Cavalry - CFA Institute · PDF file 2015-07-17 · a stake in Hippo Valley Estates....

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Transcript of Cavalry - CFA Institute · PDF file 2015-07-17 · a stake in Hippo Valley Estates....

  • Cavalry holdings This report is published for educational purposes only by students competing in the CFA South Africa Investment Research Challenge.

    Important disclosures appear at the back of this report 1

    Highlights over the past six months

     Significant expected expansion in sugar production: Management intends to increase sugar production by 77.22% by the end of the 2009/2010 season.

     Consolidation of Zimbabwean operations:

    Following a shift to a Dollar and Rand based economy, Zimbabwean operations have been reinstated in the interim results through a large take-on gain.

     World sugar price at an all-time high: Supply

    shocks and increased demand have pushed sugar prices to unsustainable levels.

     Biofuel production offers the potential

    opportunity to move into energy industry: Ethanol production from sugar is a growing industry, yet true profitability lies beyond the analysts’ investment horizon.

     Anglo American Ltd offloads their 49.5%

    holding in Tongaat Hulett Ltd: Shock caused an instantaneous drop of 15% in market price, yet the entire bookbuild was quickly sold out.

    Tongaat Hulett Ltd

    25 September 2009

    Ticker: TON Recommendation: BUY Target Share Price: R113.26 Current Share Price: R91.00 Upside Potential: 24.46%

    Company Data Price R 91.00 Date of Price 25-Sep-09 Price Target R 113.26 Price Target End Date 25-Sep-10 52-week range R 102.55 - R 55.00 Market Cap R 9.56bn # Shares in issue 103,247,000 Beta 0.63


    Top 5 Holdings 10.87%  Metlife 3.19%

     Liberty Life 2.38%

     PIC 1.85%

     GEPF Equity 1.77%

     Old Mutual Life 1.68%

    Director Holdings 0.31%

    EPS P/E P/BV ROA ROE Div Yield 2006A R 6.66 16.38 2.08 11.34% 15.92% 5.03% 2007A R 0.58 157.23 2.95 8.88% 9.19% 3.40% 2008A R 5.66 9.07 1.57 7.91% 9.72% 6.04% 2009E R 8.52 10.81 1.74 7.32% 17.91% 2.71%

    Food Processing Sector

    Source: McGregor BFA

    Source: Cavalry Holdings research, company data

    Source: Cavalry Holdings research, company data

    Source: McGregor BFA

  • CFA South Africa Investment Research 9/25/2009 Challenge Student Research


    Source: McGregor BFA with additions by Cavalry Holdings

    Investment Summary The 2009 year has been very eventful for Tongaat Hulett Ltd. Tongaat has begun to reap the rewards of long-term investments in SADC countries. Furthermore, shifts in economic policy in Zimbabwe have resulted in the consolidation of Zimbabwean operations, which were previously excluded from the balance sheet. Zimbabwean consolidation In recent months, certain economic reforms were instituted in the Zimbabwean economy, which included a shift to a Rand and U.S. Dollar based monetary system. This has resulted in Tongaat being able to consolidate significant Zimbabwean assets in its financial statements. Anglo American Ltd offload On 12 August 2009, Anglo American Ltd announced the sale of its entire 49.5% stake in Tongaat Hulett Ltd. This immediately caused the market price of the Tongaat Hulett’s shares to drop by 15%. The analysts however conclude that the sale is related to Anglo American’s own liquidity and debt situation, and is not due to perceived overvaluation by Anglo American. The bookbuild was completed on 13 August 2009. Industry Analysis The global sugar industry is rife with distortion caused by protectionist measures, which can make global trade fairly challenging. In South Africa, the industry is dominated by a few large firms and will remain so due to insuperable barriers to entry. Global demand appears to be exhibiting an upwards trend, whilst global supply is being stunted by numerous external factors, such as weather. Another salient feature of the South African sugar industry is its low production costs, which bolster global competitiveness. Financial Analysis Analysis of the Tongaat’s financial statements indicates growing revenues, operating margins and cash flows, associated with expanded production. Leverage is being utilised in line with decreased costs of debt and the capital structure is well-managed. The company’s financial positioning appears fundamentally sound and conducive to growth. Investment Risks Political risk within Zimbabwe which could affect Tongaat Hulett’s Triangle Sugar subsidiary is considered a major concern associated with the company. The relevant risks associated with this operation include: exchange rate fluctuations, abnormal weather conditions, the volatile world sugar price and protectionism both within and beyond the South African context. Further causes for concern include property value, hedging risk and restructuring of the company Valuation A free cash flow to the firm model was utilised to calculate an intrinsic value of R 113.26. This was based on the planned 77.22% expansion in sugar production over the next two years, whilst accounting for the additional political risk associated with the Zimbabwean operations. Compared with the current market value of R 91.00, the derived intrinsic value indicates that the company is exceptionally undervalued. Conclusion Based on a complete fundamental value analysis, the analysts post a BUY recommendation with a 12-month target price of R 113.26.

