Barloworld: General industrial & support services

THE COMPANY: Barloworld, founded in 1902 to sell wool products, is a South African-based engineering equipment retailer. Charles Barlow expanded the business into the distribution and servicing of Caterpillar equipment in 1927. Since 1927 the company became one of Caterpillar’s leading dealerships in Europe, the Middle East, Africa and Siberia.

Barloworld has since diversified itself into a large conglomerate of businesses including: motor dealerships, cement manufacturing, paint, stainless steel tubes/pipes, household appliances and even mining through the acquisition of Rand Mines Limited. However, in 2006 Barloworld underwent restructuring, selling off manufacturing businesses and other assets that did not fit into the newly focused distribution businesses such as equipment, automotive, handling and logistics. Within these divisions the company operates in regions besides Southern Africa, including Siberia, Iberia, Australia and the south-eastern US.

The 2006 restructuring took place during an economic recession and left Barloworld exposed to a severe decline in demand for mining equipment, which comprised 50% of earnings at the time. Despite the global recession, mining production volumes continued to grow in South Africa driven by relentless Chinese demand for commodities. The overextended machinery would eventually need replacement coupled with new need from “green shoot” projects in southern Africa. This two-fold demand has driven Barloworld’s return from a bleak outlook 18 months ago.

Furthermore, Caterpillar’s acquisition of Bucyrus opens up the underground mining equipment market to Barloworld and the timely acquisition of its remaining 50% share of Siberian operations have been a key catalyst to Barloworld’s share price performance. The two acquisitions are expected to result in the re-rating of the Barloworld shares, and Barloworld is expected to trade at a mid-cycle 12m forward adjusted price-to-earnings ratio closer to 14.2 times over the next six months, compared with the current 21.7-times multiple. In a recent trading update the company indicated that the equipment order book for South Africa had increased 15.4% as of December 2011. During the 2011 financial year the margin for the group improved from 3.3% to 4.6% thanks to increased demand for its higher margin service offering in machinery.

DEVELOPMENT STRATEGY: The current CEO, Clive Thompson, took over at the end of 2006. Until that point, the strategy had been to grow through acquisitions. But the new management instead focused on Barloworld’s core distribution businesses, disposing of the manufacturing businesses and unlocking shareholder value.

While this seems to have left Barloworld more exposed to the cyclicality of customers’ end-markets, they could offer strong momentum over the next several years. The company is well positioned to capitalise on seven medium- to long-term growth drivers. They include the start of a global mining capital expenditure (capex) cycle; Bucyrus machinery distribution opportunity; a late recovery in the construction cycle through government infrastructure projects in southern Africa; a higher oil price that should boost the Angolan economy going forward; the Siberian acquisition posing significant opportunities; continued consumer-driven spending enhances vehicle sales; and current soft commodity prices supporting farming capex for 2012-13.

Currently, Barloworld’s earnings are heavily underpinned by expected growth in global mining capital expenditure of 15-20% in 2012 in combination with a strong local replacement cycle in contract mining. Meanwhile, the servicing of the established Caterpillar fleet in South Africa could further push margin growth up toward 11.5%.

Furthermore, 2014 is expected return to profitability in Iberia to the extent of a 5% operating margin. Continued growth in Barloworld’s Russian market share is expected (toward 20% from 11%) supported by the recent Caterpillar manufacturing facility expansion in the region. Caterpillar’s expansion plans negate the risk of expected increased lead times going forward.