Eqstra Holdings Limited EQS.JSE
November 13, 2015 - 5:36pm EST by
bentley883
2015 2016
Price: 2.30 EPS 0.84 0.95
Shares Out. (in M): 397 P/E 2.7 2.4
Market Cap (in $M): 912 P/FCF 0 0
Net Debt (in $M): 7,316 EBIT 0 0
TEV ($): 8,228 TEV/EBIT 0 0

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Description

 

Overview

 

 

 

Eqstra Holdings Limited (EQS - JSE), a diversified equipment and logistics company based in South Africa, has sold off ~75% from its 24 month highs and is currently trading at extraordinarily cheap levels of 2.7x TTM core earnings and 2.4x our estimated forward earnings. The stock currently trades at R2.30 per share and we believe earnings can grow from R0.61 reported in FY15 to R1.50-R2.00/share in 2-3 years, equating to 400%-600% upside using very conservative PE multiples.

 


Generally these valuations only exist for companies that are near bankruptcy, which Eqstra is nowhere near.  In fact, Eqstra’s comps trade at very high earnings multiples because these businesses possess high quality, annuity-like recurring revenue. This obviously makes businesses like Eqstra (and its peers) more predictable and higher quality.  Eqstra is dramatically mispriced for two reasons. First, though Eqstra has only 15% of its pre-tax profit composed of contract mining, investors have inappropriately classified Eqstra as a mining business. Note, if the contract mining division  is accorded no value, we still come up with a stock price of more than double where Eqstra trades today. Second, Eqstra appears to be highly levered, but it actually has a very manageable debt load. Eqstra’s debt to equity is 2:1 while its peer group average is 4.5:1. Therefore, Eqstra is actually less levered than most of its peers, yet trades at ~1/4 their valuation.  We explain further below on why we believe Eqstra is significantly mispriced.

 

 

 

Why is it Mispriced?

 

 

 

Misunderstanding; Throwing The Baby Out With The Bathwater

 

 

 

The most significant reason for the mispricing is that EQS is covered by mining analysts and thus is lumped in as being a mining company, and as such, is valued inappropriately. Note, if the contract mining division is accorded no value, we still come up with a stock price of more than double where Eqstra trades today. The sell side ignores 85% of Eqstra’s business, which is a services-focused, diversified equipment and logistics company with annuity-like earnings and comps such as Avis and Hertz. Essentially, the sell side is comping all of Eqstra to very low quality contract mining businesses when they should be comping the majority of the company’s earnings streams to high quality leasing, distribution, and services businesses.

 

 

 

Mining is hated in South Africa.  If you read the South African business newspaper or watch South African business TV, you will see nothing but abhorrence for mining stocks.  This hatred has caused unreasonably low valuations, irrational selling and a substantial mispricing of Eqstra. This is a major reason why over the last 24 months, the shares have declined ~75% from their highs and appears to be a situation where investors are throwing the baby out with the bathwater.

 

 

 

To combat this severe misunderstanding, EQS’s management is likely to hire a PR firm and will begin a domestic and international roadshow to introduce the company to a different set of investors (including traveling to New York in December). We believe more investor attention could be a catalyst for the stock to rerate. We think Eqstra is simply too cheap to remain at these levels for long. 

 

 

 

Knowledge Gap

 

 

 

What investors are focused on, versus what is actually occurring at Eqstra are extremely different. Sell-side coverage following the recent September 1st FY15 earnings announcement missed several key points:

 

  • Even though they are already less levered then their peers, Eqstra is transitioning to an asset-light model, which will significantly benefit profitability, interest/debt, cash flow, and growth capital;
  • R120m after tax benefit in low hanging fruit redeploying idle equipment (~R.31 after tax per share)
  • Neither management nor the sell side normalized Eqstra’s results for a one-time impairment charge in the second half, and thus did not show that the company generated R0.47/share in EPS in the second half of the year, or a run rate of R0.94/share in annualized EPS (putting the shares at 2.4x normalized earnings).

 

 

 

Misinformation by Financial Media

 

 

 

Based on reviewing local media reports, we believe investors do not have a clear picture of what is happening at Eqstra. For example, the financial media recently reported that Eqstra was looking to do a rights offering (they are not) and that Eqstra was recapitalizing its contract mining business (they are shrinking their contract mining business). Both of these reports are false: EQS has no plans for a rights offering and they are actually shrinking their contract mining business (redeploying idle assets is not recapitalizing). Additionally, we suspect the Eqstra “expert” who reported this information works for a fund that might be short the stock and is thus spreading false rumors.

 

 

 

Background & Business Overview

 

 

 

EQS is composed of three decentralized divisions: Industrial Equipment (IE), Fleet Management & Logistics (FM&L) and Contract Mining & Plant Rental (CM&PR). 

 

 

 

The two most significant divisional profit contributors, IE and FM&L, each hold a leadership position in its industry in terms of its asset base and each have a commanding market share in most of their product areas. Also, both divisions are recurring revenue annuity-like businesses which create revenue and earnings visibility that allow EQS’s higher leverage levels. The following tables highlight the fiscal 2015 contribution from each division to EQS overall and illustrate the historical operating model of the company.

 

 

 

Eqstra Holdings Limited

FY2015 Divisional Contribution

 

 

 

 

 

Revenue

EBITDA

EBT

Industrial Equipment

32%

28%

40%

Fleet Management & Logistics

26%

39%

47%

Contract Mining & Plant Rental

43%

33%

15%

 

 

 

Eqstra Holdings Limited

 

Divisional Operating Breakdown

 

 

 

 

 

 

 

Revenues:

2012

2013

2014

2015

 

Industrial Equipment

2,411

2,708

3,037

3,045

 

  growth %

 

12.3%

12.1%

0.3%

 

Fleet Management & Logistics

2,180

2,362

2,796

2,482

 

  growth %

 

8.3%

18.4%

-11.2%

 

Contract Mining & Plant Rental

3,707

4,223

4,515

4,094

 

  growth %

 

13.9%

6.9%

-9.3%

 

Corporate

(155)

(204)

(370)

(158)

 

  Total Revenues

8,143

9,089

9,978

9,463

 

  growth %

 

11.6%

9.8%

-5.2%

 

 

 

 

 

 

 

EBITDA:

 

 

 

 

 

Industrial Equipment

539

640

785

872

 

  %

22.4%

23.6%

25.8%

28.6%

 

Fleet Management & Logistics

991

984

1,105

1,198

 

  %

45.5%

41.7%

39.5%

48.3%

 

Contract Mining & Plant Rental

1,111

1,267

1,112

1,015

 

  %

30.0%

30.0%

24.6%

24.8%

 

Corporate

(4)