  • CFA South Africa Investment Research 9/25/2009 Challenge Student Research


    Valuation For the purposes of determining fair value, it was decided that a Free Cash Flow model would be most appropriate. The deciding factors included positive projected cash flows over the coming years, together with the expectation of revenue growth, due to the use of previously unutilised capacity. These factors could both be sufficiently incorporated into the FCF model. The reason for selecting Free Cash Flow to the Firm (FCFF) over Free Cash Flow to Equity (FCFE) was due to recent fluctuations in total leverage. Revenue Growth Over recent years the company has made significant investments in sugar cane and sugar production facilities in Southern Africa, primarily in its Zimbabwean and Mozambiquean operations. Management has repeatedly stated that it intends to increase production from 1,106,000 tons in 2008 to in excess of 1,960,000 tons by then end of the 2009/2010 season. This represents an increase in sugar production of 77.22%. However, the company has sufficient capacity to generate production in excess of these targets. The analysts prudently assumed that this capacity would only be achieved by the end of the 2010/2011 season – one year later than management’s expectations. Historically, 63% of Tongaat Hulett’s revenue stream is generated from sugar production. It was therefore decided to extrapolate a 77.22% increase in the 63% portion of revenue generated by sugar production over 3 years. As it was estimated that approximately 17.63% of the 77.22% excess will be utilized by the end of 2009, the remaining portion of 50.97% of growth was allocated as 22.87% to 2010 and 2011 respectively. It is assumed that after this period of above average growth, the growth rate of revenue will revert to the long term sustainable growth rate of 7.53%. EBIT Margin The EBIT margin for 2009, from the period of January until June, amounts to 22.06%, up from 17.15% in 2008. Both these margins are significantly above the historical average. This can be attributed to the relatively cheap sugar production within Zimbabwe and Mozambique. With the capacity expansion within both these markets, the analysts believe this trend is expected to continue. However, it is prudently assumed that this trend is ultimately unsustainable, and for the purposes of the model a constant average margin of 19% is used. Net Investment in Fixed Assets Following a period of large capital investment in Mozambique and Zimbabwe, net investment in fixed assets is expected to decline in the next three to five years.

    Recommendation: BUY

    Target Share Price: R113.26

    Free cash flow to the Firm Model Estimate Estimate Estimate Estimate 2008 2009 2010 2011 2012 Revenue 7106000 8358840 9573855 10965482 11791183 Revenue growth% 11.12% 17.63% 14.54% 14.54% 7.53% EBIT Margin 17.15% 22.00% 21.00% 21.00% 21.00% EBIT 1,219,000 1,838,945 2,010,510 2,302,751 2,476,148 EBIT growth% N/A 50.86% 9.33% 14.54% 7.53% Tax Rate 28% 28% 28% 28% 28% Tax Expenditure -341,320 -514,905 -562,943 -644,770 -693,322 Depreciation 262,000 470,000 343,000 355,914 368,828 Net Investment in Fixed Assets 1,704,000 1,380,000 1,214,400 1,260,122 1,305,844 Change in Working Capital -83,000 167,000 115,615 119,974 124,332 Free Cash Flow to the Firm (FCFF) -481,320 247,040 460,552 633,799 721,478 FCFF/share -4.6618 2.3927 4.4607 6.1387 6.9879 #shares 103,247 Weighted Average Cost of Capital (WACC) 12.74%

    Terminal Growth Rate (g) 7.53%

    Intrinsic Value R 113.26

    WACC 12.74% Cost Of Debt (after tax) 9.70% Cost Of Equity 14.99% Beta 0.63 Market Risk Premium 12% Risk Free Rate(R153) 7.43% Interest Bearing Debt to Equity ratio 0.74 Long Term Sustainable Growth Rate 7.53%

    Source: Cavalry Holdings research, company data

    Source: Cavalry Holdings research, company data

    Source: Cavalry Holdings research, company data

  • CFA South Africa Investment Research 9/25/2009 Challenge Student Research


    Source: Cavalry Holdings research, company data