Where are the risks lurking on the JSE?
Research from Intellidex has identified the ‘riskiness’ of various JSE-listed small- and mid-cap companies. This stress has been caused, and in some cases amplified, by the increasingly abnormal environment as a result of the Covid-19 pandemic and associated lockdown. The report, by analysts Phibion Makuwerere and Orin Tambo excludes micro-caps, large-caps and property stocks.
Their methodology uses a score of one to five across five factors, with one representing high risk while five means low risk. The weighted average gives a final score out of five, with the companies with higher risk profiles having the lowest scores.
The analysts made use of the following factors:
- Business risk: This includes “a subjective judgement of the industry’s riskiness relative to other industries, in the view of Intellidex analysts”, the degree of operating leverage (DOL) and degree of financial leverage (DFL);
- Liquidity risk: Here, the company’s working capital position is evaluated by using the current ratio and acid test ratio;
- Short-term debt risk: This “measures a company’s ability to meet its short- term interest-bearing debt obligations. Calculated as short-term debt divided by cash”;
- Long-term debt risk: This is a “company’s ability to meet all its interest-bearing liabilities, calculated as net debt divided by equity”; and
- Management risk: “A subjective measure which evaluates management’s pedigree in the view of Intellidex analysts, thus its ability to navigate business stress induced by Covid-19.”
The operating leverage factor in number one above measures the “responsiveness of operating profit to changes in revenue. Companies with high fixed costs (including leases) and lower margins tend to have high DOL, which means they are riskier”.
For financial leverage, the analysts measured the “responsiveness of earnings to changes in operating profit. This should be viewed in conjunction with the Ebitda-to-debt ratio (an important debt covenant used by lenders). Companies with high interest costs have high DFL, thus riskier.”
Source: Intellidex
Unsurprisingly, companies in the travel and leisure sector currently have the highest risk when measured using this methodology. Using just the sector risk profile is flawed, however. For example, the mining sector (with just four companies in this study) has two great companies (Kumba and African Rainbow Minerals), one decently rated one (Exxaro) and Wescoal, which scores significantly lower. This drags the entire sector’s average score down.
| Risk score | Industry | DOL | DFL | Liquidity | ST debt | LT debt | Management | |
| Calgro M3 | 0.54 | 1 | 2 | 1 | 1 | 1 | 1 | 3 |
| Sun International | 0.54 | 1 | 2 | 1 | 2 | 1 | 1 | 2 |
| EOH | 0.63 | 2.5 | 2 | 1 | 1 | 1 | 1 | 2 |
| PPC | 0.71 | 1 | 1 | 1 | 1 | 1 | 3 | 3 |
| Aveng | 0.89 | 1 | 1 | 1 | 1 | 1 | 4 | 3 |
| Adapt IT | 0.98 | 2.5 | 3 | 1 | 1 | 1 | 1 | 3 |
| Tsogo Gaming | 1.07 | 1 | 2 | 4 | 1 | 1 | 1 | 3 |
| Tongaat Hulett | 1.43 | 4 | 2 | 1 | 1 | 1 | 4 | 2 |
| AdvTech | 1.52 | 3.5 | 3 | 1 | 1 | 1 | 2 | 4 |
| Life Healthcare | 1.61 | 3 | 2 | 3 | 2 | 2 | 1 | 3 |
| Ellies | 1.61 | 2 | 3 | 3 | 3 | 3 | 1 | 1 |
| Comair | 1.61 | 1 | 2 | 4 | 1 | 4 | 2 | 2 |
| Phumelela | 1.61 | 1 | 2 | 4 | 1 | 1 | 4 | 3 |
| Woolworths | 1.79 | 3 | 2 | 3 | 2 | 2 | 2 | 3 |
| Invicta | 1.79 | 2 | 2 | 3 | 1 | 3 | 3 | 3 |
| Adcorp | 1.79 | 3 | 1 | 4 | 2 | 4 | 1 | 2 |
| City Lodge | 1.88 | 1.5 | 2 | 3 | 4 | 2 | 1 | 4 |
| Massmart | 1.96 | 3 | 2 | 3 | 1 | 1 | 3 | 5 |
| TFG Limited | 2.14 | 2 | 2 | 4 | 3 | 2 | 2 | 4 |
| Omnia | 2.23 | 2.5 | 2 | 3 | 2 | 3 | 3 | 4 |
| WBHO | 2.32 | 1 | 2 | 3 | 2 | 3 | 5 | 4 |
| Zeder | 2.32 | 3 | 4 | 1 | 3 | 1 | 4 | 4 |
| Oceana | 2.32 | 4 | 3 | 3 | 3 | 3 | 1 | 3 |
| Wescoal | 2.32 | 5 | 3 | 2 | 2 | 2 | 3 | 3 |
| Altron | 2.32 | 3 | 2 | 3 | 3 | 3 | 2 | 4 |
| MTN Group | 2.32 | 4 | 4 | 2 | 3 | 2 | 2 | 3 |
| Famous Brands | 2.32 | 4 | 4 | 3 | 3 | 3 | 1 | 2 |
| Cashbuild | 2.41 | 3,5 | 2 | 2 | 2 | 2 | 5 | 4 |
| Curro | 2.41 | 3,5 | 4 | 2 | 2 | 2 | 3 | 4 |
* Lower is more risky. All companies below 2.5, using the Intellidex methodology.
In this environment, companies defined as most-stressed using this methodology are also the most likely to see sharp share price movements on news (good or bad).
An example of this was EOH, which nearly doubled (from R3.30 to R6.40) in two days following the publication of a market update on June 9. The market reacted very positively to continued progress on its deleveraging plan.
Rights issues
Both Sun International and City Lodge have announced R1.2 billion rights issues to bolster their respective balance sheets. Sun International raised R1.5 billion by issuing shares in 2018. Its total debt in South Africa is R8.8 billion (as at end December), while its market capitalisation is R2.4 billion (its debt in Latin America is ringfenced to those assets). City Lodge’s problem is slightly different – it has to bail out its BEE scheme, given that it guaranteed the debt.
Comair, operator of British Airways and kulula.com, filed for business rescue on May 5, while horseracing group Phumelela followed on May 8. Trading in the shares of both companies was suspended from those dates. Both have received offers of cash injections.
Curro’s plan to raise R1.5 billion surprised the market, given that management had previously indicated that the days of rights offer were behind them. Major shareholder PSG Group has undertaken to take up additional shares if other shareholders do not follow their rights. As at end-December, it had R3.6 billion in long-term debt.
TFG Limited has also announced that it will raise up to R3.95 billion by issuing shares. It says this is necessary to “reduce debt and insulate the balance sheet, ahead of what is expected to be a sustained period of economic uncertainty”, as well as to “ensure the group has the ability to take advantage of market opportunities in line with its current strategy and which meet its investment criteria”.
In an update in mid-June, Massmart said that while its “balance sheet remains strong”, it had “secured a R4 billion inter-company loan from Walmart Inc to provide additional headroom in the event of unforeseen circumstances as we navigate through the lockdown period and beyond”.
A handful of companies on the list above have moved to shore up their balance sheets. But, based on the Intellidex methodology, the list runs to more than two dozen. The key for investors will be to separate the (real) quality from the risks.
Those companies with manageable levels of long-term debt will likely be fine. But liquidity strains are another problem entirely. There’s surely a lot more action to come.
