Dear partners and friends,
Desert Lion’s Fund returned +5.6% net for the month of June, ahead of the +4.8% return of the JSE All Share Index (J203).
In this month’s commentary we discuss recent results of one of our largest investments, Argent Industrial, which we have held in our portfolio since the Fund’s inception in 2019.
Argent Industrial Limited (OTCPK:AILTF)
Argent is an industrial conglomerate with about 24 underlying operating units across South Africa, the United Kingdom, and the United States. Its resilience is underpinned by vertical integration, self-sufficiency, and diversification across products and geographies.
I strongly believe that the market has been wrong on this one for a while now. Argent is not a hot AI stock. Maybe that is one of the reasons it is totally ignored by the market. Yet, as a real-world- economy stock, Argent’s earnings growth would make many a tech stock blush. As illustrated by the below chart, EPS has grown at a CAGR of 40% over the past 5 years.
The company lists every subsidiary on their site here.
- The South African subsidiaries span steel trading and processing, specialty manufacturers of underground mining scrapers, industrial lifting equipment (e.g., cranes), bulk steel products such as gates and fencing, and concrete mixing and distribution. They also include additional manufacturing companies with strong brands locally and internationally.
- The UK subsidiaries comprise a number of specialist manufacturers of fuel storage solutions, (including mobile fuel storage systems for the international aviation, maritime, and vehicle industries), a range of industrial doors, shopping carts and trolleys, and iron and wooden gates for the consumer market.
- The US operation manufactures speed control “retarder” systems for classification/ marshalling rail yards that separate out freight cars among various tracks.
Our strategy is to turn over as many rocks as possible in inefficient corners of the market. We uncovered an informational advantage by digging deeper than everyone else. For a very long time, Argent used to be a low return on capital value trap. But about 5 years ago, a new strategic shareholder took over the capital allocation of the group. In typical Will Thorndike’s The Outsiders1 fashion, Argent disposed of low return assets, streamlined working capital, repaid debt, bought back loads of shares on the cheap, and made higher return on capital, earnings-accretive acquisitions.
I first met the new strategic shareholder in 2019 and he mapped out Argent’s capital allocation journey during our discussion. In May this year, we were both in Omaha and again talked for hours, spending a great deal of time on Argent. Argent is a cash gusher, under competent operational management, with one of the smartest capital allocators in the background directing the flows. By still framing Argent in the same box as used years ago, the market is totally oblivious to the fact that the Argent of today is a globally diversified, high growth business compounding through a combination of organic growth and smart capital allocation.
The business is virtually debt free and is firmly on a path of sustainably higher returns on equity.
It is evident that Argent is a much better quality business today than it was 5 years ago. Yet the market is actually placing a lower valuation multiple on the business today.
This company is a great example of market inefficiency. It is small (market cap of R900m or $50m), underfollowed (only covered by one private independent analyst), under-owned (institutional ownership is less than 1% of shares outstanding), branded a “SA Inc” company (yet 60% of earnings is international non-SA), and misunderstood. At R16 per share, it is trading at a sub-4 PE and price-to-book of 0.6. We believe this is too low for a globally diversified company with exceptional capital allocation likely to continue growing earnings at 15-20% per year.
Peter Lynch wrote in his 1989 book One Up on Wall Street2 that “[t]he P/E ratio of any company that’s fairly priced will equal its growth rate” and used an inverse PEG ratio as a heuristic to determine the attractiveness of a company’s valuation. EPS growth/PE of about 1 is fairly valued. EPS growth/PE equaling about 2 is attractive and a buy. EPS growth/PE around 3 is rare and you should back up the truck. In Argent’s case, we are presented with a Lynch metric of about 4!
Argent is another example of a global company trading at South African discounts.
In closing
We continue to find compelling opportunities similar to Argent. There is a big mismatch between capital and opportunities. History instructs that the phenomenon is cyclical. We cautiously anticipate the turn.
As always, I thank you for entrusting Desert Lion with your hard-earned capital. The majority of my wealth is invested in the Fund right alongside you.
All the best,
Rudi van Niekerk
Footnotes1Highly recommended read The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success DisclaimerThis document (the “Document”) has been prepared solely for use by potential investors in Desert Lion Capital Fund I, LP (the “Fund”), which is managed by Desert Lion Capital Investment Management, LP (together with its affiliates, “Desert Lion Capital”), and shall be maintained in strict confidence. The recipient agrees that the contents of this Document are confidential, the disclosure of which is likely to cause substantial and irreparable competitive harm to Desert Lion Capital and or its investment vehicles and their respective affiliates. Any reproduction or distribution of this Document, in whole or in part, or the disclosure of its contents, without the prior written consent of Desert Lion Capital is prohibited. 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The returns for the MSCI Emerging Markets Index include realized and unrealized gains and losses plus reinvested dividends but do not include fees, commissions and/or markups. The FTSE/JSE All Share Index is referred to only because it represents an index typically used to gauge the general performance of the Johannesburg Stock Exchange as a whole. The returns of the FTSE/JSE All Share Index include realized and unrealized gains and losses, but do not include the reinvestment of dividends, and do not include fees, commissions and/or markups. The use of these indices is not meant to be indicative of the asset composition, volatility or strategy of the portfolio of securities held by the Fund. The Fund’s portfolio may or may not include securities which comprise the MSCI Emerging Markets Index and the FTSE/JSE All Share Index, will hold considerably fewer than the number of different securities which comprise the MSCI Emerging Markets Index and the FTSE/JSE All Share Index and engages or may engage in Fund strategies not employed by the MSCI Emerging Markets Index and the FTSE/JSE All Share Index including, without limitation, short selling and utilizing leverage. As such, an investment in the Fund should be considered riskier than an investment in the MSCI Emerging Markets Index and the FTSE/JSE All Share Index. Furthermore, indexes are unmanaged, do not incur management fees, costs, and expenses, and cannot be invested in directly. |
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