Jenny Ruth: Transformation works for Hirequip investors

COMMENT

Investment company Southern Capital's decision just over a year ago to transform itself into a solid operating company with predictable earnings through the reverse takeover of Hirequip appears to have paid off handsomely for shareholders.

Before the transformation, Southern Capital's directors complained that its share price was stagnating, even though net asset backing per share was climbing.

The shares certainly haven't been stagnating since: in the past year, Hirequip shares have gained 60.6 per cent to $1.14.

They are nearly 87 per cent higher than their volume-weighted average in the year before the reverse takeover was announced.

The company has also won over analysts, including Rob Mercer at Forsyth Barr and Selwyn Blinkhorne at ABN Amro Craigs, both of whom rate the stock a buy. Mercer has a 12-month target for the stock of $1.43.

After the $3.8 million first-half net profit, up from $847,000 in the previous first-half, Blinkhorne is forecasting this year's annual net result will rise from last year's $5.8 million to $13.6 million and that next year's result will rise to $21 million.

The improvement in the share price partly reflects the fact that the company has started paying dividends, although at a modest rate.

While the company earned 5.5c a share in the year ended June last year, its maiden dividend for that period was only 1.5c a share. After earning 3.4c a share in the following six months, its interim dividend was only 1c a share.

But as part of the company's transition, it has also been on the acquisition trail for similar and complementary businesses.

Southern Capital paid $17.35 million in cash for the first half of Hirequip in August 2002.

The other half, bought in May last year, was paid for in shares issued at the nominal price of 60c, or $17.86 million, to company founder Stuart McKinlay, who has stayed on as managing director.

These shares gave him nearly 27 per cent of Hirequip and made him the largest single shareholder.

McKinlay had already shown himself keen to expand the Dunedin-based business, having bought Projex Equipment Hire in 2000, which provided the company with a North Island presence.

Since the reverse takeover, Hirequip has expanded further in the North Island, buying Ready Hire's 13 branches for $21.2 million in cash in December and the single-branch Hamill Hire in Christchurch for an undisclosed sum in February.

At the time, executive chairman Graeme Wong said these two purchases increased the company's hire business revenues by 30 per cent.

And then in May, it paid $11.3 million for specialist generator hire business Power Hire, $5.8 million in cash and the rest in shares issued at the nominal price of 95c each.

Mercer expects Power Hire will contribute $1.3 million to next year's net profit.

Wong says Ready Hire has already been fully integrated with Hirequip in a back-office sense, and its equipment will gradually be rebranded from yellow to Hirequip's orange, and the same goes for Hamill Hire. These businesses were similar to Hirequip, hiring a broad range of equipment to the construction and DIY markets.

But Power Hire will continue as a stand-alone business and will also keep its own brand name, Wong says.

It is the leading generator hire business in New Zealand, supplying anything from five kilovoltamp (kVA) to 1800 kilovoltamp machines. Because most electricians don't deal with such large generators, this business requires specialist staff and specialist premises - the largest generators are the size of a 12m container.

Hirequip, which is the biggest player in its market, missed out on buying the number two player, Hirepool, last year - Owens Group sold it to a consortium including former Projex chief executive Tenby Powell for $46.6 million.

Wong doesn't expect Hirepool to come back on the market again soon, but says he has been "pleasantly surprised" with the acquisitions Hirequip has been able to make.

He thinks there is still room for further acquisitions, particularly of specialist players such as scaffolding hire businesses, although he says the company won't be pursuing growth for growth's sake. (It backed out of the Hirepool sale because it felt Owens was asking too much.)

"We've got to be able to clearly demonstrate to investors that we're creating further value."

The plan with the reverse takeover, when the Hirequip business represented about half the company's assets, was to sell all the old Southern Capital assets and to plough the proceeds into expanding Hirequip.

"It's important to get the trust of the market, that these guys can do what they said they would do," Wong says.

The assets earmarked for sale range from property developments, a nascent mussel farming venture and stakes in start-up biotech companies promoted by its former director Howard Paterson, who died last year.

Wong said a year ago that the divestments should take two years or more. Now he says the company is on track.

It sold its 30 per cent stake in a Christchurch shopping centre in February for a $3 million profit and a further $5.43 million in properties in March. The Omaha Beach subdivision north of Auckland, of which it owns 42.2 per cent, is entering its final phases and the company has sold its stake in milk company A2 Corporation.

After failing to get development consent for its Waimakariri Employment Park, it has fallen back on its contingency plan to sell the 45ha site as nine or 10 lifestyle blocks.

It is also actively marketing its Pegasus Bay site north of Christchurch - the site is in the company's books at $9.9 million but Wong told last year's annual meeting it had an independent valuation of $25 million.

Wong says the sales process has got down to a short list and due diligence stages, but he doesn't want to build up expectations. Such a sale is difficult for a public company.

"We've been very active on it, but it's not done until it's done."

The company still holds stakes in four biotech companies, including Blis and Botry-Zen, whose share prices are at present depressed.

Wong won't be drawn on whether the company will hang on until these companies look like achieving their goals - as Wong describes it, "a patient, value-optimising strategy" - or whether it will look for a quicker exit.

But the Clifford Bay mussel project, in which it holds a 22.6 per cent stake, is likely to be a longer-term play.

Wong says the project has won every single legal hearing to date, but it is still tied up in the Environment Court.

The company also owns 21.75 per cent of Tasman Farms, which owns dairy farms in Tasmania, whose shares are trading at a deep discount to net asset backing.

Blinkhorne values all the remaining non-hire assets at $46.3 million compared with their $24.5 million book value, while Mercer values them at $45 million.