Sunday, December 1, 2002

Newsletter Issue 2, December 2002

Editor: Kevin Yeh
Contact details: PO Box 71641, Bryanston, 2021; fax (011) 787 9888;

Issue 2, December 2002

Using this newsletter as a medium, we endeavour to provide you with quality investment advice that you can use to achieve long-term, sustainable equity investment success.

From the editor:

We have had very favourable response from our launch issue. Please keep sending your comments and questions. If there is anyone you know that may benefit from this newsletter, please forward this newsletter to him or her.

We will be introducing some exciting new features, so keep watching this space!

Since the festive season is almost upon us, I’d like to take this opportunity to wish you and your loved ones a merry Christmas and a prosperous 2003.

In this issue, we have:

Stock recommendations: There are two companies that we recommend in this issue: Pick ‘n Pay and WBHO. Both are in a share portfolio we have constructed at the beginning of this year, and both have outperformed the market.

Pick ‘n Pay: Established in 1967, it has been one of the best run retailers in South Africa. It has a strong brand. After the successful transition from a family run business to a business run by professional managers a couple of years ago, it is now poised for greater growth in the future.

WBHO: This construction company, which has had an excellent track record in the past few years, has many positive characteristics that would keep it providing satisfactory returns for its shareholders.

How do I invest on the stock market: This is a beginner’s guide to investing through the JSE Securities Exchange (JSE). It gives you the steps you need to follow to start investing in companies listed on the JSE.

Quotable quote: One of the most important things you should remember regarding investments.

Stock recommendation 1
Pick ‘n Pay is a company that is worth investing.

First, some facts about this company:

Full name: Pick ‘n Pay Stores Limited
Nature of business: Retailing of food, clothing and general merchandise
Classification: Food & Drug Retailers – Food & Drug Retailers
Founded: 1967
Listed on JSE: 1968
Market capitalisation: R6.8 billion as at November 2002
Vision: We Serve:
- With our hearts we create a great place to be
- With our minds we create an excellent place to shop

Why do we recommend this company?

For anyone who wants to know more about the history of Pick ‘n Pay, I highly recommend the autobiography of Raymond Ackerman, the founder and chairman of Pick ‘n Pay. The autobiography, “Hearing the Grasshoppers Jump”, is an enjoyable read. It gives an account of what shapes Raymond Ackerman. It depicts Ackerman as an entrepreneur, a man of vision, courage and determination. It tells of the triumphs, successes, as well as failures and difficulties experienced by Pick ‘n Pay. It gives you insight into what makes, and will continue to make, Pick ‘n Pay a successful company.

To summarise why we recommend this company:

ü It has built a strong household name, which has some franchise value.
ü It is able to maintain its dominant market share in the food retail industry, while it has good growth prospects locally in the retailing of clothing, housewares (through Boardmans), the development of a pharmacy chain (HealthPharm) and convenience stores (Pick ‘n Pay Mini Market).
ü It has acquired the Franklins stores in Australia. With its retail expertise, it should be able to restore Franklins Australia to profitability in the near future, further enhancing its profit growth.
ü It embraces technology to manage its stock effectively. Its stock turnover, defined as the turnover divided by the average inventory, is 17.6 times compared with Shoprite’s 10 times.
ü It has had a successful transition from a family run business to a business run by professional managers.
ü Its return on shareholders’ equity has been between 35% and 45% over the last few years, and there is no reason to believe that it cannot to be maintained in the future.
ü Strong cashflows generated by its operations

Based on our valuation, the fair value of this company is R6,662 million, or R13.40 per share. If you can buy Pick ‘n Pay’s shares at or below this price, you should be able to achieve a total return of 20% per annum over a period of three to five years. The total return consists of both dividend income and capital gains.

The current market value of Pick ‘n Pay is about R7,209 million, or R14.50 per share. This represents an 8% premium to our fair value. We believe that, while Pick ‘n Pay is a quality, “blue chip” company, it is expensive at the current price. We advise that you buy Pick ‘n Pay’s shares only when the share price falls to or below R13.40.

How much should you invest in Pick ‘n Pay?

If you have a relatively small portfolio (R50,000 to R100,000), you may want to invest R10,000 to R12,000 in Pick ‘n Pay. If you have a bigger portfolio, you may want to invest between 8% and 10% of your portfolio in Pick ‘n Pay.

