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Mondi: winning at inflation, but what is Russia worth?

The Finance Ghost
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Mondi: winning at inflation, but what is Russia worth?

In the first quarter of 2022, customer demand for Mondi’s products was strong enough to offset the impact of cost pressures, as Mondi could achieve higher average selling prices. This is music to the ears of any investor, with most companies currently seeing margins deteriorate in an environment of exceptional cost pressures.

In Corrugated Packaging, Mondi managed to pass on higher input costs. In Flexible Packaging, discussions are underway with customers regarding further price increases. Uncoated Fine Paper is enjoying favourable supply-demand dynamics and implemented price increases in 2021 and this year, with the only negative news being that the Merebank operations in South Africa were impacted by the floods (this doesn’t have a material impact on group performance). Finally, Engineered Materials achieved a “stable” performance this quarter.

The pressure on input costs came from a wide variety of sources: energy, resins, transport, wood and chemical costs. Currency movements also weren’t favourable.

A further headwind for EBITDA came from scheduled maintenance, with a EUR20 million impact this quarter and a full year estimated impact of EUR110 million.

Despite this, the EBITDA result is incredibly good with growth of 63% year-on-year and 41% vs. the previous quarter. Of the EUR574 million in EBITDA, EUR117 million was in the Russian operations. This means that 20% of group profitability was in Russia, which is why the share price is down by a similar percentage this year.

The group has decided to sell its assets in Russia based on the humanitarian impact of the invasion of Ukraine. At this stage, no deal has been lined up and there’s no guarantee that a deal will even happen. The Russian business had a net asset value at the end of December of EUR687 million. In the meantime, all capital expenditure projects in Russia have been suspended.

At the end of March, net debt to EBITDA was approximately 1x, so the balance sheet is strong. The sale of the Personal Care Components business is expected to be completed in the second half of the year. Mondi has a capital investment pipeline of around EUR1 billion which the company believes will achieve “mid-teen returns” when in operation.

The share price rallied 5% yesterday and I’m not surprised. The sell-off this year implied a total loss of the Russian operations. With the rest of the business doing incredibly well, any value achieved for the Russian business could bring share price upside from here.

This is an interesting play in my view.

DRDGOLD faces margin pressures

The Finance Ghost
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DRDGOLD faces margin pressures

After an exceptional run in 2020, DRDGOLD has been a disappointment for investors. The gold price simply hasn’t behaved itself despite periods of volatility, inflation and even war, causing many to scratch their heads over the shiny metal.

The trouble is that in a difficult environment of rampaging input costs and other issues like electricity (or lack thereof), the gold price needs to increase at a rate that at least covers the expense growth. After peaking at over R1,150,000 per kilogram in 2020, the gold price in local currency has come off sharply. It fell to just over R800,000 per kilogram in mid-2021 and is now at around R950,000 per kilogram.

I held DRDGOLD in 2021 and eventually gave up. I still have look-through exposure through Sibanye, which holds a majority stake in DRD.

The latest update from DRD covers the three months ended March 2022. Production fell 3% vs. the prior quarter (not year-on-year) and sales fell by 6%. The average gold price received thankfully increased by 3% but that wasn’t enough to offset the drop in volumes, so adjusted EBITDA fell by 3%.

The increase in cash operating costs confirms why I sold out. All-in costs increased 4% in the last quarter alone. On a per tonne basis, cash operating costs increased by 8%. When the gold price seems to be languishing sideways, this is really tough on margins.

The balance sheet is strong thankfully (R2.3 billion in cash at the end of March and no debt) so the company still expects to declare a dividend in August 2022.

DRD is a profitable business but the trend is concerning in an environment of significant input cost inflation and a lazy gold price. The share price is down by just over 5% this year.

Equites: winning with warehouses

The Finance Ghost
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Equites: winning with warehouses

Logistics property fund Equites has released results for the year ended February 2022. With a total return (change in net asset value per share plus dividends) of 17.3% for the year, it’s been a solid period for the company that targets double-digit returns in any given year.

The loan-to-value (LTV) ratio was 31.5% at period end (up by 30bps), which puts it squarely in the ballpark for where listed property funds should be. You need debt to make the returns to shareholders work but too much debt can kill you. Equities executed two accelerated bookbuilds in this period (equity capital raises) for a total of R2 billion. Those helped fund developments and acquisitions in both South Africa and the UK, avoiding a large increase in the LTV.

