Steinhoff price slump a timely reminder about rights issue rationale

The R120bn global furniture group Steinhoff's share price has now dropped to below the level at which, in July, investors were prepared to inject R18bn in fresh capital. It says much for CEO Markus Jooste's brilliant timing – but also focuses the spotlight onto an uncomfortable reality: unless forced, companies only have rights issues when their equity is expensive. Nedbank's Mohammed Nalla offers his perspectives in the context of another big recent rights issue – Woolworths – and the sliding price of its fellow retailer Massmart. – AH

ALEC HOGG: Let's get a more in-depth view of how the market's trading today. Mohammed Nalla is Head of Strategic Research at Nedbank Capital. Mohammed, let's pick up on Steinhoff, because there was a big move in the share price yesterday. We're going off with a camera crew on Tuesday to meet my old pal, Marcus Jooste who's not in the country that often, but I think he must be a little concerned at the way the market has been reacting to that trading update that came out last Friday. The share price is down from R60.00 as recently as the beginning of July, to trading at R48.50 today.

MOHAMMED NALLA: That's quite a massive smack. There've been a couple of funnies at Steinhoff. They went through this purple patch where they were the darling and everyone really liked it. They've raised a massive amount of capital recently. They have results out and the market's really going to want to see what their plans are for that capital. On the plus side Alec, they've really diversified significantly. It's now truly a global company rather than a South African company, but there's a lot of news, too. There's that tie-up with JD. Earlier in the year, JD effectively said more than 50 percent of their books are from a bad debt perspective, so I think some of that negativity filters through. There has been speculation that they may actually be looking at taking Ellerines out of the whole African Bank debacle.

ALEC HOGG: Put it into JD.

MOHAMMED NALLA: Put it into JD. I think there's a lot of news flow around that, probably a lot of noise, and I'd certainly be very interested to see what Marcus has to say because I think they're at a bit of a crossroads. With this massive capital pile, you're going to have to excite me as an investor, to show me what those plans are, going forward.

ALEC HOGG: But the interesting point here – and I was just looking it up quickly – is they raised 18-billion in the rights issue (that's a huge amount of money) at R52.00 per share. Today, you can buy cheaper at R48.50. Now that's telling you that maybe somebody who went into the rights issue has already given up and is dumping stock in the market. What is it telling us if you're prepared to make such a huge rights issue at that price? Maybe it's telling us that Marcus Jooste is a smart guy. He farmed the market at the right time.

MOHAMMED NALLA: When you see a massive move as we've seen – as you said, it's on the back of that trading update – there certainly must be some selling pressure…someone with a large position, saying 'we think it's a bit full. We're not happy with the prospects. Let's offload this position quite aggressively'. Let's see, but it's certainly ugly when you lose ten percent in the course of a week or so.

ALEC HOGG: But worse than that: if you've just gone and put new capital in, and now you could have bought in the market cheaper. We'll wait until Tuesday. I think you're right. Massmart… While we're talking about the bad guys (and you have a red tie on today), the losers on the market – that's another one that's really been under pressure.

MOHAMMED NALLA: Yes. I guess, in line with other retailers in general, there've been a couple that have actually held up quite nicely. With Massmart, it was a patchy set of numbers that came through and since then, it's really struggled. The market, coming to terms with the fact that domestically, you have a consumer who's under massive pressure… With Massmart looking at shutting down quite a few of their Game stores – it's an ugly picture and I struggle when looking at stocks with earnings multiples so far north of any reasonable level. You struggle to find value in that kind of market, so I think the market again – probably post-facts – is starting to position and say 'we're not going to get those earnings coming through'.

ALEC HOGG: Are you a chartered accountant?

MOHAMMED NALLA: No, I'm not.

ALEC HOGG: But you know numbers.

MOHAMMED NALLA: Yes, I do.

ALEC HOGG: You feel numbers. You know that when you're in a company, you can squeeze the numbers out when you need to and on the other hand, you can make them look 'not quite as nice', too.   There are many ways of doing that without being dishonest. We've just had a massive rights issue from Woolworths and pretty good results. We've had an opposite effect from Massmart who've now been acquired by the international operations. If you were seeing this happening at Massmart, why would people still be buying the Woolworths shares at an even higher multiple?

MOHAMMED NALLA: Again, it's a very fluid situation. Yes, you could massage the numbers. You could be taking up poison and pills strategy, making it look quite bad. Regardless of all of that, Woolworths has really been in a space where they've executed their strategy in an excellent manner. If you look at how they're rolling out, if you look at their plans for the next year. A big focus, domestically certainly on the food component because that is really, where they've gathered some momentum.