(17)

3

(14)

 

  Total EBITDA

2,638

2,875

3,006

3,072

 

  %

32.4%

31.6%

30.1%

32.5%

 

 

 

 

 

 

 

EBT:

 

 

 

 

 

Industrial Equipment

134

145

153

161

 

Fleet Management and Logistics

216

155

182

190

 

Contract Mining and Plant Rental

159

210

(22)

59

 

Corporate

29

(8)

21

(12)

 

  Total Net Profit Before Tax

538

502

334

398

 

 

 

 

 

 

 

Extraordinary Charges

(50)

(16)

(65)

(97)

 

 

 

 

 

 

 

EBT

488

486

269

301

 

Taxes

111

78

18

47

 

Net Income (including e/o charges)

377

408

251

254

 

 

 

 

 

 

 

Shares Out. (fd)

            426.1

            402.9

            396.3

            396.6

 

EPS (including e/o charges)

R 0.88

R 1.00

R 0.61

R 0.61

 

EPS (x- e/o charges)

R 0.77

R 1.04

R 0.77

R 0.79

 

 

 

 

 

 

 

Note: EBT excludes e/o charges, EPS from continuing ops.

 

 

 

 

 

EQS is in the midst of partnering off its loan books to South African banks to de-lever its balance sheet over the next 12-18 months, further de-risking the business and providing a huge opportunity for growth. Eqstra’s balance sheet optically appears to be levered, but this is simply a business model consistent with leasing companies. As highlighted in the following table, Eqstra is less levered than peers.

 

 

 

Comparative Analysis - Leverage Ratios

Global Fleet Management & Industrial Equipment Companies

       
   

Leverage

Fleet Management:

Stock

Debt/Cap.

Debt/Equity

Avis Budget Group

CAR - NYSE

95.8%

2256.5%

AMERCO

UHAH - NASDAQ

53.9%

116.8%

Barloworld

BAW - JSE

45.2%

82.4%

Europcar Group S.A.

EUCAR - ENXTPA

81.5%

441.8%

Hertz Global Holdings

HTZ - NYSE

87.7%

710.5%

Imperial Holdings

IPL-JSE

47.7%

91.3%

Ryder Systems

R - NYSE

73.6%

279.2%

       

Industrial Equipment:

     

Invica Holdings

IVT - JSE

59.6%

147.4%

Neff Corp.

NEFF - NASDAQ

132.2%

N/A

Rocky Mountain Dealerships

RME - TSE

71.6%

251.7%

Tat Holdings Ltd.

T03 - SGX

44.5%

80.1%

       

  Group Average

 

72.1%

445.8%

       

Eqstra Group

EQS - JSE

66.6%

199.5%

 

 

 

 

 

Industrial Equipment (IE)

 

Since 1984, the IE division has been leasing and renting mobile capital equipment (e.g., forklifts, heavy trucks, aerial platforms) as well as offering value added services for the materials-handling, industrial, construction, and mining sectors. The IE division operates primarily in South Africa with additional operations in some surrounding countries and the UK. Forklifts are the division’s leading product, with South African forklift products accounting for 55% of IE’s divisional revenues, and UK forklift products providing an additional 19%. Within South Africa’s forklift market, EQS is the leading vendor with 35% share of the market.

 

 

 

Over the last few years, the IE division has grown market share in South Africa and expanded organically and via acquisition in the UK. EBITDA has been growing due to a focus on efficiency improvements, an increased mix of services, a restructuring of contracts, and the elimination of less profitable product lines. The division aims to more than double its profitability by 2020.

 

 

 

Fleet Management and Logistics (FM&L)

 

The FM&L division has over 30 years of experience offering leases, rentals, and value-added services in South Africa. EQS is the leading vendor of fleet management services in South Africa with a market share of roughly 25%. By leasing assets and providing non-capital intensive services, the division generates a high-margin, annuity-type revenue stream.  FM&L’s services include accident management, fuel management, insurance and vehicle tracking, full maintenance leases, operating leases, long-term rentals, and driver management. In addition to these traditional fleet management products, the division offers customized value added services including service scheduling, downtime management, onsite and remote servicing of vehicles, roadside assistance, tire management, replacement vehicles, accident repairs, and integrated fleet reporting.

 

 

 

Lack of access to additional capital restricted growth in Fleet Management, obscuring a record that historically had healthy, long-term growth prospects. Of Eqstra’s three divisions, FM&L enjoys the highest EBITDA margins. In FY15, EBITDA margins rose to a record high of ~48% due to increasing the level of services in the revenue mix, and implementing new cost reduction measures.

 

 

 

One of these measures is the implementation of “Quest,” a new proprietary ERP-based fleet management system, which a very innovative CTO spent five years and R200m to develop. This system should yield further efficiency gains and position the division as the premier, low-cost provider of integrated fleet management solutions. Management expects a 25% IRR on their Quest investment, or roughly 66m in PBT annually. This should partially kick in during this fiscal year and fully in FY17.

 

 

 

Contract Mining

 

While we do not need to equate any value to contract mining for Eqstra to be substantially undervalued, we still want do discuss the segment so investors understand the optionality if this business recovers and/or if new management is successful in implementing some of its initiatives. The contract mining division has one of the largest opencast contract-mining equipment fleets in South Africa. As such, this division has the capability to provide all opencast mining requirements to customers, including blasting, drilling, loading, hauling, rehabilitation and rental of heavy earth moving equipment. The division’s value chain is composed of value-added mining services, equipment rental/leasing, and sales of capital equipment at the end of its useful life. Scale gives the contract mining division a huge advantage over peers and therefore the division has contracts with many of the leading worldwide mining companies. Eqstra is well diversified across many different commodities.

 

 

 

Poor management, a lack of focus, and lower commodity prices depressed contract mining’s financial results in the past two years. In January, Justin Colling was brought in as the new contract mining division CEO. He is one of the most well respected contract mining CEO’s in the world, and has made significant financial improvements in the business. We believe he is just getting started.  While we do not have a view on commodity prices, this division’s success is not dependent on rising commodity prices; rather, success will require Colling blocking and tackling some fairly simple issues.

 

 

 

Key Points on a Positive View of EQS’ Shares

 

 

 

Transitioning to an asset-light business model should improve profitability and cash flow, thereby reducing leverage.

 

 

 

In July 2015, Eqstra’s CFO Jan Sefontein took the reins as CEO. The board felt the company was not getting an adequate return on its assets and the prior CEO was hesitant to disrupt the company’s normal operations by shifting to an asset-light model, so we view Sefontein’s promotion as a positive as it will accelerate Eqstra’s shift to an asset light model. 

