PBT Group: Amidst the Noise, Opportunity

For background to this article, read my original post: PBT Group: Very Much Worth Looking At…

We now have PBT’s FY 17 set of results to work with (see here), thus I believe it is time to update my view of the unique ICT Group.

The problem is that there is a lot of noise in these FY 17 numbers. During this period, PBT sold Prescient Financial Services (PFS) to Stellar Capital and then distributed the proceeds, it also got an agterskot for PFS from Stellar Capital, it then impaired its goodwill, wrote off bad debt, and saw tax changes negatively impact on its Middle-East/Africa (MEA) business…

This all results in chaotic IFRS numbers, but not much of this is actually all that relevant for understanding how the operation (and, hence, the business’s fair value) is doing.

First, let me touch on the bad part of the business: MEA. In short, tax changes (thanks SARS!) have made a large portion of this segment’s pan-African and Middle Eastern operations unprofitable or, at best, seriously dented its profitability (Withholding Tax knock of R16.86m during the period) while a bad debt was written off (R18.4m loss; total debtors of less than R1m have been written off over the lifetime of the Group, so this is unusual).

These all combined to trigger an effective impairment of the Group’s goodwill on its balance sheet of R31.6m.

[Interesting side note: The impairment was done after management and auditors built a fair value for the entire Group. That fair value resulted in the balance sheet being written down to this value and the difference being taken out of goodwill as an impairment. In other words, management have actually valued the Group/businesses/share for us, and that value is Net Asset Value (NAV) of 34.6cps versus the stock’s current price of 20cps.

Management’s assumptions include Cost of Equity (CoE) of 17% (I use one of 20.5%), medium-term EBITDA growth of 8% y/y (I use 10%), and terminal EBITDA growth of 6% y/y (I use 8%). I.e. On a balance of things, not bad assumptions, but they definitely will have access to more accurate budgets than my forecasts…

I would not normally care about a service company’s NAV, but this is a rare case where management have pretty much put out into the public domain their view of fair value. I think this hint would be worth at least considering, given where it comes from…]

Anyway, PBT Group is evaluating its options in MEA, but I have conservatively decided to wind these operations down to zero over three years (linear). This may or may not come to pass, but we will see. Still, at worst, MEA will be break-even next year (management guidance), so this segment can be considered to have nil value for now.

Now, secondly, moving onto the two major (well-performing!) segments: South Africa and Australia.

South Africa’s revenue grew +18% y/y while Profit Before Tax was flat. The former was as further clients keep getting added to the Group’s scarce and in-demand services, while the latter is due to some of MEA and Australia’s costs being absorbed into this segment. Expect a much better bottom-line in FY 18E from this segment.

Australia saw flat revenue, but profits rose over +38% y/y. Like I noted above, these profits do exclude some costs that SA absorbed, but a key takeaway is that this business continues growing and de-risking (it has added a new, potentially large client to its business).

So, when you put all this chaos together and take out all (of what I consider) once-off’s and non-operational items, I arrive at a FY 17 “Core” HEPS of 1.9cps. This is quite a guestimate, but it is interestingly close to my forecasts (in the prior article) of 2.0cps.

Finally, before I go into valuation, it is worth noting that PBT has R92.3m worth of agterskot (of which is R26m is cash) from Stellar. This translates into a once-off (free) capital injection of 5.7cps.

Therefore, if we exclude this capital injection, PBT Group’s share price of 20cps means that the market is valuing the operations of the Group at 14.3cps. Thus, on a 1.9cps Core HEPS (see above), this implies that the share is trading on a “clean” Price Earnings (PE) of 7.5x. This is reasonably cheap versus the slightly-smaller, more-niche ISA Holdings (ISA) that trades on an 8.9x PE.

In fact, if one only uses ISA’s PE as a benchmark, this implies that PBT Group’s share is worth c.23cps.

I’ve previously touched on some of my assumptions for my Discounted Free Cash Flow (DCF) valuation of the Group. Using these and a couple more assumptions (Working Capital = 30% of revenue, etc), my fair value comes out at 23cps.

Jumping to a Sum-of-the-Parts (SOTP) model, I arrive at a fair value of 21cps and 27cps respectively using a PE and Price-to-Book (P/B) approach. The latter I would normally never use for service companies, except that PBT Group’s balance sheet has only just been fair valued.

Blending all these valuations together, I arrive at a conclusion that the stock is worth about 24cps (or +20% higher than its current share price). But, don’t forget that management appear to think that their Group is worth at least 34.6cps. Thus, I do think that my valuation is conservative and risks upside from here.

Personally, I like buying cheap stocks that risk upside beyond what I am budgeting for!

Either way, PBT Group is a stock I like and I continue to hold it in AWSM Fund.

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