Ask any old market hand to name a JSE-listed mid-cap stock that should be clear beneficiary of the euphoria surrounding the government of national unity (GNU); IM would wager blue-chip Hudaco would be near the top of the poll.
For more than 100 years, the counter has been seen as a bellwether of the domestic economy because of its range of businesses and diversity across the consumer, industrial and mining landscape.
It is principally an importer and distributor of high-quality branded industrial, automotive and electronic consumables. There are few sectors that do not require some part or product supplied by Hudaco. With more than 230,000 product lines, supplied by 800 international suppliers from 29 warehouses and 130 branches, Hudaco is a microcosm of the South African economy.
The company has successfully pivoted its business over the past decade away from the struggling industrial and mining sector towards consumer goods such as Cadac and Makita power tools, alongside acquisitions in the security and communication equipment, fire detection and filtration sectors.
These bolt-on deals, paid for in cash, have been an integral part of Hudaco’s growth for some years, allowing the company to show earnings growth in a challenging economic environment. However, year to date Hudaco’s share price is only ahead 7.1%, though it has risen 13% since mid-April. Its performance has been subdued as many other stocks, such as Murray & Roberts and Raubex, have raced ahead on hopes of an uplift in government infrastructure spending.
To show better earnings growth, Hudaco, much like Invicta, needs an improvement in domestic economic activity, lower interest rates and some glimmer that South Africa’s dismal GDP is starting to tick higher after years of stagnation.
For much of 2023, the share price was stuck in a rut, trending sideways between R140 and R165. The market has fretted about the single-digit earnings growth rates in what is a fragile economy. Financial 2023 results to November reported headline earnings increasing 7% to R21.48 a share.
A full year of profits from acquisitions will help and rightsizing errant assets will curb losses
Despite a conservative balance sheet, share buybacks and solid dividends, Hudaco has been a pedestrian stock. Much of this is due to the environment. Interim results to May were weak as the company suffered from business inertia arising from uncertainty in the run-up to the election and constrained consumer spending.
Hudaco did warn about this scenario at its year-end 2023 results, and it transpired. Revenue for the six months fell 6.3% to just under R4bn with profit before tax declining 19.4% to R325m. Headline earnings slipped 15.2% to 785c a share but, showing the strength of the business, the interim dividend was maintained at 325c a share.
In the period 57% of revenue was derived from engineering consumables and the balance from consumer products, where it operates 12 businesses. Those hit Hudaco’s interims hard. The consumer unit saw a 15.7% decline in revenue but an eye-watering 36.2% slump in profit as the Cadac business, only acquired in early 2022, and the energy/battery business performed poorly.
These businesses led to a R93m hit to operating profit. Buffering results was a modest 3.9% increase in the engineering consumables side, where profits rose 19.5%. Those 19 businesses saw operating margin improve with contributions from the engine parts businesses, and recent acquisitions Brigit Fire and Plasti-Weld performed well. Acquisitions added R41m to operating profit. The steel assets remain lacklustre.
Financial 2022 was clearly Hudaco’s heyday, with bumper margin in both the interim and final results. Since then, thanks to the deteriorating economy and rand, Hudaco has had to eke out a more constrained living. Looking into the second half, Hudaco has increased stock levels and is fixing the errant Cadac and energy businesses.
The company traditionally has a stronger second half due to the skew of its products. With the GNU boosting business sentiment and giving some political certainty, for as long as that lasts, the company will be well positioned, and any interest rate relief will be a sector boost and improve investment sentiment.
Load-shedding is now seemingly a thing of the past, and into the second half Hudaco has several improving business touchpoints. A full year of profits from acquisitions will help and rightsizing errant assets will curb losses. Hudaco is in a financially strong position to take advantage of any tentative green economic shoots.
At the current share price levels, Hudaco has been left on the sidelines in the recent mid-cap stock market rally. But IM believes this creates an opportunity. Based on IM’s interpretation and expectations, it seems appropriate to make Hudaco this month’s pick with a target price of R201.50 — representing potential upside of 17%.
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