 

 

 

Perhaps the most important impact of transitioning to an asset-light model will be the significant reduction in overall debt, which should then halve EQS’s interest expense. Instead of taking on the risk and debt of funding the asset book for product leasing/rental in its IE and FM&L divisions as well as the equipment used in its CM&PR division, Eqstra is removing this debt from their books by partnering with their banking/financial partners. Reducing overall debt should provide new opportunities for significant growth, because EQS’s growth in the past was restricted by a lack of access to capital. Management should have the leasing book partially partnered by March 2016 and fully completed by June 2016. Therefore, we will see some of the results in this fiscal year and all of the results in the next fiscal year, leading to a step function in earnings over the next two years. As illustrated below, we estimate potential savings of ~R300m from disposing the IE and FM&L loan books and repaying higher costs South African debt as well as from a re-rating of the remaining debt. Under this scenario, EBITDA/interest coverage will more than double from ~5x to ~10x+.  

 

 

 

Projected Interest Savings

From Disposing Loan Books

 

 

 

 

 

 

Interest

Interest

 

R (Mil's)

Rate

Costs

SA Debt

5,932

9.4%

555

ROW Debt

1,587

6.2%

98

  Total Debt

7,519

8.7%

653

 

 

 

 

Disposal of Loan Books

(3,000)

 

 

 

 

 

 

SA Debt

2,932

9.4%

274

ROW Debt

1,587

6.2%

98

  Total Debt

4,519

8.2%

372

 

 

 

 

Re-rating of SA Debt

 

-1.0%

(29)

 

 

 

 

SA Debt

2,932

8.4%

245

ROW Debt

1,587

6.2%

98

  Total Debt

4,519

7.6%

343

 

 

 

 

Total Savings

 

 

310

 

 

 

Illustrated below is an estimate of the pro-forma impact of disposing a portion of the loan books of the IE & FM&L businesses. From a high level, the reduction in revenues is more then offset by lower interest and D&A charges, yielding about a 48% increase in net income and EPS. We used reported earnings in this table, but keep in mind that normalized earnings are much higher than reported earnings.

 

 

 

Pro-Forma Impact Of Disposal Of Loan Books On FY15 Results

R in millions, except per share

 

 

 

 

 

 

Reported

Adjustments

Adjusted

% Chg.

Total Revenues

9,463

(1,267)

8,196

-13.4%

 

 

 

 

 

Operating Expenses

6,378

(138)

6,240

-2.2%

%

67.4%

 

76.1%

 

D&A

2,034

(894)

1,140

-44.0%

%

21.5%

 

13.9%

 

 

 

 

 

 

Operating Income

1,050

 

815

-22.4%

%

11.1%

 

9.9%

 

 

 

 

 

 

Interest & Other

653

(405)

248

-62.0%

Special Charge

97

 

97

 

 

 

 

 

 

EBT

300

 

470

56.6%

%

3.2%

 

5.7%

 

Taxes

47

48

95

102.1%

Tax Rate

15.6%

 

20.2%

 

Net Income

253

 

375

48.1%

 

 

 

 

 

Shares Out.

396.6

 

396.6

 

EPS

R 0.64

 

R 0.95

48.1%

 

 

 

Additionally, transitioning to an asset-light model will make the company less capital intensive, so cap-ex requirements will be reduced. When combined with increased profitability, this change will translate into increased cash flow.

 

 

 

Deploying idle assets in CM&PR division should add significant gains to earnings.

 

 

 

When Justin Colling came in as divisional CEO in CM&PR, his biggest initiative was to put idle equipment back to work. In the last FY, this idle equipment cost Eqstra R160M in EBT. We estimate by the next FY there will be no idle equipment and we will see the entire benefit of that R160M in EBT. Colling has already reduced idle equipment from R750M to ~R300M through gaining numerous large new contracts and is well on his way to further lowering that number.

 

 

 

The contract mining division is rebounding significantly from recent improvements. CM&PR reported a R24m EBT loss in the 6 month period (1H) ending June 2014, EBT turned profitable in 1H of FY2015 and increased to R53m in the 2H of the year. Worth noting, this rise in profitability occurred without the benefit of increased commodity prices.

 

 

 

If the CM&PR is successful in deploying all of its idle equipment and producing revenues, EBT profitability in the division should approximate R300m. This would represent a significant improvement over the R59m profit (before a R97m impairment charge) that the division achieved in FY15. Looking out further into the future, Colling believes it is possible that the division can increase EBT profitability to ~R500m even with commodity prices at current levels. If we see a commodity upswing, he thinks EBT will be even higher, approaching the R500m-1b range. While we put no weight in those numbers, we simply view it as a free option we are not paying for.

 

 

 

Selling Benga assets should reduce uncertainty and raise cash.

 

 

 

The contract mining division is in late-stage negotiations to sell one of its largest assets, which is a huge positive because it will further shrink the contract mining business as well as provide a significant injection of capital into the business. We estimate the sale of this asset will bring in about R600m. As the Benga asset has been an open issue of uncertainty, a favorable resolution would bolster investment sentiment.

 

 

 

Tangible Earnings Power Of R1.50-R2.00 Per Share

 

 

 

As discussed above, a number of factors should increase Eqstra’s earnings power over the next 18-24 months. First, transitioning to an asset-light business model will decrease interest expense by 300M. Management estimates that partnering off its loan books should reduce debt levels from R5.6b to about R4.0 to R4.5b, resulting in annual interest savings of ~R300m. Second, management also indicated that successful deployment of idle equipment could reduce CM&PR costs by ~R225m. Additionally, CM&PR’s R97m asset impairment charge booked in FY15 should not recur. Third, selling Benga assets could provide additional interest savings or growth capital.

 

 

 

The table below provides a conservative estimate of EQS’s earnings power. We made the following assumptions to devise this conservative estimate: a no growth sales environment (this is not management’s expectation), no improvement in commodity prices, and a 28% tax rate. Using these assumptions, the three factors delineated above increase Eqstra’s earnings power by R622m in EBT, R448m in net income, and R1.13 per share in incremental earnings compared to the FY15 reported numbers. This puts total earnings power around R1.75 per share, or in the middle of our R1.50-R2.00 per share estimate of earnings power.  

 

 

 

Eqstra Earning Power Calculation

 

 

 

 

R million's

EPS

FY 15 Net Income

254

 R          0.64

 

 

 

Asset Impairment

97

 R          0.18

Interest Savings

300

 R          0.54

Standing Equipment

225

 R          0.41

 

 

 

Total EPS Power

876

 R          1.77

 

 

 

Note: Assumes 28% SA tax rate.

