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Craig Martin on Calgro M3, a 27-bagger with more to come!

Calgro M3 Holdings Ltd (CGR) is a small-cap company in that is listed under the "Construction & Materials" sector of the JSE, which is enough information to have many investors shy away from the investment. However, they would have missed out on arguably one of the best performers on the JSE over the past four years. In April 2010, Calgro could have been picked-up for around 31c a share, today it trades at between 830-840cps. It has been at least a 27-bagger in just over four years.

Calgro is different to many of its listed peers. It is not involved in large construction of shopping centres, airports, stadiums, mining, road repairs and all those other areas that have proved challenging to its contemporaries in the sector.

The business model of the group is fairly simply in that it finds land at a good price and the proceeds to go through every stage of a housing development from feasibility to project management of civil infrastructure, services installation, town planning, marketing and finally the construction of homes. There developments are mostly based in Gauteng, but the Scottsdene project in the Western-Cape is also significant. Projects range across government funded housing, subsidised housing and fully bonded housing, but are predominantly focused on entry-level buyers or lower LSM markets.

The company came out with half-year results to the end of August and indicated that it has a pipeline of projects in excess of R17bn which is about 17 times their underlying inferred revenue. Calgro do hold their own land on many of its development, but they also develop on government owned land. Of the R17bn, approximately 1/3 of that revenue number will be from government-owned land and projects.

Calgro's share price over the last 3 years Rudi van Niekerk of Magnum Opus Investment Partners feels that "the South African housing backlog means there is huge demand which won't be satisfied for many years to come and that Calgro have the ability to grow the book beyond the pipeline of R17bn, which already offers growth opportunities for at least the next 5 to 6 years." He adds that "CEO, Ben Pierre Malherbe has indicated that they have other opportunities that might be better than what is in the current book, so much better that they are willing to pay the breakage penalties for walking away from some of the opportunities in the pipeline."

Keith McLachlan, Fund Manager at Alpha Wealth reminds us that "The margin being earned by Calgro during a project depends on which stage of the project the Group is working on (e.g. bulk services is much lower margin than top structures). At a Group-level, though, the Group has diverse mix of simultaneous running projects that both lowers the revenue concentration risk and results in a slightly more stable margin from reporting period to reporting period."

CEO, Ben Pierre Malherbe, has indicated that first-half saw a large amount of housing development which offered good margins of around 20%, but the next six months of the year margins are expected to decline from these levels as there will be less housing development and more preparatory work.

I have been sceptical of Calgro's ability to deliver purely because we have seen a number of smaller construction companies that also operated in the low-cost housing market, such as RBA Holdings and SeaKay fail. I asked Keith McLachlan what makes Calgro different, and he provided three solid differences.

"RBA and SeaKay both focussed on single sub-markets in the housing market (i.e. fully bonded and RDP housing respectively). Calgro focusses on a full range of housing from RDP all the way up to middle-to-high LSM housing. This means that the Group can focus on different sub-markets at different times depending on the market." "These former examples of failures did not have the same risk mitigation focus as Calgro has. For example, in the case of Calgro, houses are not built before they are sold (mitigating liquidity risk) and management can pull the majority of the Group's overheads within months if the economy turns down (mitigating solvency risk). Finally, RBA and SeaKay were under-capitalised.

Calgro is bigger, better financed and just simply has a better management team," concludes McLachlan. Rudi van Niekerk points out that the company also has "an attractive margin of safety thanks to significantly undervalued land carried on the balance sheet. Calgro carries land acquired for R550m at cost while the market value is in excess of R1.3bn, as per independent valuations. So the stated NAV is about R4 per share but if it is adjusted for the market value of the land NAV jumps to about R10 which is substantially higher than the present price of 830c-840cps." Keith McLachlan puts this NAV argument into perspective by saying that "Calgro M3 often does not buy development land until the related project is secured.

Rather, Calgro tends to buy options on potential development land (this spreads its capital further and, once again, lowers its risk). The combination of this and the ultimate capitalisation of land into inventory could well lead to an argument that NAV is understated. That said, I would argue that when investing in Calgro, you are not buying its underlying land or NAV, rather you are buying what it will do with the land. In other words, you are investing into the project pipeline, its execution and blue sky potential of the Group." On Friday (24 Oct) there was a SENS announcement regarding a new bond issue by the group, we asked McLachlan whether he should be concerned about this additional gearing and his response was, "no, I would consider Calgro M3 as possibly a bit ungeared as a property development business against some of its peers. Property development naturally draws down on a large amount of capital upfront that only turns into positive cash flow much later in the project cycle.

Having a diverse project portfolio at different stages of their project life cycles helps partially smooth cash flows over at Group-level." Van Niekerk adds, "many commentators are concerned about Calgro's gearing but IBD/Equity has actually decreased from 94% in the previous reporting period to 62% in the latest reporting period. They also have cash on hand of R167m so we are not too concerned about gearing." So the verdict seems to be that Calgro has a number of years' worth of growth left in it. It has already managed to achieve a respectable ROE over the past 3 years of 27% and recent growth in HEPS of 27%. It is on an undemanding historic PE of less than 9, which means that at forecast growth rates this is a share that can still be brought with some confidence.Craig Martin on Calgro M3, a 27-bagger with more to come!