RECM: Assessing Ketso’s PPC departure, Mittal’s fight with the State

Yesterday afternoon's shock announcement that PPC chief executive Ketso Gordhan had left with immediate effect because of a dispute with the directorate caused a 7% drop in the share price. After another 1% loss this morning, are value investors keen to accumulate? Not yet, says RECM's Wilhelm Hertzog. But if the shares, now R30, fell to around R25, they'd become attractive. In this CNBC Africa Power Lunch interview today, Hertzog also offered updated views on the firm's favourite turnaround counters Anglo Platinum and Arcelor Mittal. – AH

ALEC HOGG: Wilhelm Hertzog is in our Cape Town Studio. He's with RECM. Wilhelm, the big story that came out late yesterday afternoon – resignation of Ketso Gordhan at PPC. We've had him in the studio a few times. He was certainly shaking up the executive remuneration approach. I know it's something that the guys at RECM would be fairly supportive of, and now he's gone. What is it telling us?

WILHELM HERTZOG: It took us by surprise as well, specifically in the context of Mr Gordhan having bought quite a lot of PPC shares in the not too distant past and having taking PPC into Africa. He really implemented a number of strategies and put into a place a number of things, which you'd expect to lay the groundwork for a longer-term future with the company. This is quite odd and it does point to a disagreement with the board. I guess we haven't really seen the details of what exactly the disagreements amounted to but obviously, there was something material in Mr Gordhan's view, which resulted in this outcome. It was quite a surprise and I guess, a bit disappointing. We do like to see executives committing themselves to the company in the way that Mr Gordhan has and it's probably a bit of a disappointment, I would say.

ALEC HOGG: Wilhelm, the share price dropped seven percent yesterday. It's down another one percent today. As a value investor, is this the kind of opportunity you look for?

WILHELM HERTZOG: Well, a seven percent drop is big in the context of one day, but it's not really that material if you look at the longer-term picture and what happens to share prices in longer-term timeframes. Sure, if you were seeing value in PPC two days ago then the current share price is a good bargain. Our clients don't own PPC shares, so we haven't been buying in the dip that we've been seeing yesterday and today. Nothing's changed our stance on that.

ALEC HOGG: Well, two years ago, it got to as low as R25 per share. That's not far from where we are now, at R29.80. If it were to come back to that level and you could buy it at 2011/2012 prices, would that start whetting your appetite?

WILHELM HERTZOG: Definitely. That definitely looks a bit more interesting to us. We have our fair value on the share, which I won't disclose right here, but we've been watching the stock carefully. It is a type of business, which lends itself to decent economics through a cycle. Cement is a capital-intensive business, but if you have access to a good limestone resource and your location of your plants and your facilities are favourable in relation to end markets then the transport costs serves as a good barrier to entry, to protect your local markets. It is a type of business, which we like to keep an eye on and certainly, if PPC comes to prices that we consider to be attractive and well below our fair value, we'll definitely pounce on the opportunity. However, as I've mentioned, that's not quite our assessment at this point in time.

ALEC HOGG: We did try to get hold of Bheki Sibiya, the new Executive Chairman of PPC – that means he's going to be running the company – as well as the CEO of course, the outgoing Ketso Gordhan who was pretty easy to talk to – usually. Neither of them are prepared to discuss it with us, but I'll leave you with a quote that came from Ketso, which said 'I'm leaving with a heavy heart'. That was on the Stock Exchange news service. Also with a heavy heart I guess, is Chris Griffiths. I was at a conference last week with Sanlam where he was one of the invited guests. He was talking about the decisions that are being implemented now at Anglo Platinum (one of the biggest stocks that you have in your portfolio), were actually taken eight years ago, to make the company more profitable and more socially acceptable. He thinks they've gone a long way down the road. How far down that road, do you think they are, Wilhelm?

