Digging through the JSE dustbin
They say one man’s trash is another man’s treasure. It applies in the markets too.
Successful investing is about buying the right shares at the right price. End of story. It doesn’t help to overpay for even the best companies in the world. The markets exist because opinions differ on whether companies are trash or treasure. Often, it’s just a matter of timing.
As a reminder: the Nasdaq took around 15 years to fully recover from the Dot Com crash. Going “all-in” just before it crashed after the turn of the millennium was not a good strategy, no matter how many wise souls told you that market timing isn’t important.
It is important. Of course it is!
A few years ago, JSE investors were piling money into companies like Ascendis, EOH and Steinhoff. Now, they have all been relegated to the JSE dustbin, in some cases with their heads peaking out. Some may never make it out.
If you got into these companies at the wrong time, you will never get your money back. The end. Most of it is gone.
However, if you buy at the right time after they crash and burn, the profits can be remarkable. In this article, I touch on some of the polished turds currently available on the JSE and why investors are blocking their noses and persevering with them.
Before we get into the detail on some of these companies, I ran a sentiment poll on Twitter to see which of these companies people would invest in:
EOH came out tops, so let’s start there.
EOH: the collision of fraud and ambitious acquisitions
- Peak: July 2015; R172 per share
- Now: R7.34 per share
- 12-month return: 150%
- Do I hold shares? Yes
Down 95% from its peak in 2015 when people didn’t realise we were only halfway through this country’s Lost Decade, EOH is an interesting story.
After doing all kinds of dicey deals with the government, while acquiring any and every IT business that didn’t run away quickly enough, EOH fell off a cliff in 2017. Needless to say, there was a management shake-up and Stephen van Coller was appointed in September 2018 to try and fix the thing.
He joined a group with 272 legal entities and a fifth of its revenue from the public sector. That’s the perfect recipe for a compliance disaster in South Africa. To make his job even more exciting, EOH was also drowning under a R4.5bn debt pile.
Fast forward to 2021 and the debt is down to R2bn. Five of the eight “problematic” public sector contracts have been settled. The IP business, unfortunately with the juiciest margins in the group, is being disposed of to try settle the debt once and for all.
What the market didn’t appreciate is the latest trading statement’s total lack of detail on EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation), the key earnings metric that ignores the effect of debt on profits. The trading statement only gives details around net earnings, which is as helpful as trying to sell AfriForum merchandise at an EFF protest.
As is typical with these high-risk plays, the share price is volatile. In under two trading days last week, the price went from R7.41 down to around R6.90 before bouncing back to close at R7.34 on Friday. My in-price is around R8.30 and my thesis is that the share could return between 50% and 100% from these levels once the debt is sorted out.
The underlying EBITDA (which is now a mystery) was R500m based on previously available numbers, so a market cap of R1.3bn isn’t a big ask provided the IP businesses can be sold and the debt paid down.
However, I get very nervous when trading statements are low on critical details. EOH may well be the hill that I die on.
Ascendis Health: right at the bottom of the dustbin
- Peak: September 2016; R28 per share
- Now: 50 cents per share
- 12-month return: 22%
- Do I hold shares? No
Fondly referred to as “Descendis Health” by an ex-colleague of mine, I wrote on this company in detail earlier this month.
In a busy week for dustbin stocks, Descendis also released a trading statement. To give them absolute credit, it was really detailed. If anyone from EOH is reading this, kindly refer to the Ascendis SENS for a reference point on how to give your shareholders a feeling of transparency.
When a company is in this much trouble, net profit is basically pointless. A huge headline loss is expected because the company would likely go bankrupt without a debt restructure.
The critical line to analyse is EBITDA in the underlying companies in the group, which would form the basis of their valuations. These businesses need to be sold for cash or given to lenders in a debt-for-asset swap at market value i.e. handing over the keys to the best assets in exchange for settling the debt.
