10 April 2013

Publication: Moneyweb
Author: Sasha Planting

CAPE TOWN – The share price of small cap Sephaku Holdings (JSE:SEP) has rocketed by over 80% since January – proving that when the fundamentals look good, investing in a company whose main productive capacity is not even built is not too much of a leap of faith.

Sephaku is a black-owned investment company whose core investments are a 36% stake in Sephaku Cement and 100% in Metier Mixed Concrete, a smaller, but complementary cement business.

It is the possibilities inherent in Sephaku Cement that are getting investors so excited. The company is two thirds of the way through building its R3.2bn cement producing facility in Aganang, in the North West and milling plant in Delmas, Mpumalanga. This is the first new cement facility to be built in the country since 1934 and production is expected to begin in October this year.

The company is run by Peter Fourie, Duncan Leith and Duan Claassen, old hands in the cement industry, and is backed by Nigeria’s Dangote Cement, Africa’s biggest cement producer.

The cement industry, along with the construction sector has been in the doldrums since 2010, but activity levels are rising. Yes supply exceeds demand, but that is expected to reverse within five years, Sephaku Holdings CEO Lelau Mohuba told delegates at the small and mid cap companies’ conference in Cape Town earlier this year. “The anticipated shortfall in cement capacity is due to lack of investment and shortage of high quality limestone deposits,” he says.

Sephaku, which has mineral rights and mines its own limestone, will be the lowest cost producer of cement in the country. Its plant is being built using the latest technology, which is not only more environmentally friendly but more efficient too.

This means the company should be able to compete on price with its better established competitors PPC, Afrisam and Lefarge.

“Cement is a fantastic business,” says Peter Armitage head of investments at Anchor Capital. “Pricing is high, margins are wide and cash flow is good because you are not investing heavily in stock – the raw material comes out of the ground.”

Sephaku Cement’s management team has years of experience in the cement industry, he says. The company has an additional advantage in that its competitors all have highly indebted balance sheets and cannot afford a price war.

Hugan Chetty, construction sector analyst at Afrifocus Securities notes that there is evidence of growing stability in the construction industry. “A recovery in the cement industry will drive revenue growth for industry participants,” he says. But he’s cautious about Sephaku’s immediate prospects, despite management’s established relationships in the industry. “It is always tough for a new player to break into the market. They will need to offer really competitive prices, and they need to change patterns of buying behaviour.”

This is where this year’s acquisition of Metier was so strategic – even if some argue that it was a little pricey. The supplier of ready-mix cement will consume 10% to 20% of Sephaku’s production, says Armitage.

Combine this with an industry that is growing at 4% pa and he expects that Sephaku could reach the 20% market share required to sell its production within 2-3 years. “The market should be receptive to them. There has not been significant price competition from the current players, who grew up in a regulated cartel.” He notes though, that Sephaku has no intention of entering into a price war.

The 2.5m tonne capacity plants will cost in the region of R3.4bn and debt will peak at around R2.2bn. The company is expected to deliver healthy returns on capital. Armitage expects the return on capex to be in the region of 30-35%, and the return on equity to exceed 70% within a few years.

The share price, at R6.67, has run hard and is more difficult to predict. “I imagine it could hover at R7.00 for a while. There is a lot of road between now and actually selling a product.”

Encouraged to speculate he suggests that the share price could be: R8-R10 by the end of 2013, and R13-R15 by the end of 2014.

This is one small cap stock worth a second glance.