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Do we take Central Bank guidance at face value?

TreasuryONE
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Do we take Central Bank guidance at face value?
  • Central banks talk the talk

Central banks use verbal guidance as a tool to prompt financial markets to adjust long before a policy-changing decision is taken and implemented. Forward guidance, as it is referred to, has been used as a tool more often by central banks following the 2008 financial crisis and involves providing information about its future monetary policy intentions based on its assessment of the outlook for price stability. This aims to influence the financial decisions of economic actors by providing a guidepost. The greater the credibility of the central bank, the greater the market response, and the heavier the burden of self-regulation that is carried by the financial markets to moderate the cycle.

One must think about the interplay between financial markets and the yield curve a little more deeply to fully appreciate the power of this tool. It also means that a central bank need not act as tough as it communicates, and therein lies the conundrum for investors. Should they take the central bank at face value, or should they rather focus on how much the underlying bond market has already priced in and achieved in moderating the cycle? The answer is always a bit of both.

  • Forward guidance has a pre-emptive impact in the markets and the real economy

The Fed this year has taken on a notably more hawkish stance towards its monetary policy, with this peaking recently when Chair Powell suggested that more than one 50bp rate hike could be on the cards for this year. The market has responded with the USD surging, while UST yields have climbed to highs not seen since 2019. This rise for UST yields has been more concentrated along the front end of the curve, flattening it out to the extent that the curve inverted over the 10v2 spread briefly at the start of April.

The fact that interest rates over the short-term have risen to near longer-term rates suggests that the market sees heightened near-term economic risks. These risks have come from the expectation that the Fed will hike rates aggressively over the coming months, choking liquidity in the market and effectively tightening financing conditions already without the Fed actually hiking aggressively yet.

This hawkish forward guidance will also send a message to financial officers of companies that interest rates are set to rise, impacting the decision to roll over debt. Higher interest rates in the near term will make rolling over debt less attractive as it will have to be repriced at a higher rate. If options are limited and revenues are weak, debt may need to be rolled over regardless, leading to higher debt servicing costs which will threaten the longer-term profitability and growth prospects of a company.

The tightening effect that this hawkish talk has in the real economy can already be felt, with US mortgage rates surging to over 5.00% recently. This compares to levels closer to 3.00% at the start of the year. This more than 200bp increase for 30-year fixed mortgage rates has come while the Fed has hiked, until now, by only 25bp. This perfectly illustrates the power that forward guidance can have, and that the aggressive talk with regard to tightening monetary policy can manifest in the markets as tighter financial conditions without rates actually being hiked so aggressively. These higher mortgage rates have already translated into lower house prices and weaker sales, as reflected in the chart below:

  • Bottom-line:

Global central banks have drastically stepped up their aggressive hawkish communication in order to prepare the markets for the tightening of monetary policy. The markets, therefore, have priced in a future of lower liquidity and higher interest rates, effectively doing some of the work of the central banks for them. However, the Fed and its peers will need to follow through with their hawkishness to some degree and hike after this aggressive guidance to ensure their credibility. Otherwise, the market will begin ignore future guidance, limiting its impact and forcing even greater policy moves in the future to achieve the desired policy goal.

EOH updates pro forma numbers

The Finance Ghost
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EOH updates pro forma numbers

EOH has released updated pro forma financial effects related to the disposal of the Information Services Group. In simpler terms, this means that the company is helping investors understand what the financial picture will be after the latest sale of assets to help settle debts.

EOH has been managing to dispose of its “intellectual property” assets at EBITDA multiples of just over 5x. This leaves behind the core businesses of iOCO (an ICT distributor and systems integrator) and NEXTEC, focused on people outsourcing solutions and intelligent infrastructure.

When the Information Services Group deal was initially announced, the pro forma effects were based on EOH’s results for the year ended July 2021. As these are outdated and differ from the latest results by more than 10%, EOH is required under JSE rules to provide updated pro forma effects.

“Pro forma” just means that the accountants present numbers at a specific date as though the transaction had gone ahead, even though it hadn’t. In this case, EOH has used 31 January 2022.

On this assumption, Headline Earnings per Share (HEPS) would’ve been 34 cents instead of 41 cents, as the company has sold off some of its earnings. Net asset value per share would’ve been 108 cents instead of 114 cents.

To give an idea of how much trouble the balance sheet is still in, net tangible asset value per share (i.e. excluding intangible assets like goodwill etc.) would be negative 380 cents per share.

