Grinrod keeps its head above water

Grindrod is managing its way well along the bottom of the shipping cycle. There is probably one more year of shipping losses in prospect and thereafter the company could well experience a number of years of meaningful growth.

Yesterday the company announced a seemingly impressive 22% increase in earnings to 122c, but this should be seen in the context of 504c of earnings in 2008 and a return on equity of only 7.4%. The company has R10.2bn of shareholders’ equity (R16 per share) and all the businesses outside of shipping are beating the company ROE target of 15%. Debt to equity is only 7%; very low for a shipping business.

At 1737c the company is trading at an historic PE of 14.2x and a forward PE of 11.6x, based on our projection of 150c for 2013. There’s still no shipping earnings in those forecasts; but this division could get back to well over R1 per share (R600m) of earnings in 2-3 years. It’s quite conceivable that Grindrod could earn 300-400c in two to three years, which at a 10x PE would give a share price of R30 to R40. If the market expectations 12 months are for a turn in the shipping market in 2014, the share could well be R30 by the end of 2013.

So there is clearly significant upside, but it never feels comfortable at the bottom of a shipping cycle. Conditions are still dire out on the waters and Grindrod is earning about US$7,000 a day on its Handysize ships, with a break-even of around US$8,500. At the peak in 2008 this number was close to US$30,000. Ironically growth in seaborne demand has been sustained at above 5% for many years, but it is the record number of new ships delivered in 2009-2012 that has destroyed the supply/demand balance. Shipowners all around the world are making losses, but Grindrod is protected somewhat by 40% contracted profitable revenues in 2013.

Grindrod is also starting to take bets on the turn in markets and has started to buy new ships from beleaguered shipping yards at prices 30-40% off the peak. These new fuel-efficient models should deliver excellent returns in years to come. The proverbial “fly on the wall” must be intrigued watching Grindrod board meetings at present, where the bulls will be pushing for more shipping spend, while the more conservative members will be uncomfortable with investing while losses are sustained.

But there is an entirely new attraction developing in Grindrod, which might mean the share offers value even if shipping markets take longer to recover – African infrastructure. The African growth story is one of the most compelling in the world and Grindrod is signing off big cheques in this space. This includes ports, terminals, rail concessions and intermodal facilities across the continent, but concentrated in Mozambique.

This spend should earn handsome returns in years to come and the business model is attractive – consider a coal terminal which is like a tollgate collecting fees every time product passes through its structure. Grindrod invested R1.2bn in non-shipping capex in 2012 and at least another R600m is committed for 2013, with undoubtedly more to be added to this number during the year. We find it intriguing that close to R600m was spend on African rail in 2012, which is a new growth area.

So the bullish story is as follows: You are paying very little for a shipping business which will probably make R1bn (R1.70 per share) at some stage in the next few years. It made close to R2bn at the peak. The profits are currently being sustained by a SA and African freight and infrastructure business which should have the tailwind of strong sustained growth for many years to come. These are strategic and “sexy” assets which will have growing annuity earnings and capacity growth is only limited by the appetite of the company to invest. The current share price is only marginally above net asset value and dollar earnings will probably contribute over 80% of earnings in 2014 and beyond. With current investment sentiment of “long-Africa/short-South Africa”, Grindrod is an ideal play with a cheap entry ticket.

And the risks to this? Africa is not for the faint-hearted and political risks are high. If African growth stutters, expensive fixed-cost infrastructure can be a big drag. In addition, shipping markets may take a lot longer to recover than industry experts predict. 2014 could be a tough year if shipping markets stay becalmed, as the proportion of contracted profitable earnings declines further.

At the current share price, it looks like a bet worth taking. Our view is that by the end of 2013:

·        If the shipping market prospects remain poor into 2014, the share will probably be trading in the R15-R18 range.

·        If the shipping market prospects are reasonable (R100m to R300m profit from shipping), the share will probably be trading in the R20 to R24 range.

·        If the shipping market has shown a marked recovery (R500m profit from shipping in 2014), the share could be trading above R30.

Bottom line: Keep a careful eye on that Baltic Freight Index.

Thank you Peter Armitage

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