ALEC HOGG: Do you see what they are charging for food?

MOHAMMED NALLA: But, at the end of the day…

ALEC HOGG: Sometime the penny has to drop, R1.000.00 a kilogram for biltong.

MOHAMMED NALLA: They play in a different LSM group and this leads you to the whole question around income elasticity's and the propensity to spend and so forth. Woollies plays in a very fairly well protected segment of the domestic market and more and more, I guess with the acquisitions in Australia, starting to look like a bit more of a global play when you are starting to look at Woollies as well. I think good strategy execution on Woollies, whereas on the Massmart side they have disappointed the market, probably now for the last two to three years, and that's starting to come through, in terms of their share price.

ALEC HOGG: Interesting – that's an interesting story that.

MOHAMMED NALLA: Do you disagree?

ALEC HOGG: Totally. I think that often we sit in our… we look at the numbers and we see it from a market perspective and we forget what's happening on the ground, and on the ground, when you start comparing the prices…I just take it…

MOHAMMED NALLA: I like the Woollies' story, so maybe I'm talking about the book here.

ALEC HOGG: Maybe, well lots of people… also, I've been around long enough to know that companies raise money when their stocks expensive and Woollies has just raised a pile of money, as Steinhoff has done as well. Sanlam hasn't raised money lately and they seem to be going full steam. What did you think of their numbers?

MOHAMMED NALLA: Sanlam's numbers continue to surprise, I guess, to the upside market really liking it, so the stocks up today. Again, these businesses, if you just cast your mind back to two or three years ago, all trading at significant discounts to embedded value, they are now trading at significant premiums to embedded value, so if you ask me, 'where are we sitting right now'? It may be looking a little bit full, specifically on a short-term basis. I wouldn't be surprised to see some pressure come through but, in aggregate, I like the business. I like the management team. I like what they've done with regards to the international diversification that they are picking through, and that's a trend that you are seeing, actually accelerate even within that Sanlam stable. I like that story. I've been pretty big on the outside of South Africa, diversification theme, for a very long time now with good reason. I mean, let's look at what's happening domestically.

ALEC HOGG: Well you've been on the money there.

MOHAMMED NALLA: Yes, a stock like Sanlam, maybe looking a little bit full. I don't think it's a sell per se'. It is definitely not a buy at these kinds of levels but if you've got it in the portfolio, certainly you could justify a hold-on on a stock like that.

ALEC HOGG: I guess that's what people are saying, for instance MTN is another good example, ex or big operations outside of South Africa. If you haven't got it in the portfolio, you might have to be adding to it. If you own it already, despite the fact it's having such a good run, you stick with it.

MOHAMMED NALLA: No, you stick around. A stock like MTN you'd roughly say around 30-odd percent of their exposure is to South Africa. The rest is ex-South African, exposed to very nice, high growth markets on MTN. Telecoms, specifically, becoming a very mature industry, specifically locally, so stocks like MTN and Vodacom have become nice, healthy dividend payers. I think there's a different rationale to be holding some of those stocks, so if it's a health div payer, if you expect fairly, decent, stable growth, with the prospect for an upside growth surprise from other markets they play in, it makes a compelling investment case to certainly, keep that in the portfolio.

ALEC HOGG: And they are huge in Nigeria. There was a press statement that came out today, another little shift that they've done in Nigeria that they are such an enormous player in that market and there's a lot of runway for them still to go on too. Just to close off with, a good move today for Attacq, the property company. Their listing has been, well received.

MOHAMMED NALLA: Certainly, if you look at that property space we had a raft of consolidation of the smaller plans. Attacq has come in as a nice playoff, of quite some substance. I guess it boils down, at the end of the day, in terms of your view on rates and, right now, I think the consensus is shifting towards a 'flatter for longer type of rates' profile. These companies all develop or deliver fairly decent earnings growth that comes through, decent yields coming through and vacancies haven't really ticked up as a massive issue. Personally, I quite like the offshore property players. I have for quite some time and we've discussed the likes of [inaudible: 07:59], we've discussed even [inaudible: 08:01] Properties and Attacq has, I can't recall which one, but Attacq has; one of those offshore players is actually associated to Attacq, so yes, generally I think I like it. I like the yield play and for investors looking for that underpin, for an income underpin to their portfolios, is probably stock still looking pretty decent but does hinge on what your view is, with regards to where rates are going to go.