Steinhoff: Weighing up the odds

The collapse in the Steinhoff share price is continuing, albeit at a slower pace, as investors regroup following an event-filled week that saw the CEO, Markus Jooste, resign amid allegations of fraud and financial gerrymandering.

The share is trading between R6 and R7, at a market cap of R25 billion, a fraction of its previous value.

While most institutions holding Steinhoff took action last week, many retail investors are left holding stock that they don’t know what to do with.

When making a decision on whether to sell, hold or buy more shares one has to separate fact from hysteria.

Here’s what we know:

Steinhoff assets include its stake in listed investments (Steinhoff Retail Africa, PSG, KAP) and are worth roughly R15/share. According to Steinhoff it will sell these assets to release funding to pay down debt;
Steinhoff owns European property, plant and equipment worth €5.8 billion. At an exchange rate of R16.04/EU1 this translates to value of about R15/share;
Net debt is sitting at €6.5 billion or R104 billion, which translates to negative value of R24/share.
Summing this up leaves one with tangible value of R6/share and that is before one accounts for earnings. Rolling 12 month headline earnings per share to March 31 2017 was euro 29.2c, equating to ZAR 468cps using the above exchange rate. These numbers are likely to be restated, so it is difficult to ascribe any value, but it is likely to be a positive value at the very least.

The resignation of the CEO has removed a further concern many investors had; an inability to get satisfactory answers from him on a number of issues: accounting treatment and the abnormally low tax rate to name but two.

Here’s what we don’t know:

• The nature and amount of financial irregularities and possible fines and penalties;
• Has there been fraud perpetrated; if so the quantum;
• Why external auditors did not pick up irregularities in the past; were there none or are the amounts immaterial?

Here’s what we are concerned about:

• Intangibles at €7 billion at end March is high; especially viewed against shareholder funds of €16.6 billion. It is not in itself a problem; but it does beg the question; has the company overpaid for assets?
• The investigation into the validity and recoverability of certain non-South African assets of the Company which amount to circa €6 billion.
• The asset turn of the company has been falling for years; again an indication they might have overpaid for some recent acquisitions; Mattress World a case in point;
• Has the business been permanently impaired?
• Can the company meet its debt obligations?
• Having its debt rated junk is going to impact the cost of borrowing.
• The credibility and integrity of existing management has taken a knock; can it be reversed?
• Have vendors who accepted a mixture of cash and scrip when selling their businesses to Steinhoff recently, got any legal comeback if fraud has been committed. If so, what is the approximate amount?
• Are reports of off-balance sheet companies correct?
  In conclusion:

The list of concerns and unknowns is long. But Steinhoff still has good assets – Steinhoff Retail Africa and some of the European businesses. These businesses will continue to generate profits into the future, although in the case of the European businesses they may look very different.

• In the event all loans are recalled; the company has tangible assets to sell.
• The margin of safety is wide; even allowing for some overstatement of profits and possible fraud; at 600c Steinhoff is trading on a forward P/E of 1.28x. Assume revenue has been overstated; normalise the abnormally low tax rate and halve earnings; that still leaves the share at trading on a single digit P/E that is less than international peers, who are in the mid to upper teens.
• Management is going to have to go the extra mile in terms of disclosure and transparency in future; addressing every concern the investment community may have, no matter how trivial. An obvious starting point would be clarity of alleged off-balance sheet companies and round tripping that has emerged.

With these details in mind, Moneyweb got advice from three different investment houses:

First Avenue Investments portfolio manager, Nadim Mohamed, believes it will be extremely difficult for the Steinhoff executive team to restore trust after these issues. “Tesco has similarities to Steinhoff as its profits were overstated by £264 million in 2014. Similar to the Steinhoff situation, the Serious Fraud Office in the UK launched an investigation into the company. In an effort to recover from this offence, the Tesco chairman stepped down and eight senior executives were suspended.

Despite an admirable turnaround effort, the company still has lost c.50% of its 2013 peak value and has never fully restored market trust. We believe this is the most likely path forward for Steinhoff.”
In other words, the share is unlikely to recover.

Gryphon’s Cassie Treurnicht and Reuben Beelders believe that at current values the share now offers value. “With Steinhoff trading around 600c it has a market cap of R25 billion. The company indirectly holds
 76.81% of Star-issued share capital, which at the current market price of 1750c has a market cap of R60 billion. “So that means Steinhoff’s holding is worth R46 billion, hence all the other Steinhoff businesses, such as Mattress Firm, Poundland, Conforama, etc. are going for free. We think that’s worth considering.”

But Beelders adds: “This is speculation, don’t speculate with money you can’t afford to lose.”

Vestact’s Byron Lotter is less convinced:

“This is a tough call because no one really knows where it will go from here. The share is definitely trading below the current NAV but when you have very angry debt holders knocking on your door everything is worth a little less.

“We are making decisions on a client-by-client basis, but in many cases their holdings are so small already you may as well sell.

I wouldn’t advise buying for anyone to be honest. Far too speculative!”

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