Marc Hasenfuss Editor-at-large

The calamitous collapse in the market capitalisation of a share as popular as the (once) mighty Steinhoff International does inevitably sharpen investors’ senses in detecting warning signs of pending value erosion. 

In this light, the recently released interim results of Namibian-based investment company Trustco — like Steinhoff, a widely diversified counter — make for an intriguing scan. This is especially so because Trustco’s shares have defied gravity and more than doubled in price over the past 12 months.

Unaudited interim numbers to end-September show earnings dropped by two-thirds to just 7c/share but did nothing to shake sentiment — though it must be said that Trustco shares are tightly held, with scant interest from mainstay institutional investors.

Straight off, in the half-year to end-September Trustco reported much-reduced profit before tax of R28m (previously R150m).

Profit after tax, though, came in at R53m (R168m last year), bolstered by a tax credit of R25m. The tax credit is listed under Trustco’s investment segment, which shows that neither the insurance nor the banking segments — which are both reporting profits — paid tax.

The situation was the same in the 2016 interim period (with another R16m tax credit listed under investments). For the full financial year to end-March 2017 Trustco reported a tax bill of just R51.5m, despite posting net profit after tax of almost R530m. Trustco’s effective cash tax rate over the longer term is startlingly low — literally a sliver of reported headline earnings. One should be able to safely presume a listed company would not be underpaying its taxes, and assume that the assessed tax loss of R50m from financial 2007 can’t really be a factor any more.

So, then, is it possible to deduce that Trustco is not generating "real" profits — that is to say cash profits?

The cash flow statement shows a net cash outflow from operations of R108m. Finance costs on the R1.7bn debt alone was R121m.

While Trustco’s operating companies have taken strain due to tougher economic conditions, it seems that previous profits were mostly "generated" by large fair value gains in the company’s property portfolio. In financial 2017 the property segment claimed a profit after tax of R440m compared with a group profit of R530m. In the previous three financial years the property segment profits accounted for more than three-quarters of group profit.

With the Namibian property market in a funk it would have been difficult for Trustco to record more fair value gains (as well as bumper sales transactions) through the income statement on its key Elisenheim and Lafrenz real estate developments.

The interim numbers show the investment properties to be worth R1.04bn — not much higher than the R1.01bn reflected in the corresponding interim period in 2016.

It is at this critical juncture that Trustco is weighing up rotating auditors, pointing out that BDO has crunched the numbers for more than 10 years. While the appointment of a new auditor will provide more intrigue, there are more immediate issues that shareholders might pay close attention to in the months ahead.

At the end of the interim period Trustco held just R21m cash on hand, which hardly provides directors with the ammunition to "continue to exercise its mandate to aggressively repurchase its shares".

It is also not the kind of war chest needed when looking to expand aggressively into diamond mining — after striking a staggering R3.6bn scrip-funded deal to acquire assets from Trustco’s CEO and major shareholder, Quinton van Rooyen. The mining assets acquired from Van Rooyen have not exactly kicked in with any vigour. The interim results disclosed that diamond mining at the Northern Namibia Development Company as well as diamond polishing operations at Morse Investments had been suspended pending the granting of a long-awaited mining licence.

The low cash levels might have worried shareholders a lot more if US-based investment company Riskowitz Value Fund (RVF) had not recently pumped in R250m via a convertible loan agreement. That loan has since been converted into new equity at 425c/share, markedly increasing RVF’s already large exposure to Trustco.

Then, last month, RVF pumped more money into Trustco, proposing to buy 20% of Trustco insurance subsidiary Legal Shield for R1.2bn — a deal that sparked a huge rally in Trustco’s share price on suspiciously low trading volumes.

RVF has already paid over the first R600m "as a deposit", with a due diligence still required early next year before the transaction is officially closed.

These cash injections are clearly critical for Trustco. Readers may remember that in late 2016 Trustco announced it would embark on a specific share buyback of 5.4% of its issued shares from US-based investment group Buckley Capital.

At that stage, the buyback price — to the surprise of many market watchers — was set at roughly a 20% premium to Trustco’s ruling share price. The interesting part of the deal was that Trustco would only need to settle up with Buckley in January 2018 — more than a year after the buyback was announced.

This transaction value is about R200m, which Trustco might arguably have strained to settle without the R250m convertible loan from RVF. Naturally, the fallout in sentiment if Trustco could not fund the share buyback — or needed to sell off assets to raise the necessary capital – could have been nasty.

A case of cash crisis averted ... for now?