The net asset value growth mainly came from the UK, as property valuations were flat in South Africa. In contrast, the UK valuations increased by 13% in sterling.

Although local valuations may not have increased, the portfolio is fully occupied. This is another reminder of how well the logistics property sector has been doing. With incredible disruptions to supply chains and high levels of growth in online retail, logistics remains the most attractive property class in this market. Shareholders will be pleased to learn that the company believes that “demand for prime logistics space showed no signs of abating” in this period.

Interestingly, the fund hasn’t seen growth in online retail as a major factor in South Africa yet. My view is that online shopping still has a long runway in this country, so that tailwind is still coming.

In South Africa, construction inflation for a warehouse was between 10% and 15% in 2021, so the fund expects to see rental growth coming through (and this implies asset value growth as well).
Distributable earnings grew by 29.9% in the period and the dividend per share grew by 5.2%, so the fund has been retaining earnings for growth.

Separately, Equites announced that its UK subsidiary (Equites Newlands Group) has agreed to sell land for around R969 million to Promontoria Logistics UK. As part of the deal, Equites Newlands will then develop two distribution centres on a turnkey basis at a cost of R955 million. This is expected to generate a profit of R212 million.

The Equites Newlands business has a development pipeline of around R20 billion and is entering into these types of deals to help fund that pipeline. I think it’s a clever model, with the land sold at approximately fair value and the development profits helping to achieve a return for shareholders.

All proceeds are being reinvested in the pipeline rather than being distributed by Equites. This deal would also brings the loan-to-value (LTV) ratio down by 140bps.

The net asset value per share is R18.61 and Equites is trading at around R20.80, a premium to book of around 12%. The share price has been trading between around R20.30 and R23.50 since September 2021.

This is a great example of an investment thesis that needed to catch up to the share price. I like what Equites is doing strategically, but I’m always nervous of a property company trading at a premium to book value.

Sanlam forms a R33 billion Allianz

The Finance Ghost
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Sanlam forms a R33 billion Allianz

In December 2021, Sanlam gave us the first hint that a deal of some sort might be on the table with Allianz SE, a global financial services group listed on the Frankfurt Stock Exchange. Both companies operate in Africa, so the options clearly ranged from a strategic alliance at one end of the spectrum to a full-blown merger at the other.

We now know that the groups have decided to execute a long-term strategic joint venture related to African operations excluding South Africa. The companies will contribute their operations into a new company, so this is a bit like a merger after all. The joint venture has a minimum period of 10 years, which is why I say “a bit like” as it can presumably be unwound at a later date.

Sanlam operates in 30 countries and Allianz operates in 11 countries. Although the term “pan-African” tends to be overused in the market, this clearly meets the definition. Allianz may have the smaller footprint of the two, but the African business has existed since 1912 and has around 2,600 employees servicing 2 million customers.

This ultimately a scale play and a clever one at that. It brings together two financial services giants and broadens and deepens their reach simultaneously. Sanlam also highlights the strength of its digitally enabled distribution network, which now benefits from a wider product offering.

Sanlam is the larger business and so it will have the controlling stake in the joint venture (60%), with Allianz holding the remaining 40% with the ability to increase this to 49% over time. This means that Sanlam is effectively taking control of Allianz’s African footprint.

We now need to flick across to Santam before we finish talking about Sanlam.

Santam deal

Sanlam subsidiary (and separately listed insurance group) Santam will dispose of its 10% interest in SAN JV to Allianz as part of this transaction. This is a life and general insurance business operating in 25 countries. The parties have executed a framework cooperation agreement to govern the working relationship going forward, so Santam no longer needs to retain its equity stake in this joint venture. If Santam wanted to stick around, it would need to be willing to invest capital as and when required for further investments, which isn’t in line with Santam’s strategy.

Separately, Santam will look to sell its 10% stake in the general insurance business of Sanlam Emerging Markets in Africa that is held outside of SAN JV. It will retain its stake in Santam Namibia. Just to add further complications, Sanlam is transferring its economic participation rights in Santam Namibia to the JV.

Santam will receive EUR120.5 million (around R2 billion) for the stake, subject to various potential adjustments. Attributable earnings were just R8 million in FY21.

Santam shareholder approval is not required.

