Description

Investment Thesis: Formed in its current composition by acquiring the premier high return, recurring revenue parts of the old Eqstra Group in a transformational acquisition and combining them with it its legacy operations, enX Group (ENX) has put together the foundation of a major South African centric industrial equipment player with a differentiated and attractive business model. Under the direction of a relatively new, aggressive, growth oriented owner-operator management team with lots of skin in the game, and driven by both accelerated organic growth and accretive tuck-in acquisitions, the company, by our estimates, should grow profits at ~20% CAGR over the next 3 years.

The shares are mis-priced due to investors not being able to easily understand the complex acquisition of Eqstra Group and the combined pro-forma business model, the synergies of the new company post the Eqstra acquisition as well as local investor uneasiness with a 20% equity ownership in Eqstra’s old mining operations (now called eXtract Group) that was tied to the acquisition. We believe the proper way to view an investment in ENX is to value the shares on the basis of the core industrial earnings and look at any returns from its mining ownership as a free call option. Based on this conservative approach, the shares, selling at 9.7x/6.8x August FY17/18 EPS, and a EV/EBITDA multiple of 3.6x/3.2x and are attractive on both an absolute basis and relative to comp’s, which trade at about  a P/E of over 13x and a EV/EBITDA multiple of ~8x.

Importantly, management has stated that it views its equity investment in eXtract as temporary and will return to shareholders any proceeds that it receives, or asset sales from this company, in the form of special dividends. Thus, with active negotiations underway and reported progress at eXtract to sell its unused assets, we believe it is a realistic possibility for ENX to receive 25%-50% of its original investment within a 18-24 month period, which would equate to R2.80-R5.60/share in dividends, or ~15%-30% of the current share price. As such, this free call option in eXtract could translate into additional meaningful returns to ENX shareholders.

Based upon a re-rating of the shares of ENX to about a comparable 13x earnings multiple to its peers due to ENX’s higher recurring revenues and margins as well as its stronger growth, we believe the shares can sell in the mid R30’s levels (from its current R18.50 price) on just the earnings from its core industrial operations and before the potential proceeds from its equity interest in eXtract. Adding the potential dividends received from eXtract, could add up to a R38-R40 equivalent return over the next 24 months translating into a very attractive IRR.

1 USD = 12.95 ZAR

Company Profile; A Growing & Diversified Industrial Player: enX Group’s predecessor company, Austro Group’s roots date back to 1980 as a manufacturer of professional wood working equipment and tooling. Following the acquisition of a diesel generating and rental company, leading to the establishment of a second division, Austro listed on the JSE in 2007. Following a period poor execution by the former management team, White Rose Capital (formally called Ricophase Proprietary Ltd.) established a significant ownership position in the company, launched a successful proxy fight in April 2013, installed one of its partners (Paul Mansour) as CEO and brought new managers in to run the company’s two operating divisions. The December 2014 acquisition of a fuel distributor, followed by a change in the name of the company to enX Group, highlighted a plan to diversify into new businesses and a shift in the focus of the company into a growth mode. In October 2016, in a complex transaction, ENX completed the largest acquisition in its history and transformed the entire company by purchasing Eqstra Group Holdings’ Industrial Equipment and Fleet Management Divisions (combined with a 20% equity infusion in its miming operations) for R7.8 billion.

Currently enX Group consists of three operating divisions: Industrial Equipment, Fleet Management and PetroChemicals as well as its 20% equity interest in eXtract Group (Eqstra’s old mining operations).

• Industrial Equipment (51% of revenues & 44% of EBIT in FY17): This division provides distribution, leasing and after-market services for a range of industrial equipment, including: forklifts, port & crane equipment, power generators and hi-tech woodworking equipment. The largest of these product categories is forklifts, which came with the Eqstra acquisition. Within South Africa’s forklift market, its Eqstra Division is the leading vendor, with 35% share of the market. While the majority of revenues are derived from South Africa, the company has expanded in the UK (where it is looking for acquisition opportunities) and is targeting expansion in to the Sub-Saharan region of the continent. ENX’s legacy diesel power and woodworking equipment product lines are also contained in this division.

