Altron — Rising star

Altron has a long history of providing technology products and services to the South African market. The group helps businesses operate their IT, optimise their services and processes, and build new products or business models. Growth rates in its key technology markets are well ahead of GDP, supporting organic growth. The relatively new management team has put in place a transformation plan to evolve Altron into the leading platform and IT services business in its chosen markets. This includes hiving off non-core businesses for sale and putting in place profit improvement plans for two of the largest businesses, which had seen deteriorating performance in recent years. Key investment considerations include:

The company’s recent FY24 year-end trading update confirmed that continuing operations improved versus FY23, with HEPS from continuing operations expected to be at least 16% higher year-on-year. Management has set a medium-term target to triple operating profit over the period FY21–26, with targeted margins of at least 19% for the Platform division (including at least 16% for Netstar) and at least 7% for the IT Services division. We forecast operating profit before capital items to grow 18% in FY24, 14% in FY25 and 24% in FY26, with the margin expanding from 7.1% in FY23 to 10.8% by FY26. This results in HEPS from continuing operations growing at a CAGR of 21% from FY23 to FY26e.

Our sum-of-the-parts valuation uses average peer multiples for each division, adjusted for performance, resulting in a fair value per share of ZAR21.0, 84% above the current share price. We believe that as the company shows evidence of progress towards its medium-term margin targets, the discount to fair value should reduce. The stock has already gained 17% since the year-end trading update on 26 February confirmed positive progress.

As well as the usual risk factors relating to competition and technology, we view the following factors as having the potential to influence our forecasts and the share price: timing and proceeds of disposals, the integration of three companies into Altron Digital Business, regulation, geographic expansion, exposure to South African political and economic risk and disproportionate voting rights.

Altron is a South African-based provider of platforms and IT services, partway through a transformation programme designed to optimise growth and profitability.

Altron was founded in 1965 as Allied Electronics Corporation. The company built and acquired a series of IT-related and industrial businesses, mainly focused on serving the South African market. Altron listed on the Johannesburg Stock Exchange in 1975. Since 2016, management has been streamlining the group, selling off non-core businesses to focus on the IT sector. In 2020, the company spun-off its UK-based IT services business, Bytes Technology Group, which is now listed on the London Stock Exchange. As a result of the demerger, Altron shareholders received c £542m/ZAR10.9bn in cash and Bytes shares.

In October 2022, the current CEO, Werner Kapp, joined the company with a view to further restructuring it, improving profitability and driving growth. As part of this process, the company has undertaken a series of disposals and has several businesses held for sale.

Until the end of H124, seven of the eight businesses that make up continuing operations were combined into four groups, Platform (Netstar, Altron FinTech, Altron HealthTech), Digital Transformation (Altron Systems Integration, Altron Security, Altron Karabina) and Managed Services (Altron Managed Solutions), with Other including the Altron Arrow distribution business and central costs. In Exhibits 1, 2 and 3 we show the split of revenue, EBITDA and operating profit in H124 by business line. Annuity revenues made up 59% of group revenue in H124, with 50% for Digital Transformation and Managed Services combined and 82% in the Platforms group.

In H124, Platforms contributed 73% of EBITDA before central costs and 62% of operating profit before corporate and consolidation costs, while Digital Transformation and Managed Services combined contributed 22% and 30%, respectively.

The new management team put in place a strategy that aims to create the leading platform and IT services business in its chosen markets, with the key levers outlined in Exhibit 3.

Management is focused on the following three growth levers:

Exhibit 4 shows the progress update reported with H124 results. Initially, management undertook a detailed review of each business in the group and initiated profit improvement strategies in Netstar and Altron Systems Integration (ASI), which had already started to bear fruit by H124. ASI reported a year-on-year increase in EBITDA margin from 1.6% to 3.5% and Netstar reported an increase from 33.0% to 35.7%. The company has developed target operating models for each business to reduce cost inefficiencies and improve operating margins. Management has also worked to optimise the balance sheet and improve capital allocation.

Altron Nexus, a provider of enterprise connectivity and critical communications services, was restructured and moved into discontinued operations as management believes it no longer fits with the core business. Altron Document Solutions (ADS) remains within discontinued operations as a previously agreed disposal did not complete. We discuss the performance of the individual businesses within continuing operations later in the report.

The charts below show the structure within continuing operations up to the end of FY24 and the new structure implemented from 1 March this year, when Altron Managed Solutions, Altron Karabina and ASI were combined to create Altron Digital Business. We note that FY24 results will be reported under the previous group structure.

As part of the strategy, management has put in place the following operating margin targets:

Overall, the target is for continuing operations to generate operating profit of ZAR1.1bn by FY26, tripling from the ZAR371m achieved in FY21. Adjusting for a disposal within Altron Managed Solutions in H124, Altron reported operating income of ZAR352m in H124 and we forecast ZAR695m for FY24.

We forecast steady growth in revenue and margins across the two divisions, with Netstar the main driver of profit growth as it regains market share, grows its enterprise business and optimises its cost base, followed by the turnaround in ASI. At a group level, management is keen to harness the large volumes of data it generates and the recent hire of Dr Bongani Andy Mabaso, previously CEO of SITA (State IT Agency), as chief technology officer (CTO) supports the group with this strategy.