 

 

 

 

While revenue growth has been constrained recently due to capital conservation measures, this setback should abate as the business model transition continues and cash flows improve. Additionally, the divisional managers in each of Eqstra’s three divisions have articulated tangible growth opportunities. With revenue growth a key component of EQS’s 2020 business plan, there could be upside to the above midpoint estimate of R1.75 per share. Given some improvement in available growth capital, earnings power could extend to the upper end of our estimated range, approaching R2.00 per share.

 

 

 

Management Recently Buying Stock, Shows Its Confidence

 

 

 

One of the qualities we, and many other investors, seek in a potential investment opportunity is management that personally buys into the company’s story and puts their money where their mouth is. Since June, EVERY SINGLE member of Eqstra’s senior management have been aggressively purchasing shares. These purchases were at share prices higher than current levels, with the average at ~R2.80 per share. From our perspective, it seems clear that management has a high level of confidence in the business outlook.

 

 

 

Valuation

 

 

 

The shares are well below comparable peers; attractive on the basis of just its services business, while getting contract mining for free

 

 

 

We believe EQS’s shares are attractive on both an absolute and relative basis. Based upon trailing 12-month results, the shares are currently valued at only about 2.7x EBITDA and a P/E of 2.9x core operating earnings. This valuation is attractive for a company with market leadership and high-quality, high ROIC annuity-like earnings streams. Despite having somewhat comparable margins, EQS’s valuation is significantly below other comparable diversified, industrial equipment and service-oriented companies in South Africa and globally, especially on a P/E basis. Analyzing EQS on a relative basis just using current financial results, one could easily make the case that the shares should sell at a valuation of at least double its current level.

 

 

 

Comparative Analysis - Profitability & Valuation Multiples

Global Fleet Management, Industrial Equipment & Mining Companies

             
   

Profitability

 

Valuation

Fleet Management:

Stock

EBITDA

EBT

 

EV/EBITDA

P/E

Avis Budget Group

CAR - NYSE

13.5%

11.6%

 

15.0

13.1

AMERCO

UHAH - NASDAQ

35.8%

24.1%

 

8.4

19.0

Barloworld

BAW - JSE

10.0%

6.2%

 

4.5

9.3

Europcar Group S.A.

EUCAR - ENXTPA

12.9%

11.6%

 

15.2

15.3

Hertz Global Holdings

HTZ - NYSE

9.9%

6.6%

 

15.6

21.3

Imperial Holdings

IPL-JSE

7.6%

4.9%

 

6.1

12.7

Ryder Systems

R - NYSE

26.6%

9.8%

 

5.2

15.2

  Group Average

 

16.6%

10.7%

 

10.0

15.1

             

Industrial Equipment:

           

Invica Holdings

IVT - JSE

10.9%

9.7%

 

10.7

8.2

Neff Corp.

NEFF - NASDAQ

28.0%

25.4%

 

7.0

8.2

Rocky Mtn. Dealerships

RME - TSE

4.3%

3.6%

 

13.1

8.6

Tat Holdings Ltd.

T03 - SGX

14.4%

-0.6%

 

9.8

N/M

  Group Average

 

14.4%

9.5%

 

10.2

8.3

             

Mining & Minerals:

           

Basil Read

BSL-JSE

1.9%

N/A

 

3.9

3.9

Freeport - McMoRan

FCX - NYSE

31.2%

8.9%

 

5.5

8.7

Oz Minerals Ltd.

OZI - ASX

44.0%

11.6%

 

2.5

12.8

Rio Tinto

RIO - ASX

34.1%

22.7%

 

5.7

13.0

South 32 Ltd.

S32 - ASX

16.0%

4.2%

 

4.3

14.2

  Group Average

 

25.4%

9.5%

 

4.4

10.5

             

  Average All Companies

18.8%

10.7%

 

8.3

12.2

             

Eqstra Group

EQS - JSE

32.4%

4.2%

 

2.7

3.1

 

 

 

With 85% of Eqstra’s EBT profits  coming  from the IE and FM&L divisions, the value of its shares should be more consistent with other diversified global services companies with annuity-like business models. As illustrated in the table below, the financials from both the IE and FM&L divisions, when combined, show outstanding profitability relative to the above comparables.

 

 

 

FY15 Earnings From IE and FM&L Divisions

 

 

 

 

 

 

IE

FM&L

Corp.

Combined

Revenues

3,045

2,482

 

5,527

EBITDA

872

1,198

(14)

2,056

%

28.6%

48.3%

 

37.2%

EBT

161

190

(12)

339

%

18.5%

15.9%

 

16.5%

Taxes @ 28%

45

53

 

95

Net Income

116

137

 

244

 

 

 

 

 

Shares Out.

396.6

396.6

 

396.6

EPS

R 0.29

R 0.34

 

R 0.62

 

 

 

 

 

Valuation:

 

 

 

 

EV/EBITDA

 

 

 

4.1

P/E

 

 

 

4.5

 

 

 

 

 

Note: Assumed 28% SA corporate tax rate

 

 

 

 

 

Despite the superior margins/profitability that IE and FM&L generate, EQS has a valuation well below its peers if one values the company on just these two businesses (and excluding the contract mining profits). Valuing the annuity-like profitability streams of these two divisions at a P/E of only 8x-9x (still a healthy discount to its peers) ttm earnings of R0.61 (which includes the full corporate overhead and the higher South African corporate tax rate) translates into a valuation of ~R5.00-5.50 per share, which is +120%-140% higher than the current share price. Keep in mind, global peers trade at ~15x earnings and thus our 8-9x is very conservative. To be clear, this ascribes absolutely no value to the profitable CM&PR business. Thus, on ttm results, Eqstra’s shares should be double the current levels and investors would end up with the CM&PR operations for free. We think we have a heavy dose of conservatism in our numbers.

 

 

 

Looking toward the next 18-24 months, we believe Eqstra has earnings power of ~R1.50 to R2.00 per share. It seems very likely that when these earnings materialize, the multiple will expand rapidly as investors re-value the shares. Assuming a P/E of only 6x-7x of the entire earnings stream, EQS could reach a share price of ~R9.00-R14.00. This represents upside of 4-6x the current R2.30 share price.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • EQS’s management is likely to hire a PR firm and will begin a domestic and international roadshow to introduce the company to a different set of investors (including traveling to New York in December).
  • The sale of the company's Benga assets, which will likey bring in ~R600m.
  • Success in begining to partner off the IE and FM&L loan books, which will reduce the company's leverage.
  • A further reduction in putting idle equipment back to work, which will increase CM&PR pofitiability.
  • The roll out of the company's "Quest" new proprietary ERP-based fleet management system in the FM&L division, which should imcrease profitability.
  • Posting further semi-annual improvement to EBITDA and EPS (we believe management will not be breaking out core earnings, excluding extraordinary items).
    sort by    

    Description

     

    Overview

     

     

     

    Eqstra Holdings Limited (EQS - JSE), a diversified equipment and logistics company based in South Africa, has sold off ~75% from its 24 month highs and is currently trading at extraordinarily cheap levels of 2.7x TTM core earnings and 2.4x our estimated forward earnings. The stock currently trades at R2.30 per share and we believe earnings can grow from R0.61 reported in FY15 to R1.50-R2.00/share in 2-3 years, equating to 400%-600% upside using very conservative PE multiples.

