6 Month Interim

Famous Brands have released their interim numbers to August 2014 this morning. Revenue up 14 percent to 1.57 billion Rands (same store sales up 3.4 percent), operating profits up 19 percent to 303 million Rand, which all translates to headline earnings of 212 cents per share (up 18 percent) and the dividend up 19 percent to 155 cents. Very generous with their payments, remembering that this company is completely ungeared, very little debt. In fact they have a debt to equity ratio of a mere 2 percent, 25 million Rand in total, much criticism could be levelled at the team for have a "lazy balance sheet". It is not that the company is not afraid of taking the risks, they are trading under cautionary currently, it could be a sizeable acquisition, all that could change quickly. For that we will have to wait.

The low margin logistics business topped one billion in revenue for the first half for the first time (got that?), operating margins are razor thin (3.7 percent), it was however much improved from the last period notwithstanding increases across the board, labour, fuel and the much talked about etolls. So credit must be given where it is due, sweating the same assets harder. In the manufacturing division there was a turnaround not to be cheesed at, I mean sneezed at, the Coega Cheese manufacturing plant managed to reverse their loss from the six months prior, leading to a 40 percent increase in operating profits for the division, margins increasing as a result. The company continues to identify this manufacturing plant as being key to the overall profitability of the business.

Ultimately it is about your customer in any business, the consumer does not worry too much how the bun and the burger patty gets there, they are standing in the queue and ordering the product because all they care about is value for money. The consumer has many choices, the consumer shops up or down as a result of money in their back pockets being more or less. The stresses of the South African consumer has been well documented, in the prospects column the company spells out what they see during the next few months, in particular the holiday season: "Management anticipates that current trading conditions will persist for some time", of course it is not all bad news: "Despite constrained consumer discretionary income, management has high expectations for the forthcoming peak trading period."

The store footprint looks like it will top 2500 by the end of the financial year, at the end of the last financial year Steers (551), Debonairs (446) and Wimpy (621 in total, local and UK) are make up the bulk of those, there are more FishAways than there are Mugg & Bean outlets, those two number more than 150 each, only Mr. Biggs (171) falls into the category. Milky Lane has over 70 stores, your favourite cup of joe from Europa, Brazilian or Fego is harder to find than a burger or breakfast, or a pizza for that matter.

Obviously the 49 percent purchase of Mr. Bigg's has seen their portfolio in Nigeria mushroom (no chicken pies) to the second biggest territory across the continent and indeed across all their territories, with 179 stores as at the end of last financial year. Mauritius (25), Botswana (28), Zambia (30) and Namibia (35) are roughly 5 percent of the store footprint of the total business, as at year end. South Africa by contrast will by the end of the year have over 2000 stores. This is very definitely still a domestic business, Kevin Hedderwick, the CEO at a group level (remember he moved one up the ladder), said in a CNBC Africa interview this morning that there was no silver bullet for continental expansion, saying that you needed to be patient and work hard. Like everywhere else I guess.

The business is still trading under cautionary, in the same interview Hedderwick said that he had several cups of coffee with a few people, suggested that he is talking. The businesses that were desirable were too expensive and he said that the company was not interested in fix-me-uppers (distressed businesses), he was looking for something in-between that. Cheap businesses in a desirable industry are hard to come by.

It is of course all about the consumer and the relative price that you pay. Let us presume that the price goes sideways for three years and that the company still achieves growth rates of around 15 percent per annum, both top line growth and earnings growth, a share price of 102 Rand currently. Three years out, to 2017, the company trades on a 16.5 multiple, still not cheap. They have a dividend cover of 1.4 times. At that sort of return, the dividend payment should be around 10 percent of the current price over the next 3 years, again, hardly a kings ransom.

The market does however afford a fast growing company a higher multiple, EPS has grown at 19.1 percent per annum over the last five years, the market not afraid to lend the company a forward multiple of 25 times, the average multiple over the last five years has been in the high teens, more recently in the mid twenties. For the purposes of this exercise, let us presume the market will rate Famous Brands at the same rate that they have managed to grow earnings, in other words a PEG ratio of 1 times, Price to earnings divided by growth rate. 19.1 times. On a forward basis you would say that the price is just right currently, next year that could be around 118-120 Rand. Taking a less conservative route, more aggressive at 22 times and the forward share price translates to around 135 Rand.

It is always tough to predict share prices and often tells you one thing, you care only about the public price of the company over the next year. If the market were to close tomorrow for three years (an awful event that people would eventually get used to), are you happy to hold this company? The short and long answer is yes, I suspect that they are poised for transactions and deals that would see leverage potentially ramp up earnings. We are positive on this company and positive on the sector as a whole, we continue to maintain our buy recommendation.