These updated pro forma numbers should be read in conjunction with the deal circular. You can read this here

Impala Platinum volumes under pressure

The Finance Ghost
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Impala Platinum volumes under pressure

Impala Platinum has released a production report for the three months ended 31 March 2022, which represents the third quarter of the financial year. Mining companies have been disappointing the market in the past couple of weeks, with production numbers taking knocks from supply chain issues and Covid-related disruptions.

Gross group concentrate production fell 2% in this quarter and tonnes milled fell by 4%, so Implats wasn’t immune to issues. Refined 6E production fell by 8%, impacted by lower concentrate volumes, while 6E sales volumes declined by 3%.

There was a general reduction in stock levels in the comparable period (especially in iridium and ruthenium). This period also saw some destocking of inventory (evidenced by a lower impact on sales than on production volumes).

With a nine-month lens, Implats has seen a 6% decrease in gross refined 6E concentrate production. This is attributable to more maintenance needing to be done in this period than in the prior period. Sales volumes of 6E fell by 4% with the same destocking explanations applying.

Impala Rustenburg had a particularly rough quarter, with production down 10%. Numerous issues including safety stoppages, cable theft, electricity curtailment (I assume this means load shedding) and community disruptions were at play. Over nine months, refined 6E production fell 16% with the additional impact of maintenance.

Zimplats achieved marginal improvements in this quarter. 6E matte production in the nine-month period was 2% higher than the comparable period.

In smaller operations, Marula achieved a 5% increase in 6E concentrate production this quarter and is up 9% for the nine-month period. Mimosa saw a 6% decrease in production in this quarter and for the nine-month period. Despite numerous issues, Two Rivers increased concentrate production by 7% in the quarter and flat volumes for the nine-month period.

Looking abroad, Impala Canada experienced a 4% drop in concentrate production in this quarter. The nine-month result is a 3% drop in production.

The IRS operation achieved 5% growth in refined 6E production in this quarter, with higher deliveries from third parties helping to offset delays from Mimosa and Zimplats. Over nine months, mine-to-market receipts dropped by 3% and third-party and toll receipts were slightly higher. The announcement doesn’t indicate a percentage change in production over the longer period.

And in case you’ve been living under one of the rocks at the mines, Impala Platinum is in the process of acquiring Royal Bafokeng Platinum via an offer to shareholders. Impala holds around 37.79% in Royal Bafokeng thanks to shareholders who already accepted the offer. The offer is still open.

Importantly, guidance for the full year that was provided at the time of the interim results has been reiterated.

Strong market demand at Industrials REIT

The Finance Ghost
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Strong market demand at Industrials REIT

The world’s most practically-named REIT has released a trading update for the fourth quarter of its 2022 financial year, which covers the January – March period.

The fund experienced a record quarter for deal volumes i.e. leasing transactions. This means that demand remains strong for multi-let industrial space in the UK. 53% of completed leases were structured as the REIT’s short-form digital “Smart Leases” which is encouraging for the platform. Driving leasing enquiries through the company website means that the company is engaging directly with tenants rather than working through third party agents or portals.

Importantly, average rent increased 22% for the quarter, which is a number that office and even retail funds can only dream of. Uplift was as high as 34% on new lettings! This is the sixth quarter where average uplifts on new lettings was over 20%.

These uplifts only apply to renewed and new leases, of course. Looking across the entire portfolio, like-for-like rent increased by 1.5% during the quarter and met the goal of 4% to 5% growth per annum.

The average lease term granted increased from 4.2 years to 4.9 years, with the average rent-free incentive up from 1 month to 1.2 months.

The fund executed GBP21 million of acquisitions in this quarter and has a strong pipeline of opportunities. The acquisitions are being executed below replacement cost.

After the end of the quarter, a further deal of GBP3.1 million was executed on a net initial yield of 5.2%. A further two industrial estates are under offer with a combined value of GBP7.2 million.

The loan to value ratio at the end of March was 31%.

The share price has fallen 8.6% this year and is 10.5% higher over the past 12 months.

Clicks is struggling in wholesale

The Finance Ghost
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Clicks is struggling in wholesale

The Clicks share price is flat this year, so it’s been a much better investment than the US tech companies that the market got too excited about in 2021. Like those companies, Clicks trades on a substantial multiple.

The market sees this as a defensive stock, which I’ve always found a little odd as the model has significant reliance on selling small appliances in the so-called “front shop” – the part of the store unrelated to the dispensary. Margins on pharmaceuticals are regulated and aren’t terrible exciting, so the magic for shareholders happens between the pharmacist and the queue in the front of the store.

