The world is changing fast and to keep up you need local knowledge with global context.
By Charl Botha*
Caxton is a JSE-listed publishing, printing and packaging company. It’s been listed on the JSE since 1949, and as of today – 21 February 2022 – Caxton shares are trading at R9.20 a share. If you had the money and were so inclined, you could have all of it for about R3.4bn. The question is: is it worth it? Is Caxton worth R3.4bn or R9.20 a share? I believe so, and will try to show why in what follows.
As you will see, Caxton is a business with quite a number of moving parts. I thought it best to unpack the business under three headings: what does it own; what does it earn; and is it worth it? But before we miss the forest for the trees, here is my Caxton elevator pitch.
Caxton is not a growth company. In fact, it’s a no-growth company and, in parts of the business, even a growing-in-the-wrong-direction sort of company. This is not good. If a company cannot sustainably grow its revenues – which is the major challenge Caxton faces – it cannot sustainably grow its profits. And if it cannot sustainably grow its profits, it cannot sustainably grow its share price.
On the other hand, Caxton is a particularly well-run company. These guys know how to print, publish and package … very efficiently. In the accounting profit equation, where profits are equal to revenue minus costs, they may be struggling on the revenue side, but its management is a master of cost control. The most miserly would look positively wasteful by comparison. So, despite (recent) declining revenues, it has been able to cut costs at a rate matching the decline in revenue. The result: even with lower revenues, the company’s profits have remained largely unchanged, excluding once-offs.
Finally, this company has a better balance sheet than a money market fund. It’s as far from insolvency as a lifeboat is from sinking in the Dead Sea. But, this is not an unadulterated positive.
What does it own?
As noted, Caxton is involved in the publishing, printing and packaging business, largely in South Africa. In (physical) publishing, the company owns several local newspapers including The Citizen in Johannesburg. In (digital) publishing, it owns or is part owner of a number of digital assets, including afristay.com, safari.com, and privateproperty.com, the second most frequented property website in South Africa. They also have a textbook publishing operation. In printing, it is active in everything from beer bottle labels to magazine inserts.
Finally, in packaging, Caxton is directly – and indirectly – involved in the making and selling of a wide variety of products. Directly, in the manufacture and sales of everything from cigarette cartons to box wine and indirectly, through its 31.6% stake in Mpact, the largest packaging company in South Africa.
Apart from its operating assets, the company holds investment stakes in several other businesses. By far, the most important is its 31.6% stake in Mpact. At the current Mpact share price – it’s also JSE-listed – this investment is worth about R1.47bn or close to half the R3.4bn value the market is assigning to Caxton as a whole. However, in the unlikely event these Mpact shares are sold, in the short term at least, the tax man would require a not insubstantial R150m pound of flesh. Still, whether it’s R1.47bn before tax, or R1.3bn after, Mpact is material in the greater Caxton scheme of things and crucial to its valuation.
As noted, a possible tax bill could reduce the value of the Mpact stake by about R150m as of today. But the investment could also be worth significantly less than its current R1.47bn – or R32 a share – because Mr Market may be too taken with it at present. Maybe. Having a proper go at valuing Mpact here would require another 2,000 words of its own; a bridge you will be glad to hear that I won’t cross here. It cannot be ignored, so here is a back-of-the-envelope 100 words on Mpact’s possible lower bound values. I ignore the upper bound because if I miss the mark, I want to miss low, not high.
My assumptions: The market isn’t always right, but it’s unlikely it will be very wrong for a decade or more. Hence, I will apply the lowest P/E the market has afforded Mpact during the last decade to its most recent headline results. That should provide a reasonably conservative valuation estimate. On such an accounting, the value of Caxton’s Mpact stake reduces to R772m or almost exactly half its current indicative value.
What does it earn?
Caxton earned revenue of roughly R6.4bn in each of 2017, 2018 and 2019. In 2020, the company’s sales were about a billion less than the year before – a decline of 12% – for a June year-end total of about R5.5bn. The reason for the 2020 versus 2019 sales decline? Covid-19. The revenue number for the most recent financial year – July 2020 to June 2021 – was just over R5.2bn, 6% down on the R5.5bn 2020 total. However, it should be noted that the company closed down an operation during the 2021 financial year that generated R460m in the 2020 financial year; thus, the most recent 2020 to 2021 revenue decline of 6% is somewhat cosmetic.
Whichever way you cut it, Caxton is not a growth company, even with the help of inflation. For example, if the company’s sales kept up with inflation – SA’s consumer price inflation averaged just over 4.3% for the period – its revenues would have been almost R6.7bn in 2017, just under R7bn in 2018, and just over R7.2bn in 2019, or 17% more than the level of revenues it actually earned in 2019. Simply put, during the most recent five-year period, ignoring Covid-19, Caxton’s sales were going nowhere slowly with inflation and backwards without it. With Covid-19, the picture the numbers paint is even less pretty. Yet, as we shall see, there is a silver lining.
Gross profits and cost of sales
Gross profits are the difference between revenue and costs of sales; the difference between the quantity and price at which goods are sold, and the costs incurred to make and get them ready for sale (such as raw material costs, manufacturing costs). And Caxton’s have been declining for five years … why?
Because Caxton didn’t pass on the costs required to make what they sell to their clients. It likely didn’t do so because it couldn’t. And it likely couldn’t because what it sells – cigarette cartons, beer bottle labels, box wine packaging – can be made by almost anyone, which means that if it raised prices and its competitors didn’t, its sales performance would likely have been worse than it turned out to be. Such are the economics of a commodity industry.