     


    Generally these valuations only exist for companies that are near bankruptcy, which Eqstra is nowhere near.  In fact, Eqstra’s comps trade at very high earnings multiples because these businesses possess high quality, annuity-like recurring revenue. This obviously makes businesses like Eqstra (and its peers) more predictable and higher quality.  Eqstra is dramatically mispriced for two reasons. First, though Eqstra has only 15% of its pre-tax profit composed of contract mining, investors have inappropriately classified Eqstra as a mining business. Note, if the contract mining division  is accorded no value, we still come up with a stock price of more than double where Eqstra trades today. Second, Eqstra appears to be highly levered, but it actually has a very manageable debt load. Eqstra’s debt to equity is 2:1 while its peer group average is 4.5:1. Therefore, Eqstra is actually less levered than most of its peers, yet trades at ~1/4 their valuation.  We explain further below on why we believe Eqstra is significantly mispriced.

     

     

     

    Why is it Mispriced?

     

     

     

    Misunderstanding; Throwing The Baby Out With The Bathwater

     

     

     

    The most significant reason for the mispricing is that EQS is covered by mining analysts and thus is lumped in as being a mining company, and as such, is valued inappropriately. Note, if the contract mining division is accorded no value, we still come up with a stock price of more than double where Eqstra trades today. The sell side ignores 85% of Eqstra’s business, which is a services-focused, diversified equipment and logistics company with annuity-like earnings and comps such as Avis and Hertz. Essentially, the sell side is comping all of Eqstra to very low quality contract mining businesses when they should be comping the majority of the company’s earnings streams to high quality leasing, distribution, and services businesses.

     

     

     

    Mining is hated in South Africa.  If you read the South African business newspaper or watch South African business TV, you will see nothing but abhorrence for mining stocks.  This hatred has caused unreasonably low valuations, irrational selling and a substantial mispricing of Eqstra. This is a major reason why over the last 24 months, the shares have declined ~75% from their highs and appears to be a situation where investors are throwing the baby out with the bathwater.

     

     

     

    To combat this severe misunderstanding, EQS’s management is likely to hire a PR firm and will begin a domestic and international roadshow to introduce the company to a different set of investors (including traveling to New York in December). We believe more investor attention could be a catalyst for the stock to rerate. We think Eqstra is simply too cheap to remain at these levels for long. 

     

     

     

    Knowledge Gap

     

     

     

    What investors are focused on, versus what is actually occurring at Eqstra are extremely different. Sell-side coverage following the recent September 1st FY15 earnings announcement missed several key points:

     

     

     

     

    Misinformation by Financial Media

     

     

     

    Based on reviewing local media reports, we believe investors do not have a clear picture of what is happening at Eqstra. For example, the financial media recently reported that Eqstra was looking to do a rights offering (they are not) and that Eqstra was recapitalizing its contract mining business (they are shrinking their contract mining business). Both of these reports are false: EQS has no plans for a rights offering and they are actually shrinking their contract mining business (redeploying idle assets is not recapitalizing). Additionally, we suspect the Eqstra “expert” who reported this information works for a fund that might be short the stock and is thus spreading false rumors.

     

     

     

    Background & Business Overview

     

     

     

    EQS is composed of three decentralized divisions: Industrial Equipment (IE), Fleet Management & Logistics (FM&L) and Contract Mining & Plant Rental (CM&PR). 

     

     

     

    The two most significant divisional profit contributors, IE and FM&L, each hold a leadership position in its industry in terms of its asset base and each have a commanding market share in most of their product areas. Also, both divisions are recurring revenue annuity-like businesses which create revenue and earnings visibility that allow EQS’s higher leverage levels. The following tables highlight the fiscal 2015 contribution from each division to EQS overall and illustrate the historical operating model of the company.

     

     

     

    Eqstra Holdings Limited

    FY2015 Divisional Contribution

     

     

     

     

     

    Revenue

    EBITDA

    EBT

    Industrial Equipment

    32%

    28%

    40%

    Fleet Management & Logistics

    26%

    39%

    47%

    Contract Mining & Plant Rental

    43%

    33%

    15%

     

     

     

    Eqstra Holdings Limited

     

    Divisional Operating Breakdown

     

     

     

     

     

     

     

    Revenues:

    2012

    2013

    2014

    2015

     

    Industrial Equipment

    2,411

    2,708

    3,037

    3,045

     

      growth %

     

    12.3%

    12.1%

    0.3%

     

    Fleet Management & Logistics

    2,180

    2,362

    2,796

    2,482

     

      growth %

     

    8.3%

    18.4%

    -11.2%

     

    Contract Mining & Plant Rental

    3,707

    4,223

    4,515

    4,094

     

      growth %

     

    13.9%

    6.9%

    -9.3%

     

    Corporate

    (155)

    (204)

    (370)

    (158)

     

      Total Revenues

    8,143

    9,089

    9,978

    9,463

     

      growth %

     

    11.6%

    9.8%

    -5.2%

     

     

     

     

     

     

     

    EBITDA:

     

     

     

     

     

    Industrial Equipment

    539

    640

    785

    872

     

      %

    22.4%

    23.6%

    25.8%

    28.6%

     

    Fleet Management & Logistics

    991

    984

    1,105

    1,198

     

      %

    45.5%

    41.7%

    39.5%

    48.3%

     

    Contract Mining & Plant Rental

    1,111

    1,267

    1,112

    1,015

     

      %

    30.0%

    30.0%

    24.6%

    24.8%

     

    Corporate

    (4)

    (17)

    3

    (14)

     

      Total EBITDA

    2,638

    2,875

    3,006

    3,072

     

      %

    32.4%

    31.6%

    30.1%

    32.5%

     

     

     

     

     

     

     

    EBT:

     

     

     

     

     

    Industrial Equipment

    134

    145

    153

    161

     

    Fleet Management and Logistics

    216

    155

    182

    190

     

    Contract Mining and Plant Rental

    159

    210

    (22)

    59

     

    Corporate

    29

    (8)

    21

    (12)

     

      Total Net Profit Before Tax

    538

    502

    334

    398

     

     

     

     

     

     

     

    Extraordinary Charges

    (50)

    (16)

    (65)

    (97)

     

     

     

     

     

     

     

    EBT

    488

    486

    269

    301

     

    Taxes

    111

    78

    18

    47

     

    Net Income (including e/o charges)

    377

    408

    251

    254

     

     

     

     

     

     

     

    Shares Out. (fd)

                426.1

                402.9

                396.3

                396.6

     

    EPS (including e/o charges)

    R 0.88

    R 1.00

    R 0.61

    R 0.61

     

    EPS (x- e/o charges)

    R 0.77

    R 1.04

    R 0.77

    R 0.79

     

     

     

     

     

     

     

    Note: EBT excludes e/o charges, EPS from continuing ops.

