Published on the Value Lab 05/23/23

Remgro Limited (OTCPK:RMGOF, JSE: REM) is another one in our recent spate of high-conviction ideas. It is a holding company controlled by South African billionaire Johann Rupert, who is also the chairman of Compagnie Financière Richemont SA (OTCPK:CFRHF) and the son of Anton Rupert, who founded Remgro. Remgro used to own Vodacom Group Limited (OTCPK:VODAF), the major South African telco player and subsidiary of Vodafone Group Public Limited Company (VOD). Much like Berkshire Hathaway Inc. (BRK.A, BRK.B), Remgro has facilitated deals in a PE-esque way for their portfolio companies like the recent merger of DISTELL GROUP HOLDINGS LTD. (OTCPK:DSTZF) with Heineken (OTCQX:HEINY) as well as the selling of a stake to Vodacom in their wireline infrastructure business in CIVH.

The Remgro stock is liquid on the JSE, well into the millions in USD-equivalent, and the appeal of Remgro is that most of its holdings are listed or have recent precedents that can help peg the value. Taking very conservative assumptions about its non-public holdings, some of which are elite like their 50% ownership in Air Products and Chemicals, Inc.’s (APD) South African business, we still arrive at very high price appreciation opportunities due to the meaningful discount from adjusted NAV. With the added fact that not all their assets are in South Africa, like Mediclinic International plc (OTCPK:ANHGY) which is prominent in Switzerland and accounts for more than 30% of their adjusted NAV, and with earnings contributions from its holdings likely to move positively and with a good history of ad hoc payouts around portfolio events like the recent Grindrod shipping share-dividend at shipping markets’ peak, Remgro has catalysts to close the discount over time and is a high conviction buy into the Rupert family value creation plan.

Let’s Start With Our Valuation

In this case, let’s begin by presenting the table for the Remgro NAV calculation, where later we will break down all the assumptions that went into these figures, mostly mark-to-market valued, and highlight the businesses associated with the largest, needle-moving holdings to demonstrate a high margin of safety in their valuations and therefore a conservative 64% upside for Remgro:

The relevant stakes in each of the public and private holdings are reported in the last annual report, and we’ve tracked the press releases since to keep track of any reductions or disposals of the listed assets, most recently delineated along with Remgro’s proposed values for each of the holdings in the December 2022 NAV report.

Write-offs and Base Assumptions

In contradiction to the proposed fair value figures by Remgro for its holdings, we’ve written off all the investment vehicles which are investments in various Africa-focused and China-focused funds, since some of these funds are dictated by pretty early stage mandates and are likely impaired or have features to their mandates that we don’t like or don’t think will work in the long-term.

Also, aside from the specified cases, we have used the lower of the book and intrinsic values of the assets for non-public holdings.

Together with the write-offs of the investment vehicles and using mostly the book rather than the Remgro-proposed intrinsic values that rely on management assumptions, we bolster conservatism into the NAV-based valuation above.

Main Holdings

Mediclinic

The first major element of the Remgro portfolio is Mediclinic. They intend to be fully bought out by Remgro and MSC Mediterranean Shipping, whereas before Remgro owned 44% of this London-listed holding. The given figure in the NAV calculation is based on the pre-buyout value and ownership proportion of Remgro because the transaction isn’t closed quite yet, with Mediclinic still trading on public markets.

We have every reason to believe that the marginal multiple paid for the rest of Mediclinic at 9.94x EV/EBITDA is a reasonable one, and likely leaves some more upside as Mediclinic makes a fuller return from COVID-19-related surgery and procedure drops as an owner and manager of healthcare facilities. A 10x EV/EBITDA multiple is not a lot for a company that is rich with real estate and medical equipment assets accounting for more than 60% of total assets, and decent 10% margins.

Revenues are up 10% thanks to post-lockdown volumes despite some offsetting mix effects, but absenteeism and generally higher labor costs (especially in Switzerland) as well as expansion plans in the Middle Eastern operations which account for about 25% of current sales put pressure on margins and saw adjusted earnings decline by 16.9%. On a headline basis the earnings actually grew, but it’s due to some depreciation changes penalizing last year’s results as well as a positive cantonal tax change in Switzerland for this year – the adjusted figure is what matters for business performance, although lower taxes still mean higher cash flow for which shareholders should be grateful.

A more normalized labor environment, calming inflation and wage effects as well as a more normalized rate of inpatient and day patient care will likely reset Mediclinic to normalized organic growth in the future, as well as inorganic growth from facility construction in the Middle East. The asset-rich nature of the company keeps us satisfied about the valuation that was established by Remgro at the point of buyout, with no expectation of impairment in the longer-term of this asset. 10x is not a lot.

Distell

Distell is a beverage company with a strong cider franchise that has recently been taken off the public markets due to an acquisition by Heineken, which is merging it with another Namibian brewery to try to corner the flavored beverage markets in South Africa. Since this is a completed sale and the company used to be publicly traded on the JSE until a couple of months ago, we can include the last-traded market value of Distell in the NAV calculation since that value will likely become the payout for Remgro confirmed in the upcoming releases. The tax effect has been included in the ‘potential liability’ line and so is accounted for in the NAV calculation.

