by Peter C. Thoms, CFA
This past May, while on an investment research trip to South Africa, I stopped into the Johannesburg offices of Calgro M3 Holdings to meet with the company's senior management. Calgro M3 is a mixed-use/integrated residential development company focused primarily on the affordable housing segment in South Africa. Founded in 1995, it trades on the JSE (Johannesburg Stock Exchange) under the symbolCGR.
We have been investors in Calgro M3 for a few years now—first through our private client accounts and more recently through our newly-launched Africa fund.
After an hour-long meeting with Calgro M3 CEO Ben Pierre Malherbe and Financial Director Wikus Lategan, I left highly confident that much growth remains ahead and attainable for Calgro M3 and that management has a solid plan in place both to mitigate industry risks and to capture opportunities resulting from the very large and growing housing shortage in South Africa.
Calgro M3's Business Model
Calgro M3's business model is to maintain at least 80% exposure to integrated or low-income development projects and a maximum of 20% exposure to the mid-to-high income segment. The company builds large-scale projects of affordable housing across South Africa and also in Windhoek, Namibia. The company endeavors to build integrated developments that incorporate health, education, municipal and sporting facilities. Roughly 4 million South African households fall into Calgro M3's market segment, and the housing shortage in this segment is estimated to be roughly 700,000 homes and growing by 100,000 homes per year.
Unlike pure builders, Calgro M3 owns the land upon which it builds, capturing value along the entire value chain from land procurement to financing to planning to infrastructure (roads, water, sewer, electric) to the construction and marketing of homes. The majority of construction is done in-house, but the company also outsources to subcontractors when necessary. The company's turnkey approach offers several advantages, including easier quality control and control over the pace of development. The company plans to keep all of the gross profit in these steps and aims for a 25% margin.
Massive (and Growing) Pipeline of Future Developments
Relative to its current size (revenue in the financial year that ended Feb. 28, 2015, was 932 million rand), Calgro M3 enjoys an immense backlog of 19.6 billion rand worth of projects that it expects to complete in the coming decade. Not only is this backlog about 20 times the company's current annual revenue, but it also continues to grow. In fiscal 2015, the secured backlog increased from 17 billion rand to 19 billion rand.
Mitigating Risk One very effective way the company minimizes risks to it admittedly capital-intensive business is that it does not build a house unless it has already been sold. One of the major risks the company faces as it embarks on a higher growth trajectory is risk in finding enough qualified staff. To this end management has identified and incentivized key staff members to stay at the company.
Financial Performance and Valuation In year ended February 28, 2015, Calgro M3 posted a 31.9% increase in headline earnings per share (HEPS) on a revenue increase of 18.7%. Return on equity was a strong 33.7% for the year and the company generated cash of 224 million rand before capital expenditures. Another support to the stock's valuation is that the company carries land in its financial statements at its cost of 550 million rand. However, external valuations have placed the true value of the company's land portfolio at closer to 1.4 billion rand. (This land value accounts for just over half of the stock's current valuation.)
The company also has a strong balance sheet with debt of 491 million rand and a current ratio of 1.45. In conclusion, we believe Calgro M3 remains a solid investment for us and for our fund investors. Even though it has been the best performing stock on the JSE for the last 5 years, we think that if management is able to continue to execute against the company's large opportunity that the stock still has substantial upside potential. Management has done an excellent job, in our view, and given that it owns about 36% of the company, we believe it is properly incentivized to execute well. Disclosure: The information contained herein reflects, as of the date hereof, the views of Africa Capital Group LLC and sources Africa Capital Group LLC believes to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein. In addition, there can be no guarantee that any projection, forecast or opinion in these materials will be realized. Past performance is neither indicative of, nor a guarantee of, future results.
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by Peter C. Thoms, CFA