If I look at the pain and agony inflicted on Massmart shareholders by a disruptor like Takealot, it’s not obvious to me why the small appliances business at Clicks won’t face the same pressures. Only time will tell.

In the latest period, Clicks’ turnover from continuing operations only increased by 9%. This was good enough to increase continuing diluted HEPS by 20.1% and the interim dividend by 26.3% to 180 cents per share.

If you adjust for the second SASRIA insurance payment, diluted HEPS from continuing operations only grew by 10.2%.

The reason for reporting results from continuing operations is that Musica was closed in May 2021. That business is therefore in the base, so Clicks effectively excludes it to give a meaningful comparison.

The Covid-19 vaccination programme has been great for Clicks, with the store network helping with a national roll-out of vaccines. The group has administered over 3 million vaccinations since the start of the programme.

As we dig deeper into the turnover number, we find that retail sales grew by 13.6% and distribution turnover only increased by 0.6%. I would interpret this as the effect of the vaccinations, as that would be captured in the retail sales but not in the distribution sales. I can’t think of another reason why the difference would be so large.

Vaccinating people is a low margin business, so retail margin was negatively impacted by 40bps. Distribution margin increased by 20bps despite the low revenue growth.

Retail costs grew by a substantial 12.2% due to growth in the business, with costs on a like-for-like basis increasing by 6.5%. The impact of inflation is clear.

Margin pressure in UPD is becoming a real issue. Distribution costs increased by 8.4% based on higher fuel, security, insurance and electricity costs. Compared to practically no growth in distribution revenue, that’s a proper headache for management that might take more than over-the-counter pills to cure.

The overall impact on margins is a 20bps decrease in group adjusted operating margin to 7.8%.

On the plus side, inventory days decreased which means that less cash was tied up in stock. Cash generated from operations was R590 million and capital expenditure was R352 million, considerably higher than R269 million in the comparable period.

Share buybacks were R446 million and dividends of R848 million were paid. At period end, the group held cash resources of R838 million.

The second half of the year will be supported by a further 28 stores being opened. Although the vaccination programme is ongoing, I suspect that the bulk of the revenue from that initiative has already been made.

The biggest risk in my eyes is UPD, the wholesale business. Clicks notes that normalised activity (including at hospitals) will be positive for UPD’s customers. Shareholders will certainly hope that this will be the case!

With a planned capital expenditure bill of R876 million for the full year, shareholders should pay close attention to the level of free cash flows in the business. Return on equity of 47.2% is excellent and means that the company generates economic profits by investing shareholder capital, but the focus should actually be on return on incremental invested capital, a number that very few companies ever report. It’s worth doing some research on the concept if you are serious about your investing.

Clicks expects diluted adjusted HEPS from continuing operations for the year to be between 8% and 13% higher than in FY21. This implies a level between 904 cents and 946 cents.

With a share price of R320, this is a forward Price/Earnings multiple of around 35x

Karooooo needs long-term belief

The Finance Ghost
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Karooooo needs long-term belief

I have a long position in Karooooo (i.e. I own the stock) that I initiated a couple of months before the big announcement came of a migration to the Nasdaq (back when it was called Cartrack).

Since then, the company has been growing revenue at solid rates but this hasn’t translated into profit growth, as the cost of acquiring a customer is high. It takes many months for Karooooo to achieve break-even on a new customer. In a period of high customer growth, this causes a decrease in profit margins.

The latest quarter does include a swearword in this economic model: churn. That’s not what I want to see. Customers need to come onto the platform and stay there for a few years, otherwise Karooooo loses money on new customers. The company attributes this to financial pressure on customers from the pandemic.

The latest financial update by the company is for the fourth quarter of the 2022 financial year. It includes the numbers for the full year as well.

By the end of February 2022, Karooooo had 1,525,872 subscribers vs. 1,306,000 a year prior. This is a 16.8% increase in subscriber numbers over 12 months. As noted above, the impact on margins is negative, with gross profit margin decreasing from 71% in FY21 to 68% in FY22. The company believes that gross margin can increase in FY23. I certainly hope it will!

For the year, operating profit in the Cartrack business increased by just 1% to R731 million. Growth initiatives Picup and Carzuka incurred operating losses of R3 million and R13 million respectively. The net result was a decrease in earnings per share of 3%. With once-offs removed, it would’ve increased by 1%.

