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4 February 2014 Grindrod Rail has secured opportunity to work with Northwest Rail (a Zambian company) to build a new 590km Cape gauge railway line from Chingola (Zambia) to Kansanshi/Kalumbila mines, to the Angolan border, they will also be responsible to operate and maintain it.

20 January 2014 One needs to regularly redo analyses of Grindrod, as their value fluctuates especially with what one can achieve on the commodity shipping markets. I redid it over the weekend, because I'm looking for shares to buy, and it's now trading only 15% to 25% below what I consider to be fair value. I'm not buying more at that level, as I want at least a 30% margin of safety. But not planning on easily selling what I have either!

I spotted this article in Bloomberg Business Week about Grindrod's new locomotive leasing division (GPR Leasing). I love it that Grindrod is moving more into the locomotive area, as I believe that rail transport is going to gain more and more of a competitive advantage over road transport as oil prices inevitably go. "Grindrod's freight services unit has formed a jv with Pembani Remgro Infrastructure Fund to provide leasing of locomotives & wagons to the African rail industry". A large part of the business will be providing funding for clients, through FMB, to purchase locomotives & wagons, mostly built by Grindrod Rail. Grindrod will own 55% of the JV, and has already secured orders for 31 locomotives from state owned rail companies outside SA & mining companies in Mozambique & Zim.

"Grindrod locomotives are 30% to 50% cheaper up front than other diesel-electric locomotives in the market," says Grindrod director and CEO of GFS Dave Rennie. "The proven track record of the locomotives and their exceptional performance mean the funding institutions are keen to finance them."

"My role in RMB for about the last 10 years has been in rail, and I can tell you that Grindrod do produce very competitively priced and robust locomotives," says Greg McKenzie, who is involved in structured finance at RMB. "Rail infrastructure in Africa is in a very sorry state. So there’s a need to invest in rail infrastructure; for GPR Leasing there’s a lot of room to grow." Remgro is also a shareholder in RMB, which is the mandated lead arranger and funder for GPR Leasing.

1 Dec 2013. I just LOVE investing alongside directors - they generally have the most knowledge about the company.

Grindrod is a beast of a company to analyse. It has a lot of moving parts (pun intended!) - divisions varying from financial services to shipping (characterised by volatile, cyclical profits). Adding to the complexity, a lot of the operations aren't wholly owned. It's a difficult company to get one's head around, so take that into account when you think about the probability of my analysis being wrong. There's also the matter of its balance sheet likely to become more geared as it spends on its major projects. This is not a share for the faint-hearted.

However, seeing directors buying always energises me to do some homework!

Grindrod offers end-to-end commodity supply chain solutions in the movement of cargo by road, rail & sea; using inter alia vehicles, locomotives, ships, ports, terminals, warehouses & depots. The company owns assets which are expensive to replicate, and in cases like ports impossible to exactly replicate.

Results to 30 June 2012 Look Average...but

At first glance the results for the first half of 2013 look mediocre compared to the first half of 2012. However, "non-trading" relates to profits resulting from business acquisitions and disposals, which is clearly not a sustainable source of profit. If this is stripped out, the first half of 2013 results suddenly look a lot healthier compared to the previous period:

- There has been a large amount of capital expenditure, which has depressed profitability, but earnings will only follow later. Because of the huge amount of capital expenditure the group is doing, the depreciation & amortisation expenses may be higher than the spend needed to sustain current operations.

Shipping Profits look set to rise

In the first half of 2013 Grindrod reported R1914m revenue from shipping, an EBITDA of R287m, and profit of R106m.

Let's look at how the current spot rates for shipping commodities around compare to the average in the first half of the year:

• First the bad news - the Baltic Clean Tanker Index fell about 10% (I say about, as I couldn't find good data, so had to estimate this from graphs - some 640 average in H12013 to 579 spot).

• The Baltic Supramax Index is up by 78% (dry commodities like grain/iron ore/coal, carried in the smaller Supramax vessels).

• The Baltic Panamax Index is up by some 80% (dry commodities carried in the larger Panamax vessels)

• The Baltic Cape Index is up by 123% (dry commodities carried in the largest Capesize vessels, so named as vessels were originally too large to go through the Suez Canal, so had to travel to Cape Town and onwards).

Note that I've ignored the commonly used Baltic Dry Index, as it's skewed towards Capesize carriers, whereas Grindrod has a lot of Handysize bulk carriers.

In their fleet profile as at August 2013, Grindrod reported that it was using 17.5 Handysize vessels, 1 Supramax, 0 Panamax and 3 Capesize vessels. I did a back of the envelope estimation that the increase in dry commodity shipping rates for Grindrod's mix of ships, is roughly 100%.

