The list of JSE construction and related stocks that have collapsed into a pile of dust or are a shadow of their former selves is long. Aveng, Basil Read, Group 5, Stefanutti Stocks, WG Wearne and Murray & Roberts spring to mind.
For many stocks the halcyon days of the 2000s, the new millennium and the unbridled expansion of infrastructure tied to the 2010 soccer World Cup were the zenith.
Expansion, mostly funded via debt, seemed pervasive. Construction stocks fell into the trap of gobbling up assets both at home and overseas. Many would regret that in later years as boom turned to bust, leaving them heavily debt exposed in a weak operating environment.
The companies that were seen as staid and conservative and that sat on the deal sidelines were often ignored. But that very conservatism, fostered by organic growth and prudence on their balance sheets, led to two success stories 10 years after the World Cup construction sector bust. Afrimat and Raubex are the two strong and flourishing survivors.
Afrimat, trading at R34.15 — with a market valuation of R4,9bn — has been the sector’s star performer. Listed in 2006 at 500c a share, the business was an amalgamation of several aggregate and quarry businesses, all with long and solid track records. It has been a consistent performer and hit a record high of R36.50 recently after its upbeat annual general meeting.
Raubex listed a year after Afrimat, in 2007, at a placement price of R15 a share. Having traded as high as R44 in the frenzy after listing, the stock has trended sideways in a range of R18-R25 for more than a decade. IM believes its opportunity to break out may be near.
At the time of writing it’s trading at R23.40 and has a valuation of R4.3bn. In terms of its share price its growth may not have been as stellar as Afrimat’s, but there has been a reassuring consistency in conserving shareholder value.
The current combined market valuations of Afrimat and Raubex is R9.2bn. For that modest sum you could pretty much buy out the entire heavy construction sector of the JSE, comprising seven stocks — Aveng, Basil Read, Calgro M3, Stefanutti, Murray & Roberts and WBHO. How the mighty have fallen.
How did Afrimat and Raubex survive the collapse in the construction sector and actually thrive in difficult domestic economic conditions?
The answer is simple — the two companies have solid, no-nonsense and, dare we say it, salt-of-the-earth management who call a spade a spade and, perhaps more importantly, are owner operators. Executive management understand the nuts and bolts of the businesses they operate in, kick the tyres and surround themselves with excellent colleagues. These are no spreadsheet CEOs — they are operators who have their sleeves rolled up.
Further, both stocks avoided the use of debt where possible, have been fastidious about cash generation and management, and diversified away from their initial listed core into complementary products to mitigate concentration risk.
Afrimat endured a period of weakness after listing, but then rapidly found its footing. It has not put a step out of place since. Management, under the consistent leadership of CEO Andries van Heerden, rebalanced the portfolio away from construction materials, adding industrial minerals and bulk commodities to the mix.
Debt free and sitting on net cash, recent results for the 2020 financial year detailed revenue of R3.3bn and an operating profit of R601m with headline earnings increasing 48.5% to 347.7c a share.
Today, Afrimat’s revenue is derived 52% from construction materials, 17% from industrial minerals and 31% from bulk commodities. The last two are far more profitable and higher margin than the original base.
The ability to harness the core skills set of being great quarry and site managers in complementary areas to improve margins has been the key to success for Afrimat. It is brilliant at buying rough diamond assets and polishing them to a profitable sparkle.
Every deal Afrimat did — generally one every 18 to 24 months — was well considered.
Two examples will suffice. Afrimat bought the Glen Douglas industrial minerals business from Exxaro in 2010 for the amount of R35m.
The dolomite mine was a key supplier to the steel industry but was a tiny cog in the wheels of giant Exxaro. It was overcapitalised, had too much expensive equipment and lacked operational efficiency.
Afrimat swiftly restructured the unit, cut costs and improved efficiencies. In a few years Glen Douglas was making profits equal to its original purchase price.
