This company has grown HEPS at a CAGR of 31.55% over the last 5 years

1400 word deep dive unpacking one of my highest conviction stocks

Argent Industrial is a core holding in my JSE portfolio and recently just published full year financial results for the 2023 financial year-end. In this post I will provide some insights based on my assessment of the results and some key metrics and some colourful commentary along the way.

To kick things off, I will provide a brief overview of the business for those readers that are not familiar with the company. Argent describes themselves as steel-based beneficiation group and have a diverse portfolio including international brands. Beneficiation is any process that improves the economic value of ore (for example iron ore) by removing unwanted minerals resulting in a higher-grade product.

Argent holds the following subsidiaries:

• American Shutters
• Argent Industrial Engineering
• Argent Industrial Investments
• Castor and Ladder
• Gammid Group
• Hendor Mining Supplies
• Jetmaster
• Kochs Cut & Supply Steel Centre
• Megamix
• New Joules Manufacturing
• Phoenix Steel Group
• Pro Crane Services
• Tricks Wrought Iron Services
• Xpanda Security
• Cannock Gates & Burbage Iron Craft
• OSA Door Parts
• New Joules Engineering North America
• Fuel Proof
• Roll-Tec Safety
• Partington Engineering
• Argent Industrial UK
• Fluid Transfer International
• Flofuel Support

These businesses cover a huge spectrum of products from manufacturing and steel-based trading to concrete building products, mobile and static bunded fuel storage and dispensing systems and bespoke trolleys.

Some of the newer additions in the Argent portfolio include custom-made adjustable louvre shutters and market-leading aviation refuelling vehicles and systems. Argent has a total of 24 operating units that operate in South Africa the United Kingdom and the United States. Manufacturing is the primary activity of the group however they have a vertically integrated strategy and thus have downstream steel-beneficiation operations.

Looking to the financial highlights in the annual report I noted that headline earnings per share (HEPS) has grown consistently over the past five years even throughout COVID. HEPS has grown from 104.4c in 2019 to 411.3 in 2023 at compounded annual growth rate (CAGR) of 31.55%. The share price of Argent has closely followed earnings over this period, and had you bought Argent shares 5 years ago you would have achieved a return over 30% a year. This is an impressive feat and has resulted in shareholders achieving real returns (after considering the effects of inflation) well in excess of 20% a year.

Looking to the net asset value (NAV) per share, an important metric for a capital intensive industrial business, Argent has grown NAV at a CAGR of 15.5% per annum. On 31 March 2023 Argent had a NAV per share of R26.84. The counter therefore trades at a large discount to book value and currently sits a price to book of 0.61.

Revenue growth on the other hand has been rather muted when compared to HEPS but has been steadfast, nonetheless. Revenue has grown at a CAGR of 7.42% from R1.72 billion in 2019 to R2.46 billion in 2023. While 7.42% per annum may not seem, impressive this has outperformed global manufacturing growth rates through the period. According to Statista the global manufacturing industry is expected to grow at an annual rate of 3.57% from 2023 to 2028.

So given that revenue has only grown at 7.42% per annum you might wondering how management have managed to grow to HEPS at over 30% per annum? There are multiple reasons for this but of the primary reasons are aggressive share buybacks from management. When earnings remain flat, and your number of shares outstanding is constantly reducing year after year this results in a growing HEPS. If this is not intuitive to you then think in terms of how HEPS is calculated, headline earnings divided by weighted average shares outstanding. If the dominator of your fraction decreases while the numerator remains constant this will result in a higher value.

Another reason for high earnings growth despite revenue low revenue growth is due to effective cost management and cost savings. This is due to the vertical integration of the business allowing efficiencies and cost savings to be passed up stream from steel beneficiation operations to manufacturing businesses. The last reason I identified that has also contributed to higher headline earnings is a lower effective tax rate. This is likely due to foreign operations, in jurisdictions with a lower overall effective tax rate, starting to make a larger contribution to overall earnings resulting a lower effective tax rate.

Looking at the five-year financial review of the business the balance sheet has remained robust throughout. The current ratio of the entity is currently a solid 2.8 and has remained above 2 over the last 5 years. The gearing of the entity has also come down significantly over the period from 23.1% in 2020 to 9.4% in 2023 which is an incredibly wise move given the interest rate hiking cycle over the period. The de-gearing of the business has result in lower finance costs which also ultimately also contributed to HEPS growth.

Every business is subject to key risks and Argent is no different. I had to summarise the risks identified by management into two words it would ANC and Eskom, but this is more detailed summary of the key risks of the business:

• De-industrialisation of South Africa the decline in manufacturing and capital spend are indicators that will result in declining revenue and profitability for the group and only diversification away from the South African market will mitigate this risk.
• Political and labour instability the growing risk of labour and political instability is forcing diversification to more geographically stable regions.
• Energy price and availability risk the lack of stability of electrical supply is disruptive to economic and business recovery and the need to invest in power supply independent of the national grid over and above basic generators is critical.
• The 2024 South African general elections.

When going over the CEOs review of the business he provided shareholders with some insight into what to expect in the future for the performance of the business as well as the overall strategy going forward. The CEO noted that overseas operations had an incredibly good year, and this is expected to continue given the current order books. Management however have inspiration to place the companys operations and production elsewhere in the world given the fun show put on by the current elected party and thus there is a good chance we expect Argent to start divesting out of South Africa while continue to expand through acquisitions in offshore markets. While majority of the groups revenue came from South Africa (57.78%) compared to offshore markets (42.22%), the profit contribution however was flipped with SA operations contributing 41.91% and the rest of the world contributing 58.09%. Management will continue to examine investment opportunities in the UK that will yield a high ROE while being disciplined on valuation.  Additionally, the share buyback programme will continue which a positive signal as this has been a key driver of HEPS.

The cash position of the group remains strong and there is currently R255 million in cash on the balance sheet which is roughly 28% of the market cap of the stock. Debt levels are currently low and can easily by covered by cash. Interesting-bearing liabilities on the balance sheet are only R94.77m. Looking at the statement of other comprehensive income I noted that foreign exchange gains contributed roughly R63m or 21% to overall total comprehensive income. This just goes to show the importance of holding SA Inc companies with foreign operations in times when the rand continues to lose value. A weakening rand however is not a sustainable form of business growth. 

Argent continues to be a cash cow with strong free cash flow generation. Free cash flow generated for the period amounted to R184.43m and this places the stock on P/FCF of 4.95.

For investors seeking income yields Argent has doubled their dividend from the 2022 to the 2023 financial period. Full year dividend is 95c and the counter has trailing 12-month dividend yield of 5.83%. Argent continues to remain a core position in my portfolio and the 2023 financial results have only strengthened my conviction in the company. Management continues to be astute allocators of capital and focus on not overpaying for acquisitions while returning capital to shareholders in the forms of share buybacks and dividends.