Top Ten Small Caps

Exert below is from June 2019 letter to investors (link) where I touch on high-level commentary around our top ten small cap investments. Where applicable, I have inserted links to other articles or resources for further reading:

Datatec Ltd (code: DTC) – Datatec’s turnaround of its Westcon International continues to gain traction in, what we believe, is the build-up to the final sale of this subsidiary and the value-unlocking return of this capital to its shareholders. In the background and equally important, Logicalis continues to grow as a global ICT services group. From our portfolio’s perspective, all this uplift is being generated independently of South Africa and is not dependent on local politics, Eskom or macro-data to drive upside. If anything, a weaker local currency creates more upside in this hard currency play. [LINK]

Hosken Consolidated Investments (code: HCI) – Trading around a thirty percent discount to its listed sum-of-the-parts, HCI continues to steadily unlock value across its diverse portfolio. The recent unbundling of the hotels business from the casino business (Tsogo Sun Hotels from Tsogo Sun Gaming) is yet another step in the right direction. Beyond these listed assets, the Group’s unlisted investments—particularly the investment in Impact Oil & Gas—are increasingly valuable while management’s capital allocation track record provides further comfort. In a way, HCI offers the blue-sky upside of any return to growth in South Africa while giving us the margin of safety of investing in this exposure through a massive holding company discount and on a relatively diverse manner. [LINK]

Coronation Fund Managers (code: CML) – With a share price trading on a historical and, likely, forward dividend yield that is above cash (i.e. > c.5.75%), Coronation offers a uniquely high returning (its Return on Equity is over 50%!) option on either a recovery in Emerging Markets and/or a recovery specifically in South Africa. Preferably both. Given the share’s current below-mean valuation against its Assets Under Management (AUM) and the relative transparency with which we can track its performance (i.e. via its underlying funds), we are being paid to wait in this investment and getting any recovery free.

Adcock Ingram Holdings (code: AIP) – Adcock Ingram is a highly-profitable, well-branded pharmaceutical and healthcare product business with defensive, high-margin underlying, a large and winning public sector underpin and an ungeared balance sheet offering acquisition, dividend and/or share buy-back optionality. More recently, the fast-approaching BEE deal unwind should shift Bidvest (code: BVT) into a controlling position at the Group. This may precede an offer to minorities (at an attractive premium; we estimate a low-end price of c.7500cps) and the ultimate delisting of the stock. Either route we stand to gain on this relatively under-priced, defensive security while earnings a c.3.2% dividend yield. [LINK]

Stor-Age Property REIT (code: SSS) – The self-storage property asset class offers a diversified income (lots of little tenants instead of a few large ones) with real asset underpin (if a tenant does not pay, their stored property can be sold to claw-back rental owed) that is very defensive in nature (consumers tend to cling to their material possessions). Any investment in self-storage has high barriers to entry given that the properties cannot be pre-tenants (i.e. tenants sign before the property is built) and new properties carry speculative risk until enough tenants have been signed to reach break-even. This background coupled with the fact that Stor-Age Property REIT compares attractively against the few global peers that exist on profitability, gearing, qualitative (e.g. internal ManCo) and valuation metrics provide the basis for our investment in what we believe is a defensive and undervalued REIT currently offering a fast-growing 7.4% dividend yield. [LINK]

Master Drilling Group (code: MDI) – A global pioneer with a fleet that is multiples the size of the nearest competition, Master Drilling is not a South African business. Rather, we view it as a global, industrial technology play leading in the field of hard rock and commodity drilling services that should diversify (read: boost drill rig average utilisation) across territories (¾ of their revenues is already ex-South Africa) & commodities, drilling services (read: addition of horizontal and main shaft) and even industry (read: construction, hydro-electric, amongst others). As an absolutely special asset, Master Drilling is the definition of a South African-listed small cap stocks that is not South African and should not be trading on such a low Price Earnings as 7.4x. Our risk is that management and/or private capital agree with our view and delist the stock. Sure, this will likely be at a premium to its current share price, but it will mean that we won’t participate in the Group’s future. [LINK]

Sabvest -N- (code: SVN) – Sabvest is currently trading at a large discount to its majority unlisted and seemingly conservatively valued investment portfolio. We expect the collapse of the -N- and Ord structure into a single share class to boost liquidity and further lower this discount. Indeed, management incentives now include the share’s discount to its own NAV. Finally, the Group’s unlisted portfolio is quite attractive with a very strong Rand Hedge element protecting it. Even after a large investment holding discount and a non-controlling discount (due to the -N- shares), we still estimate that Sabvest -N- shares are trading on a c.37% discount to their fair value. [LINK]

Sirius Real Estate (code: SRE) – Sharing some of the same characteristics that make Stor-Age REIT attractive, Sirius plays exclusively in the German property space. While the Group does have some long-lease, single-tenant properties, the Group’s real edge comes in buying industrial parks with large void (i.e. vacant space that is unlikely to ever be tenanted, and hence is not charged for in a property transaction) and then developing good margin, tenantable smart space (office, industrial, logistics or storage) that the Group then tenants efficiently. The uplift in both rental and value of the property is potentially material while the in-house platform managing the tenanting and leases captures material margin (as opposed using external agents). Lowering our exposure to South Africa while offering a Euro-based, fast-growing yield, Sirius provides growth, diversification and long-term upside to the portfolio in a well-positioned counter.

Wescoal Holdings (code: WSL) – At Wescoal’s current Free Cash Flow (FCF) Yield of c.33%, we are paying for about 3 years of mine life. Once you work through the detail, though, Wescoal has a current average 6-year Life of Mine (LoM) and several longer-life green- and brownfields projects that should add materially to this. There is also a profitable coal trading business that we are getting free. Eskom’s sustainability and the general pressure to “go green” remain risks to the longer-term Group, but given the valuation, we are not paying for this longer-term. Anything beyond ‘Year 3’ is a bonus at this valuation. An argument may be against the Group’s capital allocation, its capex requirements or its rehabilitation provision (note: The Group does continuous rehabilitation as it mines, thus this last argument appears factually incorrect), but the current cash flows are quite real as are management’s intention to launch a material share buy-back programme to return surplus cash flows to shareholders. We are cognizant of the risks of junior (coal) mining but we believe that the rewards far (far) outweigh these risks. In every way imaginable, this is a contrarian investment: a South African junior miner in the coal space. Such compounded negative sentiment often emotionally misprices assets and, hopefully, we stand to gain from this inefficiency. [LINK]

Santova Logistics (code: SNV) – Well-regarded Super Group (code: SPG) recently acquired a local, asset-intensive logistics business on a forward Price Earnings of 8.1x (naturally, this is a lower PE than Super Group’s share’s own PE). This acquisition is roughly the same size as Santova’s market cap. As opposed this 2/3PL business that Super Group acquired, Santova is a 4PL non-asset based, globally-trading (c.60% of earnings outside of South Africa) logistics provider. And Santova is currently trading on a historical PE of only 5.8x. Why? For no reason that we can see. We genuinely believe that Santova is a well-run, globally competitive and sustainably growing logistics service provider. Our risk is that companies like Super Group realize this and—as with a range of our above investments—someone delists it. Yes, we will get a short-term pay-out from such an action, but we will lose the option on the long-term growth that such a business can deliver. [LINK]

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