An even more startling deal was the acquisition of the liquidated Diro iron ore mine in 2016 for a total consideration of R400m. Renamed Demaneng, the small 1Mt a year iron ore mine near Sishen in the Northern Cape had quality iron ore that could command a premium on international markets due to its lumpy, low-contaminant qualities. But the business simply could not turn a decent profit, so ultimately went bust for its original owners.
Afrimat rapidly rehabilitated the mine, added more efficient plant and equipment and turned a loss-making business into one that in financial year 2020 contributed 53% of group operating profit, or R322m, just from iron ore.
To Afrimat’s credit, executives also know when to walk away from a deal. In 2019, Afrimat considered its largest ever deal when it bid R2.1bn for Australian-listed Universal Coal, whose assets were principally in the coal fields in Mpumalanga. The deal would have been a game changer for Afrimat, taking the operation into a whole new area of business with sizeable revenues.
The deal would probably have stretched debt and even necessitated a large Afrimat rights issue.
Universal was profitable. But on extensive due diligence the numbers simply didn’t meet Afrimat’s exacting standards for returns, despite the unsurpassed quality of the deal.
Raubex, on listing, was best known as an excellent road builder, mainly in the Free State. However, management realised that being a one-trick pony was an inherent business risk for the longer term.
Over the past years under the solid leadership of CEO Rudolf Fourie, Raubex has diversified away from road building as contacts became scarcer and government finances shakier, and margins thinned. National roads agency Sanral remains a material client and much of Raubex’s work is allied to government in some way. However, diversification has been Raubex’s key to continued profitability.
Like Afrimat, Raubex has managed its business wisely with a focus on cash. The company entered Covid-19 and the lockdown with R1.3bn — a good cushion for the R800m of group debt.
Raubex’s revenues of R1.2bn at listing in 2007 (derived mainly from road works) rose to R8.7bn in the 2020 financial year.
Three key divisions now balance the business.
Materials comprise 31% of revenue but is the main profit source, at about 50%.
Roads, and earthworks and infrastructure, both have revenues of more than R3bn each, but hefty losses in roads has affected recent results. This division has been restructured due to the lower volume of work available. Infrastructure has won major contracts in renewable energy, offsetting weakness in roads.
Raubex remains a sizeable and profitable entity driven by materials and infrastructure projects, and in 2020 delivered operating profits of R480m and headline earnings of 161.7c a share — an increase of 184% year on year.
The company lives and dies by its order book. This stood at R10.1bn at its year end, though that could dramatically change in the coming weeks.
Afrimat and Raubex have six-month interim results to August due. The Covid-19 lockdown from March 27 to early May will affect both companies, and earnings will be weaker.
However, Afrimat is somewhat shielded, as the iron ore price has risen by 46% in the interim results period, and that will offset weakness experienced in construction materials and industrial minerals.
Raubex will not be as lucky, and has already indicated its interim results to August will decline by 80% as the general construction sector was hard hit due to the lockdown.
However, there are potential silver linings ahead for Raubex in the second half and into the 2021 financial year. The same goes for Afrimat.
The government has not issued any infrastructure and roads tenders in months due to the pandemic. However, Sanral was due to announce up to R30bn of new roads tenders in August and Raubex was hopeful of winning R6bn-R8bn worth of these. In total, Raubex has R18bn of general roads and infrastructure tenders awaiting adjudication and Fourie says they could be a "game changer" for the group.
The recent announcement by President Cyril Ramaphosa of major investment in domestic infrastructure raised sector hopes. Both Afrimat as a construction materials supplier and Raubex as contractors are well positioned as they have the size, scale and balance sheets to participate when many sector competitors simply no longer have the capacity.
With news pending on infrastructure and roads tenders, Raubex looks interestingly poised. A further tender for $170m or R2.5bn for the Beit Bridge upgrade is also due.
In the case of Afrimat, the resumption of work in the construction and industrial sector has kick-started these divisions. A recent conversation with the CEOs of Afrimat and Raubex indicated they had upbeat post-Covid business uplift expectations.
For long-term investors, IM would recommend accumulating both stocks.
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