The local industrial manufacturing sector is hardly a beacon of investor optimism these days: higher raw material prices, higher inflation, higher interest rates and a high likelihood of disruptive load-shedding are all givens. But KAP Industrial is digging in for the long haul, despite profits buckling badly in the six months to end-December.
“We are doing a lot of work around three primary areas — electricity, water and security — to secure our plant and ensure we can continue to operate,” says CEO Gary Chaplin.
KAP is planning to have about 40MW of its own power generation capacity soon, which covers a chunk of the 80MW-90MW the group’s various production entities consume in a year.
We are out there making plans to mitigate risks, and then making plans to find opportunities in this environment
— Gary Chaplin
Capital allocation is also under the spotlight. Says Chaplin: “We need to reassess where we allocate capital and what our portfolio of businesses looks like ... We are out there making plans to mitigate risks, and then making plans to find opportunities in this environment.”
That was probably all drowned out by the thunderous clunk of interim headline earnings dropping 17% to 31c a share.
Which would explain why shares in KAP — a pick for so many value punters — have had a rotten year: they’ve lost almost a quarter of their value since January alone. At about 330c they’re at levels last seen in late 2020.
But as ugly as things are, there still might be a few reasons to buy KAP as a sturdy recovery play.
The diversified industrial group spans timber, specialist chemicals, logistics, bedding, automotive components and niche technology, and can be viewed as a proxy for the local economy.
So it’s been hit hard by disruptive load-shedding, waning consumer demand, higher inflation, currency fluctuations and higher interest rates. Group margins took a fair beating in the six months to end-December, settling at 9.3%.
Adding to KAP’s woes was a serious breakdown at its sprawling chemicals business, Safripol, which saw a chunk of production lost at a time when demand was strong and margins thick. Then there is the group’s substantial debt, which happened to coincide with a 90% slump in cash flow from operations to just R100m on the back of markedly higher working capital demands.
I like a business that is positive and constructive. These guys don’t cry into their beer … they just get on with it and invest in their future capacity
— Graeme Körner
Yet Graeme Körner, director at Körner Perspective, praises KAP for its convincing longer-term strategy and good underlying businesses. “I like a business that is positive and constructive. These guys don’t cry into their beer ... they just get on with it and invest in their future capacity. KAP is a better business than the market gives them credit for ...”
Körner says if KAP can manage 60c a share in earnings for the full financial year to June then, on a 10 times earnings multiple, there could be considerable upside to the stock.
“In the past they have proved that their capex does generate good returns. There are enough good ingredients here for KAP to be a new Bidvest,” says Körner.
Essentially KAP — which in its distant past incorporated listed businesses including Glodina, Kolossus and Silveroaks — now revolves around three large profit contributors: timber specialist PG Bison (34% of operating profits), polymers business Safripol (32%) and logistics hub Unitrans (23%). Bed manufacturer Restonic, automotive trimming specialist Feltex and fledgling transport technology group Drive Risk are much smaller, but each has compelling longer-term attributes.
In the first six months of the 2023 financial year PG Bison saw robust demand across most market segments, which allowed the raw board plants to operate at planned capacity.
Its performance was hampered by the value-added timber production being hit by unscheduled maintenance on three of the MFB (melamine face board) presses and a delayed commissioning of a seventh press (due to semiconductor chip shortages). It partly explains the margin squeeze from 20.6% to 18.4%.
Safripol, which manufacturers PET (polyethylene terephthalate) for use mainly in soft-drink bottling, benefited from an R80m profit kicker courtesy of higher rand-based raw material margins. But this was offset by lower sales volumes which, Chaplin says, was due to lower consumer demand and reduced offtake due to stage 6 load-shedding. What’s more, Safripol had to contend with a “major breakdown” at the PET plant. It lost 38 days of production, which was reflected in a sales volume drop of 11%.
Chaplin explains: “Electricity failures are not good for a polymer plant, which operates at high temperatures and high pressure.” Safripol’s interim operating profit was down 26% to R450m with margins melting to 8.7% (previously 12.7%).
Unitrans held up despite a weak showing in Africa, with revenue rising 12% to R5.5bn and operating profit down only 3% to R334m. Feltex was the star performer with solid operating profit of R97m (earned on an 8.9% margin), but Restonic reported operating profit down 57% to R41m with “lots of retail time lost to load-shedding”.
It’s still early days for Drive Risk, but a R10m operating profit from revenue of R288m will increase enthusiasm for a decent slug of annuity income in years to come.
The second half looks better — especially for the key timber and PET hubs. Chaplin expects high demand, due in part to export markets
The second half looks better — especially for the key timber and PET hubs. Chaplin expects high demand, due in part to export markets.
And he’s banking on a stable operational performance at Safripol — also with the development of export markets to supplement local demand.
At current levels KAP’s shares hardly look expensive. That said, the market’s enthusiasm for local industrial counters (Hudaco being the exception) is on the wane, and there seems no need to rush into KAP at this point.
Dividends might even be open to question, with Chaplin placing considerable emphasis on the need to ease KAP’s debt load with interest rates at 10.5% — even if the group is predicting a significant improvement in working capital and a reduction in net debt expected during the second half.
Investors able to focus on the long-term horizon would do well to watch KAP for further weakness. It could be a rare opportunity to grab shares in a quality business at a knock-down price.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.