• Fleet Management (29% of revenues & 46% of EBIT in FY17): This new division came over with the Eqstra acquisition. The division has over 30 years of experience offering leases, rentals, and value-added services in South Africa and is the leading vendor of fleet management services in the country. By leasing assets and providing non-capital intensive services, the division generates a high-margin, annuity-type revenue stream. The division’s services include accident management, fuel management, insurance and vehicle tracking, full maintenance leases, operating leases, long-term rentals, and driver management. In addition to these traditional fleet management products, the division offers customized value added services including service scheduling, downtime management, onsite and remote servicing of vehicles, roadside assistance, tire management, replacement vehicles, accident repairs, and integrated fleet reporting. Lack of access to additional capital restricted this divisions growth at Eqstra, obscuring a historically record of healthy, long-term growth. Of the company’s three divisions, FM&L enjoys the highest returns, with impressive 45%-50% EBITDA margins and ~20% EBT profitability, which helps differentiate ENX from traditional industrial equipment companies. The implementation of “Quest,” a new proprietary ERP-based software fleet management system, which the company spent five years and R200m to develop should yield further efficiency gains and position the division as the premier, low-cost provider of integrated fleet management solutions.

• PetroChemicals (20% of revenues & 10% of EBIT in FY17): This division manufactures markets and distributes oil & lubricants as well as being the leading reseller and distributor of polymer, rubber, fillers and specialized chemicals. While PetroChemicals is the smallest of ENX’s divisions, it is the fastest growing. This growth was aided by two acquisitions in mid-calendar 2016, and a new distribution agreement with Exxon Mobil, both of which significantly add to the division’s size and scale and FY17/18 financial results. Near term growth will be fueled by the new distribution agreement and expansion into Sub-Saharan Africa.

• eXtract – (20% equity ownership): This publically traded company (EXG: JSE) provides contract mining services for a variety of minerals in Sub-Saharan Africa, including: drilling, blasting, load & haul, short-term rental and long-term leasing.

Eqstra: A Transformative Acquisition & The Foundation Of Future Growth: The October 2016 acquisition of Eqstra’s Industrial Equipment and Fleet Management Divisions was a major transformative acquisition which increased the revenue base of the company by ~6x, diversified the company’s portfolio of products/services and added new platforms for future growth. By our estimates, with over 80% of revenues and over 90% of ENX’s profits coming from the acquired Eqstra operations, one could view the transaction as somewhat of a reverse merger. Importantly, from our perspective, these two divisions of Eqstra were the crown jewels of the former company due to their #1 market share position, high margins and significant recurring revenues. Moreover, the business models of these divisions which make up the bulk of ENX’s profitability clearly differentiates the company from a traditional industrial equipment company and in our opinion should be valued at a premium of other comparables. (For more details, I would refer you to the VIC report on Eqstra Holdings Ltd. dated 11/13/15) as well as a copy of the Eqstra acquisition investor presentation, which can be found at: http://www.enxgroup.co.za/wp-content/uploads/2016/10/Eqstra-Transaction-Equity-Cap-Raise-Presentation.pdf

In a complex transaction, ENX management was able to negotiate a very attractive and accretive deal for its shareholders (that was also acceptable to Eqstra) due to the markets failure to correctly value these to assets under the ownership of the former company, which was overshadowed by Eqstra’s financially challenged mining operations and the Group’s weak and highly leveraged capital structure. By our estimates, ENX acquired these two divisions from Eqstra at a ttm EV/EBITDA multiple of under 4x.

Management views the Eqstra acquisition as the cornerstone of building the next regional industrial titan. In addition to the low acquisition price, we find the deal attractive on a couple of levels, including:

• Leadership Market Share: Both divisions enjoy the #1market share position in their respective markets. Within South Africa’s fork lift market, ENX’s Eqstra Division is the leading vendor with ~35% share of the market while Its Fleet Management Division the leading vendor of fleet management services in the country with a market share of roughly 25%.

