Best of Ghost Mail: Afrimat buys when there’s blood on the streets

The local cement industry isn’t an easy way to make money. In fact, it’s rather hard. Ba-dum-tiss. 

Highlights: 

• PPC has been dealing with all kinds of difficulties, with a balance sheet that had too much debt and not enough certainty of cash flows from African subsidiaries.
• Afrimat Limited (AFT) has dived into the sector and grabbed Lafarge with both hands, with an equity worth just $6 million.
• More on Standard Bank Group and FirstRand. 
• It’s very tempting to put all banks in the same bucket. As recent updates have demonstrated, this would be a grave error. 

PPC Limited ( JSE:PPC) is the most followed company in this industry. The group has been dealing with all kinds of difficulties in recent years, with a balance sheet that had too much debt and not enough certainty of cash flows from African subsidiaries. Goodness knows we’ve seen this movie elsewhere, like at Nampak. But unlike Nampak Limited (JSE:NPK), PPC seems to have emerged from the pain and gotten the balance sheet under control, not least of all thanks to an excellent management team.

PPC’s local business usually takes strain from cement imports. A weak rand is helpful in that regard, but it’s still a hollow victory as low levels of infrastructure investment in South Africa mean that PPC has perpetually low capacity utilisation. In the year ended March, EBITDA in the “SA obligor group” (South Africa and Botswana) fell by 26%. The group is still profitable and has made further inroads into the debt balance, but the trajectory is worrying.

At Sephaku Holdings Limited (JSE:SEP), the South African operations can’t even claim to be profitable anymore. Presumably facing the same headwinds as PPC but from a position of less strength, the local business is only at breakeven levels.

Despite the obvious challenges here, Afrimat Limited (AFT) has dived into the sector and grabbed Lafarge with both hands. The market was very excited by this news, with the share price rallying strongly on the day of the announcement. International owner Holcim Group is heading for the exit, with Lafarge South Africa seeing its EBITDA drop from R311 million in 2021 to just R38 million in the 2022 financial year.

The equity of Lafarge South Africa is worth just $6 million, but there’s also a shareholder loan from Holcim of R900 million that needs to be repaid. R500 million will be repayable when the deal closes and the rest will need to be repaid within twelve months.

Afrimat’s dealmaking track record is enviable to say the least. This is a classic case of buying when there is blood on the streets. The risk is that the market seems to immediately price in the benefit as the deal is announced, which means high risk of disappointment for shareholders from there.

What can diamonds and rubies teach us?

On the same day, De Beers (part of Anglo American) released a sales cycle update and Gemfields reported another excellent auction, this time for its rubies from Mozambique.

Starting with the diamonds, De Beers sold $450 million worth of rough diamonds in the fifth sales cycle of 2023. This is lower than $479 million in the fourth cycle and much lower than $657 million in the comparable cycle last year. I see diamonds as an affluent product rather than a true luxury product, as wedding culture means that many people who wouldn’t ordinarily buy luxury goods end up spending a fortune on diamonds.

There’s no “pressure” to buy rubies, so this is arguably a better measure of the luxury market. With revenue at the latest Gemfields auction up by 20% vs. the previous auction, my thesis seems to stack up. We know that the luxury market continues to do well, with the affluent market starting to get squeezed by inflationary pressures and increasing interest rates.

As a further data point, the last emeralds auction at Gemfields also showed no signs of the luxury market slowing down.

Not all banks are created equal

It’s very tempting to put all banks in the same bucket. As recent updates have demonstrated, this would be a grave error.

African Bank isn’t something you can invest in right now, but the company still reports results as though you can. We’ve seen the credit loss ratio blow out severely in South Africa, which tells us that lower income consumers are really struggling.

At Standard Bank Group Limited (JSE:SBK), we’ve also seen the credit loss ratio move in the wrong direction, though nowhere near as severely as African Bank because Standard Bank has a far more diversified base of lending clients. Still, it’s the corporate and investment banking business that is flattering the result, as only the largest and most powerful balance sheets aren’t coming under strain in this environment. Consumers and smaller businesses are looking a lot weaker than a year ago. Still, Standard Bank is making good money in this environment, with HEPS expected to be at least 20% higher year-on-year.

At FirstRand Limited (JSE:FSR), we are seeing a different story. The credit loss ratio is well under control thanks to a conscious decision in the past couple of years to focus on higher quality lending opportunities, even at the expense of revenue growth. We are working off trading updates rather than formal results here, so we don’t have every metric available to us. FirstRand focused on giving return on equity (ROE) guidance, noting that it remains at the upper end of the 18% to 22% range.

Although the credit provisions look different at Standard Bank vs. FirstRand, the one commonality is that bankers (not just banks) make a lot more money when times are good. Variable remuneration is always a sticking point for shareholders, as bankers make outlandish bonuses in the good times and still demand strong packages in the bad times.

At least the local banks are nowhere near as bad as the likes of Goldman Sachs in the US. Those organisations are mainly run for the insiders, with the shareholders always last in line to be rewarded.

Have you been buying the dip? 👀In the latest Best of Ghost Mail feature, the Finance Ghost explores how not all dips are created equal, looking at the retail and banking sectors. 

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