For the past 12 months we have been debating the potential attractiveness of PPC given its price decline from over R33 (currently R11.25) and the aggressive expansion plans into Africa. Historically, the market was prepared to pay for the yet unknown potential opportunity in Africa. As value managers we hate paying up for the promise of future growth which may or may not materialise, especially if there are significant risks attached and up to now we resisted the temptation to invest our client’s money in PPC.
In spite of the share price fall and the potential emerging value, the risks have been increasing significantly. Our major concerns had to do with the how the company would fund the rising capital expenditure on the several new projects in Africa. In total the company is expected to spend R11bn on expansion plans outside South Africa (versus the current market cap of R8.3bn). Significant debt funding is required with peak funding requirements potentially hitting R12bn in the next two years. The last reported after tax profits were R660m and with debt substantially greater than profits from existing operations this does not leave much of a margin of safety if things were to go wrong. In addition, a lot of this debt is in the form of USD denominated project finance, while revenues would be earned in local currencies creating a significant potential mismatch in the event of a shock (for example, a collapse in hard currency earnings from commodity exports).
While we had no foresight into the collapse in commodity (and oil) prices, the impact on African economies has made it particularly difficult for many businesses operating in Africa. In particular, liquidity and access to foreign currency has all but dried up which is impacting the day to day running of operations.
Unfortunately for PPC, the home fires have also been smouldering due to increased cement supply from the two new entrants resulting in a significant oversupply in the local market. It’s very hard for commodity companies to out manoeuvre industries in oversupply and this has resulted in price increases well below cost inflation for the past few years. As a result operating margins have halved since their peak in 2007 and are at the lowest levels since the cement cartel ended in 1999.
At Denker Capital, we don’t consider the potential upside without understanding how much capital we are putting at risk to achieve the potential upside. Our concerns around balance sheet pressures have proven to be correct and today the company announced it will be looking to raise between R3bn and R4bn of equity capital via a rights issue. At the time of writing the share price is down 18% on the day and 67% from its peak in 2013 and should we become more comfortable with the risks, the current prices may present an attractive entry point.
By Ricco Friedrich