• High Margins: Each division has a high return business model. Based on latest reported data, Eqstra’s Industrial Equipment Division reported ttm EBITDA margins of 30.3% while Fleet Managements EBITDA margins were an impressive 50.9%. With both of these returns above ENS’s, this adds to the accretive nature of the deal.

• Recurring Revenues: Given the multi-year contractual nature of the deals entered with its customers, the revenues from each division tend to be highly recurring in nature.

• Growth Opportunities: Given that Eqstra Holdings was in a cash conservation mode in the prior 12-24 months before the deal due to its high gearing and upcoming debt repayment timetable, growth capital was constrained. A successful capital raise by ENX immediately following the deal will help fund the transaction and provide working capital for growth purposes. With access to new capital, both divisions should see an acceleration in organic growth in the near future.

• Diversification/New Platforms: The acquisition not only diversifies ENS’s exposure to various industries, it also provides new growth platforms for the company. For example, roughly 20% of Eqstra’s fork lift revenues are derived from the UK. Management has stated that it will focus its efforts on growth in the UK market and surrounding markets both organically and via acquisition. Also, in both the Fleet Management and PetroChemicals Division, management has plans to expand in Sub-Saharan Africa.

A Well Seasoned Management Team, With Plenty Of Skin In The Game & Properly Aligned With Shareholders: After White Rose Capital’s management team took control of the Group in FY13, they installed new management in each of the divisions. As illustrated in the following table, with a focus on growth initiatives (including tuck-in acquisitions) and proper cost alignment, the company’s financial performance experienced a healthy rebound thereafter. Note, in FY16 results were impacted by sales/margin issues in the company’s Power Division (its largest division, pre-Eqstra acquisition) associated with post load-shedding and subdued macro-economic environment, especially in the construction sector. Management has indicated that they have seen a recovery in this division in 1H FY17.

Post the Eqstra acquisition, ENX has maintained the senior management team of Jacqui Carr and Gary Neubert to run the Fleet Management and Industrial Equipment divisions. Both executives are well seasoned (27 & 17 year’s experience respectively) and have an excellent track record of accomplishment at Eqstra; in a somewhat challenging and constrained environment. Additionally, former Eqstra CEO, Jannie Serfontein, will remain as Group CEO of the operating divisions.

Post the Eqstra acquisition, the White Rose Capital executive team, lead by Paul Mansour (Executive Deputy Chairman) and Steven Joffe (Non-Executive Chairman), will continue to oversee the group and focus on long-term strategic issues. Given their long-term plan of “Building The Next JSE Industrial Titan” and their financial/banking backgrounds, a major focus of their time will be on growth initiatives, including strategic acquisitions.

One of the appealing investment characteristics of the ENX story is that across the board all levels of management have a lot of skin in the game and are aligned with shareholders, given their healthy stock ownership and are properly incentivized with performance based options. In December, following the close of the acquisition, the three senior members of the old Eqstra management team that joined enX Group, in addition to receiving options in ENX, all made open market purchases of shares in the new company. Wild Rose Capital and management own ~22% of the outstanding stock. Note, page 22 of the previously indicated investor presentation highlights the individual stock ownership and options of each of the executives.

FY17/18 Will See An Acceleration in Growth & Profitability: Tied to the close of the Eqstra acquisition in October 2016 ENX raised R1.5 billion in new equity to help fund the transaction and provide working capital. As part of the capital raise, management provided guidance for FY 17/18, including a detailed bridge on achieving these expectations. Management’s guidance is presented in the previously mentioned investor presentation.  

The following is our estimate of FY16 (ending August) pro forma results for the combined companies and managements estimates for FY17/18.

Some of the key points relative to the forecast that we would point out are:

• Organic growth of 11%-13% during the FY17/18 period includes price increases of ~6%-7% tied to inflation and aided by the availability of growth capital in the former Eqstra Holdings business units. Regarding the later, as pointed out previously, growth in these business prior to the acquisition were severely constrained by Eqstra’s need to conserve cash. Given the availability of growth capital, organic growth at these businesses (which comprise over 80% of revenues in the new ENX) should accelerate.