In the last quarter of the year, total revenue increased by 20% year-on-year to R742 million. This is a similar growth rate to revenue for the full 2022 financial year.

The expectation for the 2023 financial year is subscriber numbers between 1.7 and 1.9 million, subscription revenue between R2.95 billion and R3.1 billion and adjusted EBITDA margin in Cartrack of between 45% and 50%.

The group has R718 million in cash after raising R349 million when it listed on the Nasdaq in April 2021. R70 million was used to acquire Picup in September 2021.

Free cash flow of R379 million in 2022 was down from R460 million in 2021. This puts the group on a lofty free cash flow multiple of around 40x, so growth needs to be maintained.

Disclaimer: The Finance Ghost holds shares in Karooooo

Netcare is the perfect example of operating leverage

The Finance Ghost
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Netcare is the perfect example of operating leverage

In a voluntary trading update for the six months to March 2022, Netcare announced that it achieved revenue growth of between 2% and 2.5%. You’ll probably agree that even the hospital food is more exciting than that.

The business was impacted by the Omicron variant in December and January. As I’ve written several times before, the pandemic was negative for hospital groups. As counterintuitive as it seems, the reason is that elective surgeries were impacted and this affected occupancy levels in the hospitals.

Despite this modest revenue growth, EBITDA margin still increased. This gives us insight into the extent of operating leverage in hospitals, as small improvements in utilisation can drive growth in profits. Occupancy in February and March averaged 62.4%. Another benefit to EBITDA margin was a drop in Covid-19 protective equipment expenditure.

Group EBITDA increased by between 8.5% and 9%, with normalised EBITDA margin improving by 100bps to 15.8%. If I understood the SENS correctly and if strategic project costs are excluded, the margin was 16.8%. At all times, I would treat normalised margins with suspicion as an investor. If strategic projects are required on a regular basis for the group to compete, then they shouldn’t be ignored by investors.

Net debt to EBITDA has improved over the past twelve months from 2x to 1.7x. The latest number is in line with the September 2021 (interim) level. In absolute terms, debt has declined from R6.1 billion to R5.4 billion in the past year. The group has cash resources and undrawn committed facilities of R3.4 billion.

I was saddened to note that March 2022 saw the highest mental health occupancy levels since the start of the pandemic. This is the true legacy of the virus and the response to it by governments around the world. We’ve really been through a lot.

Moving to segmentals, Hospitals and Emergency Services grew revenue by between 2% and 2.5% and EBITDA by between 7.7% and 8.2%. EBITDA margin of 15.5% was well up on the comparative interim period (14.7%) and FY21 at 15%.

In Primary Care (e.g. medical and dental clinics), revenue growth was between 5.2% and 5.7%. This drove a substantial increase in EBITDA of between 30% and 32%, with the effect of operating leverage clearly visible. EBITDA margin expanded from 18.4% to 23% year-on-year.

In terms of strategic projects, the 427-bed Netcare Alberton hospital opened in April and construction of the 36-bed Akeso Richards Bay facility is complete. Another project highlighted in the announcement is the CareOn electronic medical record project, with 20 hospitals on track to be completed by the end of 2022.

ESG enthusiasts will also be pleased to learn that Netcare is the only healthcare institution in the world to win Gold Medals in all four categories of environmental sustainability in the global Health Care Climate Challenge.

The share price is slightly lower this year and just 4% up in the past twelve months. It has traded in a range between R14 and R16 in the past 6 months.

South32 production on track but there are cost pressures

The Finance Ghost
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South32 production on track but there are cost pressures

It’s been a rough week or so for mining production numbers, so a quarterly report from South32 may have been met with some nervousness from the market. This is a good time to remind you that the JSE attracts mining companies with operations all over the world, so pressures in South African production don’t translate into pressures on businesses with offshore operations.

With that out the way, it may make more sense to you that South32 released unchanged production guidance for FY22, with operations delivering according to plan. The group operates in Australia, Southern Africa and South America. It’s a bit like the old days of Super Rugby.

With a pre-feasibility study completed for the zinc-lead-silver Taylor Deposit in Arizona, the group also looks set to expand in the northern hemisphere.

South32 has reported strong quarterly production results in aluminium, copper, zinc, nickel and coal. Manganese production fell due to planned maintenance at the South African mines. This is the first time the group has reported copper production, now that the Sierra Gorda investment has been completed.

Supply chain issues are in play here, particularly in the aluminium value chain where movement of inventory at operations has slowed down. The company is obviously mitigating this to the greatest extent possible.