Grindrod also reported using 10.5 medium-range tankers, 4.5 small tankers and 1 chemical tanker. Let's use the Baltic Clean Tanker Index as a proxy for their rates (decreased by some 10%).

So, what is the split between drybulk and tankers? In 2012 Grindrod reported revenue of R2847m from drybulk compared to revenue of R1163m from tankers. If this ratio held true in the first half of 2013 (which it wont have), then there's roughly a 68% increase in the rate at which it's currently earning, compared to the rate in the first half of the year.

But, the 68% increase is in US Dollars. Taking into account that the Rand has weakened from 9.23 average in the first 6 months of the year to 10.20 against the USD. We're looking at a roughly 86% increase in Rand terms in the current spot rates versus the average rates in the first half of the year.

Since shipping costs are roughly fixed, an increase in rates goes almost all to the bottom line!

In the first half of this year Grindrod earned R106m from shipping. I guestimate that if current spot rates persist, they'll be generating a whopping R450m earnings from shipping per half year! Note that the second half of 2013's earnings from shipping will probably be a lot lower, as spot rates have generally been lower than they are today, and the company engages in forward freight agreements.

This has happened before - in 2008 the shipping division had an attributable income of R1,794m. As the financial director said at the time : "Drybulk earnings more than doubled on the back of higher earnings on the spot exposed handysize and capesize bulk carriers and a fixed cost base".

Having said all of this, I cannot stress enough that the spot rates for shipping (upon which this analysis is based) are very sensitive and volatile, with small changes in demand (eg if there's a Chinese slowdown) or supply resulting in huge moves. The analysis also depends on the exchange rate, which most people are aware is also very volatile. It's entirely possible that they could plunge downwards just as fast as they went up.

Freight Services

Freight services made a trading profit of R300m in the first half of 2013, 75% up on the prior period's performance:

• Ports, Terminals & Rail achieved trading profits of R251m, 81% up on the prior period.

  • This was despite a derailment on the Ressano Garcia railway line which resulted in line closure for 60 days (although the 1.2m lost tonnage was partially offset by insurance proceeds).

  • Strong performances were reported on the Maputo car & sized coal terminals. The ports business is a particularly exciting potential driver of long-term increases in earnings. Grindrod owns 24.7% of the Maputo Ports Development Company, which has a concession to run and expand the Port of Maputo until 2042 - this involves massive capital investment, but also provides huge barriers to entry (importantly, the Maputo Government is a 49% shareholder in the venture, with Dubai Ports World owning the remaining 25%). Maputo's cargo capacity has increased to 17m tons, from 5m tons, with plans to increase it to 50m tons within 10 years. The volume of cargo handled increased from 10 million tons in 2012 to 15 million tons in 2012 and is expected to grow to 17 million tons in 2013 and 40 million tons by 2012. Sappi has recently announced it will ship all its dissolving wood-pulp exports originating at its Ngodwana mill in Mpumalanga via Emirati marine terminal operator DP World's dedicated container terminal in the port of Maputo. Grindrod is well positioned to win further concessions to operate ports in Africa, thanks to its positive experiences in Richards Bay and Maputo.

  • The rail business is starting to perform to expectation, and the offer to buy shares in RACEC will further strengthen Grindrod's position in the rail value chain (Competition Commission approval was obtained in October). Grindrod will have the opportunity to market RACEC's capabilities among its clients. This is an industry with tailwinds, as this analyst expects the competitive position of rail (versus road) to have improved and continue improving as the oil price increases. Grindrod Rail has operations across sub Saharan Africa; including in Sierra Leone, the DRC, Nigeria, the Republic of Congo and Zambia. G

  • Grindrod expects the performance at Ports, Terminals & Rail to further improve in the 2nd half of 2013. Coal exports are expected to be depressed, and magnetite will increasingly underpin performance at the Maputo terminals. The outlook for rail is positive.

• Logistics had trading profits of R49m, 50% higher than the prior period. The automotive & petrochemical transport operations were much improved. However, the petrochemical transport sector was impacted by excess capacity following the commissioning of the Transnet fuel pipeline between Durban & Johannesburg - outperformance from Petrologistics in Botswana & the expansion into Mozambique & Namibia will mitigate the impact. Grindord expects challenges in the Logistics business to continue, but there being a positive outlook for the automotive business.