Operating profits and operating expenses
Operating profit is what is left after operating expenses are subtracted from gross profits. And operating expenses are all those that are required to keep the company going – salaries, rent, advertising – hence the name ‘operating’ expenses. It is here where management can shine and where Caxton management has shone. The evidence: gross profits may have declined by 34% from 2017 to 2021, but operating costs declined by almost 50%.
This is remarkable since several significant operating costs, like rent, would have been fixed, which would typically (everything else been equal) have led to an increase in operating expenses, never mind the actual decrease achieved. But everything else wasn’t equal. For example, Caxton management cut or froze salaries across the board, consolidated production, instituted flexihours, shuttered non-performing assets, reduced raw material wastage and, unfortunately, let go of about 36% of the workforce.
The result: Caxton has managed to generate an operating profit in each of the most recent five years, despite a much-reduced revenue base. Even more impressive is that it managed to do so despite a cost structure – many fixed costs – in which it is typically no easy feat to turn a declining top-line into a positive bottom one.
Is it worth it?
The fundamental value of a company depends on three things: future cash flows, cost of capital, and the returns it’s expected to generate on that capital. Getting the formula right is simple, populating it with reasonable inputs is something else entirely.
Caxton’s cash flow expectations
Caxton is not growing at a revenue level and is unlikely to do so in the near term, at least not organically. Moreover, there is just so much cost-cutting even the best management team can do before it becomes economically unhealthy. To paraphrase the well-known saying somewhat: ‘You need to spend (some) money to make money’. The bottom line: I think Caxton will be lucky to grow revenues at the rate of inflation; zero to two percent is my best guess.
Caxton’s return on capital and its cost
There is a very good reason why Caxton is trading at a discount of almost 50% to its book value of R16.50 a share. It’s not earning enough on its assets to cover their cost, both on its operating and investment capital. Take the operating assets first:
In 2021, Caxton earned R374m in net operating profit on R3.62bn in operating assets for a return on assets or capital of 10%. The five-year average return was 8.4%. Would you spend R3.62bn on printers, publishing houses, and travel websites to make just 10%? And a 10% that is above the medium-term average in a cyclical industry in a pedestrian economy. I wouldn’t … and I suspect you wouldn’t either. If I had the money, I wouldn’t write a cheque or scan a QR code for R3.62bn on these kinds of assets unless I could reasonably expect to make 20% per year on my investment.
Caxton’s assets’ going return is 10%. The required return is 20%. How is the circle to be squared? In one of three ways. One, the assets must start (sustainably) generating double the profits they did in the most recent year; the profits must rise from R374m to R748m. If the profits double on the same amount of assets or capital, the returns on those assets or capital will also double; Caxton’s 10% will turn into 20%. Only then should we see the price to book multiple track higher, and its share price start converging on its book value.
Or, secondly, the profits can stay the same, but the asset price must halve. If R374m on R3.62bn worth of assets is 10%, then R374m on half of R3.62bn is 20%.
Finally, the 20% required return can be met by any suitable combination of increasing the profits and decreasing the assets required to generate them. Given that Caxton’s market value in its entirety is R3.4bn, it’s clear the market is valuing the operating assets at much less than the R3.62bn it is measured at in the company’s accounts. In other words, the market thinks – as do I – that the operating assets are unlikely to generate a great deal more profits than what they currently do – hence the asset discount.
Caxton’s investment assets
As noted, Caxton holds a sizeable and valuable investment stake in Mpact; at current prices, R1.47bn worth. I also argued that this investment might be worth substantially less, especially if the market is too enamoured with Mpact’s near or medium-term prospects. I assigned a value of R772m to take account of the markets possible pricing error. It’s the number I will run with going forward.
Caxton also has almost R2bn in (net) cash … and that’s way too much. Given this amount of cash, insolvency and liquidity will never be an issue. Investors looking to invest in a publishing, printing and packaging business don’t want to see management put most of it in the bank. They can do that by themselves. Investors don’t want to earn bank returns in a share investment.
On the other hand, this mountain of cash affords management an outsized opportunity to take advantage of any price weakness in their industry or closely related ones. It’s a call option and it has significant value; just how much will depend on the likelihood management invests the money, how much of it invests and, naturally, where it invests it. For an example of what could happen if management decided to be a bit more adventurous with this capital, take the Mpact investment as an example.
Caxton management allocated R656m to a packaging (paper and plastic) business in the middle of Covid-19. The result, a 31.6% stake in Mpact, the largest packaging business in South Africa, worth R1.47bn at Mpact’s current share price. Almost a 100% return in less than two years. Naturally, the rate of return on the Mpact investment going forward will be a great deal less impressive, but I’m pretty confident that it will beat the bank in the medium to long term. Although, I’m not counting on it and neither am I certain that management will shortly withdraw some of the remaining R2bn for more risky application elsewhere. Naturally, a few more Mpact-like investments would be a welcome development, but if Caxton is a buy or hold, it must be so on the current facts, not on what they may be.
So, given all that has been said, what is Caxton worth? On my reckoning, at least R3.11bn or R8.38 per share; 9% less than the current R9.20 per share. It could be worth a lot more but in my opinion, not a lot less.
- Charl Botha CFA
- The author holds shares in Caxton
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