Metair, but not met dividend

• South Africa
• Automotive, Corporate action, Dividend, Metair, Unbundling, Value investing
• October 1, 2020

There’s a lot going on at Metair, ranging from a cancelled dividend through to fascinating potential corporate actions. It’s worth spending some time learning about this company that supplies a range of automotive components through companies in South Africa and Eastern Europe.

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Declare. Defer. Defer again. Defend.

Back in March, Metair announced a gross dividend of 120 cents per share. The share price was already in freefall as investors panicked about pending lockdown, so it worked out to a dividend yield (dividend divided by share price) of just under 9%.

Sounds great, except the world blew up.

Later in March, the company announced that the dividend would be deferred to protect the company’s liquidity. In other words, the company got scared that they might need the cash to survive lockdown, so paying a dividend to shareholders wouldn’t make any sense.

A further deferral decision was made in August.

Since more than 120 business days have now elapsed since the dividend was declared, the Companies Act compels the Board to reapply the solvency and liquidity test before paying the dividend.

Without going into too much legal detail, this requires the Board to take a long, hard look at whether the company is in a strong enough financial position to pay the dividend, based on current values of assets and debts as well as cash available to pay further debts over the next 12 months.

If directors get it wrong and there is a dispute further down the line, there is nasty potential for personal liability. Needless to say, directors err on the side of caution in applying the solvency and liquidity test.

It’s therefore not overly surprising that the dividend has been cancelled altogether.

This is a blow to anyone who invested around the current share price of R18 per share, hoping for an immediate return of R1.20 as a dividend, but doesn’t change the long-term potential of the company. This is proven by the share price shrugging off the cancelled dividend.

Investors are clearly appreciative of a more conservative approach. After all, there isn’t much point in a dividend followed by a rights issue, is there?

Rombat, Mutlu and other things

At nearly R3.6bn market cap, Metair is a strong mid-cap player on the JSE with significant business interests in South Africa and Eastern Europe supplying a variety of automotive parts and batteries.

Subsidiaries include companies like Rombat and Mutlu – you are forgiven for thinking this sounds like an Aussie wildlife doccie. Management would’ve preferred a wildlife doccie to the horror movie that was lockdown.

Automotive manufacturing shut down in South Africa for weeks on end, severely hurting Metair’s business of supplying the likes of Ford and Mercedes-Benz with components ranging from wire harnesses to plastic and chrome-plated parts. Vehicle production volumes dropped more than 40% to end-June in South Africa.

The European businesses fared a lot better, with energy storage companies Mutlu and Rombat able to trade throughout the period, albeit with subdued demand. The benefit of supplying OEM as well as after-market batteries was felt during a time when new car sales nosedived globally.

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Which numbers matter?

Revenue was down -27.5% in the six months to end June 2020. Gross profit was down nearly -55% so it’s really no surprise that the company slipped into an operating loss. It’s painful reading compared to the operating profit of around R500m for the comparable period in 2019.

The bulk of the revenue pain was felt in South Africa (34.5% down) vs. the European businesses (15% down in Rand). The exchange rate exposures in Metair are complicated with several underlying currencies of relevance to the group, including other emerging market currencies. I personally wouldn’t rush to describe Metair as a Rand hedge.

To get an idea of the real story on the ground in Europe with no currency translations, Metair disclosed that operating profit in the European businesses was down around 80% in local currency. Not pretty, but also not reflective of the long-term fundamentals of the business.

Big changes are coming

The company has made it publicly known that the intention is to split the company into two. Although the South African and European interests are both linked to the automotive industry, the fundamentals are totally different and so are the country risk profiles.

The company believes that the two businesses will be worth more separately than together. This is because specialist investors or acquirers can be found for each business. For example, any investor taking a meaningful position in Metair in current form needs to get comfortable with the intricacies of several different markets all at once.

This is far greater hurdle than e.g. a Turkish investor taking a view on the European energy business without having to also invest in the South African business.

Metair has gotten the attention of so-called “value investors” who agree with management that the current share price is undervalued. It’s worth highlighting that Value Capital Partners is the largest shareholder with a 12% stake and representation on the board.

When Value Capital Partners is involved, action is on the horizon.

Metair made an attributable net profit of around R625m in 2019, implying a Price/Earnings multiple around 5.7x if we ignore the nightmare that is 2020. The share price is only down 22.7% this year which shows how investors have supported a through-the-cycle view.

I’ve seen analyst commentary that EBITDA could achieve a through-the-cycle (i.e. 2019 – 2022) compound annual growth rate (CAGR) of nearly 10%. That would be a decent result for shareholders.

Growth is being driven primarily by contracts in place with top automobile manufacturers who have taken advantage of one of the ANC’s few success stories: positioning South Africa as an attractive market for car manufacturing and export.

The balance sheet also looks ok under the circumstances, with the company still enjoying significant breathing space in its debt covenants.

The dividend cancellation is a prudent decision and the market has agreed with that view. The more important assessment is whether Metair will achieve its objective and create shareholder value by splitting the company up.

Much like cars, perhaps Metair is worth more when broken down into parts.

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