With freight pressures, higher raw material input prices and major currency movements, guidance for operating costs per unit has been revised higher.

Capital expenditure guidance has been reduced by USD36 million to USD702 million, attributable to a deferral of spend at Worsley Alumina into FY23 among other things.

At the end of March, South32 had cash of USD52 million after acquiring a 45% interest in the Sierra Gorda copper mine for USD1.4 billion during the quarter. This was funded by USD600 million cash and USD800 million from a short-term acquisition bridge facility. The bridge was repaid after the end of this period through the company’s inaugural USD bond issuance, in which USD700 million in senior unsecured notes (due 2032) were issued. These carry an interest cost of 4.35% per annum.

A group like this is always busy with deals. For example, the sale of the Metalloys manganese alloy smelter is not proceeding and will remain on care and maintenance for now. In better news, the group received approval from the Brazilian Competition Authority for the acquisition of an additional 18.2% interest in the Mineracao Rio do Norte bauxite mine, taking the ownership stake to 33%.

Finally, South32 is no longer selling commodities to Russian entities. Exposure to the country has historically been limited and no new business relationships are planned.

Alphamin: the market loves tin

The Finance Ghost
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Alphamin: the market loves tin

Tin miner Alphamin has been one of the most interesting and exciting stories on the JSE in recent times. Over 12 months, the share price is up more than 130%. This year, it’s up around 32%.

The company produces around 4% of the world’s mined tin from its high-grade operation in the Democratic Republic of Congo. On a regular basis, it has been announcing drill results from the area. The bad news is that you need a geology degree to understand most of it.

For example, you’ll be thrilled to learn that subsequent drilling has “intersected visual cassiterite” – sounds exciting!

The Mpama South resource offers exciting growth prospects and is getting plenty of attention in the market. Mpama North is currently in operation and Mpama South is the next area of expansion for the company.

Back in March, the company announced the results of 102 drillholes. The latest update covers the results from 12 drillholes, which have given the best intercepts received thus far at Mpama South.

After releasing strong numbers for the first quarter of the year, this is further good news for Alphamin shareholders. In the March update, the company noted that Mpama South would take Alphamin to 6.6% of the world’s tin production and that the operation would be expected to achieve first tin production by December 2023. No update to this guidance was given in the latest announcement.

PSG proposes an unbundling and delisting

The Finance Ghost
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PSG proposes an unbundling and delisting

There was a double-whammy of announcements from PSG. The company released results for the year ended February 2022 as well as a firm intention announcement for the value unlock transaction.

I’ll start with a brief overview of the results.

Net asset value per share was R127.49 as at 28 February 2022, representing an increase of 38.9% over the past 12 months.

PSG Konsult achieved a 32% increase in recurring HEPS, demonstrating once more the benefit of owning the client relationship rather than creating financial products. Curro could only manage an 8% increase in recurring HEPS. Zeder also contributed positively, with a meaty fair value gain and dividend income to sweeten the deal.

Moving into the smaller investments, PSG Alpha incubates new businesses (although its stake in Stadio can hardly be considered a startup) and recognised a gain in fair value for the year. Dipeo Capital is a B-BBEE investment holding company and suffered a drop to a negative equity value, which isn’t uncommon in these structures that are funded by preference shares with a high level of gearing i.e. very little equity value, like buying a house with a tiny deposit.

Of course, the market has been focusing on the unbundling rather than the underlying results. There is finally clarity on what the directors are planning here.

If the deal goes ahead, the following investments will be unbundled to shareholders: 60.8% in PSG Konsult, 63.6% in Curro, 34.9% in Kaap Agri, 47% in CA&S and 25.1% in Stadio. You probably aren’t familiar with the CA&S name. The FMCG company trades on the Cape Town Stock Exchange and will migrate its listing to the JSE before the unbundling.

PSG shares would then be acquired from shareholders at a price of R23 per share, which would reflect the assets that aren’t being unbundled (Zeder and PSG Alpha, including part of the stake in Stadio). The “Remaining Shareholders” (who currently hold 34.6% in PSG) would hold 100% of the vehicle once delisted.

This transaction is a direct result of the stubborn discount to net asset value that PSG has been trading at. The same is true for most investment holding companies in South Africa, so this is a structural issue in the market.

Of course, a deal like this requires shareholder approval. An independent expert is being appointed to provide an opinion to shareholders on whether the proposal is fair and reasonable.

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