Proplastics spin-off: unlocking value in pipes

Proplastics spin-off: unlocking value in pipes

By Ray Chipendo, JOHANNESBURG, June 17 (The Source) Last week’s listing of Proplastics breathed a fresh breeze of life into the capital markets. Proplastics, previously part of Masimba group was unbundled and listed separately.  This is a small cap company with a market capitalisation of around $4,9 million. Share price is now  two cents. In the first week of trading Proplastics dipped 73 percent from the listing price of three cents to 0.8 cents.

The share movement trajectory confirms to a certain extent the assertion we made on spinoffs in a recent commentary – “Innscor Spinoff – A special situation for making a profit”. In our commentary we observed that based on history and research spinoffs do experience a sharp fall in share price days after listing. We explained that ownership in a spin-off is involuntary for owners of the group company. After listing, some investors, mostly institutional money leaves the spinoff and moves back to the holding company as the newly created company might not be fitting in their investment mandate.

Growth prospects

We like to look at Proplastics as Warren Buffett would define such one company – boring and beautiful. There is little glamour in producing plastics, sewer plastics for that matter. Yet the economics of this business are defensive in nature, particularly in an economy where household spending is under pressure.  Proplastics pipes find their way into the telecoms; irrigation, water infrastructure and mining. In our view these idiosyncratic sectors are less tied to the performance of private consumption which makes them defensive.  As government leans on the agriculture to spur growth economy-wise, new farmers will require extensive irrigation systems which is a boon for pipes. The need to revamp water and sewer infrastructure in cities and towns and a sprawling of housing projects in major centres is placing a significant demand on piping systems as well. We think this is an enduring business model.

In addition to local demand, Proplastics exports pipes regionally. Rapid urbanisation in Africa coming from a low base is a strong headwind for the industry. To support this projected growth, Proplastics recently set up an HDPE plant which will enhance product offering to local and export markets. The company has also reported a plantmodernisation program which will see improvementin product range and production efficiency.We think Proplastics’ growth prospects are remarkable.

Quality of the business.

Proplastics seem to be starting from a stable base – very little or no debt as shown by December 2014 financials.  We expect this clean balance sheet to provide the company with flexibility to expand and invest in its future performance.

We have however identified a few stains- Margins and return on invested capital have both weakened in recent years. For the latter we could attribute high capital expenditure in the last year. Gross margins have shrunk from a high of 31 percent in 2010 to 21 percent in 2014. Operational margins were 19 percent in 2010, went down to two percent in 2012before climbing to 5.7 percent in the last financial period. As the company stands alone, we expect pressure on administration costs but we hope an increase in revenue supported by better strategic direction and focus will improve the overall margins of the business.

Valuations

Proplastics’ valuation is tied to how the company’s margins and revenue will perform in the near future. If revenue significantly goes up and margins continue on an improvement trend they have maintained in last two years we expect value to begin reflecting in share price. Based on current data both our income and asset valuation models suggest Proplastics, at a price range of 2-2.5cents, is in fair value region. However, Proplastics is a growth company and despite size, it could also be classified as a quality company. Such attributes lend themselves to valuations that are future oriented. If Proplastics grows its earnings, which we do expect, then this company may be viewed as undervalued.

As the ZSE automates and online share trading becomes live, trading in penny and small cap stocks will become more practicable for retail investors. Despite an obvious bear market, we think exciting times lie ahead for the ZSE.

Ray Chipendo is Head of Research at Emergent Research. He can be reached on: ray@emergent-research.com

The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy thereof. Such information and the opinions expressed are subject to change without notice. A report, update, article or note is not intended as an offering, recommendation, or a solicitation of an offer to buy or sell the securities mentioned or discussed – Editor