• Highlighting the recurring revenue nature of the Fleet Management & Industrial Equipment businesses and the future visibility provided, management notes that in FY17 it already has 52%/36% of the incremental profit growth it has forecasted for each division already contracted and in FY18 it has 27%/20% already contracted.

• In ENX’s Industrial Equipment business, given the availability of capital, management anticipates making an accretive acquisition in its fork lift business in the UK to expand its geographic reach.

• The significant growth in PetroChemicals is due to the combination of: two recent acquisitions, a move to a new plant with increased capacity and a new distribution agreement from Exxon Mobil.

• The significant growth in ENX’s diesel power generation business is a function of a return to more normal business condition tied to a gradual recovery of market to pre-load-shedding levels.

• Synergies from the Eqstra acquisition will be meaningful in FY17 and account for about 28% of the incremental improvement in profitability. The full implementation of the “Quest” ERP system in the Fleet Management Division should also help efficiency and profitability.

• Net interest costs will decline as FCF is used to reduce debt levels.

• No additional outside funding will be necessary during this time period.

While management includes a contribution from its 20% equity investment in eXtract, we would focus on growth and earnings from ENS’s core industrial business for investment purposes. On that basis, ENS’s earnings are expected to show healthy growth in the current FY17 (ending August) vs. pro-forma FY16 earnings. In FY18, when the full impact of synergies and growth initiatives will be felt, earnings are forecast to grow a very healthy 42%. Thereafter, a lot will depend on management’s plans to grow the company’s market presence via acquisition. Barring a major transformative acquisition (with some tuck-in’s likely), we believe a low-to-mid teens growth in earnings is realistic.

Attractive On An Absolute & Relative Basis Due To Some Misunderstandings Of The Business: We believe the shares of ENX are attractive on both an absolute basis as well as relative to other comparable South African industrial companies. Based on management’s estimates for the current fiscal year, the shares are valued at an EV/EBITDA multiple of 3.6x and a P/E of 9.7x. We submit this valuation is attractive for a company like the new ENX, with a leadership position in its major markets, a high content of recurring revenues, healthy profit margins and given its ~20% earnings CAGR in the next 3 years. As highlighted in the comparative analysis table below, the new ENX, post the Eqstra acquisition, has profit margins notably higher than the comp’s, however, it is valued at a significantly discount to the group.

We believe that one of the reasons for the mis-pricing of the shares is that investors have not taken the time to put all the pieces together to understand the business model and economics of the new ENX, post the Eqstra acquisition, and lack the understanding of how high quality the business are that were acquired. When the company reports its bi-annual results for the 6 month period ending February, it will be the first report card for the new enX Group and will provide investors visibility as to the company’s new business model and earnings base. This should be one of the catalysts to a re-rating of the stocks valuation.

In addition, we believe investors have a general misunderstand of the company’s balance sheet and leverage. One thing that may confuse investors is that while ENX is classified as an industrial company (like its comps), it business model is closer to a leasing company (unlike most of its comps). While ENX’s balance sheet optically appears to be levered, but this is simply a business model consistent with leasing companies and is what drives its high recurring revenues. As highlighted in the following table, ENX is less levered than similar companies with leasing type business models.

eXtract Could Be A Very Rewarding Free Call Option For ENX Investors: The remaining piece of Eqstra Holdings that was part of the ENX acquisition, is its Contract Mining Services operations, which has been renamed eXtract Group, and now trades separately on the JSE (EXG: JSE). Currently the company has a number of contracts to provide a range of mineral extraction services for worldwide customers in Sub-Saharan Africa. A major overhang in eXtract’s financial results is the impact of the commodities recession in the region, which has had a significant impact on overall mining activities.

