In case you’ve been living under a rock for the past few years, there have been many examples on the JSE of management teams returning home from faraway lands with their tails between their legs.
Though there were plenty of solid macroeconomic reasons to seek opportunities in places that have electricity, the problem was that many executives neglected their core businesses.
Mpact managed to avoid that trap, with the management team focusing on building resilience into the core business during a tough period for South Africa. There were some major headaches along the way, with the Competition Commission certainly on that list and the recent fight with Caxton & CTP featuring as well. There were also some major wins, including investment in local manufacturing capacity and a renewable energy strategy that was ahead of its time, making Mpact look like a genius in the current energy environment.
The share price has been on a rollercoaster of note over the past decade. When the news broke of a Competition Commission raid in 2016, the share price fell, then trended downwards until the pandemic. To call that journey painful would be an understatement, as Mpact traded above R51 in 2016 before bottoming out at about R7.50 in March 2020. Now trading at nearly R30, it’s been sideways action for the past year, as the recovery happened in 2020 and 2021.
With a market cap of R4.4bn, Mpact is firmly in mid-cap land, but not liquid enough to be a serious option for institutional investors. This is the ongoing conundrum on the JSE, leading to the delisting of many companies that can tell a similar story about liquidity.
When it comes to the valuation multiple, though, don’t feel too sorry for Mpact. With headline earnings per share of 430.1c for the year ended December 2022, the trailing p:e is about seven. That looks like an absolute bargain in the context of earnings growth over the past 12 months, but the longer-term pain for shareholders won’t be easily forgotten. It’s important to remember that cyclical businesses tend to trade on lower multiples, and with good reason.
To invest in Mpact, you need to form a view focusing on the paper business, as it generates five times as much revenue and operating profit as the plastics business. Referring to Mpact as a diversified group is ambitious when well over 80% of the profits come from one segment.
The good news is that the paper segment is where the magic is happening. Plastics could only manage flat volumes in 2022, but the paper business enjoyed substantial demand and grew its volumes by 6.9%. Selling price growth in plastics was a meaty 9.7%, so the flat volumes were less of an issue, and the paper business increased its pricing by nearly 9.5%. The pricing power in both businesses has been a major driver of performance.
The year-on-year revenue performance was blunted by the Baywhite distribution agreement with Mondi that terminated at the end of December 2021, so group revenue only increased 7.1%. It would’ve been up 15.2% without that agreement skewing the numbers.
Still, the revenue increase of 7.1% was enough to drive growth of 22.9% in earnings before interest and tax (ebit). This gives you a sense of the operating leverage in the business, which works very well in good times but can be particularly nasty in a downturn. With exposure to pricing dynamics in the sector that are cyclical in nature, this is part of why the market is hesitant to place a higher valuation multiple on the 2022 earnings. If the group can’t push through pricing increases, the ebit story looks completely different.
Mpact is throwing its weight behind the export fruit sector, investing R1.2bn in the Mkhondo paper mill in response to growing demand for virgin containerboard. A look-through to the agriculture sector adds more cyclicality to the business, with the counterargument being that this is an attractive sector in South Africa that can benefit from our natural resources and weak currency. There is also investment in further renewable energy projects.
The outlook for 2023 is mostly positive, supported by efficiency gains in the underlying operations as certain facilities either come on stream or reach critical mass. Load-shedding remains a risk, though, with Mpact not immune to slower economic growth.
On a dividend yield of 3.8%, Mpact isn’t a bad way to hang on to equity exposure this year. IM just wouldn’t go overweight on this one, given the macroeconomic conditions.