SIM’s Vanessa van Vuuren: “Tsogo Sun is still a buy”

Tsogo Sun came out with middling H1 2014 results last week in the face of some bracing and unseen headwinds. Vanessa van Vuuren, portolio manager of the SIM Small Cap Fund explains to us why this may just be a squiggle in a pretty decent road and that CEO Marcel von Aulock needs to be commended on steadfast focus in a solid business. – CP


CANDICE PAINE: Hi, this is Candice Paine from Biznews. I’m interviewing Vanessa van Vuuren today, who is the Portfolio Manager of the SIM Small Cap Fund. We’re going to be covering Tsogo’s Sun’s results, which came out last week. Vanessa has been a very positive advocate of the stock for a while. Vanessa, tell us a little bit about your thinking around the results that came out.

VANESSA VAN VUUREN: Good morning, Candice. I think the results were probably received in a bit of a mixed way by the market if we look at what happened with the share price performance. When the results came out, the price dropped quite aggressively after a period where the price had moved up quite a bit and there’d been quite a lot of positive sentiment on the stock. What we’re clearly seeing is a bit of concern about what’s happening in the company. With flat earnings coming out, the market’s obviously disappointed. If we just unpack it a little bit further, many of the factors that have caused that flat earnings performance are out of management’s control. If you consider that the gaming environment has been particularly weak, with gaming being 60 – 70% of their turnover, they only saw gaming growth of 2% in their portfolio.

The areas that they operate in have been very muted, except for the Western Cape where we’ve seen a bit of an uptick in gaming stats. That’s the one big contributor and that’s really, just a function of the macroeconomic environment – consumers under a lot of pressure. On the hotel side, we’ve seen a bit of a slowdown in the hotel cycle in South Africa. In the prior few years, you saw quite a big recovery in hotel occupancies and we’ve seen quite a slowdown this year and we’ve seen that in City Lodge’s results as well. They’ve had a similar experience in South Africa. Their occupancies have largely, been flat.

CANDICE PAINE: Why is that with tourism on the increase in the South African context?

VANESSA VAN VUUREN: Yes, it’s interesting. It’s because they are more of a domestic and a Government play in terms of tourism so they would look at domestic corporate travel and Government travel (being their major clients), and then they would have a little bit of tourism exposure but it’s a lot smaller for them. They did indicate that in these results, Government travel materially dropped and that’s a big contributor for them, because they take very big groupings on behalf of state owned enterprises, etcetera. If that drops off, it has an impact on them, and so they saw that in these results. In addition, on the African hotel portfolio, we know what’s happening with Ebola and they’ve obviously seen a massive drop in occupancies in the regions they operate in, in Africa. If you just put all of that together, those factors have caused this performance in the business.

Having said all of that though, I think it’s very much a cyclical short-term phenomenon and you can see the confidence that the management are showing by continuing to invest in their business, that this is not the permanent status quo of the business.

CANDICE PAINE: Okay. Let’s talk a little bit around that ‘investing into the business’… They’ve had to bed down a couple of acquisitions recently. A major shareholder (SAB) exited and they would have had to buy back their shares. What impact has that had on the results as well?

VANESSA VAN VUUREN: We haven’t yet seen the full impact of… It’s actually a negative impact in the short-term because what’s happened is they’ve had to raise debt to fund buying back their shares. It was a chunky amount. It was just over R2bn. The impact of the reduced shares in issue hasn’t come through yet. We’ll see that impact in the full year but on the full year, it will be a very positive impact because basically, you’re reducing the shares in issue by around 12 percent, so that’s very positive.

CANDICE PAINE: Okay. Let’s talk a little bit around the Silverstar Casino that they just finished in Krugersdorp. They’ve actually had a lot of refurbishing in many of their hotels through this period as well, which I presume drew down on earnings.

VANESSA VAN VUUREN: Exactly, and this is one of the things that I really like about this Tsogo investment case, is that they don’t make decisions based on the short-term. They are making five to ten-year decisions as a management team, and they have very good capital allocators. They’ve looked at their portfolio and they’ve seen where we can extract additional gain, where there’s capacity to put new casinos in or upgrade the casinos and they continue to invest through the cycle. Gold Reef City’s undergoing a large investment. Silverstar is now complete. Sun Coast is another big one, which is potentially going to double those casinos. That’s in the KwaZulu Natal region, which is quite a high growth gaming area. You can just see how the management is thinking about their business.

They’re not making decisions because they’ve had one-half of difficult gaming when they’re actually making longer-term decisions and it’s a very positive attribute of the management team.

CANDICE PAINE: And the casinos obviously contribute quite a large amount to the earnings. Are we at capacity yet, from a South African perspective, in the casino market? How much more space is there for growth?

VANESSA VAN VUUREN: It’s a difficult question to answer because what you’re seeing is that there haven’t been any new licenses issued in South Africa for many years, and so it’s a very captive market. You have the licenses out there in the industry, dominated by Tsogo and Sun International and then the smaller players like Peermont. What you’re seeing is that there has been a limitation. The growth has slowed down as the consumer has come under a lot of pressure. We had a very strong growth in gaming in the previous decade. Having said that, since you haven’t had a lot of capacity coming on, there must be some pent up demand…that as soon as the economy improves, people feel wealthy, and there are better consumer disposable income levels, you should see the gearing of the current casinos to that.

Hopefully, at that point, you could see capacity additions with the gaming boards awarding additional positions. You probably won’t see new licenses being awarded very easily, so that’s probably capped out but new positions within particular regions could be inherent growth for the casinos.

CANDICE PAINE: Vanessa, your outlook for the stock: are you a buyer or a seller?

VANESSA VAN VUUREN: I’m definitely a buyer of the stock. I don’t look at an investment case because of its six-month earnings. I take a longer-term view of the share. I believe that management will do all the right things, despite the difficulty in the current trading environment, to secure long-term, better operating leverage to an improvement in the economy. As you see, the gaming spend tick up…they’re highly levered to that, so you will see a nice result coming through in the future as soon as the actual gaming spend picks up and the hotel cycle style continues to improve. I’m very positive on the share. I think it’s trading on reasonable metrics and as these expansions come through – Sun Coast, Silverstar, Gold Reef City, and Montecasino (due for another upgrade), there will be a lot of further momentum within the existing portfolio. I’m very positive.

CANDICE PAINE: So is it safe to say that currently, Tsogo Sun has just been hit by unforeseen headwinds and that regrouping from management and going forward, you still see value in the stock?

VANESSA VAN VUUREN: That would, pretty much, some up my view. I would say definitely, short-term headwinds beyond management control. I think there’s still value in the stock. I don’t think it’s ridiculously expensive and I still think there are very decent organic growth prospects in the stock without them needing to go and acquire offshore or any activities like that. Just within the South African markets, they have great prospects.

CANDICE PAINE: Vanessa, thanks so much for your time.

VANESSA VAN VUUREN: It was a pleasure.

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