Ellies was established in the late 1970’s and is one of the largest manufacturers, wholesalers and distributors in Southern Africa of television reception-related electronic products such as satellite and aerial products as well as domestic electronic and industrial audio products.  It is also a leading importer of all associated products.

Approximately 55% of the revenue of the group is derived from the manufacture, import and distribution of premium quality TV and video equipment-related products under the "Ellies" brand. Approximately 45% of the revenue of the group is derived from the manufacture, import and distribution of premium quality satellite and associated equipment under the "Elsat" brand.

These percentages are all before the post-listing acquisitions of the power generator business, Megatron, and the lighting company, Reeflite.  See my article on Ellies’ recent acquisitions here.

With the leading position in the distribution of TV aerials and installation equipment in South Africa Ellies is ideally situated to capitalise on the very increasing demand for these products.  Just a simple test I did was I walking down my road…and I was very impressed to see that every single aerial I could see on each house was an “Elsat” one.  This simple test proves two things: first and most obvious is that Elsat is an incredibly strong and valuable brand, and secondly the TV is actually a “necessity”, i.e. for each house there must be at least one aerial.  After all, how many people that can afford a house cannot afford to install TV in it…?  With the expanding number of houses in South Africa after the construction boom Ellies is set to grow.

In Ellies’ prospectus they site the most significant risk facing the group is that competitors may try to increase their market share by importing cheaper equipment of lower quality from Asia.  According to the company there has been no indication of any significant inroads as regards the products being manufactured and distributed by the group and that the risk is largely mitigated by the high quality of its products.  After the above test on my road I must say I tend to agree with Ellies that there is little risk, but I am no judge of quality…rather I would rely on the strong brand names of the group to ward off the competition.

Looking again at the power generators I found it very interesting how in an interview with the CEO, Wayne Samson, he mentioned how he over the next few years generators could contribute over a third to Ellies’ bottom line.  With Eskom in tatters and a general perception that the electricity crisis will continue for the next five to eight years I really see Ellies’ investment in power generators (that range from one for a couple thousand rand to half a million rand) as very promising from both a short-term and long-term perspective.

Before I go any further I must say here how I really like the Wayne Samson, the CEO.  He worked his way up from an assistant in dispatch to CEO of the whole Group with the philosophy that “…there’s no success without hard work…”.  This humble beginning and fierce loyalty to the company means that he has both an invaluable insight and understanding of how Ellies runs from bottom up and that this extremely useful knowledge will not soon be lost.  In an interview he even went so far as to say that “…I bleed Ellies…”

For these reasons I hold Wayne Samson in the highest regard.

What is even better about the Ellies’ Board is that along with Mr Samson the original founder, Elliot Salkow, still holds a position and so can contribute his substantial knowledge and experience.

Broadcasting is entering the digital age with digital terrestrial on the aerial side to be one of the large contributors of organic growth to Ellies.  Ellies has a strong relationship with MultiChoice, who is becoming more aggressive with their marketing drive.  At the same time the digital push should lead to a large number of reinstalls of aerial and, as the pioneer of prepaid installation vouchers, Ellies is perfectly positioned to benefit from this market move.

On the Elsat side of things the ElSat Rentals is one of the group’s fastest growing focus areas and facilitates the rental of TV reception equipment.  This provides invaluable annuity income to the business that can be utilised to grow the other divisions.  Another fast growing division is the Ellies Corporate Services that offers the group’s services to the corporate market from design to project management and installation to conclusion.  Customers of this division include Protea Hotels, Sun International, Netcare, Bedford Shopping Centre, Coega, and Famous Brands.

The only problem I have with Ellies exposure to the TV market is how much the online world is growing in South Africa.  Time is the consumer’s most valuable asset and time spent online (which is growing) cannot be spent watching TV…albeit as the expanding middle class begin to buy into the home entertainment industry Ellies will no doubt benefit.

Another obvious opportunity in the TV market for Ellies is the 2010 World Cup and the related package TV/entertainment deals that will be encouraging demand just like they did during the recent Rugby World Cup.  The Rugby World Cup effect was noted in their recently released interims as “…trading…was driven by increased demand in the retail and DIY sectors and Rugby World Cup promotions.”

Looking at the interim results Ellies actually beat its own forecasts Net Profit by 12.8% to bring in EPS of 7.26c for the four months ending 31 August 2007.

Revenue was up 7% while profit from Operations expanded 13.7% due to lower administration costs.

Gearing is very low with D:E of 0.46 and current and quick ratio’s of 1.73 and 1.12 respectively.  Stock Turnover is nicely up from 3.37 in the pro-forma historical results to the present 4.12 while Debtors Days is down slightly to 57 days from 50 days.

In the interim’s I found it very interesting that the board had the following to say: “The board does not expect that any general economic slowdown will diminish the group's prospects”.  Unfortunately the present economic environment is not as bullish as it was a year ago, so this statement might actually end up being very important.  On a similar note Ellies’ sales is hardly effected by the National Credit Act due to the cash nature of their transactions.

Overall I felt that they were a very strong set of interim results.

Looking forward Ellies forecasts growth of 28.47% for 2008 and 23.19% for 2009.  This is very interesting, because calculating the Price Earnings Growth (PEG) ratio with this future growth rate of around 25.8% and its PE of 8.87 produces a very temptingly low 0.34 ratio.  The PEG ratio shows how much you are paying for one unit of growth.  In other words, anything below “1” means you could be getting a bargain.  A 0.34 ratio means that you probably are getting a bargain.

The forecast EPS for the 12 months ended 30 April 2008 come in at 20.44c, but these figures don’t take into account the recent acquisitions.  Most notable of these is the Megatron acquisition with its positive exposure to Eskoms failings.

Although no pro-forma results have been put out there from these acquisitions I am confident that they will be profit enhancing.  With power generators in short supply in South Africa and Ellies organically out-performing its own interim forecasts I think it is reasonable to estimate that final EPS for 2008 could come in around 15% higher than forecast: 23.51c.

Ellies’ current PE is only 8.87, while its growth rate is in the 20%’s…so, taking into account the risks facing the newly listed company I still feel that the PE should at least be approaching the growth rate (i.e. bringing the PEG in line with “1”).

Say, given a 40% discount to the growth rate Ellies should be trading at a PE of 15 (=25 x 60%).

Thus with my forecast EPS of 23.51c Ellies could well be trading as high as 353c within a year.  Ignoring my implied PE ratio and using Ellies current PE (rounded up for growing market confidence) the share’s low-side forecast is 212c (= 9 x 23.51c).  Given this range, the strength of Ellies brands and management, and the recent acquisitions I feel more inclined to forecast a one year share price nearer to the high-side of 353c.

Due to this forecast and my overall perception of Ellies as a strong long-term investment I have decided to recommend it as a SmallCaps.co.za buy.

Kind regards,

Keith McLachlan

Independence: No, I do not own ELI shares.

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