Back to Sanlam

We needed to deal with the Santam deal before carrying on, as Allianz will contribute the 10% shareholding in SAN JV (assuming all goes ahead) to the new joint venture.

Interestingly, Sanlam’s Namibian subsidiaries are excluded from the deal at this stage. They may be contributed to the joint venture at a later stage.

The total Group Equity Value of the new joint venture will be over EUR2 billion (around R33 billion). Net income for the six months to June 2021 would have been EUR25 million for these assets.

This looks like an exciting opportunity for Sanlam. It seems that the market had already priced it in, with limited share price action in response to the announcement. Santam traded slightly higher after the announcement.

CMH’s blockbuster year

The Finance Ghost
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CMH’s blockbuster year

Combined Motor Holdings (or CMH as everyone calls it) has released financials for the year ended February 2022. With Headline Earnings per Share (HEPS) up 117%, it was a year to remember.

Revenue increased by just over 30% and operating profit jumped by 75.7%, reflecting the joys of operating leverage (fixed costs in the cost structure) and positive JAWS (income growth higher than expense growth).

The operating profit margin has expanded from 4% in FY21 to 5.4% in FY22. A particularly impressive outcome was the jump in return on equity from 19.6% to 37.1%.

Looking at the segments, the core retail motor division (94% of group revenue) increased revenue by 28% and the car hire business recovered sharply with a 92% jump in group revenue. That division only contributes 4% of group revenue. A further 1% is from Financial Services and 1% is in the Corporate Services and Other division, which all accountants know is like that weird drawer in your bedroom where you keep lots of random things.

HEPS increased from 230.4 cents to 501 cents and dividends per share increased from 100 cents to 235 cents, reflecting a payout ratio this year of around 47% which is slightly higher than in the prior year.

To put that blockbuster year into perspective, I’ve included the HEPS chart below from the results booklet:

The share price of R28 reflects a trailing Price/Earnings multiple of around 5.6x on these earnings. The multiple is closer to 10x if we use pre-pandemic numbers as a more normalised view on the business.

CMH’s share price is up 12.5% this year and nearly 53% over the past twelve months. The motor trade has been an unlikely winner during a period of tricky supply chains. The difficulty for investors lies in estimating the extent to which these earnings can be maintained.

Cryptocurrency: Inflations’ power over consumers widens while the case for gaining exposure to cryptos grows

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Cryptocurrency: Inflations’ power over consumers widens while the case for gaining exposure to cryptos grows
  • A basket of goods in 2013 grew by 36% in just 4 years, due to inflation
  • The deflationary power of cryptos such as BTC and ETH reflects the financial shift that we are witnessing today
  • Blockchain research house Glassnode, shows that BTC holders are in this for the long-term

Unlike rands or any other traditional currency, Bitcoin is designed to have a limited supply, so it can’t be devalued by a government or a central bank distributing or creating too much of it. While over the past few years, the traditional currencies we use have diminished our buying power, while those who opted for digital currencies have seen an increase in theirs.

To illustrate this point, we took a basket of goods from a decade ago and escalated the prices by the consumer inflation rate. Assuming that basket of goods cost R5,000 in 2013, by early 2022 it had nearly doubled in price to R9,375.

Using BTC as the currency, that same basket would have cost 4.75 BTC in 2013 and today, it costs 0.01 BTC.

Ethereum, the second-largest crypto as measured by market cap, has been around since 2015 so we have less data to work with. The ETH price was extremely volatile in the first two years of its creation, climbing from about R3,000 in early 2017 to just short of R20,000 in early 2018, before collapsing more than 90% to around R1,200 later that year.

Then Ethereum began its steady but inexorable climb to above R75,000 in late 2021, before giving up some of its gains. In April 2022, it traded at R47,000.

Our R5,000 basket of goods had escalated in ZAR to R6,800 by 2017. If we used Ether as the purchasing currency, it would have cost 1.65 ETH in 2017 and then more than doubled in price to close to 4 ETH in 2019. That same basket of goods today would cost 0.21 ETH.

Source: Jaltech, StatsSA

Bitcoin and Ethereum have entirely different use cases: Bitcoin is regarded as a digital store of value, while Ethereum is challenging financial orthodoxy through the use of blockchain and smart contracts.