  • On the 20th Dec 2013 it was reported that United Refineries Ltd, a Bulawayo based fast moving consumer goods company, was on a firm recovery. Grindrod bought 84% of URL & injected $2.2m as working capital...but will need to sell down to 49% at some point to comply with indigenisation laws. Grindrod is also finalising the purchase of 49% of Victoria Foods for $3.2m

Trading

Attributable income from the Trading Division fell from R96m in the first half of 2012 to R1m in the first half of 2013:

• The Agricultural business is the sick man in the Grindrod family. Because of the volatile and inverted agricultural markets, the business embarked on a deliberate strategy to limit volumes traded in the first half of 2013, which resulted in an inability to cover overheads. The business is transforming from a pure trading company to a fully integrated agricultural business with investments made in businesses operating oilseed crushing plants, maize and wheat mills. They recently made an investment in Senwes (which this article's author also owns a slice of).

• Whilst the Marine Fuels buiness produced volume growth, it also suffered compressed margins.

• In all ferrous and ferro alloy products there was margin pressure due to weak global & domestic industrial commodity pricing.

• There was a decline in chrome shipments in the first half of 2013 due to the 2012 mining strikes & unrest.

• Coal trading performed well, despite the lack of available coal to trade.

Financial Services

Earnings increased from R22m in the first half of 2012 to R48m in the first half of 2013.

• Grindrod Bank Limited (strong reputation in property finance): Strong earnings from the Banking division, with both net interest margin and fee income ahead of expectations. Core funding increased by 14% to R4.1bn and bank advances increasing 13% to R3.6bn. In April 2012, the South African Social Security Agency project commenced, with 9.7m account holders having been issued with bank cards at the time the interim results were published. Fee income from an increased card base is expected to be significant, while low levels of corporate activity place pressure on corporate finance fees. Increasing regulatory requirements with respect to liquidity will increase cost pressures and inevitably reduce overall net interest margins.

• Grindrod Asset Management : Assets under management (mainly a preference share portfolio and exchange traded funds) increased 12% to some R12bn. I'm a bit confused as to how well these funds are doing relative to benchmark; as Grindrod reported that the majority of funds had performance exceeding benchmark, but when I looked the majority of funds are doing worse than benchmark since inception.

Profit History

Profit in R'm (note the glory days of 2008). When investing in a cylical industry it's heartening not to be investing when they're at a cyclical high.

Competitive Moat

Parts of the business require huge capital investment to get going, which shields the business from competition. The ports are impossible to replicate exactly.

Terrorism in Mozambique

Apart from the risks mentioned in the Grindrod reports, there is the risk of terrorist attacks spreading from the Sofala Province further south, and disrupting the supply chains to the Port of Maputo, and possibly even spreading into Maputo.

Earnings Growth - Ports & Terminals

There is plenty of free capacity available as a result of the capital expenditure. Here's a rough approximation of the level of drybulk use, based on use in the first half of 2013 and including capacity under construction:

• Maputo coal terminal: 40%

• Richards Bay: 62%

• Durban (Maydon Wharf): 62%

• Walvis Bay: 66%

• Maputo coal terminal: 88%

• Maputo automotive: 62%

There's also the possibility that because of its good performance, the company could get to run other ports around Africa.

Decision

To summarise what I really like about the share is:

• It's built up a large competitive moat in parts of its business, and created businesses which link up nicely.

• Current profits are depressed as a result of the capital expenditure's impact on depreciation and interest costs, with a chunk of the benefits yet to flow.

• Shipping spot rates have increased, which should result in higher earnings from shipping in the 2nd half of 2013.

• Directors are buying.

• In the long-term it's well positioned to be the chosen partner for more ports business in Africa.

Caution must be exercised as, inter alia:

• Grindrod operates largely in volatile, cyclical industries.

• it is highly likely that its balance sheet will continue to be geared up as it continues with its capital expenditure program.

• Some of its key operations are in Mozambique, where the risk of terrorism has heightened.

• A slowdown in, for example, the Chinese economy may result in the demand for exports from southern Africa decreasing and shipping rates could plunge.

• Analysis risk : Because it's such a diverse company, I have focussed on what I believe are the big ticket items. I haven't fried any of the the smaller fish, and it's possible I missed something significant.

As mentioned it's possible I'm completely wrong, but I believe the odds are in my favour and I've bought quite a few shares. My thumbsuck at fair value is that it's currently somewhere in the range from R35 to R45 a share.

It's healthy to end off by pointing out that not everybody agrees with me, and that you, dear reader, need to make your own mind up - don't rely on anybody! Here's a couple of extracts from broker notes:

• "The share is currently trading at a 27% premium to its tangible NAV, which we feel fairly values the share. Due to the difficult prevailing trading environment we would only recommend the share as a hold to speculative buyers".

• "Based on our current earnings forecasts, GND trades on a 12-month rolled FPE of 14.1 and a foreward dividend yield of 2.0%. We expect GND to deliver a 3-year annualised return of 2.6%. We maintain our SELL recommendation"

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