Recent news

8 Cotober 2002: Pick 'n Pay results for the 6 months ended Aug 02

Pick 'n Pay reported what it described as an outstanding performance for the six months to Aug 02, posting a 54% rise in revenue to R12.9bn, a 45% increase in trading profit to R261.1m and 35% rise in operating profit to R296.3m. The group said that revenue growth for the period, excluding the results of Boxer and Australia (which were included for the first time in the interim statements) were 19% greater than those for the corresponding period, reflecting significant growth in both volume and market share. Headline earnings of 37.76cps were 34% higher than the 28.24cps of Aug 01 with earnings per share static at 30.94cps (30.22cps).

The retail division showed good growth in profitability and improved shrinkage levels. Score showed an aggressive turnover growth, opening seven new stores during the period. Boardmans was set to open three new stores during the coming period with the first Boardmans Superstore in Cape Town, to occupy around 3000 square metres of space. Development of the IT infrastructure of HealthPharm was delayed due to requirements from the group's Australian operations but should see significant progress in the next six month period. Franklins Australia posted revenue of R2.4bn and a loss of R50.9m -- an improvement over the R84m loss for the six months to Feb 02. Figures for the six months to Aug 02 included a R30m once off cost and Pick 'n Pay was confident that this division would return to profitability in the following 12 months. Negotiations for the acquisition of an additional six stores were in progress which would increase the total to 75 and the group was planning an additional 33 new stores for the six months to Feb 03, spread across all brands.

27 June 2002: Pick 'n Pay's online service grows 15% per month

Pick 'n Pay's online shopping website is now one year old and has shown steady growth of 15% per month since Mar 02. Although the business is still small, Adrian Naude, general manager in charge of online shopping, said that it is on track to meet its original breakeven target at some point in the 2003 year.

22 April 2002: Pick 'n Pay's pharmacies take off

Pick 'n Pay said that while plans are in place to open 30 Healthpharms a year, it has already attracted 180 expressions of interest. The group currently (Apr 02) has five stores around Gauteng with expansion in Cape Town and Durban scheduled for the end of 2002. So far, its franchise agreements have not been rejected by the Pharmacy Council. The Healthpharm arrangement is a franchise fee reviewed annually, based on the size of the store and the extent to which the pharmacy uses group services.

1 November 2001: Pick 'n Pay pharmacies are in demand

HealthPharm (Pick 'n Pay's new pharmacy chain) MD, Eric Wilson said that the group has already received in excess of 70 applications from pharmacists to buy into its new chain and that agreement has been reached with 180 pharmaceutical suppliers. The chain is expected to roll out 15 to 20 stores in the 2002 year and 20 to 40 stores per year thereafter, adding between 1.5% and 2% to group earnings within three years. Pick 'n Pay will earn cash through a franchise fee paid by pharmacists. Legislation currently disallows the group from participating in the profits of the chain and from having any equity in any of the franchised operations. Wilson said that some large multinational pharmaceutical companies were proving more difficult to get on board and said that some of the leading pharmaceuticals at the group's pilot store in Bryanston showed that prices were on average about 30% to 35% lower than at other pharmacies.

17 October 2001: Still need for small shops

Raymond Ackerman said at the sixth African Congress of Shopping Centres that there has been a swing amongst consumers to convenience and that there are many areas that need small shops in small centres. He did not negate the need for large retail stores, but said that the need for smaller convenience centres presents huge opportunities. Encouraging initial results have been received from the group's home shopping venture but profits from this area are not anticipated . Effort is being expended on keeping home shopping at around 5% of its overall food business.

Stock recommendation 2
WBHO is a company that is worth investing.

This is a company that we have been following closely since the end of last year. Its share price has risen dramatically from R6.66 at the end of last year to a recent high of R10.

First, some facts about this company:

Full name: Wilson Bayly Holmes-Ovcon Limited
Nature of business: Civil engineering and building contractors
Classification: Construction & Building Materials – Other construction
Founded: 1975
Listed on JSE: 1988
Market capitalisation: R540 million as at November 2002

Why do we recommend this company?

Its business

ü Its business is simple and understandable. It has two main divisions: Roads and Earthworks and Construction.
ü Although all construction companies are subject to the construction cycle and hence the fluctuations in earnings, this company has been able to deal with the impact of the construction cycle more effectively and has produced more consistent results than its competitors.
ü Its turnover and profits have been growing steadily.
ü It has favourable long-term prospects: Locally, the construction industry is in a growing phase. Also, the provincial and local governments are spending more of the moneys budgeted for infrastructure. Globally, it is maintaining and expanding its presence in countries neighbouring South Africa and in Australia.