In January 2015, Justin Colling was brought in as the new CEO. Based on our research, our understanding is that he is one of the most well respected contract mining CEO’s in the region, and is in the process of enacting significant financial improvements in the business. Most notable are the selling of the company’s idle/excess assets and transitioning the business to an asset-light model (where the mining equipment will be provided by the customers). Consistent with this strategy, eXtract announced in December 2016 that it had signed its first asset-light contract to commence in early 2017.

A major initiative of eXtract, tied to its transition to an asset-light business model, is the proposed disposal of the company’s excess assets associated with its Benga mining contract in Mozambique (which ended in December 2016) as well as selling other South African assets. This plan was announced and approved by Eqstra Holdings shareholders in June 2016. After taking impairment charges last year, the assets to be disposed are valued at R1,147 million. The company announced that the asset sales will take place though an auction process over a 24 month period (from June 2016) and has set a floor for acceptable bids on all the equipment totaling R803 million. In a December 14, 2016 trading statement & business update SENS filing, eXtract said that so far they had sold about R346 million of assets, net after f/x.

In order to consummate the Eqstra transaction, ENX had to agree to make an equity infusion to help sure up the capital structure of eXtract, to give it time to navigate its way through the commodity downturn. As part of the transaction, ENX acquired 52.6 million shares, equating to a 20% ownership of the stock. In addition, ENX provided eXtract capital through a R700 million subordinated loan and R600 million in preferred shares as well as assuming R900 million of eXtract senior debt; for a total investment of R2.2 billion. We are not big fans of investing in mining companies and our discussions with ENX’s management suggest they feel the same way, did what they had to do to get the best assets of Eqstra, and view this investment as temporary. South African investors currently have a strong distain for investments in the mining sector, which helps to explain the valuation of both ENX and eXtract Group.

Important to the valuation of ENX is that as these excess assets are monetized the proceeds will be repatriated back to shareholders. EnX is entitled the proceeds of these asset sales ahead of senior lenders up to R1bn (as repayment of the loan and preferred). Thus, with R346 million of asset sales completed, this translates into R1.93/share. We believe eXtract management will be successful in selling additional excess assets, however, we believe it may be unrealistic to expect the full R1,147 million to be recouped. Additionally, in the December 14, 2016 trading statement & business update SENS filing management indicated that it had received an outstanding receivable payment associated with work that it had performed for one of its former customers, ICVL, in the amount of USD14 million (or about R200m at current f/x rates). An announcement of any special dividend payments from eXtract to ENX shareholders will likely be another catalyst to the shares.

Aided by the asset sales and the ICVL receivable payment, we believe it is realistic possibility for ENX to receive R500 million - R1 billion, or 25%-50% of its investment within a 18-24 month period, which would equate to R2.80-R5.60/share in dividends, or ~15%-30% of the current R18.50 share price. Thus, while the market appears to be giving no value to ENX’s investment in eXtract Group, our analysis suggests this could be a very rewarding free call option for ENX investors.

Significant Upside In The Share Price & A Very Attractive Total  IRR Possible: Based upon a re-rating of the shares of ENX to about a comparable 13x earnings multiple due to ENX’s higher margins and recurring revenues as well as its stronger growth relative to its peers, we believe the shares can sell in the mid R30’s levels (from its current R17.70 price) on just the earnings of its core industrial operations and before the potential proceeds from its equity interest in eXtract. Add to this the possible R2.80-R5.60/share in dividends, leads to a possible all-in return equivalent to a R38-R40 share price over the next 2-3 year period. This leads to the possibility of a very attractive IRR for investors.

Catalyst

• When the company reports its bi-annual results for the 6 month period ending February, it will be the first report card for the new enX Group and will provide investors visibility as to the company’s new business model and earnings base. This should be one of the catalysts to a re-rating of the stocks valuation.

• An announcement of any special dividend payments from eXtract to ENX shareholders will likely be another catalyst to the shares.
• Management has proven its ability to make accreative acquisitions. We expect additional tuck-in type acquisitions in the future.
• With the acquisition of Eqstra consumated, we exepct management will adopt a more pro-active posture with the international investment community.