Logically, to many readers, IM might have its long/short equation backward with these mid-sized industrial players.
Hulamin, trading on an earnings multiple of less than four times and a yield of over 5%, is largely seen as a deep-value play that will deliver on its promise of big earnings as the applications for aluminium grow in the beverages and automotive sectors.
Afrimat, on a more demanding 13.5 times earnings multiple and a yield of 2.5%, is largely viewed as grinding out growth as an aggregates supplier to the increasingly brittle construction sector.
Afrimat is our long this month because IM believes the company will deliver on its diversification strategy — which has in recent years entailed moves into specialist mining. At the time of writing Afrimat was still in the throes of acquiring substantial coal assets to complement its position in iron ore.
Every acquisition, especially those aimed at diversifying operations, carries execution risks. Afrimat probably deserves more than the benefit of any doubt around bedding down and extracting (enormous) value from acquisitions.
Under the astute leadership of Andries van Heerden, whose disdain for costs and corporate frills is perhaps only matched by Astral Foods CEO Chris Schutte, Afrimat has accumulated assets smartly and without ever straining the balance sheet (just check the superb dividend record).
Ten years ago, when Afrimat’s rivals were indulging in an acquisition binge, Afrimat refrained from overpaying for assets in the pre-Soccer World Cup euphoria in the construction sector. When the 2010 hangover set in, Afrimat was able to sift through the many distressed companies to snap up bargain assets that could be turned around quickly.
IM believes that while prospects for the broader infrastructure sector in SA remain iffy, the interim results to end-August will further confirm that Afrimat has made another smart move into iron ore. In the year to end-February the bulk minerals segment spun from a loss of R33m to an operating profit of R201m. This represented more than 40% of total operating profit.
Sturdier pricing for iron ore and the possibility of further capacity for exports should mean a reinforced level of profitability for Afrimat’s iron ore segment in the interim period. This could have a marked impact on bottom line and cash flows.
Yes, there are questions around how Afrimat will fund its new venture into coal, with the prospect of a rights issue obviously weighing on the share price. But IM reckons the coal mining operation (which did attract other suitors) will pay for itself in relatively quick time, so investors with a long-term view should be snatching Afrimat scrip at these levels.
Many investors may hold that Hulamin’s share price cannot go much lower. The share, at the time of writing, was not far from a record low of 304c.
But IM is concerned at a number of issues at Hulamin — most notably that the company is not managing its costs effectively enough to take advantage of weaknesses on the rand/dollar exchange rate.
Technically speaking, Hulamin should earn at least an additional R200m (yes, you are reading correctly: R200m) for every R1 of weakness against the US dollar.
At a recent AGM a worried shareholder pointed out that since 2011 (when the rand was R7.50/$) Hulamin should have earned an additional R1.4bn in profit.
However, this extra profit never materialised.
Even though confirming the profit benefit from the weaker rand, Hulamin explained that market prices for aluminium products had declined in recent years due to additional competition (mainly from China) and additional cost inflation (Eskom, take a bow).
Hulamin has indicated a determination to refocus on products where the combination of costs and capability competitiveness results in optimum returns for shareholders. But the body language of the board of directors leaves much to be desired on the question of chasing these priorities.
At the recent AGM Hulamin executives came in for stern criticism for not "setting the tone at the top" in terms of commitment to cost-cutting endeavours.
The company’s 14-strong board was deemed excessive and costly at R5.1m a year. By comparison, Anglo American (originally the parent company of Hulamin) only had 12 directors, even though it was nearly 500 times bigger (by market value) than Hulamin.
One has to question just how committed such an expensive board would be to making Hulamin "leaner and meaner".
One needs to remember that Hulamin has spent around R3.9bn in capital expenditure since 2007 — nearly four times the current market capitalisation — with not much to show shareholders.
It seems it might be some time before Hulamin, which is unlikely to produce pretty interim profits, really gets to grips with its cost base. IM reckons the share price could consequently drift down further in the months ahead.
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