This post is inspired by Rudi van Niekerk. Rudi runs Desert Lion Capital, an investment partnership dedicated to South African stocks. Scott Miller (of Greenhaven Road Capital) and Chuck Royce seeded Rudi’s fund. Desert Lion gives US investors a chance to capitalize on the many price dislocations within the region.
After reading some of Rudi’s work I decided to download an Excel file of every single publicly traded company in South Africa’s Johannesburg Stock Exchange (JSE). Going through the list one by one is eye-opening.
Businesses are cheap in South Africa. This isn’t to say these same businesses aren’t without hair (spoiler: they have hair). Yet one can’t make it through 15-20 companies without stopping and thinking, “damn, this place is cheap.” Especially when you compare them to United States companies.
One quick mention. I converted all figures from South African Rand into USD (for ease of analysis).
With that introduction out of the way, let’s dive in to the company.
The Elevator Pitch
York Timbers (YRK) incorporated in 1916 and went public in 1946. The company specializes in integrated forestry through two operating segments:
- Ownership of plantations and processing plants
- Wholesale distribution network
The company vertically integrates timber for its customers, providing both the source and the shipment. Over the last 11 years, the company’s averaged double digit CAGRs in a multitude of financial metrics:
- 9.6% Revenue
- 5.1% EBITDA
- 6.3% Cash Flow from Ops
- 6% Biological Assets
These above figures translate into impressive per-share CAGR as well. Over the same 11 year period, EPS sported 21% CAGR, NAV increased 9.1% and ROE averaged 13%.
The pitch is simple. You can buy YRK at an 80% discount to its biological assets (timber) while getting the (steadily growing) profitable operations for free.
Breaking Down the Asset Value
I found Neto’s Notes piece on KEWL helpful in figuring out a simple, easy-to-understand method for valuing YRK.
YRK has 232,244 acres spread across South Africa (see map for reference).
According to their most recent annual report, the value of those acres is around $198M. Dividing $198M by our 232K acres gets us around $853/acre.
We can then find out how many acres per share YRK owns by dividing acres by shares outstanding: 0.0734 acres/share.
Arriving at Per-Share Value
Now we can get an acre value/share figure by multiplying our acres/share with our value-per-acre:
$853 * 0.07343 = $62/share in acre value.
If we subtract our net-debt from the value of the acres, we get net value-per-acre of $153.9M (or $662.69 per acre). Applying the same valuation method above gets us $48.70/share in net acre value.
The stock currently trades around 160 Rand (or $10.67 USD). This means the market is valuing YRK at an 82% discount to total acre value and a 77% discount to net acre value.
Projecting Biological Asset Value into 2021
YRK’s grown its biological assets at an 11-year CAGR of 6%. If we assume those historical figures, the company will have roughly 276.6K acres in 2021. Using 2018 valuations for those assets we get $236M in total value (and our constant $853.53/acre).
But given the increase in acres, we now have 0.0875 acres/share versus 2018 figure of 0.0734. Multiplying our new acres/share figure on the $853.53/acre value gets us $74.71/share in biological asset value. That’s a near 86% discount to current prices.
How Safe is the Balance Sheet?
Looking beyond the biological assets York sports a strong balance sheet. The company’s Debt/Equity ratio is 0.26 and current ratio floats around 2.3. They also have $3.27/share in cash.
What happens if we remove all the biological assets from YRK’s balance sheet (this will come into play later in the Risks section)? Current ratio falls to 1.44.
Assessing YRK’s Operating Segments
We know that YRK’s cheap on a biological asset basis. York also has profitable operating segments to go along with that asset value — something not always found in timberland investments.
The company did $123M in revenue last year through its processing plants and wholesale distributor network. YRK realized $37.64M of that revenue in gross profit, which marks its highest gross margin since 2013. The company recognized $13.28M in operating profit and a 30% margin improvement from 2017.
Most of the margin improvement is courtesy of improved supply chain management at YRKs Highveld plant. These costs savings and integrations drove an incremental $11M in profitability. On a lesser note, margins improved due to fewer external purchases of logs as well as increased capacity at YRKs new plywood plant.
How Cheap Can You Buy Operating Segments?
York generated $9.5M in after tax earnings in 2018. Given its $33.7M market cap, you can purchase YRKs operations for 3.5x current earnings, or 6x EV/EBIT. That’s good enough for a 28% after-tax earnings yield on 9.44% ROIC.
Things get even cheaper when you project out three more years (2021). If we assume YRK’s historical earnings growth rate of 20% we end up with 2021 earnings of $16.4M and a 2.06 P/E. It’s not quite Mohnish Pabrai’s “Hidden P/E of 1” by 2021. But it’s close.
There’s three main reasons why YRK is cheap: political, workforce and illiquidity risk. While its impossible to assign a direct probability to each risk’s potentiality, the end ranges are slightly scary. I will make no attempts to assess the geopolitical landscape of South Africa. Any attempt at doing so is comically beyond my circle of competence.
Political Risk: Land Expropriation without Compensation
This is by far the largest existential risk York faces going forward. The South African government is debating whether to amend their constitution to enable the expropriation of land without compensation. If passed, here’s how it could play out.
The South African government could walk onto York’s timberland. Draw a plot around however many acres they wanted. Then they would tell York, “This is ours now.” Clearly not a good scenario. We won’t know about the amendment until June of 2020.
My take: My initial take is that it’s a DEFCON Level 5 threat. But what happens if we take away 50% of YRK’s acres? We still have a 30%+ discount to biological asset value.
Workforce Risk: Union Strikes & Hostage Situations
Rival unions NUMSA (National Union of Metal Workers South Africa) and CEPPWAWU (Chemical, Energy, Paper, Printing, Wood and Allied Worker’s Union) continue to strike, causing delayed work hours and reduced volume of sales.
What’s the beef? The NUMSA isn’t recognized by the Bargaining Counsel in South Africa for the Wood and Paper sector. The problem for NUMSA is that the majority of their 318K union workers (as of 2014 data) are in the Wood and Paper sectors.
We’ve seen the dangers and financial costs of the strikes. As recently as 2018, York’s Highveld facility burnt down during union strike (costing 40M Rand). York Timbers workers were also held hostage in late 2018.
Illiquidity Risk: Concentrated Shareholders, Little Float
The company believes shareholder concentration is a headwind from the stock price reflecting intrinsic value. In their 2017 investors presentation, York noted that 81% of shares were held by only 10 shareholders.
The metrics get more concentrated for 2018. 1.55% of shareholders own 90% of the common stock. I want to stress that its not the shareholders that are the risk, but the lack of free float to push share prices higher.
One issue for US investors is that the stock only trades on the Johannesburg exchange (JSE). Investors would need the ability to trade on the JSE.
If there’s a silver lining, its that the majority shareholders seem to be permanent capital. The Industrial Development Corporation of South Africa holds 29% of the stock, followed by Lereko Metier Capital (private equity) at 17%. Rounding out the top 4 is Old Mutual Group (14%) and Bridge Creek Trading (9%). Together the top four shareholders own 69% of the company.
Other Risks: Lumber/Plywood Prices, Housing Demand
When dealing with commodity-linked businesses, the price of the underlying comes into play. There’s strong lumber price competition in SA. This competition drives down margins and has shrunk YRK’s market share (nothing crazy).
YRK’s made up for this decline via their plywood business, which has strong local demand.
York Timbers seems priced for bankruptcy over the next three years. If the company can stay afloat, maintain profitability and grow biological assets (without expropriation!), shareholders should be rewarded in the long-term. It’s a hidden P/E of 2 in three years with stable, growing biological assets.