Phantom Shares: The party trade is here

• South Africa
• Connect Group, Distell, MTN, Net1, Net1, The Foschini Group, Truworths
• November 8, 2021

Phantom Shares is my weekly summary of the more interesting stories and themes from the prior week on the JSE. It is first published in the Daily Maverick 168 newspaper on a Saturday and then in Business Maverick each Monday. It is reproduced here with the permission of Daily Maverick.

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The party trade is upon us

If Covid stays away, we are in for a big summer in South Africa. Pent-up demand for the jol is strong. You can feel the buzz in the air as we get closer to December.

If you don’t believe this thesis, you can just refer to Distell’s results. There’s a lot of noise in the numbers from alcohol bans and civil unrest of course, but the underlying theme is clear: South Africans love drinking.

Distell doesn’t disclose exact revenue growth numbers. South African growth is “in the thirties” in the latest quarter and group revenue growth is “in the twenties” – both of which are worthy of a toast for investors.

Fascinatingly, the group highlights demand for Savanna Premium Cider as a major driver of growth. It’s dry and a lot of people seem to drink it.

South Africa still lags in online shopping

When retailers like Truworths and The Foschini Group (TFG) release results, it presents a great opportunity to compare online shopping adoption in Africa to regions like the UK and Australia. Retailers talk about “sales participation” which means the percentage of total sales attributable to a specific product (e.g. shoes) or channel (e.g. online).

We can’t isolate South Africa unfortunately, as the retailers generally give commentary for Africa as a whole. South Africa is typically the bulk of these segments though, so we can still draw meaningful conclusions from the numbers.

In Truworths, online retail contributed 3% of sales in Africa. Interestingly, TFG reports the same online participation in Africa of 3%. In the UK, Truworths reports online participation of 45.5% while TFG reports 43%. TFG gives us an additional data point in Australia, with participation of 17.8%.

The high online adoption in the UK is part of why that market is so tough for clothing retailers. Last-mile delivery costs are expensive and customers love ordering clothes online and then returning them. Online sales can be margin-dilutive unless there are incredible systems in place.

South Africa is a long way off these numbers, especially in clothing. Ironically, that’s probably good news for local retailers.

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MTN – to the moon?

MTN has been one of the market darlings this year. If you had foretold this prophecy to people a few years ago, they would’ve laughed at you.

The horrors of Nigerian fines and major cash flow pressures are all but forgotten. MTN has its first investment grade debt rating from S&P since 2016. If the balance sheet has strengthened that much, you can imagine how happy the equity investors feel.

In the wake of the pandemic, higher commodity prices have been a major boost for important African economies. This has created wealth in those regions and improved the fiscal balance sheets. This has helped MTN repatriate funds from countries like Nigeria. In the latest quarter alone, MTN upstreamed R4.6 billion from its operating companies, of which R2.3 billion was from Nigeria.

The growth in data and FinTech is helping to drive strong revenue and margin performances. Much like we are seeing in tech companies overseas, MTN is improving its EBITDA margin while posting impressive double-digit revenue growth. The EBITDA margin is now 45%, a blend of regions like South Africa at 41.6% and Nigeria at 52.6%.

The big question is: can it keep going?

MTN has guided that capex investment in 2021 will be R31.1 billion, a direct response to the opportunities presented by growth in demand for data. With a focus on products like merchant payments and insurance and a population that is increasingly doing everything on smartphones, the sky may well be the limit for MTN.

The share price is up more than 125% in 2021 alone.

All the buzzwords

Net1 is buying Connect Group for R3.7 billion. The announcement used every buzzword except “metaverse” in trying to convince investors that a forward EV/EBITDA multiple of 12.8x is reasonable.

Connect Group offers FinTech (I warned you) services to micro, small and medium enterprises. The total addressable market (there we go again) in South Africa is 700,000 formal businesses of this size and a further 1.4 million informal businesses.

Buzzwords aside, the business is growing quickly. The three-year revenue CAGR is 30% and the operating profit CAGR is 40%. It’s always good to see a faster growth rate in operating profit than in revenue, as this means that expenses are growing at a slower rate than revenue.

The funding of the deal is complicated, with a combination of debt, existing cash reserves and a deferred issue of shares. There’s a significant retention mechanism planned for key Connect Group employees, which makes the deal even more expensive for Net1.

Shareholders of Net1 seemed to like it though, sending the share price 13.5% higher on the day. At such a lofty multiple, the business will need to perform.

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