Description

Long Calgro M3

All values are given in ZAR unless otherwise stated

To continue the Net-Net theme, Calgro M3 is a home-builder and memorial-parks operator trading at 0.5 times its Net Current Asset Value and less than 45% of tangible book value. That while it’s a homebuilder which has grown book value at a pretty impressive 18% CAGR over the past 14 years. Management owns a decent amount of stock (just under 8% of the company) and the CEO has bought shares in the market last December, 15% above the current price.

The company has an NCAV of around 750 million and a net tangible book value of 875 million. Given that the current market cap is about 345 million, one can see this company is in the bargain basement level. Net debt stands around 780 million, and all debt is used to finance construction of houses. Given that most of the land has been on the books for about a decade, and inflation in SA is quite high, the book value is understated.

Put another way, this company for many years before 2018 made between 100 and 200 Rand in net profit, and the company can be bought in the market for around 380 million. Since last year when they made a 132 million net profit, it appears the company is back on track to return to profit levels last seen in 2017.

Backlog

Calgro M3 has a very big house backlog. They sell around 2,000 to 2,500 homes in a good year, and have a pipeline of 24,000 building opportunities equaling 15 billion in revenues. They also have a purchase option on a plot in Johannesburg with an additional 20,000 units (and a similar revenue pipeline). Given that the company has a 20-25% gross margin in normal years, a 15 billion revenue pipeline equals 3-3.75 billion gross profit, or about 10 times the current market cap.

A large backlog for a homebuilder has a few distinct advantages. They are not so much obliged to purchase land at whatever the cost, and thus can be more opportunistic in their purchases. It also lowers the capex requirement in the near term, so more cash from operations can be used to reward shareholders as compared to purchase land to replace sold units.

Earnings power

Since the IPO, Calgro M3 was a darling stock until they hit a rough spot in 2018-2020 (more on that below). They build lower cost housing units in South Africa, for which there is a very large need in the country. For example, in Cape Town, 600,000 people are on waiting lists for social housing. And in the past, Calgro was a large builder for social housing entities. While they moved away from most social and subsidised housing developments, they are still building houses in the lower price range of the market.

They are also pretty efficient at building lower cost housing. Since their IPO, the book value has grown at 18% CAGR, despite some tough periods (2008-2010, 2018-2020). In good years the ROTE is around 30%, while in bad years it was still positive.

Difficult years

SA is a pretty difficult environment to operate in, and Calgro is no exception to the rule. The company hit a snag in 2018-2021, which brought down the stock from above 20 rand to below 2 rand in a few years. Some of these factors were in their control, but there was a lot of bad luck as well.

In 2018, their construction business somewhat hit a bad spot and started underperforming. This was quite normal in the SA market, as I mentioned in a previous writeup of Stefanutti stocks a few years ago. Given the difficulties, they just decided to wind down their own construction division and only work with contractors going forward. This way they made the business a lot more simple.

But then more bad luck came their way. In 2018 and 2019 they had issues with site invasions by squatters on their largest development site (Fleurhof). Fleurhof is responsible for around 50% of their completions in the recent years, so violent protests and invasions had a major effect on the profitability of the company. Since then they increased vigilance and security on their sites, but it took a while to get these people out. And then in 2020 and 2021, everyone knows what happened, which again was not very beneficial for a company which operates in the house building industry. These 3 successive years of negative news have left the stock for dead in the market, even though management have turned around the business. The gross margin is back where is used to be (around 20%) and the ROE is getting closer to where it used to be (now around 15%).

There are still some issues, like the company this year pulled out of the Kwa-Zulu Natal state, due to the pressure they get from the construction mafia. That is a practice where they put companies under pressure to use only contractors which are affiliated with them. They just decided to put these project on hold, so that did lower the ROE somewhat this year.

The memorial parks business

Like most people know, memorial parks is a pretty stable business in terms of demand. In the COVID period, there was higher demand than usual, but in general the death rate is a pretty stable number over time.

This business is as simple as one would expect. They make most of the capex at the beginning of the park to design the layout and do the basic infrastructure, but after that it is a pretty good and stable cash-flowing business with pretty high margins.

The company still wants to grow this memorial parks business with the stated goal for this business to cover the fixed and interest costs of the total business (housing + memorial parks). The income of this segment, which is less susceptible to the economic cycle and other disruptions like mentioned in the ‘difficult years’, should shield the company from the cyclicality which is very common in housebuilding.

To achieve this goal, the memorial parks business only has to become about double to triple in size from where it is now. But once this is achieved, the company should be on a sound footing no matter the economic environment.

There is however one point about this business which can me abused, but I will assume the numbers the company uses are correct. The company sells a burial plot to the mourning family to burry their loved one. This sale is a one time purchase and doesn’t come with any maintenance costs. The company uses a large part of the sale from these plots into a fund which should be sufficient to cover future maintenance obligations. That is an area where there is a possibility for mismanagement.

To counterbalance this, if they would be underreserving for maintenance, it shouldn’t be an issue for at least the first 25 years (and probably even a lot more). That is because they currently sell around 2,000 burial plots a year, and they have a backlog of more than 100,000 plots. Even if they double the rate at which they sell these plots right now, it will take time to exhaust their backlog. To give you an idea about the cost of maintenance, at the current level of sales, maintenance takes up just 15% of the revenues from plot sales.

Capital Allocation

An added reason why I think an investment in Calgro could be a sound investment is that management is what appears to be pretty good at capital allocation. In 2020 they bought back a decent amount of shares (4.6%) at 2.10 Rand a share from a large investor which owned a large block of shares but got into trouble (coincidentally, that listed company got written up on this site, and was named Conduit Capital). They also have a pretty good grasp of what the business is worth, and the CEO mentioned a while back that a correct valuation should be between 12 and 15 Rand a share, which I mostly agree with.

They also took a page from the NVR playbook, by acquiring options on land (the large Frankenwald property is an option) so they don’t have to tie up the capital for a long term,  which increases the ROE above many peers in the sector.

Capex to project completion is a very important consideration for them, and you can see it referenced in about every single project.

Catalyst

While value is usually the best catalyst, the SA market can be somewhat quirky. And the same is true for this company. While the turnaround after some of the bad luck and covid has delivered good results, the stock price is still lagging.

Management was very reluctant for a long time to pay dividends (due the tax disadvantages), but I think they are not very happy with the share price evolution as well. This made them rethink, and they mentioned a timeframe to start dividend payments in 12 to 24 months’ time. If you assume the dividend to be 40-50% of the net profit, you are looking at a 15-25% dividend yield. That should be a very good catalyst by itself.

The company is also aiming to significantly increase (almost double) the amount of homes they sell every year, given the very large land bank (certainly after acquiring the large Frankenland plot) this is very credible. Given the large fixed cost basis in this business model, this would probably double or more than double the net profit. So even if the PE would stay the same, the share price can still double or more.