five months of the 2023 financial year. With Covid restrictions having become a distant memory, the malls are packed and people are shopping. Interestingly, footfall has recovered to 2019 levels, which perhaps reflects the different reporting period in this update vs. NEPI below.

Tenant turnover is way ahead of pre-pandemic levels, up 19% vs. 2019. Open-air malls are running at 22% ahead of 2019 levels and enclosed malls at 16%, so perhaps some psychological impact of closed vs. open spaces during Covid has stuck.

With occupancies slightly higher at 96.4% vs. 96.3% in the comparable period, things are certainly looking up.

Disposals of remaining Western European assets are progressing well, which will leave MAS as being purely focused on the Central and Eastern Europe regions.

NEPI Rockcastle’s pre-close update for the year

The shopping centres have made a “complete recovery” from Covid

With record net operating income (NOI) and tenant sales above pre-pandemic levels, NEPI Rockcastle is happy to put the nightmares of Covid to bed. Despite the tail-end of restrictions still impacting the first quarter of this financial year, NOI is expected to be 8% higher than 2019 and 18% higher than 2021.

This is despite footfall still being lower than 2019 levels, with year-to-date footfall in October coming in 12% lower than 2019 on a like-for-like basis. Although one can deduce that this means a permanent change in shopping habits, the MAS update above makes me think that this is just a timing thing, as the NEPI update includes the months at the start of the year.

Having recently announced some significant investments in Eastern Europe, the estimated loan-to-value ratio after these transactions is 36.5%, which is a very manageable level. The company is targeting a reduction below the “strategic threshold” of 35% in the next 12 to 18 months.

Speaking of the balance sheet, the group takes full advantage of the ESG movement by issuing green bonds at attractive rates, like a €500 million bond at a fixed coupon of 2% that was three times oversubscribed. Leaving aside any feel-good reasons, a rate like that is exactly why NEPI Rockcastle can justify the creation of a dedicated ESG department.

An upgrade by Fitch from BBB to BBB+ certainly helps with capital raising efforts.

The other major initiative this year was to relocate the holding company from the Isle of Man to the Netherlands.

Premier Fishing plays its own version of Squid Game

A deal to invest R95 million in squid business Talhado Fishing is on the table

Premier Fishing already holds a 50.3% stake in Talhado Fishing Enterprises and this transaction will take that stake to 80.65%. The deal structure is that Premier will invest R95 million in Talhado and the company will then use that cash to repurchase shares from Scofish, which currently holds 30.35% in the company.

Talhado is the largest squid player in the South African fishing market, with 15 vessels in the group and a cold room facility that can store up to 800 tons of squid.

Premier Fishing notes benefits of the deal like cost synergies, enhanced B-BBEE credentials for Talhado and an extensive international sales network that Premier will also look to access.

Talhado’s financial performance will hopefully improve considerably to justify this value, as the net asset value of the company is R23 million and the loss after tax for the year ended August was R1.9 million. It’s really not obvious why the valuation of the company is so high.

Schroder gives us insight into European debt terms

The impact of a rising rates cycle is clear to see here

Schroder European Real Estate Investment Trust has completed the early refinancing of the largest debt expiry in 2023, a €14 million loan secured against the Hamburg and Stuttgart office investments.

VR Bank Westerwald offered the most competitive terms, with a 4.75 year term and a margin of 0.85% above the benchmark rate (the 5-year euro swap rate). The interest rate is fixed for the term based on that margin, coming in at 3.80% per year.

The weighted average interest rate for the group has increased by 60 basis points from 1.9% to 2.5%, a reminder of how the rising interest rate cycle hits property funds.

Discussions are underway regarding the two other debt expiries in the next 12 months.

Transnet: of flying insects and delayed trains

The good news for our infrastructure is that the company is profitable

In today’s example of how some companies just can’t get anything right, Transnet released reviewed consolidated financial results “for the six moths ended 30 September 2022” – butterflies sold separately, I presume.

The results are released on SENS because Transnet has listed debt instruments. The more important consideration is that Transnet’s financial health has a direct impact on our mining companies, as infrastructure can’t be improved without money.

Revenue for these six flying creatures increased by 2% and EBITDA fell by 2.5%. The group is at least profitable now, with a profit of R159 million vs. a loss of R78 million in the comparable period. Cash generated from operations was R11.9 billion and capital investment was R6 billion.

Transnet Freight Rail remains the issue, contributing 45% of revenue and leading to Transnet not meeting the cash interest cover ratio of 2.5x that is required by lenders. A ratio of only 2.1x was achieved, with lenders thankfully agreeing to waive this covenant.

There are major steps being taken to deal with bottlenecks in the rail business. As a country, we can only hope this works out.

Little Bites:

  • Director dealings:
    • Mike Flax, one of the founders of Spear REIT, has diversified his investment portfolio by selling shares worth R38.9 million – his first sale since co-founding the group and acting as CEO between 2016 and 2018
    • The investment entity of directors of Ninety One has bought shares worth nearly £51k
    • A director of Argent Industrial has sold shares worth R120k
    • An associate of a director of Sea Harvest has acquired shares worth R66k
  • Although the JSE has approved the Northam Platinum circular regarding the offer to Royal Bafokeng Platinum shareholders, the complaint made by Impala Platinum to the TRP has now led to a delay in the TRP approving the circular. There can be no sympathy here, as Northam has certainly done everything possible to scupper Impala’s efforts. This soap opera continues.
  • In a major milestone for its exit from the Australian market, WBHO has entered into a settlement deed with Netflow Osars (Western) related to the performance guarantee obligations under the Western Roads Upgrade Contract.
  • Ellies has renewed the cautionary announcement related to the various discussions that the group is having to try and diversify its operations.
  • After a two year fixed term as Group Financial Director, Deon Federicks will retire from the board of Famous Brands from July 2023. Ms Nelisiwe Shiluvana will replace him, an internal appointment as part of the succession planning programme.
  • Pembury Lifestyle Group is trying hard to get back on track, with rezoning initiatives underway for certain properties and plans in place to try and finalise the 2019 audit and of course the subsequent years as well. There’s still a long road ahead, though.
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