After the SuperDogs interview that I posted recently, Rob Baker, an investment consultant in Cape Town, wrote up a short piece on one of the companies I spoke about in the interview, Conduit Capital Limited (Conduit or CND).  The analysis Rob wrote up is repeated below with his permission. In the short note, Rob raises a number of questions which I will take up with Conduit CEO Jason Druain when I meet with him next week and post comments back here.

CONDUIT SHARE ANALYSIS

I share a similar value philosophy of investing, so always make time to read updates to Adrian Saville's blog. Yesterday I watched an interview, where Adrian spoke about Cannon's SuperDogs portfolio, and their recent investment in Conduit. I had a closer look at it, and then purchased some at 85c/share (86c/share after all trading costs were factored in). Not too much, as I'm still getting to know this share.

GETTING OVER MYSELF

The share was trading at some 72c at the start of April, and then jumped up after they released an upbeat trading statement. I feel a bit annoyed that I didn't get in at 72c/share, but you can’t rewind the clock and you have to act on the info as it stands today. A good example of this was my purchase of Afrimat in January, where I felt annoyed that I'd bought it after it had gone up 7%, but three months later it's up another 26%. If you wait for a share to drop to a lower price, it may never get there, so I ignore the history and focus solely on whether the stock is currently offering me a sufficient margin of safety.

VALUING CONDUIT

I could be completely wrong, but looking in the rearview mirror I see Conduit as being worth somewhere between R1.10 and R1.30 a share.

In carrying out the valuation, I guestimated the sustainable rate of owner earnings. I assumed the investment income earned in FY2011 was a better indicator of sustainable investment income than the investment income earned in the six months to 29 February 2012. I felt that the investment income was unduly elevated in the six months to 29 February 2012, and although Conduit did not give a breakdown I suspect that it was to do with fair value adjustments. The big increase came in the Corporate & Investment Services segment, from R17m over the whole 12 months to 31 August 2011 to R15m in just six months to 29 February 2012.

This rearview valuation should be adjusted by our knowledge of matters not factored into the valuation but reported on:

  1. "A legal dispute relating to 2006 and 2007 inwards reinsurance arrangements concluded through one of the Group's external underwriting managers remains unresolved. Although there is the potential that a negative outcome may be material to Group earnings, steps have been taken to reduce any financial exposure & to mitigate such risk."
  2. “Interim measures leading to the implementation of the Solvency Assessment & Management framework in 2015 affect Constantia Insurance Company's capital requirements.”
  3. "Contingent rent is payable in connection with parking for which no rental agreement exists." (Conduit didn't put a monetary value to it, but it sounds like a minor issue)
  4. Has the Constantia Insurance Group hit the sweet spot in the underwriting cycle?
  5. "The recent take-on of additional underwriting managers and profitable insurance portfolios should, over time, result in improved profitability and a meaningful reduction in the (cost) ratio to within our target range."
  6. Amalgamated Electronic Corporation (Conduit own 26.5%), was R2.30/share on 29 February 2012, and still R2.30/share today.
About Conduit
Conduit's main businesses are the Constantia Insurance Group & a stake in Anthony Richards & Associates (a credit recovery call centre).
 
Constantia Insurance Group
Conduit owns 100% of the Constantia Insurance Group, which operates through three insurance licenses:
 
Constantia Insurance Company
The company deals mainly with underwriting managers, administrators and, in turn, brokers. Experienced positive underwriting results in all insurance classes, but delivery cost ratios remain above ideal levels. Net profit after tax showed an 84% increase over the previous comparable period.  Constantia Insurance Company mainly underwrites personal & small commercial business (not marine, aviation, engineering or heavy industrial insurance). It also uses its Alternative Risk Transfer capabilities (including Rent-a-Licence/Captive facility).
 
Constantia Life
Individual funeral & Personal Accident policies, sold under the name of Goodall & Bourne, a brand which is synonymous with funeral insurance in the Western Cape over the last 80 years.  It has 43,000 lives on its books, and "althrough it is a small contributor to Constantia's bottom line, it came with a strategic property in Long Street." Premium collection agents live within the communities which they serve and have been representing the company for an average of 30 years.
 
Constantia Life & Health Assurance Company
Similar products to Constantia Life, but caters mainly for Group Scheme business.
During 2008 and 2009 Constantia shed underperforming books of business. Growth has been organic and through the acquisition of intermediaries established distribution channels.
 
 
Contribution to Profit
UMAs where Conduit has a shareholding
28%
UMAs where Conduit has no shareholding
72%
 
Conduit Direct
Conduit holds 40% of Anthony Richards & Associates (and exercises Board control), a credit recovery agency (they claim to be in the "top tier" in South Africa) which has been in existence for ten years, manages in excess of R4.2m in debt, and produced a 21% improvement in after-tax profits. Clients include the big banks, clothing retailers & healthcare providers. Their retention strategy "is one of investing in their ability to earn commission through good performance."
 
Directors have a significant stake
The Chairman is Reginald Berkowitz (since 2005), CEO is Jason Druian (since 2005) and financial director is Lourens Louw (since 2004).
 
In total the directors have a total beneficial interest of 62m shares, and rights through share options to another 4m shares (in total 26% of the shares of Conduit).
 
Acquisitions & disposals in FY2011
 
Acquisitions (R'mn)
Property, plant & equipment
R3.5mn (R3.1mn in 2010) 
26.5% interest in Amalgamated Electronics
R24.5mn 
Jointly controlled entities
R2.4mn 
Subsidiaries
R3.1mn 
 
Disposals (R'm)
Assets
R10.mn3 
Associate company
R1.5mn 
Trade debtors & loans written off
R6.0mn 
 
Dividends
Last dividend was 10c a share on the 12th December 2011 (Conduit pay annual dividends).
 
Share buybacks
On the 4th March 2011 a special resolution was passed to allow the company to acquire the company's own securities.