WILHELM HERTZOG: I think the plans and decisions taken eight years ago were probably modified somewhat in the last year or two, given where the platinum price has been and given the labour situation. Sure, they are moving in the right direction. It is still some way to get to where they want to be. If you look at the disposal process, the process of cutting costs, optimising operations, and cutting labour from the operations: that is a long-term process. In the short-term timeframe of disposing of assets, that's probably some way down the road already, and I guess you'd see that being resolved in the next year or two, at the most. The long-term process of increasing mechanising operation is another very long-term process to pursue (or a path to embark on). That type of thing only really happens very slowly because you need to design a mineshaft from inception for increased mechanisation.

It's not something you can change overnight and mineshafts take very long to start up. From design to first ore being delivered, is in the region of seven years. I guess this will be an ongoing process, which we've just, really embarked on despite what he says about the current plans having started (or being laid) eight years ago.

ALEC HOGG: Another one of your favourites is ArcelorMittal. We haven't had a chance to talk to you since Rob Davies, the Minister of Trade & Industry said that ArcelorMittal have to drop their prices for local consumers. If that were to be enacted legally, would it change your view on the company?

WILHELM HERTZOG: In the short-term, it would definitely put material pressure on profits, so that would be something one has to factor into the equation when you consider what the asset is worth. In the long-term, we think there is a very strong case to be made that a company like ArcelorMittal, given the location of its assets and the position it enjoys in the market, should at least earn returns equal to its cost of capital. That's basically, what our valuation of the company is premised on. We don't think there's a strong argument to be made that ArcelorMittal should not sustainably earn its cost of capital. The State plans to back this new five-million ton per annum steel facility. That would probably create excess capacity in the country, which can cause things to be tough for an extended period of time, so it will certainly impact the company.

Longer-term though, we're very comfortable and happy that our assessment of ArcelorMittal's fair value is realistic and sensible, given the dynamics of the local market and the positioning of ArcelorMittal within the market. It's tough in the short-term, but in the long-term the economics make sense to us, to support. Returns equals the cost of capital, which means the share is worth round about its book value, which is approximately R65.00 per share or thereabout, so nothing's really changed our view on that.

ALEC HOGG: But the concern I guess, in the longer-term has to be: if you are fighting against a State-supported competitor – and we know that the State looks at various investments that the State makes – it's never really, a commercial decision that is behind what governments do in these strategic assets. That must put a question mark in the longer-term.

WILHELM HERTZOG: Yes, it does. However, there are many examples of sectors where the private sector competed quite successfully against the State – Private Arcelor being one and airlines being another. Yes, the State doesn't make it easy and at times, capital allocation in the industry becomes irrational on the part of the State. That does weed out weaker competitors in for example, the airline industry. However, I think that if you're a strong competitor – and ArcelorMittal certainly is a very strong competitor in the local steel market – you have a good chance of staying the course and earning decent returns in the industry, despite Government's efforts to the contrary, potentially.

ALEC HOGG: Wilhelm, we started off this conversation by talking about a CEO who had departed. Now, a new CEO who is coming in at Group Five – Mike Upton's making way for Eric Vemer. Do you know him at all – the newcomer?

WILHELM HERTZOG: I haven't personally met him at all, so I can't really speak of personal experience, no.

ALEC HOGG: But it does look like a good process: the incumbent is there and they've appointed a successor. It's very different to what happened at Aveng, which in fact, is a share that you own.

WILHELM HERTZOG: Absolutely. I think we quite like what the management team at Group Five have done with the company in recent years, so we have a great deal of respect for Mike Upton as a chief there. He really brought together what seems to be a tight-knit team with a strong culture of only accepting profitable work etcetera. I do think it's encouraging. As you say, it seems to be a through, well though through discipline process of appointing an internal successor. That's a very positive sign for what's going on in the company and how management is steering the company on the road ahead.

ALEC HOGG: And Aveng, from your perspective (being a shareholder there), I guess it's more of the same.

WILHELM HERTZOG: Sure. It's more of the same and Aveng has been disappointing in terms of operational performance in recent years so yes, that doesn't take away from the fact that we think the current share price is very attractive in the context of the longer-term economics. Certainly, operational execution at Aveng has left much to be desired in recent years, compared to what's been happening at Group Five, for example.

ALEC HOGG: Hopefully, the new CEO will, as well. Well, that was Wilhelm Hertzog from RECM.