Kenyan stocks have plummeted in recent months. A strengthening US dollar appears to be the main culprit, prompting a mass exodus of global investors from frontier stocks. As a result, the Nairobi Securities Exchange’s main index now rests at its lowest level in nearly 16 months.
Big price swings like these always get me reaching for my bargain-hunting hat. And I think I’ve found one priced to reward patient investors handsomely.
Longhorn Publishers is one of East Africa’s foremost publishers of textbooks, and more recently, digital learning systems. It also publishes a wide-ranging catalog of reference books, hymnals, and novels that are fixtures on many a Kenyan bookshelf.
Here are five reasons why I believe the company is one of the NSE’s best buys now.
1. Robust Revenue Growth
There aren’t many listed Kenyan firms that can match Longhorn’s revenue growth over the past twelve months. The company managed to expand its top line 16.8%. That’s a figure well ahead of inflation, and in keeping with the company’s long-term trend. Longhorn’s sales have grown at an annualized rate of 10.4% since 2013.
It’s achieved this impressive growth, in part, by broadening its product offering beyond textbooks to include legal journals, curriculum for early childhood education and polytechnic schools, and digital content. The company has digitized more than 300 of its titles, putting them within reach of a much wider audience.
2. Widening Profit Margins
It used to be that the directs costs of publishing a book (author payments, raw materials, printing, etc.) amounted to more than half of the price that Longhorn could sell it for.
In 2013, the company’s gross margin stood at 45.6%. Today, thanks to the increased focus on digital products, that figure has increased to 54.0%. That’s an improvement in gross profitability of nearly 20%.
Management has also done a fine job of streamlining the administrative side of the business. Longhorn’s operating margin has widened from 15.8% to 21.1% over the past five years.
3. Strong Cash Flow
The improved profitability has resulted in a steadily increasing dividend and a growing pile of cash. Longhorn generated more than KES250 million worth of free cash flow during its 2018 fiscal year, building its cash reserves to KES419 million.
The company will pay roughly a quarter of this cash pile out to shareholders in February in the form of a KES0.42 per share dividend. That’s a 45% hike over last year’s KES0.29 per share dividend.
4. Expanding Geographic Footprint
One of the biggest risks to Longhorn’s continued success is its dependence on Kenyan textbooks. A curriculum change typically requires the development of new texts and materials – a costly and time-consuming process.
To mitigate this risk, the company is working to diversify its revenue across a wide range of not only products but geographies, too. In addition to Kenya, Longhorn now operates in Uganda, Tanzania, Rwanda, Zambia, Malawi, and Senegal.
Over the next several years, new CEO Maxwell Wahome and his team intend to expand further in West and Southern Africa with the roll-out of country-specific materials.
To date, these other markets remain a drag on Longhorn’s bottom line, but I expect development costs to soon taper off. When they do, the company will be left with a substantially more stable earnings base.
5. Bargain Basement Price
Longhorn’s share price has slipped 7.5% since the start of the year despite the company’s improving fundamentals. The stock presently trades for KES5.00 per stub, giving it a P/E ratio of 7.5 and an 8.4% dividend yield.
I think this is a steal. Here’s why.
Let’s assume a big investor was considering buying the entire company. It would purchase all outstanding Longhorn shares and pay off all of its debt. Doing so would result in a company capable of generating KES250 million worth of earnings each year.
If we make a conservative assumption that Longhorn’s earnings will grow at an annualized rate of 2.0% in the years ahead, an investor in search of a 16% annualized return would theoretically be willing to pay roughly Ksh1.82 billion for the entire company.
(Ksh250 million * 1.02) / (16% – 2%) = Ksh1.82 billion
Now to settle Longhorn’s debt.
Longhorn didn’t disclose its total debt level in its most recent results, but my guesstimate is that it’s approximately Ksh700 million. If we reduce this amount by the Ksh419 million that Longhorn has sitting in the bank, we’re left with net debt of Ksh281 million.
So, if paying off Longhorn’s debt would require Ksh281 million, then our investor would have Ksh1.54 billion left over to offer existing shareholders to relinquish their shares.
Ksh1.82 billion – Ksh281 million = Ksh1.54 billion
Divide this figure by Longhorn’s total shares outstanding (272.44 million) and we’re left with a price of Ksh5.65 per share.
In theory, this is what a large investor in search of a 16% annualized return would pay for the company even if earnings were expected to grow at a very sluggish 2.0% from here on.
If the shares were to reach that target within the next twelve months, investors at today’s price would enjoy a 13.0% capital gain in addition to the 8.4% dividend yield – a total return of 21.4%.
Not bad for a boring old textbook company.
Note, Longhorn shares aren’t very liquid. Centum owns most of them (60.2%) and it’s rare to see 50,000 exchange hands in any given day. But this should be plenty of volume for a small NSE investor to establish a stake in the company.
What’s your take on Longhorn? Is it priced to outperform the market over the next five to ten years? I’d love to hear your thoughts.