Behind Tongaat Hulett’s souring value
Investors on the JSE, sadly, are becoming accustomed to profit-performance shocks from companies that have long been regarded as blue-chip or solid second-line stocks.
Still, most market watchers were left aghast at developments at agribusiness giant Tongaat Hulett — which revolves operationally around large sugar and starch operations, with its sprawling property holdings in prime land near Durban considered to be a huge performance sweetener.
Tongaat, once part of the old Anglo American empire, has always been regarded as one of the stalwarts of the JSE’s food sector.
But after a shock trading update rattled the market late last month, Tongaat’s status as an appetising long-term food sector investment is being seriously interrogated.
Only 18 months ago Tongaat was in the same league as other well-regarded food conglomerates, including Pioneer Foods and RCL Foods. Today there is incredulous realisation that Tongaat — with a market capitalisation of about R4bn — is worth considerably less than fishing company Oceana Group.
In fact, Tongaat now holds a market capitalisation less than that of recently listed Libstar (R5.3bn), and is roughly the same size as other recently listed enterprises like Rhodes Food Group and Clover.
Such comparisons might convince wide-eyed punters that Tongaat, currently suffering from the vagaries of the sugar market, must be well-priced for recovery over the medium term.
Perhaps not … there are several issues that could bedevil sentiment for Tongaat for the immediate future.
The critical issues are restoring management trust and quickly easing an uncomfortable debt burden.
Rebuilding market trust in the executive team is probably the most urgent task.
The latest trading update warns of earnings collapsing by 250% and crashing deep into the red. It strongly suggests that the previous executive team, led by long-serving CEO Peter Staude, sugarcoated some harsh realities — especially around sustainable profits in the property segment. In fact, the last missive from the old executive team suggested — at the release of the interim results — that Tongaat Hulett expected an improved cash-flow performance in the second half of the financial year.
New CEO Gavin Hudson, who officially took the helm at the start of February, had the unenviable task of delivering his first formal assessment of Tongaat’s performance while on the back foot.
Former longtime Tongaat shareholder Chris Logan, the CEO of Opportune Investments, says newcomer Hudson has shattered the unsustainable illusion created by his predecessor.
"As painful as this may be, it is the basis of moving forward … While Tongaat now has a no-nonsense CEO who believes in transparency and is moving with commendable speed, Hudson has inherited a truly dire situation."
The big picture is that sugar yields increasingly poor results for Tongaat. This is unfortunate since the group has spent about R12bn of capital expenditure on sugar since 2008.
Logan notes that R12bn capex equates to three times Tongaat’s current market cap of R4bn and is roughly double the comparable depreciation on sugar over this period.
Recently released results for the six months to end-December from RCL Foods confirm that local sugar producers are not in a sweet spot at all. RCL reported that earnings before interest, tax, depreciation and amortisation for its sugar division dropped almost 70% to R63.5m "at an unacceptable margin" of 2.2% (previously 7.1%).
While sugar production volumes increased by 12.7%, RCL noted that balancing supply and demand in the local market remained challenging due to reduced domestic sugar consumption and the continued impact of imports.
RCL said domestic sugar consumption was affected by both financial pressure on consumers and declines in consumption brought about by the implementation of the health promotion levy (sugar tax). The group said market estimates indicated the sugar tax had reduced domestic consumption by up to 10% of annual industry production, or 200,000t a year.
Tongaat will clearly feel the pinch, with property sales no longer able to mask the bitter sugar yield. And it’s not only that property activity is grinding to a halt — some market watchers are worried there is also a possibility that some past land sales will be reversed.
Logan says the market missed the fact that the group’s huge land sales were totally unsustainable as the property development pipeline was filled up to overflowing. "An illusion was created, by taking the profit on these sales through operating profit, that they were sustainable. These were not and, of course, we now know that these land sales were also on credit and at risk of being reversed."
Tongaat’s land sales peaked at R1.65bn in 2016 — making up almost 67% of operating profit in that year.
In the interim period to end-September, land sales were a paltry R28m, realising an operating loss of R30m. In the previous interim period, land sales reached R705m with operating profit coming in at R441m. In the financial year to end-March 2018, land sales topped R1bn and yielded profit of R661m.
The latest trading update confirmed shareholders’ worst fears, with Hudson disclosing that — though negotiations continue — no further land sales have been concluded since the end of September last year.
Hudson indicated that land sales where debtors have not performed had been terminated, which means Tongaat is now looking for "alternative customers and replacement sales".
In other words, shareholders should probably not hold their breath for any short-term property windfalls.
The most important admission was that a thorough review of the land portfolio is under way. This open-ended statement has already sparked some interesting speculation with suggestions that the Public Investment Corp, Tongaat’s largest shareholder, should acquire the real estate.
That seems highly unlikely. But no doubt other property development entities would be interested in parts of the land portfolio, especially since it is a reasonably good time to bid with the property market, in general, not looking too chipper and Tongaat urgently needing to deal with its claustrophobic debt levels.
There are even renewed calls for Tongaat to split the property segment from the traditional sugar and starch operations — something which would not only renew operational focus but arguably also optimise opportunities for deal-making in both segments.
The problem for Hudson and his executive team is divining whether it’s more prudent to let go chunks of "shovel-ready" land to ease debt, or hold onto the bulk of the real estate in the hope that the property development cycle turns.
Some market watchers believe it is near impossible to sell land without a discounted price tag, especially north of Durban, at this delicate stage.
In the trading update, Hudson, noting Tongaat’s high debt levels and interest cost, said advisers had been appointed and that the group had entered into discussions with lenders.
At the end of September, Tongaat’s long-term debt was R51.bn and its short-term borrowings R5.6bn. Accounting for cash on hand of R2.9bn, the net debt for the group sat at a hefty R7.8bn at the end of September.
When the year-end results are released in May, most eyes will be on the borrowings line.
Already shareholders seem resigned that Tongaat will need to propose a sizeable rights offer to recapitalise the balance sheet for what might be an arduous 12 to 18 months.
The collapse of Tongaat’s market capitalisation also raises the question of whether the group will become a takeover target for a larger food group.
The only other listed food counters involved in the sugar sector are Remgro-controlled RCL Foods and Crookes Brothers.
Gut feel is that RCL, which has already moved its chicken business away from the commodity side, might not have the appetite for loading up on sugar.
Crookes is probably too small to take on any of Tongaat’s sugar operations, and the company has in any event been fairly strident in its efforts to diversify away from sugar in recent years.
Interestingly, a Sens announcement last week indicated that PSG Asset Management had markedly increased its stake in Tongaat.
Tongaat’s 2018 annual report showed PSG Asset Management as a 5.95% shareholder, but a recent bout of buying has pushed this stake to a more influential 10.68%.
A mischievous observation might be that PSG Asset Management is a subsidiary of PSG Group, which in turn controls agribusiness investor Zeder and PSG Alpha. Zeder is the largest shareholder in JSE-listed Pioneer Foods and holds various other agriculturally aligned interests, while PSG Alpha is the majority shareholder in retirement village developer Evergreen (which has worked with Tongaat on real estate projects).
PSG Asset Management portfolio manager Shaun Le Roux said the company was not commenting on Tongaat Hulett at the moment...