RCL Foods Limited (OTC:RCLFF) and Siqalo Foods

RCL Foods and Siqalo Foods are two companies in the Remgro umbrella that own lots of pretty prominent brands found in South African supermarkets, brands of things like flour, mayonnaise, peanut butter and so forth. RCL is publicly traded, and it trades more or less as you would expect for companies in an emerging country company at around 5x EV/EBITDA, and around 10x PE. That is probably a little less than fair for a consumer staples company, but we agree that ultimately multiples are going to have to be lower for South African companies despite the fact that RCL has pretty low operating earnings volatility – up around 10% last FY, and down around 10% this HY – all due to margin effects despite higher pricing. The market value of Remgro’s stake is in the NAV calculation and mark-to-market values are usually a pretty conservative way to go.

Siqalo has the same valuation in the NAV as RCL, although it’s not publicly traded. The Siqalo valuation is a little more questionable based on given headline earnings, trading around a 20x P/E, despite issues in passing costs to cash-strapped consumers in South Africa and substantially higher raw material prices. Volumes were at least flat because of the limited price hiking. While a reversal in some of the rates of inflation are coming to alleviate the earnings situation, especially on commodity prices with large spot markets like wheat and nuts, the commodified nature of some of Siqalo’s products may not be fully accounted for in that valuation, especially when comparing to RCL and considering the weaker income situation of the typical South African customer as well as a government that may move to defend consumers against key consumer corporations including RCL and Siqalo. If RCL is undervalued, with an earnings boost likely incoming from calming inflation on global commodities, then that hopefully offsets any overvaluation in Siqalo. However, in all, we don’t see any major issues here with valuations, it is all within the bands one would expect for consumer staples corporations with ownership of solid domestic brands.

OUTsurance Group Limited (OTCPK:RMRHF)

A recent 2022 addition to the JSE, OUTsurance operates in South Africa and Australia, and has plans to move into the Irish market pending regulatory approvals, dealing in shorter term insurance policies for auto and homes. The run-rate valuation is around 10x P/E thanks to insurance premium growth that is helping it stay ahead of a cost inflation in SG&A, but mainly in COGS associated with customer acquisition costs as they try to expand their footprint, which crimped their previous year of operations. A growing developed market exposure and a 10x P/E square with the sort of valuations we’d be comfortable with among insurance players, paying Remgro a decent ~5% dividend yield. We are satisfied with the value for OUTsurance in the NAV calculation.

CIVH

CIVH is an infrastructure venture that contains assets and holdings related to the dark fibre and general wireline infrastructure that supplies fibre-optic internet to South African homes. The valuation in the NAV is 13 billion ZAR, which is a hardcore low-ball valuation. The reason is that in 2021, Vodacom bought a 30% stake in an InfraCo, the other 70% owned by CIVH, for a total consideration of around 13 billion ZAR. The value of CIVH based on that precedent is at least 2x the given 13 billion ZAR used by Remgro. Even using the 44 billion ZAR total valuation implies a 12.8x EV/EBITDA, which appears to be a low valuation for infrastructure investments in the even more fervent 2022-2023 environment infra dealmaking environment, possibly because a strategic sponsor was involved in this case and contributed more than just cash in the 13 billion ZAR consideration, with Vodacom also contributing billion in value of its own assets.

We leave 13 billion ZAR in the NAV calculation since that’s what Remgro proposes but the more market appropriate figure should be around 30 billion ZAR and would bring the Remgro upside from 64% to 85%. We can definitely be confident in the 13 billion ZAR for margin of safety.

Air Products and TotalEnergies SE (TTE)

The note on these businesses is easy. Both are South African units, existing as separate but non-public entities from their parent companies of Air Products & Chemicals as well as Total, in which Remgro has a stake. Air Products South Africa is like the rest of Air Products and Chemicals, it is an industrial gas business and much in line with its parent company it saw meaningful earnings growth, up almost 20%, thanks to good volumes in industrial gases. The value we use for this stake in the NAV calculation is the book value since that’s the rule we’ve put ourselves for non-public holdings, and likely massively low-balls the value as in the case of CIVH, since the implied multiple on earnings is around 2x, which is way too low as the rest of APD trades at around 28x. While some South African discount may be appropriate, that is too large a discount, and from the conservative case a more proper valuation such as the one proposed as the intrinsic valuation by Remgro would add another 4% overall upside.

We used book values for Total’s South African unit as well in which Remgro has a stake, and the implied valuation is around 10x on the value included in NAV. That is probably a reasonable multiple for what is a refinery and gas station business.

Investments

All of the values in the investments portfolio are mark-to-market and appear to be reasonable.

