AVI is a pure consumer play. It includes brands like Pyotts and Bakers biscuits, Coty and Yardley cosmetics, I&J fish, and Five Roses and Frisco tea and coffee, all of which are aimed squarely at the South African mass market. Thus, the outlook for AVI should be a little troubling as interest rates are rising and consumer spending is slowing, with retail, car, and home sales all showing signs of struggling. This is likely the reason why AVI’s share price has stagnated even as management has delivered impressive growth, strong shareholder equity returns, and consistent profit. But, according to Sanlam Private Investments’ Olof Bergh, the share is probably undervalued. He says AVI has fantastic management, pays good dividends, invests capital with unusual acuity, and has a great long-term story, even if the next few years might be tricky. Perhaps one for the value investor? – FD
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ALEC HOGG: AVI is home to many of South Africa’s leading brands. It’s posted positive first half results and the company said it expects current constrained consumer demand to persist and possibly worsen if interest rates in this country keep rising. As you know, we’ve recently had a half of a percentage point improvement. Joining us for more now from Cape Town, is Olof Bergh who is an analyst at Sanlam Private Investments. Olof, before we go into the numbers, we had a fascinating chat a little earlier with Sasha Naryskine and between the two of us we came to the conclusion that of all the takeover opportunities that looked juicy, this one – AVI – has to be standing out among them. Do you think we’re on the right track there?
OLOF BERGH: Hi Alec. Well, it’s not cheap by any historic measures. As far as takeovers are concerned, you generally want to take over a company when it’s trading at whatever valuation you look at, but when it’s cheap relative to history and cheap relative to the fundamentals. It has certainly done much good in terms of improving its return on equity and in terms of generating earnings. It’s had a fantastic performance from its fashion brands business, which has underpinned that strong earnings growth. From a PE perspective, it doesn’t look expensive, so I guess my answer is yes and no. There have been better times to take out AVI, but it’s certainly not a bad option at the moment, particular since it’s in the mid cap range. It’s not quite as big as Tiger Brands or Pioneer Foods, but it’s not an absolute small cap. It adds enough critical mass to be considered as a viable takeover opportunity for those bigger players. Of course, from an international perspective, the international players might see it as an entry into the faster-growing emerging markets, which has been a big player and has been one of the fundamental reasons why the industry as a whole has experienced this rerating over the last five years.
ALEC HOGG: That’s what I’m getting at: that trend which was shown by a little business from Chile (CFR), who came to South Africa and saw a business in that ten to twenty billion Rand range. The Rand has fallen still further. It now becomes a more available prospect for those guys who have been doing their analysis on the African century – as we hope it’s going to be – and certainly on the short-term growth prospects in Africa. You might have thought somewhere in the world, there would be a CFR who would be looking at maybe AVI as a juicy proposition. Given that the rating is not cheap, do you think that’s worked into the share price?
OLOF BERGH: Alec, we don’t quite think so yet. AVI, only six months ago, was trading at R60.00. It’s currently trading on R51.00. It’s being sold off a little bit as the concerns around the consumer and the affect it will have on their sales, has affected the share. As we know, the shares, primarily of the foods business – more or less 60 percent of the foods and beverage business, and then about 40 percent of the operating profits – are generated by the so-called fashion brands business. In line with the clothing retailers, it has been sold down a bit. For us, the value lies closer to R60.00. Our intrinsic value is R62.00, so even though – as I mentioned earlier – from a historic perspective it doesn’t look expensive, we love what management is doing. They seem to be great allocators of capital. So far, under the reign of the current management, ROE’s have been ever increasing to very respectable levels of just under 30 percent now, so we think the value is higher than what it currently is. Maybe to answer you from that perspective, we don’t think it would be a bad thing for a company to consider taking AVI over, because we think the value of the company is higher than what it’s currently trading at in the market even though it’s not overly cheap.
ALEC HOGG: They have some wonderful brands in there. I&J did come back in this year, but still a relatively small contributor of profits. Maybe we can stick with that for a while. Is this a reflection of our seas becoming less easy to harvest or is it something internal?
OLOF BERGH: Alec, would you just repeat the question? I didn’t quite get you.
ALEC HOGG: I&J – the fisheries business: it’s up a bit in this past period, but making around 75 million is a long way from its potential and I was just wondering why or what it would take for it to reach that full potential.
OLOF BERGH: I&J has historically been a very cyclical business. As catch rates differ, as weather differs, as the exchange rate fluctuates etcetera, so earnings are influenced. Certainly, this is probably a return to normality…probably just below normal. We know from a percentage perspective, it was a great jump over the first half of the prior corresponding period. Nevertheless, as you mentioned it probably has a bit more upside. It’s difficult going at the moment. The fishing environment has improved, so the catch rates were higher compared to a year before and the exchange rate was more beneficial in that the Rand was weaker, so for an exporter like I&J there’s a benefit to be had. However, from a normalised perspective we expect a little more. Our margins are probably four or five percent higher from a normalised perspective, off a margin now of about nine percent for I&J.
ALEC HOGG: So if you’re a shareholder in AVI, what’s going to keep you there?
OLOF BERGH: What I really like about I&J is their ability to increasingly and incrementally add to their business in a manner, which enhances returns. They’ve been a fantastic dividend payer. At the last financial year-end, they reduced the dividend cover from one-point-five to one-point-two five times so essentially, they’re paying out almost their earnings in dividends. Yet, that which they’re utilising they’re utilising so well that they’re enhancing the returns on shareholder funds. That is a recipe to grow the business in that when you get higher returns, you have to supply less capital to grow the business at a faster rate. In addition, in terms of the core business, they’re not overly exposed to the highly commoditised milling and baking business, which, in my mind, is set to come under increasing pressure from both imports as well as in-house brands and the like. Bear in mind that they are currently at very profitable levels – the milling and baking businesses – so there’s lots of scope for competition and still, to remain at reasonable returns. Fortunately, for them, they’re not exposed to that. They operate in more niche spaces in the beverage categories. Their Snackworks business is doing very well, even in this constrained environment and specifically with regard to their fashion brands business. We’ve seen it in other developing countries that when a country moves from a low LSM to a high LSM average, some of the industries that fare the best are this ‘beauty and personal care element’ where people like to incrementally spend their discretionary income. In that regard, they’re well placed to benefit from an uptake in Africa’s LSM migration. The fashion…their foot care and apparel business is still small, so whilst the consumer is under pressure at the moment and they’re feeling the effects of that with not much growth within that division, they still have scope to grow, relative to the bigger players, for example Truworths and Foschini. We therefore see structural growth from the footwear and apparel business, good export growth from the personal care business, and we think that the niche businesses within the food category will continue to do well for AVI.
ALEC HOGG: That was Olof Bergh, an analyst at Sanlam Private Investments.
