Several small- and mid-cap companies have sparked into life in the tentatively positive trading environment ushered in by the government of national unity and the prospect of more interest rate cuts.
But few punters would have picked South Ocean Holdings (SOH), a light electrical cable maker, as a leader in what is hopefully a small-cap revival.
SOH comes with huge legacy issues, having stumbled badly with ill-considered and costly corporate action after listing in 2007. The listing, by the way, was an enormous success, with SOH’s private placing heavily oversubscribed. Shares were placed at 700c, raising a not insubstantial R367.5m. The fresh capital, unfortunately, was not put to good use.
In a bid to diversify from its cabling core, SOH forked out R485m for Radiant. It was a terrible capital allocation decision. The scale of this folly is still reflected in the fact that the Radiant purchase price, even 17 years later, is larger than SOH’s market value.
SOH finally got rid of Radiant in 2018, selling it to ARB Holdings for less than half the original purchase price. By that time the market was less than impressed by the cabling business. Investor sentiment fizzled because of a lack of property development and, of course, load-shedding.
To its credit SOH knuckled down, and between the 2020 and 2023 financial years it collectively generated earnings of 114c a share and paid out dividends topping 29c a share. Investors who bravely dabbled in SOH shares in early 2020 — at levels between 21c and 25c — can’t be too unhappy today.
More recently, SOH is up 25% over three months, 55% over six months and a whopping 115% over a year. It’s easy to argue that the easy money has already been made. But SOH is down by roughly a quarter from the 274c high registered on August 20 this year.
The share, at current levels, trades on a modest earnings multiple of five and offers an attractive 5% yield.
Is this the time to plug back in? The interim results to end-June give off some mixed signals. Encouragingly, revenue was up 5% to R1.3bn and gross profit up 11% to R115m. Operating profit crept up 1.6% but markedly higher finance costs of R12m pushed bottom-line profits down from R48.5m to R44m. Headline earnings dimmed to 21.5c a share (2023: 23.9c).
In a bid to diversify from its cabling core, SOH forked out R485m for Radiant. It was a terrible capital allocation decision
It’s worth remembering that SOH traditionally earns the bulk of its earnings in the second half of the year. Management expects the seasonal trend to continue in future — though this was not the case in the 2023 financial year, when the group finished with 43.6c a share after posting interim earnings of 23.9c a share.
SOH’s comments on second-half prospects were hardly illuminating, with management noting that the macroeconomic environment was not expected to improve soon.
CEO Andre Smith said the group would focus on customer service and reducing costs. SOH would also harness technology to drive growth, productivity and greater efficiencies in a more sustainable manner — which, Smith believed, would improve the profitability of the operating entities.
The first cut in interest rates should offer some relief on the interest bill, though shareholders will no doubt be keener to see second-half cash flows markedly diminishing the debt pile.
The interim cash flow, as in the previous year, was negative to the tune of R182m. Smith said working capital increased by R268m (2023: R274.4m) mainly due to the increase in inventory. He added that working capital investment was now at 54% (2023: 45.3%) of revenue.
After accounting for debt repayments and capital expenditure, the group’s net cash utilised during the interim period topped R260m. This stretched the negative bank balance to almost R177m, from about R123m last year.
Some investors won’t find this trend reassuring, with SOH finishing the year to end-December 2022 with R134m in the bank and the 2023 financial year with R84m.
Cash generated from operations for the full 12 months of 2023 was only R21m. Hopefully SOH can finish 2024 with more convincing cash flows, though the R105m managed in financial 2022 might be too big an expectation.
While SOH will presumably want to extend its recent dividend record (again, depending on the traditional second-half thrust), one consideration could be for share buybacks, with the group’s “hard” NAV at about 340c a share. One hitch is that 85% of SOH is held by a handful of shareholders, which limits the repurchasing options on an already illiquid share.
The discount to NAV — and the recharging of SOH’s operational performance — might, of course, also raise the question of the group being a takeover target. SOH’s focus might not fit well with diversified industrial conglomerates such as Argent, Invicta and Hudaco, and it seems electronics giant Reunert might have bigger fish to fry outside its old cabling core.
Perhaps an exploratory share buyback exercise might be a precursor to what the FM has long felt is an overdue and logical action — a buying out of minority shareholders. The most significant of these is large asset manager Ninety One, with a 4.78% stake.
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