Bitcoin has been dismissed time and again by many of the titans of Wall Street, among them Warren Buffet and JP Morgan Chase’s CEO Jamie Dimon, who called it a ‘fraud’ and ‘worthless’, yet the number of corporate investors present at the recent Bitcoin Conference in Miami suggests cryptos are here to stay. There will be some spectacular failures along the way, but virtually all major banks now have at least one or two analysts dedicated to studying and following cryptos. They dedicate their time to identifying the tracking the winners, such as BTC and ETH.

Graphs like the one above can no longer be dismissed by serious analysts. The deflationary power of cryptos such as BTC and ETH reflects the financial shift that we are witnessing where annual interest yields of 20% or more are being earned on decentralised finance (DeFi) platforms, where collateralised loans can be taken out without having to submit so much as a name or email address, where transactions can be settled in seconds rather than days. Where credit committees and bank managers are rendered irrelevant.

The growth in crypto value will never be a smooth line, but crypto enthusiasts are accustomed to this. After peaking above R300,000 in 2017, BTC dropped 84% in price over the following year, before reversing the trend and shooting above R1 million. ETH dropped more than 90% in 2018 before screaming back up more than 2,000%. The peaks and troughs are often extreme, but the same volatility was evident in the early years of Amazon and Apple stock trading. It is already clear that both ETH and BTC are far less volatile today than was the case just a few years ago.

Blockchain research house Glassnode shows that BTC holders are increasingly in this for the long haul. They can now stake their coins – putting them to work on the blockchain for which they earn rewards – and they can borrow against their cryptos to leverage their positions. In other words, the case for owning cryptos is getting more compelling by the month.

Jonty Sacks – Partner at Jaltech

For information about Jaltech’s Cryptocurrency Basket, click here.

Jaltech offers everyday people effortless and convenient access to the cryptocurrency market.

One of Jaltech’s investments is its Cryptocurrency Baskets which is tailored for investors who are looking for an investment option that provides investors with exposure and diversification across protocols, digital currency and blockchain technology.

Renergen’s life is still a gas

The Finance Ghost
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Renergen’s life is still a gas

There were two announcements released by Renergen yesterday. One was a formal financial report and the other was an excitement-filled update on progress at the Virginia Gas Project. Nobody can ever accuse Renergen of not injecting a little passion into SENS.

The financial report in question is a preliminary report on the year ended February 2022. As I often remind you, the company’s valuation is not based on anything you’ll find in the income statement. The key Virginia Gas Project is still being brought into operation, which is why Renergen gives such frequent and detailed updates on its progress.

Revenue was just R2.6 million and the loss attributable to shareholders was R33.8 million. See what I mean?

Operating costs decreased by R6.8 million thanks to lower consulting fees and employee costs, along with swings in net foreign exchange. The benefits were mitigated to some extent by listing costs and other legal and professional fees.

In September 2021, Renergen made a final drawdown of R112.1 million on the loan facility from the US International Development Finance Corporation. The local Industrial Development Corporation (IDC) gave Renergen a loan facility of R160.7 million in December 2021, of which Renergen has used R158.8 million. Developing a resource production facility isn’t a cheap exercise.

The real story behind the company is found beyond the financials. Renergen has been busy securing LNG and helium offtake agreements and has enjoyed 5 out of 6 drilling successes from the exploration campaign.

To give more context to the achievements, offtake agreements with Consol Glass and a subsidiary of Italtile have already covered 60% of planned phase 1 production of LNG. The remaining 40% is going to the logistics market in a dual fuel application for heavy trucks.

On the helium side, 65% of planned phase II production has already been contracted under take-or-pay contracts that are between 10 and 15 years in length. The group is hanging on to the rest, with an intention to place it in the spot market.
In and amongst all this, Renergen also developed a transportation solution for vaccines called Cryo-Vacc. Demand for vaccines has fallen off a cliff, but Renergen may be able to find a market for the technology in verticals like gene therapy and similar niches. Renergen spent R10.9 million developing this solution, so they need to generate a return somehow. It pales in comparison o the R260.7 million on the Virginia Gas Plant in this period but is still a meaningful number.

Renergen had R95 million in unrestricted cash reserves at the end of the period. Subsequently, Ivanhoe Mines subscriber for shares for over R200 million. A much larger deal is the planned sale of 10% of Renergen’s operating subsidiary to the Central Energy Fund for R1 billion. The proceeds will be used for the phase II development.

The share price is up 18% this year and over 60% in the past twelve months.

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.

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