Its management

ü It is able to adapt quickly in a changing environment to ensure the most effective use of its resources.
ü Unlike many companies which raise debts to finance acquisitions and expansions, this company has been expanding steadily while reducing its debt.
ü The directors control the company: together they own 46.1% of the shares. This gives them freedom to do what they think is in the company’s best interests.
ü A stable board of directors with a long working relationship.

Its financials

ü It has a stable operating profit margin.
ü It has maintained a high level of return on shareholders’ equity. From 1996 to 2001, the average is 31.4%.
ü Strong cashflows generated by its operations, and a large proportion of the company’s market value is underpinned by cash in the bank.

There is one concern we have though, and it’s the effect of AIDS on the company. AIDS studies have indicated that the construction industry has a high HIV prevalence rate. If not dealt with effectively, HIV/AIDS could significantly slow down the profit growth of the company. The company has not communicated its HIV/ AIDS policy in its annual report.

Based on our valuation, the fair value of this company is R540 million, or R9.75 per share. If you buy WBHO’s shares at or below this price, you should be able to achieve a total return of 20% per annum over a period of three to five years. The total return consists of both dividend income and capital gains.

The current market value of WBHO is about R540 million, which is at its fair value. Don’t buy when the share price is significantly above R9.75, otherwise your chance of getting a 20% return per annum will be reduced.

How much should you invest in WBHO?

If you have a relatively small portfolio (R50,000 to R100,000), you may want to invest R10,000 to R12,000 in WBHO. If you have a bigger portfolio, you may want to invest between 8% and 10% of your portfolio in WBHO.

Recent news

12 October 2002, Business Report

WBHO maintains 30% earnings growth rate Roy Cokayne
Pretoria - Wilson Bayly Holmes-Ovcon (WBHO), the listed construction group, had increased earnings at an impressive average rate of 30.3 percent a year since the merger with Wilson Bayly Holmes in 1995, Mike Wylie, WBHO's chairman, said yesterday. "This achievement is even more significant when viewed against the backdrop of the cyclical nature of the industry and the far-reaching changes that have occurred in South Africa in recent years," he said in the company's latest annual report. In the year to June, WBHO reported a 27 percent increase in headline earnings to R80 million while turnover rose 34 percent to R2.28 billion. Wylie said growth was achieved across the board, with certain divisions achieving exceptional results. The roads and earthworks division in particular had managed to exploit its larger capital base, which arose from the acquisition of Stocks Civil Engineering last year, and had once again achieved record profit. Wylie said civil engineering concrete work continued to fill the gap created by the decline in building work, but the group nevertheless managed to fill its order book with a number of significant building contracts in most of the major centres of South Africa as well as Botswana and Malawi. Work beyond the borders of South Africa continued to constitute a significant portion of the company's operations, increasing to 34 percent of group turnover during the year compared with 28 percent in 2001. Turning to the group's prospects, Wylie said the building industry was expected to remain quiet this year, while moderate growth in mining infrastructure and other reinforced concrete civil projects was expected to continue. "The demand for roads and earthworks projects in South Africa and sub-Saharan Africa is expected to remain strong." Wylie said the group had a good-quality order book of more than R2 billion and should achieve higher headline earnings this year. WBHO is budgeting to spend R100 million this year compared with R83 million last year on plant and equipment because of the higher contribution to turnover of the roads and earthworks division and the rise in the prices of plant and equipment. WBHO was unchanged at R9.