1. FirstRand (OTCPK:FANDY) is a retail and investment bank that operates mainly in South Africa. It trades at around a 9x P/E, which seems more or less reasonable for an advisor/lender given the current valuations in the global banking landscape.
2. Discovery Limited (OTCPK:DCYHF) is a L&H insurance group in South Africa. While some parts of the South African markets may be a little more questionable compared to developed market sensibilities, South Africa actually has a highly developed insurance market. Discovery trades at around a 13x P/E on forward earnings, and this seems about right given international and domestic peers.
3. Momentum Metropolitan holdings is a diversified financial services group, substantially a retail investment advisory company. They trade at around a 6-7x P/E, which is quite cheap, but is consistent with some of the other asset management names on European markets at least, and also some domestic players as well.
4. Other investments include investments in companies like British American Tobacco p.l.c. (BTI).

Risks

The positions we just discussed account for almost all the value within Remgro Limited, with only marginal elements being left undiscussed. In most cases valuations seemed mostly fair, and in some substantial cases, mainly CIVH but also in Air Products, there was a meaningful amount of undervaluation that could together account for another 25-30% upside from the conservative 64% proposed based on book values for non-public or updated mark-to-market valuations for the public holdings. Relevant multiples for the South African markets already incorporate discounts and have been leveled at the public holdings.

However, there are a couple of risks. The first is that of the South African Rand, or the ZAR, which is South Africa’s domestic currency. It has declined meaningfully over the last five years by about 40% relative to the USD. The picture isn’t a whole lot better compared to the EUR. About 20% of Remgro’s income comes from outside of South Africa, but still a lot is ZAR denominated. We have some optimism about the ZAR, which is connected to very large natural resource reserves in South Africa, including mainstays like Platinum, Gold and Iron ore, as well as other platinum group metals, the latter having substantial upside in the renewable transition in connection to the hydrogen economy, to the extent that you as an investor believe in the hydrogen opportunity. For the investment thesis in Remgro, we will not argue upside on the ZAR. The borrowing cost of hedging the ZAR is about 100 bps annually at worst for retail customers, and can be done by simply shorting the ZAR against the USD in proportion to value of your Remgro holding multiplied by about 0.7-0.8x which is the proportion of Remgro that is ZAR denominated.

Considering that Remgro is basically a very savvy fund for retail investors, a 100 bps in annual expenses associated with a hedge on the ZAR is about what you’d pay a mutual fund. The Remgro corporate costs are really low, so it really does end up working that way.

The other risk comes down to considerations about short-term direction, which may be influenced by the earnings contributions from the holdings and their respective proportions, since it seems that the NAV for now is not being paid attention to.

While expansion in the Middle East and inflation reversals may help Healthcare (Mediclinic) income continue to grow but now on an organic basis, there are risks with the consumer products incomes since they are more input price sensitive due to their dependence on the South African consumer, which is not doing that well right now with global commodity inflation. Domestic prices aren’t so high and they are resource rich, also global inflation of commodities in reversing as economies cool down, but it is a consideration and consumer products were trending poorly as of the last results. However, besides consumer products, and possibly industrials which are levered to commodity prices somewhat, where Total is already seeing declines, the earnings picture looks good. CIVH continues to expand its fiber footprint, and the financial services businesses continue to be resilient thanks to AM and insurance exposures. Still, earnings direction isn’t necessarily phenomenal, especially since Mediclinic may also be slow to benefit from an inflation reversal since a lot is coming from labor inflation in a relatively solid economy of Switzerland, which may not experience as aggressive of a cooldown.

Bottom Line

Remgro Limited management really knows what they are doing. They paid out Grindrod to shareholders as a share dividend, which was a shipping company, at the peak for shipping markets, and the discount to NAV is profound even with the most conservative assumptions for some of the more promising non-public holdings, including relevant infrastructure and important industrial holdings with parent companies whose valuations are stratospheric as in the case of APD. They manage to find value-accretive transactions for key investments, now giving infrastructure a boost thanks to a calcified alliance with Vodacom thanks to their joint ownership of the fiber InfraCo, with the Distell sale being decent at around a 13x PE realized multiple.

They are also looking to get rid of some other assets, like Total’s South African unit which may also fetch nice prices with strategics, although a slower dealmaking environment may preclude that for the moment. Healthcare assets like Mediclinic may also prove popular with PE still looking to allocate but only to the most resilient ideas like in healthcare in the current environment. While the ZAR risk is present, it can be pretty cheaply hedged and creates costs commensurate with what you’d pay to own a fund controlled by the savvy Ruperts, whose family wealth goes easily into the $10 billion+.

The assumptions we made were sometimes conservative beyond reason, yet the upside is still at over 60%, with an eventual recovery in the dealmaking environment likely to highlight the discount and become an eventual catalyst. The earnings direction is also relatively alright, with large declines being very unlikely, and growth being possible as global commodity prices come down as well as general inflation, which has been a headwind for many of the holdings. Also there are millions in USD-equivalent daily liquidity for the stock on South African markets.

It’s difficult to find such clear discounts in any market nowadays, and this one is pretty irrefutable with almost 90% of the Remgro Limited portfolio being market-valued. With the company also being intelligent about payouts with the precedent of having paid Grindrod out in shares to Remgro shareholders at the markets’ peak, there are plenty avenues to hit the upside here over the next few years as parts of the Remgro portfolio turnover or just continue to produce income. Remgro Limited stock is a very clear buy for the intrepid value investor.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.