Johannesburg-based AVI (AVI:SJ) is one of Africa’s largest manufacturers and purveyors of consumer goods.
With a product line that ranges from biscuits to handbags, the company benefits directly from rising African income levels.
Its fast-growing beverage division distributes coffee and tea (including my personal favorite, Rooibos). Its snack line boasts a 42% share of the South African biscuit market. Its cosmetics operation is small but quite profitable with an operating margin of 19.2%. And its fashion division is shooting the lights out thanks to its enormously popular Carvela dress shoes.
This lineup has been very good to AVI shareholders. The company’s share price has climbed 412% over the past decade.
But, year after year, AVI’s seafood division has proven to be a disappointing drag on the group’s growing profitability.
The division, which trades under the I&J brand, trawls for and processes a wide range of seafood, including hake, abalone, and squid. It operates a growing fleet of fishing vessels and several onshore processing facilities.
I&J’s assets account for more than a quarter (26.2%) of AVI’s total assets. The problem is that it contributes only 12.7% of AVI’s total operating profit.
In fact, it hasn’t come close to pulling its own weight since 2009.
The fishing business is capital intensive, and I&J consistently requires more expenditure on plant and equipment than any of AVI’s other divisions.
In the coming year, for example, management has budgeted R669 million worth of capital expenditure. Of this amount, expenses related to replacing and maintaining fishing boats account for roughly 45% of the total planned spend. They’ve recently purchased two new fishing boats and announced that they intend to double the production of their abalone aquaculture project.
Granted, AVI is free of long-term debt and much of the additional expenditure will be paid for out of its impressive cash flow. But I’m not convinced this is the best use of AVI’s resources.
The company has taken on a significant amount of short-term debt to finance growth and its chunky dividend in recent years. Finance costs took a 3.5% bite out of pre-tax income during the 2015 fiscal year, and the company expects debt levels to remain on the high side again this year.
Moreover, South Africa’s hake fisheries appear to be dwindling.
I&J’s average daily catch of the subtly-flavored fish has dropped steadily from a high of 11.9 tons n 2011 to just 8.5 tons today. That’s a total reduction of over 28%. Meanwhile, the South African government recently reduced the total allowable catch by 5%. CEO Simon Crutchley says that fishing rates are the worst he’s seen in his ten years on the AVI board.
So, AVI would likely be a more profitable company if it cut I&J loose. In doing so, it would not only liquidate the assets tied up in the business, it would be free of the huge ongoing capital expenditure it requires.
The balance sheet would accumulate even more cash than it does presently, with which AVI could invest in more profitable divisions, pay down debt, boost dividends, or buy back shares.
Alas, management doesn’t appear to be considering a sale or spinoff. Far from it. With the purchase of two new boats, they appear to be committed to wringing a profit out of I&J for as long as they possibly can.
Fish or Cut Bait?
So, what’s an AVI investor to do?
AVI currently trades at a P/E ratio of 18.6 and at 6.4x book value. These multiples are well above their historic averages but pretty much in line with other firms within the industry.
I’m a holder of the shares here because the company (even with I&J) is such a cash-spinner, and has been relatively generous with its dividend policy. But in the absence of a plan to jettison the fishing business, it’s probably time to disembark.
Sometimes, the best investments are the ones that you catch and throw back.
[Disclosure: At the time of publication, Ryan held a beneficial interest in AVI shares.]