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South Africa: Pioneer Food's Gearing is Moving Too High
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Business Day (Johannesburg)
COLUMN
15 May 2008
Posted to the web 15 May 2008
Ben Temkin
Johannesburg
TWO of the companies in the Private Investor portfolio have been in the media spotlight recently. At Afrox's annual general meeting last Friday, MD Tjaart Kruger gave an update on the company's operations and plans.
On Tuesday Sasol's directors issued a trading update for the financial year to June . I've read both the update reports and plan to write something about them. While both statements contain valuable investment information, there is no reason for us to reconsider either investment. Afrox's share price obstinately refuses to rise, while Sasol's hit a new high of R485 on Tuesday.
And so, at last I have some space to write on Pioneer Foods, the newly listed, though not new, food company.
You may recall that my interest in the company was attracted by an example of its excellent customer service. I have, however, watched the company's record over several years. It has been a somewhat strange entity. It was a large company with a broad shareholder base and its shares were easily traded over the counter. Yet the directors doggedly resisted a listing on the JSE, although they expected the shares to be listed at some time in the future.
We're still suffering shock-waves from the huge bank write-offs triggered by defaults on subprime mortgage debts and made worse by financial derivatives created from these debts and marketed globally. As banking liquidity dried up -- and remains, in general, dry -- the most popular corporate banking game has been suspended.
This is the buyout game, the buy out of market-listed shares, either financing the company's management to buy the shares or holding the shares as a private equity operation. The intention in either case is to continue to build up the unlisted companies and, when considered appropriate, re-list the shares at a capital gain.
These buyouts were especially popular while interest rates were moderate. Financial gearing is positive as long as return on equity is higher than the borrowing rate. With much higher interest rates, it is much more difficult to maintain positive gearing. I'm forced to ask if Edgars is wincing or writhing in pain?
The management of Pioneer Foods had, before its listing on the JSE, concluded that its future earnings growth required further capital investment of R500m. This was not a surprise. Between the financial years 2003 and 2007, its annual capital expenditure had risen from less than R200m to well more than R600m, the weight in the last two years being on the cost of replacing fixed assets, additions to fixed assets having stuck around the R200m level.
At the end of the 2004 financial year, Pioneer's net interest bearing debt (its debt:equity) was 17%. At the end of financial 2007, it was 33%. The reason for the higher gearing was explained at the pre-listing presentation: the substantial increase in fixed capital in 2006 and last year, aggravated by the time lag between capital spending and its contribution to earnings.
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The result was a fall in return on assets and, therefore, a lower return on equity. Who wants higher gearing when this is happening and interest rates are rising?
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