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H&L deal gives GraceKennedy fair return; new owner avoids merger issues, big debt

Published:Friday | June 26, 2015 | 12:00 AMCamilo Thame
This Rapid True Value store at Constant Spring Road, Kingston.

ON THE face of it, GraceKennedy (GK) Limited could more than double its original investment in Hardware & Lumber Limited (H&L) when it closes the sale of its shares in the company next month.

Twelve years ago, the conglomerate paid $420 million - $190 million in cash and the transfer of all the shares in Agro Grace and Rapid Sheffield to H&L - for the majority stake in the agriculture and hardware retail chain.

The conglomerate has now inked a conditional deal to sell its shares for up to $870 million.

Still, the valuation of the stake is less than 25 per cent higher in real terms. For example, the acquisition placed the market capitalisation of the company at US$10.5 million back in 2003 compared with a maximum of US$13 million based on the current offer.

Also, the purchase price in 2003 was just around book value then as the current offer is now.

The deal, therefore, provides GraceKennedy with a fair return as it exits the hardware business to focus more on food and financial services - a goal set by group CEO Don Wehby.

The new owners of H&L - a consortium of local and regional investors who are buying the stock through a special purpose investment vehicle called Argyle Industries (Jamaica) Limited - are not facing a merger; major staff cuts and store closures; or a sizable debt.

a unified brand

When GK and Pan-Jamaican Investments - which sold its controlling interest in H&L - combined their business interests 12 years ago, they had to pull together five brands, including Hole In The Wall and OSL Scaffolding, as well as three separate IT systems, under one roof.

It also meant the consolidation of 15 hardware and five farm and garden stores.

The company unified its brand under True Value in 2005, built a new store in Ocho Rios in 2006, and implemented a new management information system by 2008, after a setback with the IT project pushed management to identify new software in the middle of the upgrade two years earlier.

Since then, H&L has consolidated its store count - it now has 10 Rapid True Value outlets across Jamaica, and six Agro Grace retail centres. Seven of those stores have been renovated to make them "more aesthetically pleasing" and add state-of-the-art paint stations, according to the company.

The hardware and agriculture retail chain also underwent staff rationalisation in 2008 - when 88 of its personnel were cut - and it switched its employees from a defined-benefit pension plan to a defined-contribution scheme in 2013, after which changes in the value of the plan no longer impacted the profit and loss.

Importantly, following hurri-canes, a cement shortage which severely impacted the construction industry in 2005 and 2006, and a deep and long recession that began at the end of 2007, H&L managed to cut its debt from $1.3 billion at peak in 2008 to $200 million today. It currently has $155 million cash in the bank.

consistently improving

The company achieved this by enhancing its inventory management - it improved stock turnover from a little over 2.5 times a year a decade ago to over four times a year today - and since 2010, it has been consistently improving sales while maintaining a gross profit margin of 26 per cent.

H&L's improvement in financial performance largely reflected its agriculture supply business. This segment's revenue doubled to $1.8 billion and its operating profit tripled to more than $240 million over the past decade. The hardware side of the business posted roughly the same amount of sales last year - $5.3 billion - as it did in 2005, without accounting for inflation, while incurring losses half of the time over the last 10 years.

Still, H&L's pre-tax profit has been trending upwards since 2008 when it incurred a $400-million loss. By 2010, its bottom line was back in the black with a modest $20 million in earnings. Last year, net profit reached $217 million.

Earnings dipped by just under 15 per cent during the first quarter of 2015, owing to delays in clearing shipments caused by a major fire and the Riverton City landfill in March and the "inability of suppliers to meet order requirements".

However, the last 12 months' net profit of $212 million puts the price-to-earnings ratio of the company at seven times based on the maximum exercise price - $18.50 - of the conditional purchase agreement, which prices the stock at around book value of the company, or close to $1.5 billion.