Years of outrageous balance sheet behaviour truly put the END in AsENDis. It’s just a matter of time until the lenders decide how to eat the cake.
Is all lost for shareholders? No, not necessarily. Although the market cap of R245m is tiny, a positive outcome to the debt restructure could result in a company that is worth two or three times that amount when all is said and done.
Or, it could be worthless. That’s the problem.
Ascendis is a desperate seller of assets and any prospective buyer would know that. Once you factor in the ruthless reputation of the private equity funds that have bought the debt in Ascendis, you realise how significant the risks are.
If you feel like rolling the dice at the JSE casino, this is probably the riskiest table right now.
Steinhoff: a season ticket to Dustbin Stadium
- Peak: March 2016 (noticing a pattern yet?); R97 per share
- Now: R2.25 per share
- 12-month return: 103%
- Do I hold shares? Yes
If you think lockdown has been going on for a long time, take a look at the extent of the pain in a Steinhoff share price chart. Here’s a five year chart from tradingview.com which is a favourite of mine:
From its abrupt and painful demise in December 2018, the share price kept dropping until April 2019 when there was nobody left to buy the dip.
If an investor bought in November and sold in December 2018, that person lost 80%. If another investor bought that poor soul out in December (“buying the dip”) and sold a few months later, the second person also lost 80%. Many dips. Much pain.
In the past few months though, there have been some signs of life in the old girl.
I must confess: I have not remotely attempted to understand the Steinhoff balance sheet and the intricate web off legal claims. I leave that to the CEO who appears to be earning very well for his efforts there as a glorified in-house counsel. Steinhoff is expected to pay around R16.5bn to settle legal claims.
Included in that amount are costs of over R500m in case you need a reminder of who makes money when this stuff happens (the lawyers and consultants).
I bought into the recent price action in the hope that perhaps the Reddit crowd would climb in, since they were discussing it on r/wallstreetbets. They didn’t, but I’m ok with hanging around to see what happens here. I put in a small amount relative to my portfolio – not by any means my proudest trade.
Tongaat: sometimes these trades do work
- Peak: November 2014; R173 per share
- Now: R10.50 per share
- 12-month return: 210%
- Do I hold shares? No
Of all the dustbin stocks, sugar company Tongaat Hulett is the sweetest. That’s the first and last pun I’ll use.
A victim of more accounting “issues” that left a very large hole in the balance sheet while shareholders were told they “shouldn’t rely on the accounts” and trading was suspended, Tongaat has richly rewarded shareholders who took a punt at the bottom.
The company is doing it the old-fashioned way too: by generating great results and paying down debt. In the interim period to September 2020, Tongaat smashed its debt in half to R6bn. The company recorded a 95% jump in operating profit.
Over this period, the company also had to deal with Barloworld trying everything possible to get out of its deal to buy the starch business from Tongaat. Tongaat’s CEO Gavin Hudson was having none of it and made sure Barloworld bought the asset they had agreed to buy.
Final comment: the turnaround CEOs never starve
Let’s start with Stephen van Coller at EOH. In the last financial year, he made R11.5m and notably turned down a R3m bonus that the board approved for him. Good man.
Mark Sardi at Ascendis also appears to have his head in the right place, paid just R3.6m for 9 months or so of the last financial year as he was appointed during that year. His predecessor had made R17.7m in the 2019 financial year so Sardi will probably come out at similar levels to van Coller for this financial year. We will only know when the remuneration report is released.
We don’t know yet what Tongaat CEO Gavin Hudson will be paid for the year to March 2021 for this incredible effort, but his remuneration in the 2020 financial year in round numbers was a cash package of R7.5m and turnaround incentives of R17.5m for a total package around the R25m mark.
Then we have the CEO of Steinhoff. Sit down for this one. Louis du Preez is being paid a cash package of over R60m. That’s more than the CEOs of EOH, Ascendis and Tongaat put together.
Honestly, some companies just never learn.