by Sridharan Raman.
With the political turmoil in South Africa, we turned to the region to see if there are companies that may be undervalued there, hidden gems so to speak. We looked for companies that may be able to withstand the political unrest, with strong earnings quality that might also be undervalued. We screened for companies in South Africa that have more than $1 billion dollars market cap, in the top quintile of our Earnings Quality model and in the top quintile of our Relative Valuation model. One company that shows up is Mondi Ltd. (MNDJ.J) which is in the paper and packaging industry. Let’s open the wrapping.
As you can see in the chart above, return on net operating assets is at a 10-year high of 19.3%. RNOA is a measure of operating efficiency, and this is a sign of strong earnings quality. Mondi has done well in keeping costs down, which has helped operating margins (at a 10-year high of 13.5%). It’s one reason why Mondi scored in the top decile of the operating efficiency component of our Earnings Quality model. Mondi implemented some price increases. That seems to have helped margins recently and demand has continued to remain strong. Europe in particular has seen strong demand in paper products, which is likely to continue going forward.
Strong cash flow
Another sign of strong earnings quality is in the cash flow numbers. Earnings supported by strong cash flow tend to be more sustainable in the long run. In the last semi-annual period, net income was at a 10 year high of €308 million. More encouraging, is that cash flow from operations exceeded net income and was also at a 10 year high of €671 million. Those strong cash flows have helped the company lower long term debt and shore up its balance sheet.
Also a good value
Mondi does not appear expensive. Based on the current market price, backing into the StarMine Intrinsic Valuation model, we see that the company has a 5 year market implied growth rate of just 3.3%, that is, to justify current prices, earnings will have to grow by 3.3% a year for the next five years. That seems overly conservative based on the fact that earnings grew by 17.8% over the past five years. The StarMine SmartGrowth rate, which systematically eliminates analyst biases, is higher at 12.6%, which is still near the levels of the industry median. That tells us that the stock may be undervalued.
On the last earnings call in May, CEO David Hathorn stated that “supply/demand balance in Western Europe is actually pretty decent. Our order books are bang full.” That shows that earnings are likely to remain strong and the regional political turmoil is having little effect on Mondi’s strong operational performance.