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I mentioned that the CEO of Buildmax was buying into the company, and that I saw value, and bought a bit of it. Now, this is a classic example of why it's worth watching director purchases (and sales!). Because, lo and behold, yesterday the following was announced:

"Voluntary announcement relating to a new contract awarded in the Republic of Botswana The Company’s board of directors is pleased to announce that Buildmax, through its subsidiary, Diesel Power Mining (Pty) Ltd, registered in the Republic of Botswana, a subsidiary of Diesel Power Opencast Mining (Pty) Ltd and trading as Diesel Power Botswana (“Diesel Power Botswana”), has been awarded a new long-term contract to provide hard-rock open cast mining services to Messina Copper Botswana (Pty) Ltd (trading as “African Copper”) in respect of two of African Copper’s existing open pit copper mining operations (“the Contract”). African Copper, registered in the Republic of Botswana, is wholly owned by AIM-listed African Copper PLC, which is in turn 84.19% owned by JSE-listed ZCI Limited. The Contract commenced during February 2014 with a duration of 52 months, of which the first 4 months will be served at the Thakadu Mine and thereafter the remaining 48 months will be served at the Mowana Mine, located approximately 130 kilometres north-west of Francistown. The Contract is denominated in Botswana Pula (“BWP”) and is valued at approximately BWP1 billion over the contract period. The scope of the Contract is conventional open pit mining, including drilling and blasting, with an initial investment of approximately BWP160 million. The majority of the required mobile plant and equipment for the Contract will be sourced from the existing fleet of the Group and all required asset based funding will be funded jointly by Diesel Power and by a third party financier. A highly qualified management team, with extensive experience in Africa, will be assigned to the project and the Group will establish permanent support structures at Mowana Mine and in Botswana. It is anticipated that the Contract will contribute positively towards improving operating margins, commensurate with commodity and country risks. This Contract will further the Group’s strategic objectives of diversifying into hard-rock commodities and into geographic regions outside of Mpumalanga, to compliment the Group’s existing operations in South Africa and in the Republic of Congo."

Win some, lose some, but I prefer betting with the directors. The share price rose to R2.80 yesterday.

2014-01-24. Back to the JSE. On Thursday Terry Bantock invested R42k into Buildmax, at R2.50 and R2.55 a share - well, his trust did anyway. Terry is CEO of Buildmax, and a man who knows a good investment - he spent 4 years as an industrial advisor to Brait Private Equity.

To understand Buildmax we need to look into its history. Firstly, it's a waste of time looking at anything prior to FY2009, as the company was too different from what it is today. They used to specialise in the manufacture & distribution of building related products.

The purchase of the Buildco group of companies and Diesel Power became effective on the 2nd April 2008; and positioned Buildmax as a supplier of opencast mining services, bulk earthworks & construction materials.

Things went exceptionally well in the first year to 28 February 2009, with a pro forma EBITA of R335m.

In the year to 28 February 2010, the proverbial hit the fan. At this stage Mining Services consisted of Diesel Power and Vukuza Earth Works. Excessive rain the last 4 months of the FY negatively impacted productivity, and there was also the trouble of industrial action at Diesel Power. The decision to extend the use of equipment past its 1st life resulted in increased subcontractor & plant maintenance costs, coupled with poorer than anticipated plant utilisation. As there wan't enough money for the capital expenditure required at Vukuza, its opencast mining contracts were mostly terminated shortly after 28 Feb 2010.

The year to 28 Feb 2011 was a financial disaster. A slowdown in the construction industry and resultant loses were add to the continued problems with mining services. It involved closing the loss making Vukuza operation and selling off its assets. The method of handling depreciation was changed, effectively accelerating it and increasing depreciation for the year by R63m. Rising maintenance costs and a depressed equipment market continued to lead to losses. It's interesting that they again blamed excessive rainfall in the last 4 months of the year (wonder if that was a copy & paste error from the 2010 accounts) - isn't it always very rainy on the Highveld in the 4 months to 28 Feb? An Equipment Sales & Rental business unit was carved out of mining services, to improve the sale of its assets.

In the year to 28 Feb 2012 they sold the Construction Materials business unit (Watertite Guttering on 1 March 2011, Benoni Sand on 31 Aug 2011, Buildmax Industries on 30 Nov 2011, Columbia DBL on 30 Nov 2011 and Cast Industries on 31 Jan 2012). This means one has to carefully strip it out of past figures, in trying to assess future profitability.

