Good cash flow allows Massmart to invest

ON Wednesday and yesterday, there were two news reports relative to the investment fundamentals of Anglo American (Anglo), one of the 10 counters held by the Private Investor portfolio. The first news was that Anglo has sold 61-million Hulamin shares to Coronation Asset. The cash injection from the sale is R732m, equivalent to about 93m.

This, no doubt, will not give much pleasure to former deputy chairman Graham Boustred, several other former Anglo executives and other Anglo shareholders, who think Anglo would perform better as a conglomerate.

They can hardly complain about the second news item, which was reported as I began today’s column. Kumba Iron Ore, one of Anglo’s core mining assets, in which it holds 63% of issued shares, reported in a trading update that it expects bottom-line earnings per share to have been between 1 050c and 1 085c in the half-year ended June 30 . Earnings per share in the comparable previous period were 890c.

I hope to write more on Kumba when its half-year results have been published. Right now, my focus remains on Massmart .

Massmart’s share is still trading around R76, at which price it has a price:earnings ratio of 11,8, an earnings yield of 8,5% and a dividend yield of more than 5%. These ratings were based on the 2008 financial year’s figures, and I suggested they were a good baseline for the ratings for the year ended June 30 .

However, Massmart’s 2009 financial year is over, and any value rating on the share has to be made on the 2010 financial year.

As Massmart’s business depends on its ability to be price- competitive, its operating margin — its return on sales — has to be maintained at a low level. The 2008 return on sales was 5,24% and its stated medium-term target is 5,5%

The other main driver of return on assets is asset turn — the ratio of sales (turnover) to assets. This ratio of 3,34 was enviable. From the model on return on assets managed, Massmart’s return on assets last year — the product of asset turn and return on sales — was, therefore, 17,5%.

It has to be accepted that even if the economic recession improves, Massmart will battle to improve sales and there is not much scope to improve its operating margin. Fortunately, its businesses generate robust cash flow that provides finance for investing in new assets, either by expanding floor space in stores or opening new stores.

Given the success it has already achieved in Africa, notwithstanding currency translation losses reported in the trading update, I reckon that there is a high probability the company will continue this strategy. It could well improve its asset turn in these market sectors and also possibly improve return on sales there.

My feeling is that a target rate of return on assets managed of last year’s 17,5% is optimistic. I don’t know if this is Massmart’s target but I’m sure it will try to maintain its asset turn.

Massmart’s share price market ratings seem to share my view — maintaining bottom-line earnings per share in 2010 at best. However, there’s long-term value around R76 a share. I wait eagerly for the company’s own prospects when the year-end results are reported next month.
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