     

     

     

     

     

    EQS is in the midst of partnering off its loan books to South African banks to de-lever its balance sheet over the next 12-18 months, further de-risking the business and providing a huge opportunity for growth. Eqstra’s balance sheet optically appears to be levered, but this is simply a business model consistent with leasing companies. As highlighted in the following table, Eqstra is less levered than peers.

     

     

     

    Comparative Analysis - Leverage Ratios

    Global Fleet Management & Industrial Equipment Companies

           
       

    Leverage

    Fleet Management:

    Stock

    Debt/Cap.

    Debt/Equity

    Avis Budget Group

    CAR - NYSE

    95.8%

    2256.5%

    AMERCO

    UHAH - NASDAQ

    53.9%

    116.8%

    Barloworld

    BAW - JSE

    45.2%

    82.4%

    Europcar Group S.A.

    EUCAR - ENXTPA

    81.5%

    441.8%

    Hertz Global Holdings

    HTZ - NYSE

    87.7%

    710.5%

    Imperial Holdings

    IPL-JSE

    47.7%

    91.3%

    Ryder Systems

    R - NYSE

    73.6%

    279.2%

           

    Industrial Equipment:

         

    Invica Holdings

    IVT - JSE

    59.6%

    147.4%

    Neff Corp.

    NEFF - NASDAQ

    132.2%

    N/A

    Rocky Mountain Dealerships

    RME - TSE

    71.6%

    251.7%

    Tat Holdings Ltd.

    T03 - SGX

    44.5%

    80.1%

           

      Group Average

     

    72.1%

    445.8%

           

    Eqstra Group

    EQS - JSE

    66.6%

    199.5%

     

     

     

     

     

    Industrial Equipment (IE)

     

    Since 1984, the IE division has been leasing and renting mobile capital equipment (e.g., forklifts, heavy trucks, aerial platforms) as well as offering value added services for the materials-handling, industrial, construction, and mining sectors. The IE division operates primarily in South Africa with additional operations in some surrounding countries and the UK. Forklifts are the division’s leading product, with South African forklift products accounting for 55% of IE’s divisional revenues, and UK forklift products providing an additional 19%. Within South Africa’s forklift market, EQS is the leading vendor with 35% share of the market.

     

     

     

    Over the last few years, the IE division has grown market share in South Africa and expanded organically and via acquisition in the UK. EBITDA has been growing due to a focus on efficiency improvements, an increased mix of services, a restructuring of contracts, and the elimination of less profitable product lines. The division aims to more than double its profitability by 2020.

     

     

     

    Fleet Management and Logistics (FM&L)

     

    The FM&L division has over 30 years of experience offering leases, rentals, and value-added services in South Africa. EQS is the leading vendor of fleet management services in South Africa with a market share of roughly 25%. By leasing assets and providing non-capital intensive services, the division generates a high-margin, annuity-type revenue stream.  FM&L’s services include accident management, fuel management, insurance and vehicle tracking, full maintenance leases, operating leases, long-term rentals, and driver management. In addition to these traditional fleet management products, the division offers customized value added services including service scheduling, downtime management, onsite and remote servicing of vehicles, roadside assistance, tire management, replacement vehicles, accident repairs, and integrated fleet reporting.

     

     

     

    Lack of access to additional capital restricted growth in Fleet Management, obscuring a record that historically had healthy, long-term growth prospects. Of Eqstra’s three divisions, FM&L enjoys the highest EBITDA margins. In FY15, EBITDA margins rose to a record high of ~48% due to increasing the level of services in the revenue mix, and implementing new cost reduction measures.

     

     

     

    One of these measures is the implementation of “Quest,” a new proprietary ERP-based fleet management system, which a very innovative CTO spent five years and R200m to develop. This system should yield further efficiency gains and position the division as the premier, low-cost provider of integrated fleet management solutions. Management expects a 25% IRR on their Quest investment, or roughly 66m in PBT annually. This should partially kick in during this fiscal year and fully in FY17.

     

     

     

    Contract Mining

     

    While we do not need to equate any value to contract mining for Eqstra to be substantially undervalued, we still want do discuss the segment so investors understand the optionality if this business recovers and/or if new management is successful in implementing some of its initiatives. The contract mining division has one of the largest opencast contract-mining equipment fleets in South Africa. As such, this division has the capability to provide all opencast mining requirements to customers, including blasting, drilling, loading, hauling, rehabilitation and rental of heavy earth moving equipment. The division’s value chain is composed of value-added mining services, equipment rental/leasing, and sales of capital equipment at the end of its useful life. Scale gives the contract mining division a huge advantage over peers and therefore the division has contracts with many of the leading worldwide mining companies. Eqstra is well diversified across many different commodities.

     

     

     

    Poor management, a lack of focus, and lower commodity prices depressed contract mining’s financial results in the past two years. In January, Justin Colling was brought in as the new contract mining division CEO. He is one of the most well respected contract mining CEO’s in the world, and has made significant financial improvements in the business. We believe he is just getting started.  While we do not have a view on commodity prices, this division’s success is not dependent on rising commodity prices; rather, success will require Colling blocking and tackling some fairly simple issues.

     

     

     

    Key Points on a Positive View of EQS’ Shares

     

     

     

    Transitioning to an asset-light business model should improve profitability and cash flow, thereby reducing leverage.

     

     

     

    In July 2015, Eqstra’s CFO Jan Sefontein took the reins as CEO. The board felt the company was not getting an adequate return on its assets and the prior CEO was hesitant to disrupt the company’s normal operations by shifting to an asset-light model, so we view Sefontein’s promotion as a positive as it will accelerate Eqstra’s shift to an asset light model. 

