Born out of crocodile farms 6 decades ago, Padenga Holdings Limited emerged as the leading crocodile skin and meat producer in Zimbabwe. After an impressive run under the Innscor flag for 12 years, this company had a successful spin off late in 2010. Padenga Holdings went on to acquire 50 percent shareholding in Tallow Creek Ranch, Texas, USA in 2012 which turned out to be a bad investment after 7 consecutive years of accumulating losses.
It was glossy and smooth to break the news as good in 2012, but the story failed to be in sync with numbers just two years after the acquisition. The USA subsidiary has been making losses since 2015 and the management has now decided to discontinue the operation and disclose its assets as held for sale. The question is at what cost to the shareholders, below is what l think was the price paid for this mistake.
At a compounded annual rate of 10 percent between 2011 and 2018, revenue growth was showing signs of slowing down. The business had already started to move from the scaling up test stage and the mid-life crisis to the end game stage. It needed not an opportunist but a defender who could change the business story to reflect maturity. The management should have shifted its strategy right there to defending the market share and prepare to scale down as the market shrinks rather than act like a 10-year-old company.
Padenga had a strong operating profits to operating cash flow conversion rate of 89-90 percent between 2011 and 2015. This rate jumped to an average of 105 percent between 2016 and 2019 when the Nile crocodile segment (Zimbabwean business) was flourishing, probably at its peak. Following an outbreak of Covid-19, demand for Nile crocodile skins fell, operating profits remained positive, but contracted, the Tallow Creek Ranch loss making situation worsened and the cash conversation rate slipped to an average of 69 percent in the last three years. In 10 years, Tallow Creek Ranch only managed to generate profits in its first two years after acquisition and consistently accumulated losses since then.
On top of that, the return on invested capital went down from 14 percent in 2011 to just 5 percent in 2019 before stabilising at around 2 percent in 2021. Padenga has been doing exactly the opposite of what people think it’s doing for its shareholders, destroying value.
Free cash flow yield fell from 19 percent in 2011 to 3 percent in 2019. Free cash flow to debt ratio fell from 2,15 to 0,42 during the same period. Since this company has, over these years, been struggling to generate enough free cash flows, the total debt balance went up from US$2,9 million to US$68,4 million. That makes Padenga one of the best debt compounders at an annual rate of 33 percent and l am not sure if this is being talked about enough.
Here is what should have happened to create more value for investors. Between 2011 and 2015, Padenga experienced a high cash conversion rate from operations and a minimum debt, translating into a high FCF yield and FCF/Debt ratio. Capex requirements were low and in my opinion, the management had only 2 options to utilise excessive free cash flows.
For a mature company, it was either shrinking the number of outstanding shares over time and increasing dividend yields or focusing more on upgrading the local business facilities and growing from inside. Trying to artificially buy growth externally at this stage was the worst business decision ever and I would attribute that to a mismatch between management and the corporate life cycle.
Just 3 years ago, we saw Dairibord Limited walking out of Malawi empty handed after years of accumulating losses from using the same script. l think these old companies should start to adopt the way they think about their businesses to reflect stages of life cycles. They are all making the same mistake of refusing to act mature and get the same mediocre results.
Padenga is one of the worst performing companies at the moment in terms of real value creation and every old company that tries to follow the same blueprint in future will surely get the same result. Shareholders are the biggest losers.
HY2022 revenue went up by 184 percent driven by both increasing gold production and gold prices in the first quarter of the year. The gold mining segment contributed 91 percent of the group’s revenue and production is expected to keep growing, but it is important to note that gold prices are cyclical. With rising interest rates and the US dollar strengthening, gold prices won’t stay high for long. Prices have gone down by over 6 percent since the beginning of the year and I expect the downward price trend to continue throughout the second half of 2022.
As much as I wish to see a rebound in the crocodile skin market, I am convinced that the market will remain depressed in the near term. Increasing competition coupled with low demand due to oversupply of skins will leave a dent on crocodile farming in the long run. I forecast FY2022 revenue to increase by at least 50 percent relative to 2021, driven largely by increasing gold output. Free cash flows are forecasted to remain negative for FY2022 and ROIC to jump to around 5 percent from 2 percent. Padenga looks fully priced and my estimated intrinsic value is 37 cents.
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Sylvester Mupanduki/Phone: 0771 623 648/Twitter: @Real_UncleSly/Email: [email protected]