Previously RBA would not own the land upon which the houses it sold stood, but it has begun to purchase these properties in order to increase margins.  At the same time—and in response to increasing interest rates—RBA has begun to lease out some of its houses…this latter development actually fundamentally changes the company from a pure property development company in a hybrid that includes normal property stock characteristics.

Put differently, due to this divergence from its historical business model I feel that RBA effectively becomes a half-way house between a construction stock (the construction and outsourcing segment of the business) and a property company (the underlying land ownership and exposure to interest rates).

This is in some ways similar to Acc-Ross, but targeting different markets: while ACC aims for the high-end leisure market, RBA aims at the entry level middle and lower class segments…but not so low as to need government assistance.

I feel that due to the increasing interest rates and market-wide sense of US recession we could be starting to see the beginnings of the local construction boom cooling off.  The affects of this are evident in the strategic decision by RBA to begin leasing…a move that it has never done before since its formation in 1997.

As RBA sells fully bonded homes (with no government grants or outside support) its relationships with the banks are extremely valuable to it…valuable enough to make the top of my list of their competitive advantages.  Added to this is the company’s relationship with land and infrastructure developers that allows it entry into the property market at ground level (excuse the pun).

Looking through its prospectus RBA states that it has “…young and dynamic management team…and experienced staff…”

Does this sound like an oxymoron to you?

So are the people that make up RBA young or experienced…?

Looking at the credentials of the management team it is worrying how the CEO does not come from the property industry; rather he hails from Anglo American where was a senior metallurgist for two year before leaving and heading up RBA Developments (one of the companies in RBA’s stable).  Of the six directors on the executive team none of them are over 40 years of age…and only two of them are not taking home over R1million…

I guess this is the “young” part of the prospectus…but where is that experienced part?

What is commendable is that this young management owns a significant part of RBA’s shares and many of them were the original founders.  Both of these are important for the aligning of management interests to those of the shareholders.

Now looking at the interim results for the six months up to June 2007 shows a 100% increase in attributable earnings, but cash generated from operations was down around 50%.  D:E was sitting at a rather high 0.64, but countered with healthy Current and Quick Ratio’s of 1.52 each.  There is a healthy interest cover and the company appears to be in a relatively safe position…despite the high D:E (obviously leveraged off its property portfolio).

EPS include a fair value adjustment for the properties, so HEPS feels more meaningful and it came in at 5.45c per share.  HEPS is forecast to be around 12c for the full year to 31 December.

The directors feel confident that they will achieve these forecast HEPS…but the recent move to begin leasing its investments is worrying and, perhaps, smells of a little desperation in a softer property market than a year ago.

Still, given the lack of trading updates (positive or negative) RBA should come close to its forecasts…for the 2007 year at least.

Looking at the company’s underlying value is complicated due to its lack of listed history, is now hybrid business model, and the softness in the South African property market caused by high interest rates.  Thus, I have decided to take an interesting “backdoor” approach to valuing the company:

Asset classes should offer potential return comparable to their intrinsic risk: the lowest risk asset, cash, offers the lowest return and the return increases all the way up to the riskiest asset class.

In the absence of dividends a company’s “implied return” is actually its Earnings Yield (the lesser used cousin of the Price Earnings), as this is the % profit that the company produced on its market price…almost like interest earned on a bond’s market price produces its yield.

At present the JSE Listed Property Index has an EY of around 5.47% that implies that the market feels it is safer than the AllShare (which has an EY of 6.89%).  If RBA makes its forecasts then it will have a forward EY of around 15% (=12c/80c)…which is significantly higher than Property Index’s return.

Is RBA a bargain or is the market factoring in a justified significant risk premium…?

Although I am not a property market expert—and do not profess to be—I feel the following factors are significant in my decision:

• South Africa has a significant housing backlog and the long-term economic growth to fuel private purchases of homes by entry-level middle class
• Although RBA’s management do not appear to be very experienced and a little over-paid…that do have a significant stake in their own business which breeds motivation to achieve and aligns their interests to those of minorities.  Add to this all their recent buying of RBA shares on the market and you get a very strong picture of insider confidence that is reassuring given the drop in the share price.
• RBA’s forward EY appears offer value even in an interest rate rising environment and the introduction of leasing could well produce the short-term benefits that allow the company to achieve its long-term goals and forecasts.  Given a forward EY of double the Property Index’s historical EY values the company at around 109c within a few months…which is nicely above its present price of 80c.

Overall, I feel that RBA does offer an interesting long-term entry into the property market for more risk-inclined small cap investors and it earns itself a SmallCaps.co.za buy recommendation with an eye toward our local rates dropping within one or two years.

Kind regards,

Keith McLachlan

Indepedence: No, I do not own any RBA shares

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