Anchor Capital's five JSE-listed shares for 2017

PUBLISHED: Tue, 03 Jan 2017 07:16:48 GMT
Anchor Capital’s analysts have been scouring the market for stocks it believes offer an attractive risk-reward profile. What the following shares all have in common is that they have derated materially in recent months (or are already cheap) and Anchor expects EPS growth of at least 20% from the current base. While not intended to represent a holistic, diversified portfolio (nor a comprehensive list of our current “picks”), we believe the following five shares – in no particular order – deserve a place under the tree this year.
1. Rhodes Food Group
Christmas came early for Rhodes Food Group this year, with the group having raised over R660m through the issue of 25 million shares in an accelerated book build in late November. The proceeds will be used to fund the continuation of what we believe is an attractive business model, where Rhodes continues to consolidate and turn around underperforming SMME food producers. Since listing in 2014, the group has effected eight acquisitions – with the group’s subsequent earnings growth reflecting management’s ability to successfully extract synergies and to allocate capital to expansionary projects that yield attractive returns.
An intentional focus on core product categories and product innovation has yielded market share growth, with notable success in the fruit juice & baby food categories. We expect this trend to continue, with the smaller Rhodes leveraging its dynamism in a market where the larger competing producers are slower to respond to evolving consumer preferences.
Post book build, Rhodes’ balance sheet has material capacity for additional gearing – with net debt : EBITDA at just 0.6x. Although management doesn’t guide to a specific capital structure, we would expect a net debt : EBITDA ratio of 2.0x to be a rough maximum for the business (peer group average is 1.3x). This implies gearing capacity of over
R800m, leaving R550m for deal flow after R250m in planned capex. It is also important to note that management have guided to returns in excess of the group’s ROE (25%) on expansionary capex.
Although the book build will result in short-term earnings dilution, we expect 2017 to be an active year of deal making for Rhodes and we estimate such deals could add at least 6 – 7% to group earnings on an annualized basis in year 1. This figure could be closer to 10% from year 2 onward as synergies are extracted and utilization rates are improved.
The share currently trades on a forward P/E of 16.3x, which is in line with its peer group despite the business’ superior earnings growth profile. Post 2017 deal flow, we expect that management will be able to sustainably grow earnings at around 20% per annum and on this basis we think Rhodes deserves a place under the Christmas tree this year.
2. Aspen Pharmacare
Despite an enviable long term track record, Aspen has been very disappointing in recent years, with the share down by 12% YTD following a 24% decline in 2015. It is worth noting that much of this poor performance is owing to a sharp de-rating from what was arguable an overextended earnings multiple (see figure 2), but the group’s FY16 results were also disappointing and “messy” in some ways:
 Normalised HEPS grew by 10% – well below the trend rate of growth investors have been accustomed to from Aspen.
 Not included in the normalised earnings figure was a hyperinflationary adjustment to the group’s Venezuelan operations amounting to R870m. In essence, Venezuela has been written off in their lives.
 The sale of the group’s Australian generics business cost Aspen 4.5% turnover, and was likely earnings dilutive but we believe management has done this for sound strategic reasons.
 The South African business unit disappointed, with EBITA declining 15% as a consequence of the private sector business receiving insufficient focus due to the requirement to supply greater-than-expected volumes into a government tender. CEO Saad acknowledged this was a management misstep and has expressed confidence in this issue being resolved in the coming year.
Looking ahead to FY17, management has intimated that growth should accelerate materially. Specifically, much work has been done during 2016 bedding down recent acquisitions and management expects an incremental R500m-1bn worth of synergies to be delivered in FY17 over and above the R300m delivered in FY16. In addition, the group’s commercialisation agreement with AstraZeneca for its anaesthetics portfolio could add 20% to earnings for a
full year. We expect as much as 30% earnings growth for the next two financial years (consensus is lower at +23% p.a), which unwinds the stock’s forward P/E multiple to a level last seen five years ago. Importantly, the stock’s premium rating it has enjoyed over time has also shrunk to below-average levels – despite an absolute de-rating in the broader market multiple (figure 2 below). Provided earnings expectations are delivered on, we would not be surprised to see annualised share price gains of 20% or more from
current levels.
3. Naspers
Naspers was one of the immediate major casualties of Donald Trump’s victory in the US elections – an early “Christmas Grinch” for the global tech sector, if you will. His election and communicated policies have been interpreted as having the following key implications:
• Rising infrastructure spending in the USA
• Tax cuts in the US
• Higher growth
• Higher inflation
• Bigger fiscal deficits, leading to greater issuance of US debt
The net result of the above has been a rapid and dramatic shift in capital flows from emerging markets to developed (specifically US) markets. Within these changes, we have witnessed swift sector rotation, which has generally favoured US banks, “old economy” stocks over that of more highly-rated, higher growth tech stocks. Tencent, as a widely held emerging market technology stock, has been caught up in this dramatic sector rotation, and declined in value by almost 6% during November (Facebook, similarly, declined by 8.7%), with the sell-off continuing into December.
