Rolfes: Looking for(ward to) Good Numbers

The Zupta’s have plunged the JSE’s small and mid cap sector in a sell-off and driven our local economy into a recession. (Actually, I think it is a great buying opportunity, but that is just me…) These two factors are related, as smaller companies tend to have greater exposure to domestic macroeconomics trends than their bigger, more global peers.

But there are exceptions. In fact, tough economic times tend to prove certain business models better and reveal certain management teams more resilient than others. This is a great time to be invested in quality.

I hold and believe that Rolfes Technology Holdings (RLF) is one of these high quality opportunities. I have written previously about the Group, so refer to these article for background:

With this background out the way, how is Rolfes doing?

Well, Rolfes share price is -26% QTD and c.-30% off highs of 600cps a couple months ago. The stock is currently trading on a 6.7x Price Earnings (PE). Sure, SA may be in a recession, but how does this affect Rolfes and its valuation?

Firstly, the narrative: Rolfes’ latest set of results (H1:17) saw great growth that was both acquisitive and organic. The Group both exports c.10% of its revenue and is growing its export of products across Africa, America, Europe and the Middle East. Finally, the Group earns about two-thirds of its revenue from the defensive Agricultural and Food industries. Even in recessions, rain falls, the sun shines, things grow and people need to eat and drink.

In other words, the Group is being well-run, positioned correctly and should weather this recession just fine.

Secondly, the numbers: I have done the following to adjust for both political risk in South Africa and recessionary pressures (we neither know length or depth of this recession):

  • I have hiked my Risk-free Rate (RR) from 9.0% to 9.5%. Theoretically, this RR should be pegged on the Government 10 year bond, which is currently trading at a yield of 8.545%. I think that yield is wrong, only temporarily being supported by foreign capital flows into our bond market and I am adding a premium into the rate to adjust for risk. Hence, the 9.5% RR as the basis for my CAPM that results in Rolfes’ Cost of Equity (CoE) of 17.8%.
  • I have then assumed that Rolfes’ debt costs the same as its equity. I.e. Capital becomes scarce and financing via risk capital is the only option. Put differently, I have assumed that Rolfes cannot refinance debt, the credit markets dry up in South Africa and Rolfes is forced to fund itself 100% with equity. Therefore, gaining zero benefits from financial leverage. Hence the CoE of 17.8% is the same as the Weighted Average Cost of Capital (WACC) of 17.8%. This is unrealistic, but a conservative approach of mine.

Below is the summarised results from my segmentally-driven DCF model for Rofles. These fair values are after I have tweaked the model for the above discounts:

Rolfes’ Sum-of-the-Parts

Fair Value

PE (x)

(1) Industrial Chemicals

R242 053 522

6.6x

(2) Agricultural Chemicals

R376 149 148

12.2x

(3) Water Chemicals

R68 811 625

9.8x

(4) Food Chemicals

R830 873 357

12.7x

(5) Group (Net Debt + Overheads)

-R380 556 765

1+2+3+4+5 = Fair Value of Group

R1,137,330,887

13.2x

Sources: Iress, Bloomberg, Rolfes and AlphaWealth workings

Forgive the format of the table, it looks better in Excel. But, the high value segments can be seen to be the defensive ones (12,2x and 12.7x are not unreasonable multiples for these businesses while Omnia is trading on a PE of 15.9x!).

Also interestingly, this SOTP of Rolfes only gives Industrial and Water/Mining Chemicals segments single digit PE’s while stripping out 10% costs for overheads at Group-level. Both these segment should actually do quite well once the business cycle turns (I know it feels bad now, but nothing lasts forever and that includes the situation SA finds itself in now).

What does this fair value translate into?

If I am correct with this valuation, Rolfes is worth 702cps at a 13.2x PE. Rolfes share price is trading at 424cps, so this implies that you will pretty much double your money over the next twelve months. Sure, there are risks, but that is quite a nice margin of safety.

But what will make Rolfes share price move? How will any of the negative investor notice it?

Simple: Good results.

I am expecting FY 17E results out in the next two or three months (after a likely operational and trading update, out any day now) that shows HEPS growing c.35% y/y to 71.6cps. Then FY 18E HEPS can continue growing c.14% y/y to 816.6cps…

Look for the good numbers and you will find Rolfes’ upside therein.

In conclusion, South Africa is not doing well, but hidden within this pervasive pessimism is the opportunity that is Rolfes Technology Holdings. While I am expecting to double my money on Rolfes, if I am even half right here, this stock is going to be a winner.

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