Best of Ghost Mail: Local Is Still Lekker, If You Know Where To Look 👀

Load shedding. Inflation. High unemployment. You read about the three horsemen of South Africa’s economic apocalypse in every second financial article these days.

And with many of our local household-name businesses doing particularly poorly in this challenging environment - see Pick n Pay Stores Limited (PIK) for evidence of pain and Transaction Capital Limited (TCP) as a company that really hurt even the professional investors this year - it’s little wonder that many investors are looking offshore and paying a premium for shares in companies like Nvidia and Meta.

We like to think that the grass is greener anywhere but here. Although there’s little argument that the US stock indices have outperformed the JSE over the years (especially when measured in dollars), it’s also true that the grass is green where you water it.

Once you drown out the negativity, you’ll find that there are local businesses that have rolled with the punches and watered their grass despite every challenge. This is why their results are blooming while others are looking like a midwinter Gauteng lawn.

Like the Springbok bench strategy that brings in some serious heavy hitters midway through the battle (much to the disgust of New Zealand rugby pundits), it’s possible to supplement your diversified portfolio with some companies that look like real impact players. Like in rugby and so many other things in life, it’s all about analysing the game and choosing the right strategy.

Although there has been a lot of pain on the local market this year (especially in mining), there’s been enough good news to justify more than one article on this topic. With spring and Springboks in the air, it’s time to wear the green and gold with pride.

In the first part of this series, we look at how to look at two companies in the same industry, one of which has delivered strong share price outperformance this year.

Packing a punch

The packaging industry has delivered some positive surprises this year. Nampak Limited (NPK) isn’t one of them, with the company holding its hat out to shareholders and hoping to raise the R1 billion equity required to keep the lights on. Figuratively, of course. This is South Africa and nobody can keep the lights on all the time.

The same can’t be said for Transpaco Limited (TPC) and Mpact Limited (MPT), both of which have delivered the goods this year in terms of earnings growth. The relative share price performance is fascinating though, with a very clear winner:

This is where things get really interesting for investors (and sometimes frustrating). How can two companies with so much overlap deliver such different share price outcomes? 

Before we get to the details, the strange shape on the Transpaco chart is because of a lack of liquidity in the stock. There can be large moves on the bid-offer spread, so just tread carefully on that one. If you choose to invest in the company, you’ll need patience to get the position you want.

Is the difference because of financial performance?

For the year ended June, Transpaco reported revenue growth of 10.8% and operating profit growth of 13.3%. As soon as operating profit growth exceeds revenue growth, you know that margins have improved. Headline earnings per share (HEPS) jumped 19.4%. Importantly, both the Plastics division and the Paper and Board division were solid contributors, with the latter as the standout with revenue growth of 15%.

Mpact has a different financial year-end, so the latest numbers are for the six months to June. Growth was up by 8.7% which is solid but not remarkable. Where things get exciting is on the operating profit line, thanks to great cost control and a juicy jump in margins. Operating profit surged 37%, which is the kind of number that certainly makes an impact. Although there were higher finance costs to deal with in this interest rate environment, we are still looking at HEPS growth of 33%.

As a further comment on Mpact, a significant contributor to success has been the combination of load curtailment agreements with Eskom and substantial investment in prior years in solar generation capacity. This means that when the lights go out, those solar panels kick into gear and leave Mpact looking as smug as our rugby supporters after we demolished the opposition at Twickenham.

Based on the HEPS performance and before we start to do proper analysis, it looks like Mpact’s share price should’ve outperformed, not the other way around. There’s clearly more work to do.

It’s all about the valuation vs. the performance

It’s very dangerous to just look at financial performance in isolation. This has to be considered along with the valuation, which is effectively a reflection of the expectations for that performance by the market. Where performance beats expectations, the share price does well. Where it doesn’t, the price underperforms.

Looking at dividends, Transpaco rewarded shareholders with a full year dividend of 260 cents. Included in this number is the final dividend of 175 cents which will be paid in September, so the share price is likely to drop a bit after that cash is paid as the price is effectively cum dividend at the moment. Transpaco is on a trailing dividend yield of 7.7% and on a Price/Earnings multiple of 5.9x based on HEPS of 567.8 cents. This is an easier calculation because the latest results are annual numbers, so no further adjustments are needed for this assessment.

It's a bit trickier to work out the multiples for Mpact. It’s dangerous to just double the interim result, as you’re then making an assumption about the future and working off forward earnings rather than trailing (historical) earnings. This wouldn’t be directly comparable to Transpaco.

The trick is to look at the six months to June 2023 (the latest period) and add the six months to December 2022, which you achieve by subtracting last year’s interim numbers from the full year numbers. This is a trick that professional analysts use all the time, so I’ll walk you through it.

For the year ended December 2022, HEPS at Mpact was 430.1 cents and the total dividend was 115 cents. The six months to June 2022 reflected HEPS of 142 cents and a dividend of 40 cents a share. So, if we isolate the second half of the year, we find HEPS of 288.1 cents and a dividend of 75 cents.

Now we add this to Mpact’s latest interim period (the six months to June 2023) to get the numbers for the last twelve months i.e. July 2022 – June 2023. For HEPS, this means 142 cents plus 188 cents equals 330 cents. The dividend is 75 cents plus 45 cents equals 120 cents.

On a current share price of R30.00, this means a Price/Earnings multiple of 9.1x and a dividend yield of 4%.

Transpaco was (and is) relatively cheaper than Mpact

We can now directly compare the multiples and dividend yields, revealing that Transpaco is “cheaper” than Mpact on those valuation metrics even after the big share price performance this year.

Even though both companies are doing well right now, it was Transpaco’s surprise outperformance that drove the share price to these levels.

How do you spot these opportunities in future? It’s not easy of course, but analysing earnings multiples and dividend yields within a sector will help you identify the relatively cheaper vs. more expensive shares. Focusing on the cheaper shares gives you more margin for error and creates potential for outperformance.

Of course, shares are often cheap for a reason. These are called “value traps” as they tempt investors with low valuations, yet the company itself isn’t good. This is why you need to layer strategic and operational analysis over the valuation.

Welcome to investing. It’s a beautiful puzzle.