     

     

     

    Perhaps the most important impact of transitioning to an asset-light model will be the significant reduction in overall debt, which should then halve EQS’s interest expense. Instead of taking on the risk and debt of funding the asset book for product leasing/rental in its IE and FM&L divisions as well as the equipment used in its CM&PR division, Eqstra is removing this debt from their books by partnering with their banking/financial partners. Reducing overall debt should provide new opportunities for significant growth, because EQS’s growth in the past was restricted by a lack of access to capital. Management should have the leasing book partially partnered by March 2016 and fully completed by June 2016. Therefore, we will see some of the results in this fiscal year and all of the results in the next fiscal year, leading to a step function in earnings over the next two years. As illustrated below, we estimate potential savings of ~R300m from disposing the IE and FM&L loan books and repaying higher costs South African debt as well as from a re-rating of the remaining debt. Under this scenario, EBITDA/interest coverage will more than double from ~5x to ~10x+.  

     

     

     

    Projected Interest Savings

    From Disposing Loan Books

     

     

     

     

     

     

    Interest

    Interest

     

    R (Mil's)

    Rate

    Costs

    SA Debt

    5,932

    9.4%

    555

    ROW Debt

    1,587

    6.2%

    98

      Total Debt

    7,519

    8.7%

    653

     

     

     

     

    Disposal of Loan Books

    (3,000)

     

     

     

     

     

     

    SA Debt

    2,932

    9.4%

    274

    ROW Debt

    1,587

    6.2%

    98

      Total Debt

    4,519

    8.2%

    372

     

     

     

     

    Re-rating of SA Debt

     

    -1.0%

    (29)

     

     

     

     

    SA Debt

    2,932

    8.4%

    245

    ROW Debt

    1,587

    6.2%

    98

      Total Debt

    4,519

    7.6%

    343

     

     

     

     

    Total Savings

     

     

    310

     

     

     

    Illustrated below is an estimate of the pro-forma impact of disposing a portion of the loan books of the IE & FM&L businesses. From a high level, the reduction in revenues is more then offset by lower interest and D&A charges, yielding about a 48% increase in net income and EPS. We used reported earnings in this table, but keep in mind that normalized earnings are much higher than reported earnings.

     

     

     

    Pro-Forma Impact Of Disposal Of Loan Books On FY15 Results

    R in millions, except per share

     

     

     

     

     

     

    Reported

    Adjustments

    Adjusted

    % Chg.

    Total Revenues

    9,463

    (1,267)

    8,196

    -13.4%

     

     

     

     

     

    Operating Expenses

    6,378

    (138)

    6,240

    -2.2%

    %

    67.4%

     

    76.1%

     

    D&A

    2,034

    (894)

    1,140

    -44.0%

    %

    21.5%

     

    13.9%

     

     

     

     

     

     

    Operating Income

    1,050

     

    815

    -22.4%

    %

    11.1%

     

    9.9%

     

     

     

     

     

     

    Interest & Other

    653

    (405)

    248

    -62.0%

    Special Charge

    97

     

    97

     

     

     

     

     

     

    EBT

    300

     

    470

    56.6%

    %

    3.2%

     

    5.7%

     

    Taxes

    47

    48

    95

    102.1%

    Tax Rate

    15.6%

     

    20.2%

     

    Net Income

    253

     

    375

    48.1%

     

     

     

     

     

    Shares Out.

    396.6

     

    396.6

     

    EPS

    R 0.64

     

    R 0.95

    48.1%

     

     

     

    Additionally, transitioning to an asset-light model will make the company less capital intensive, so cap-ex requirements will be reduced. When combined with increased profitability, this change will translate into increased cash flow.

     

     

     

    Deploying idle assets in CM&PR division should add significant gains to earnings.

     

     

     

    When Justin Colling came in as divisional CEO in CM&PR, his biggest initiative was to put idle equipment back to work. In the last FY, this idle equipment cost Eqstra R160M in EBT. We estimate by the next FY there will be no idle equipment and we will see the entire benefit of that R160M in EBT. Colling has already reduced idle equipment from R750M to ~R300M through gaining numerous large new contracts and is well on his way to further lowering that number.

     

     

     

    The contract mining division is rebounding significantly from recent improvements. CM&PR reported a R24m EBT loss in the 6 month period (1H) ending June 2014, EBT turned profitable in 1H of FY2015 and increased to R53m in the 2H of the year. Worth noting, this rise in profitability occurred without the benefit of increased commodity prices.

     

     

     

    If the CM&PR is successful in deploying all of its idle equipment and producing revenues, EBT profitability in the division should approximate R300m. This would represent a significant improvement over the R59m profit (before a R97m impairment charge) that the division achieved in FY15. Looking out further into the future, Colling believes it is possible that the division can increase EBT profitability to ~R500m even with commodity prices at current levels. If we see a commodity upswing, he thinks EBT will be even higher, approaching the R500m-1b range. While we put no weight in those numbers, we simply view it as a free option we are not paying for.

     

     

     

    Selling Benga assets should reduce uncertainty and raise cash.

     

     

     

    The contract mining division is in late-stage negotiations to sell one of its largest assets, which is a huge positive because it will further shrink the contract mining business as well as provide a significant injection of capital into the business. We estimate the sale of this asset will bring in about R600m. As the Benga asset has been an open issue of uncertainty, a favorable resolution would bolster investment sentiment.

     

     

     

    Tangible Earnings Power Of R1.50-R2.00 Per Share

     

     

     

    As discussed above, a number of factors should increase Eqstra’s earnings power over the next 18-24 months. First, transitioning to an asset-light business model will decrease interest expense by 300M. Management estimates that partnering off its loan books should reduce debt levels from R5.6b to about R4.0 to R4.5b, resulting in annual interest savings of ~R300m. Second, management also indicated that successful deployment of idle equipment could reduce CM&PR costs by ~R225m. Additionally, CM&PR’s R97m asset impairment charge booked in FY15 should not recur. Third, selling Benga assets could provide additional interest savings or growth capital.

     

     

     

    The table below provides a conservative estimate of EQS’s earnings power. We made the following assumptions to devise this conservative estimate: a no growth sales environment (this is not management’s expectation), no improvement in commodity prices, and a 28% tax rate. Using these assumptions, the three factors delineated above increase Eqstra’s earnings power by R622m in EBT, R448m in net income, and R1.13 per share in incremental earnings compared to the FY15 reported numbers. This puts total earnings power around R1.75 per share, or in the middle of our R1.50-R2.00 per share estimate of earnings power.  

     

     

     

    Eqstra Earning Power Calculation

     

     

     

     

    R million's

    EPS

    FY 15 Net Income

    254

     R          0.64

     

     

     

    Asset Impairment

    97

     R          0.18

    Interest Savings

    300

     R          0.54

    Standing Equipment

    225

     R          0.41

     

     

     

    Total EPS Power

    876

     R          1.77

     

     

     

    Note: Assumes 28% SA tax rate.