Given Tencent’s dominance in Naspers’ life, this has been key to the decline in Naspers’ share price over the past month or two. Perhaps more importantly, however, we have witnessed a sharply rising discount to Naspers’ sum of the parts in recent months – quite aside from Tencent’s own investment thesis, this implies that investors are increasingly losing patience with management’s ability to create value at “the centre.” Figure 3 below demonstrates that Tencent’s contribution to Naspers’ intrinsic value is at an all time high:
In our view, the key issue to unlocking much of this discount will be evidence of faster monetisation of the group’s ecommerce assets (ex Tencent) which – in aggregate – are incurring losses of more than $600m annually. In recent years, we have witnessed rising losses coinciding with evergrowing development expenditure.
For us, the 1H17 result was encouraging on this front. While consolidated development expenditure continued to grow at a rapid clip (38% yoy), losses actually stagnated. While this may not sound an impressive achievement, it highlights growing profitability of the mature assets within this portfolio. We think this bodes well for the future profitability of this portfolio of assets, and ultimately, unlocking of the discount.
As shown in figure 5 below, Naspers currently trades at a 33% discount to our estimate of intrinsic value; we believe this is an especially deep discount as it has typically tended to trade in the band of 15-25% over time when assessed on this basis.
We believe Naspers represents a compelling risk-reward equation at this juncture, especially in the context of Tencent’s recent pull-back and below-average earnings multiple. Tencent trades at a 12-month blended forward P/E of 27x, but should sustain 30% profit growth for some time.
4. Sun International
In 2017, the wise investor will follow this star to Menlyn Maine, where Sun International will unwrap their most generous gift to shareholders yet – the new Time Square hotel & casino.
The entertainment “super-complex” will be South Africa’s second largest casino (commissioning date is April 2017), which we expect will contribute over R1bn in annualised EBITDA once fully operational. We estimate that the operation will add around R32 in intrinsic value per share – significant in the context of today’s share price of R85, which in turn we think is not discounting any of Menlyn Maine’s value contribution.
2017 will also mark the 1st full year of consolidation of the newly-formed Sun Dreams operation in South America after the merger of Sun International’s Latam assets with Chilebased Dreams S.A. Favourable valuation terms of Sun’s Latin American assets in the merger should result in material earnings accretion for the group in FY’17 (we est. 150c), with recent delays in Chile’s municipal license renewal process a net positive as the effective life of existing licenses are extended.
We believe that market scepticism around Time Square’s success and overblown concerns (in our view) about the group’s balance sheet are creating an exceptional opportunity for investors to take advantage of a level of mispricing not often seen.
Taking Sun’s new financial year-end into account (December), we estimate that the counter is trading on a forward P/E of ~10x. Once Time Square is fully operational, we calculate long-term sustainable earnings of around R9.60 per share and we apply an exit multiple of 12x to calculate a fair value twelve months out of R115. A prospective return of 35% “jingles our bells” and makes Sun International one of our top picks for 2017. The key risk to our thesis is a more protracted period of moribund casino revenues currently being experienced in South Africa, which would place further pressure on margins of the group given inflationary cost escalations. In addition, debt levels are currently high, but we do not expect any covenant breaches (the South African and Latin American operations have separate covenants; SA has a temporary limit of 4.0x debt : EBITDA – we expect it to peak at 3.8x in FY17, dropping below 3x in FY18 as Menlyn Maine generates EBITDA).
5. RMI Holdings
One could argue that RMI represents the perfect “Christmas lunch” of the insurance industry. Having recently concluded some much-anticipated M&A in the form of an associate stake in UK based short term insurer Hastings Group Plc, RMI now boasts a truly diversified offering. RMI offers a nice mix of life insurance (Discovery and MMI), short term insurance (OUTsurance and Hastings Group Plc.), high growth assets (Discovery, OUTsurance and Hastings), mature assets (MMI), emerging markets (OUTsurance SA, Discovery and MMI) and developed markets (YOUI Group and Hastings Group Plc).
Prior to the investment in UK based Hastings Group Plc., we anticipated RMI to deliver earnings growth between 15 and 20% over the medium term, with growth kickers coming from a combination of Discovery’s loss making fledgling businesses breaking even and OUTsurance’s Australian subsidiary, YOUI’s, earnings to ramp up the J-curve as this business achieves scale. The current forecasts don’t factor in much earnings accretion from the investment in Hasting’s, although the investment was entirely debt funded, making short term earnings accretion highly likely.
Using simple assumptions from the latest published financial statements a possible scenario would be a c.2%boost to RMI earnings in FY17 and c.4% in FY18.
Alongside Old Mutual, RMI remains our preferred pick in the insurance sector and we view the diversification of the asset mix as a one that should deliver stable returns on capital through the cycle. The recent hail storms experienced in Johannesburg have resulted in us trimming estimates of OUTsurance’s earnings by c.3% as this business is currently experiencing cyclically high underwriting margins in the domestic market, a situation we believe could normalise with the hail-related claims that are not yet reflected in the most recent reported earnings base. From a valuation perspective, RMI trades at a 12-month rolling forward P/E multiple of 13x, offers a sector-leading EPS growth profile of 20% p.a and investors also receive a 4% dividend yield. We believe these metrics should be supportive of total returns in the region of 20%. We do note, however, that our earnings estimates for both Discovery and RMI are materially ahead of consensus expectations.

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