Thereafter they've slowly clawed their way back up, but not to the heights of 2008/2009.

Profit analysis

Buildmax has 4 strategic units, but the vast majority of its profit comes from Mining Services Diesel Power (which provides opencast mining, SHERQ management, plant hire & rehabilitation services to the mining sector) servicing mostly the coal sector. Mining Services' profitability is heavily dependent on the cost of purchasing new fleet vehicles versus the value that they can be sold for after approximately 4 years of use.

Like with Esor, the Civils division is the current sick man of the Buildmax group.

Division descriptions

• mining services (opencast mining, rehabilitation services, mine planning, pit designing, production scheduling, drilling & blasting, opencast mining, pillar mining, surveying & mine rehabilitation.) - Diesel Power SA, Buildmax Equipment & Diesel Power Congo.

  • Gauteng/Mpumalanga (Coal - Xstrato, HCI, Anglo Coal, Exxaro & Sasol)

  • Republic of Congo (Iron Ore - Exxaro)

• equipment sales & rental (sells the group's 2nd hand equipment & sometimes rents it out)

• Civils in North West & Mpumalanga (relocating water pipes, bulk earthworks, construction of terraces, access roads, storm water drainage, water reticulation, widening of roads, construction of traffic islands, road markings, road signs, tar road).

• Aggregate & quarries - owns Crushco quarry, Alfa & Witdeep Sand & Stone - Mpumalanga/ Gauteng

Management want to target business with exposure to different mining commodities in diverse geographic locations (in Africa, I think). It has somewhat succeeded, as it was awarded an iron ore open pit quarry & mining contract in Congo (what is the contribution to profit?).

The future of coal

Buildmax is rather dependent on the health of the coal industry, so it's worth pondering the future of coal. I'm a greenie at heart, but I know that economics usually trumps other concerns. My best estimate is that the future for the coal industry is bright, and it is going to grow increasingly important as oil becomes more costly. The biggest threat to it is from the gas which is coming online in Mozambique and probably in the Karoo at some point (forget it if you think protests are going to stop the march of big oil).

I can therefore believe Buildmax when they say that meeting Eskom's coal needs will require "a substantial increase above present levels of supply, and to obtain these quantities at a suitable quality and price will mean that the development of the Waterberg complex, which holds a considerable portion of South Africa's coal reserves, will be critical". The means there'll need to be a lot of infrastructure development - exactly what Buildmax specialises in.

Besides the long run tailwinds for coal, there are also some short-term tailwinds : the Rand price of coal increased by 13% from June 2013 to December 2013.

Estimate of sustainable earnings

It seems reasonable that the period from 1 March 2007 until 31 August 2013 may be a considered a full cycle - it includes 2 very strong years at the beginning of the period, 2 disastrous years in the middle and 2.5 average years since. Carving out construction materials from the history, and adding inflation in, the average historic EBITA R58m per 6 months.

The EBITA over the 6 months to 31 August 2013 was R62m, which is a bit higher than the long run average, but not an unrealistic starting point.

I think depreciation is slightly understated, because of its historic nature, and have made a slight adjustment for it.

Subtracting interest paid & tax (I allowed a bit more than in their accounts and it's possible this has led to too much conservatism in the tax) & a bit more depreciation and we guestimate sustainable average earnings of some R29m per 6 months.

Valuing the business

It's always difficult to tell what spread to use. My feeling is that Buildmax is risky, but less risky than Esor.

I could be completely wrong, but I estimate that fair value is somewhere between R3.20 and R4 a share.

This gives me enough margin of safety to buy at R2.55.

Summary

My preference is to avoid cyclical businesses and to avoid capital intensive businesses. Buildmax is both! I am also nervous about the large amount of short-term interest bearing liabilities. However, everything has a price. I do like that the fortunes of Buildmax are linked to the coal industry, a sector I'm a fan of. I also don't have any exposure to open-cast coal mining, so it adds a bit of diversification into the mix. The increase in the coal price over the last 6 months should provide a bit of short-term tailwinds.

I'm afraid that once again we're looking at a cyclical stock, whose fortunes are in some ways related to those of previous ones I've mentioned - Grindrod & Esor. Need to consider a possible concentration of risk building up in my portfolio.

Yours in concentration,

Rob

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