     

     

     

     

    While revenue growth has been constrained recently due to capital conservation measures, this setback should abate as the business model transition continues and cash flows improve. Additionally, the divisional managers in each of Eqstra’s three divisions have articulated tangible growth opportunities. With revenue growth a key component of EQS’s 2020 business plan, there could be upside to the above midpoint estimate of R1.75 per share. Given some improvement in available growth capital, earnings power could extend to the upper end of our estimated range, approaching R2.00 per share.

     

     

     

    Management Recently Buying Stock, Shows Its Confidence

     

     

     

    One of the qualities we, and many other investors, seek in a potential investment opportunity is management that personally buys into the company’s story and puts their money where their mouth is. Since June, EVERY SINGLE member of Eqstra’s senior management have been aggressively purchasing shares. These purchases were at share prices higher than current levels, with the average at ~R2.80 per share. From our perspective, it seems clear that management has a high level of confidence in the business outlook.

     

     

     

    Valuation

     

     

     

    The shares are well below comparable peers; attractive on the basis of just its services business, while getting contract mining for free

     

     

     

    We believe EQS’s shares are attractive on both an absolute and relative basis. Based upon trailing 12-month results, the shares are currently valued at only about 2.7x EBITDA and a P/E of 2.9x core operating earnings. This valuation is attractive for a company with market leadership and high-quality, high ROIC annuity-like earnings streams. Despite having somewhat comparable margins, EQS’s valuation is significantly below other comparable diversified, industrial equipment and service-oriented companies in South Africa and globally, especially on a P/E basis. Analyzing EQS on a relative basis just using current financial results, one could easily make the case that the shares should sell at a valuation of at least double its current level.

     

     

     

    Comparative Analysis - Profitability & Valuation Multiples

    Global Fleet Management, Industrial Equipment & Mining Companies

                 
       

    Profitability

     

    Valuation

    Fleet Management:

    Stock

    EBITDA

    EBT

     

    EV/EBITDA

    P/E

    Avis Budget Group

    CAR - NYSE

    13.5%

    11.6%

     

    15.0

    13.1

    AMERCO

    UHAH - NASDAQ

    35.8%

    24.1%

     

    8.4

    19.0

    Barloworld

    BAW - JSE

    10.0%

    6.2%

     

    4.5

    9.3

    Europcar Group S.A.

    EUCAR - ENXTPA

    12.9%

    11.6%

     

    15.2

    15.3

    Hertz Global Holdings

    HTZ - NYSE

    9.9%

    6.6%

     

    15.6

    21.3

    Imperial Holdings

    IPL-JSE

    7.6%

    4.9%

     

    6.1

    12.7

    Ryder Systems

    R - NYSE

    26.6%

    9.8%

     

    5.2

    15.2

      Group Average

     

    16.6%

    10.7%

     

    10.0

    15.1

                 

    Industrial Equipment:

               

    Invica Holdings

    IVT - JSE

    10.9%

    9.7%

     

    10.7

    8.2

    Neff Corp.

    NEFF - NASDAQ

    28.0%

    25.4%

     

    7.0

    8.2

    Rocky Mtn. Dealerships

    RME - TSE

    4.3%

    3.6%

     

    13.1

    8.6

    Tat Holdings Ltd.

    T03 - SGX

    14.4%

    -0.6%

     

    9.8

    N/M

      Group Average

     

    14.4%

    9.5%

     

    10.2

    8.3

                 

    Mining & Minerals:

               

    Basil Read

    BSL-JSE

    1.9%

    N/A

     

    3.9

    3.9

    Freeport - McMoRan

    FCX - NYSE

    31.2%

    8.9%

     

    5.5

    8.7

    Oz Minerals Ltd.

    OZI - ASX

    44.0%

    11.6%

     

    2.5

    12.8

    Rio Tinto

    RIO - ASX

    34.1%

    22.7%

     

    5.7

    13.0

    South 32 Ltd.

    S32 - ASX

    16.0%

    4.2%

     

    4.3

    14.2

      Group Average

     

    25.4%

    9.5%

     

    4.4

    10.5

                 

      Average All Companies

    18.8%

    10.7%

     

    8.3

    12.2

                 

    Eqstra Group

    EQS - JSE

    32.4%

    4.2%

     

    2.7

    3.1

     

     

     

    With 85% of Eqstra’s EBT profits  coming  from the IE and FM&L divisions, the value of its shares should be more consistent with other diversified global services companies with annuity-like business models. As illustrated in the table below, the financials from both the IE and FM&L divisions, when combined, show outstanding profitability relative to the above comparables.

     

     

     

    FY15 Earnings From IE and FM&L Divisions

     

     

     

     

     

     

    IE

    FM&L

    Corp.

    Combined

    Revenues

    3,045

    2,482

     

    5,527

    EBITDA

    872

    1,198

    (14)

    2,056

    %

    28.6%

    48.3%

     

    37.2%

    EBT

    161

    190

    (12)

    339

    %

    18.5%

    15.9%

     

    16.5%

    Taxes @ 28%

    45

    53

     

    95

    Net Income

    116

    137

     

    244

     

     

     

     

     

    Shares Out.

    396.6

    396.6

     

    396.6

    EPS

    R 0.29

    R 0.34

     

    R 0.62

     

     

     

     

     

    Valuation:

     

     

     

     

    EV/EBITDA

     

     

     

    4.1

    P/E

     

     

     

    4.5

     

     

     

     

     

    Note: Assumed 28% SA corporate tax rate

     

     

     

     

     

    Despite the superior margins/profitability that IE and FM&L generate, EQS has a valuation well below its peers if one values the company on just these two businesses (and excluding the contract mining profits). Valuing the annuity-like profitability streams of these two divisions at a P/E of only 8x-9x (still a healthy discount to its peers) ttm earnings of R0.61 (which includes the full corporate overhead and the higher South African corporate tax rate) translates into a valuation of ~R5.00-5.50 per share, which is +120%-140% higher than the current share price. Keep in mind, global peers trade at ~15x earnings and thus our 8-9x is very conservative. To be clear, this ascribes absolutely no value to the profitable CM&PR business. Thus, on ttm results, Eqstra’s shares should be double the current levels and investors would end up with the CM&PR operations for free. We think we have a heavy dose of conservatism in our numbers.

     

     

     

    Looking toward the next 18-24 months, we believe Eqstra has earnings power of ~R1.50 to R2.00 per share. It seems very likely that when these earnings materialize, the multiple will expand rapidly as investors re-value the shares. Assuming a P/E of only 6x-7x of the entire earnings stream, EQS could reach a share price of ~R9.00-R14.00. This represents upside of 4-6x the current R2.30 share price.

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

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