26 August, 2002, Business Report

Industry hails R30bn road plan Roy Cokayne
Pretoria - Major construction and engineering companies welcomed the cabinet's recent decision to approve, in principle, a R30 billion plan to upgrade the country's roads over the next five years, but some expressed concern over whether the industry had sufficient capacity to cope with the workload. Jo Johansson, the managing director of the roads and open cast mining division of Basil Read, said the capital expenditure programme was "long overdue and very encouraging to see", but said the construction industry had lost capacity and skills over the years. "The industry's going to need recapitalisation but that's the easiest part. The industry's lost quite a lot of human capital. "If you take the R3 billion with what is happening at Coega, it's a big ask for the industry to try and reconstruct the skills it had 10 to 15 years ago," he said. Johansson said there would be "soul searching and prioritising" by companies on where they worked and "wanted to be" because cross-border work had become "the flavour of the month" during the past five years. "Like anything else, supply and demand will start to gradually lift margins for all construction companies because they will have to lift margins to sustain training people. "In addition, the construction industry is a tremendous generator of jobs, particularly at lower skills levels," he said. Mike Lomas, the chief executive of Group Five, the listed construction company, said the capital expenditure would be "very positive" for the road-building industry in general. Lomas stressed that insufficient money had been spent on upgrading roads over the past five years and the economy needed good infrastructure and roads to grow. Lomas said he was not concerned about a lack of capacity but that this was dependent on the rate at which the road building work came out on tender. Mike Wylie, the chairman of Wilson Bayly Holmes Ovcon (WBHO), said the programme was "really good news". WBHO preferred to have its road-building team in South Africa rather than in the rest of Africa. Wylie did not foresee problems with capacity. He said concerns about the capacity of the industry were also expressed when the casino licences were awarded but the industry had "knocked off the casinos with no problems". "We have a strong industry and good foundations to increase capacity as required," Wylie explained.

18 July 2002: WBHO builds roads in Angola

WBHO said that work on a USD13m contract to rehabilitate 40km of road in southern Angola, had begun.

1 July 2002: WBHO chairman retires

Brian Holmes retired as the chairman of WBHO, but will continue to act as a non-executive director. Mr Mike Wylie, an executive director of the company, will assume the role of chairman from 1 Jul 02

How to invest on the JSE Securities exchange

One of the readers wanted to know how to invest on the JSE. The steps to take are as follows:

1. Select a stockbroker that best suits your needs. You may already have a bank that you bank with, so all you want is just a stockbroker that offers traditional stockbroking and administration services. Or you may want a stockbroker that offers other financial services such as banking services and money market investment accounts. You might prefer to deal with a personal stockbroker, or you might prefer to trade online using the internet. Whatever your needs and preferences, you need to choose your stockbroker carefully. You would want to build a long-term relationship with the stockbroking firm that’s right for you.

Go to and click on Find a broker on the left panel to see a list of brokers.
2. Request for an application form, also known as a Consolidated Mandate, from the stockbroking firm you have chosen. A Consolidated Mandate authorises the stockbroking firm to open an account for you and to act as a stockbroker to buy and sell shares on your behalf. Many stockbroking firms have the application form on their websites for you to download.

3. Fill in the form/mandate, and send it back to the stockbrokers together with any required supporting documents.

4. Deposit money into your account. After the stockbrokers have received your mandate, they will open an account for you, and advise you of their banking details so that you can deposit money into their trust account. The money will then be allocated to your account. The money required is normally at least R10,000.

5. Do your home work, or obtain expert investment advice. Before you buy into a company listed on the JSE, you need to know that this specific company meets certain criteria and thus qualifies as an investment. You can come to this conclusion either by doing your own analysis, or by obtaining expert investment advice. This is where we come in and add value by providing stock recommendations.

6. Buy shares of a listed company by placing an order online or with your stockbroker. With an order, you need to specify the company whose shares you want to buy, the number of shares you want to buy, and at what price. Be aware of the costs associated with buying and selling shares on the JSE: In addition to the brokers’ commission, which ranges from 0.5% to 1.7% of the value of the transaction, there is a STRATE settlement fee of 0.05%, subject to a minimum of R10 and a maximum of R50, and an insider trading levy of 0.0007%. A purchase of shares is further subject to a Marketable Securities Tax of 0.25%.

7. Review your portfolio. While we do not encourage investors to buy and sell shares in pursuit of short-term gains, we do encourage investors to develop better understanding of the companies they have invested in. Also, there might be times where shares of a company have to be sold when the company no longer qualifies as an investment as it was originally.

In the next issue, we will compare a few selected stockbrokers.

Quotable quote

Learn from your mistakes. The only way to avoid mistakes is not to invest – which is the biggest mistake of all. So forgive yourself for errors and certainly don't try to recoup losses by taking bigger risks. Instead, turn each mistake into a learning experience.
- Sir John Templeton, founder of the Templeton Group

In the next issue:
In addition to stock recommendations and Quotable Quote, we will compare a few selected stockbrokers and show you which one is for you.

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