Group CEO Werner Kapp joined Altron in October 2022 from Dimension Data, where he spent 22 years, most recently as CEO for Middle East and Africa. CFO Carel Snyman joined Altron in June 2023; he was most recently CFO of Aztomix Proprietary and prior to that held finance roles at MultiChoice Africa and Naspers. There are nine non-executive directors (NEDs) on the board. Independent NEDs include Stewart van Graan (chairman), Alupheli Sithebe, Sharoda Rapeti, Grant Gelink and Dr Phumla Mnganga. Other NEDs include Antony Ball and Tapiwa Ngara (who represent Value Capital Partner’s 24.2% indirect non-beneficial shareholding), Brett Dawson and Robert Venter (son of the original founder of Altron and 13.7% shareholder via Biltron).

The group executive committee includes the CEO and CFO as well as Collin Govender (chief operating officer), Marisa van Vuuren (chief marketing officer), Dr Bongani Andy Mabaso (CTO), Hansie Schutte (legal) and Mbali Ngcobo (company secretary). Werner and Carel are also supported by the managing directors of the individual business, as per Exhibit 7.

Altron groups the three businesses that are based on proprietary technology into its Platforms division. These three businesses are run independently with separate management teams. The table below shows revenue, EBITDA and operating profit by business line and for the division as a whole. We discuss each business in more detail below.

Netstar is a vehicle telematics business, predominantly supplying stolen vehicle tracking devices and related recovery services. The business was founded in 1994; in H124 80% of revenue was generated in South Africa and 20% in the rest of the world (mainly Malaysia and Australia).

Netstar operates across three end markets: original equipment manufacturer (OEM), consumer and enterprise. OEM made up 8% and consumer and enterprise combined made up 92% of H124 revenue. We discuss the three areas separately as they have differing dynamics.

Netstar has an exclusive relationship with Toyota where it fits Wi-Fi-enabled telematic devices on the production line in all Toyota vehicles in South Africa. In Malaysia, Netstar has an exclusive relationship with a distributor to supply hardware which is fitted into certain Toyota models. The device enables Toyota to offer services to customers via its Toyota Connect app (eg maintenance reminders, promotions, purchase of cellular data for use in-car), and it also provides the driver with information such as trip and behaviour data. For this, Toyota pays an upfront fee to Netstar, which Netstar recognises as revenue over five years. Netstar also shares in the profit from the sale of top-up cellular data to customers who choose to buy it, with the transaction taking place through the Netstar platform. The original contract with Toyota is nearly five years old. Netstar is in the process of developing a second-generation device as part of Toyota’s new vehicle roll-out. Once the car has been sold, the customer can choose to have a stolen vehicle recovery (SVR) device fitted by signing up for a subscription with Netstar.

Netstar sells its SVR and telematics devices and services to the consumer market via four channels: 1) auto dealers, 2) insurers, 3) direct and 4) digital. It offers four tiers of stolen vehicle recovery service, ranging in price from ZAR99 to ZAR199 per month for a three-year contract. Netstar also sells a number of value-added services such as personal security (Netstar Companion).

Netstar offers its services in five areas: 1) light fleet (eg delivery vehicles), 2) medium/heavy fleet, 3) public enterprise, 4) mining and 5) the rental car market.

The Netstar telematics and SVR device installed for enterprise customers can be used for:

Overlaid with dash cams and AI cameras, drivers can be monitored for fatigue and non-compliance (eg not wearing a seat-belt, abnormal behaviour).

Netstar recently opened a new 52-seat enterprise fleet bureau that operates 24/7 and can offer a managed service for live fleet tracking globally. According to the company, it is the largest and most technologically advanced bureau for vehicle telematics in Southern Africa. As well as offering Netstar’s traditional managed services, such as asset tracking, driver behaviour management, automated incident alerts, reporting and analytics, the bureau will facilitate and manage live video monitoring through Netstar’s advanced Streamax onboard cameras.

For mining vehicles, Netstar offers a collision avoidance system that can be used in open cast mining. This complies with South Africa’s Department of Mineral Resources and Energy’s (DMRE’s) Collision Awareness Systems (CAS) Level 9, which requires that the system automatically takes mechanical control of the vehicle, slows it down and applies the brakes if there is a significant risk of collision. Netstar also offers a pedestrian unit that communicates with vehicle units. This product is currently only available in South Africa, but the business is planning to offer it in Australia.

The majority of customers pay for Netstar’s solutions on a monthly subscription basis; this includes the cost of the hardware device and the ongoing related services. A smaller number of customers pay for the hardware devices upfront and then separately pay for services on a subscription basis.

The charts below show the progression in the number of subscribers by geography (Exhibit 9) and by end market (Exhibit 10 – data only available for these periods). The growth in subscribers via the Toyota relationship has been the biggest driver of growth over the last three years, although we note that average revenue per user (ARPU) is significantly lower for Toyota (c ZAR24 vs the non-OEM ARPU of ZAR151 in H124) as it does not include the recovery service and it contributed 8% of H124 revenue. At the end of H124, Netstar had 1.9m connected devices across 1.6m subscribers, as some subscribers have more than one device in their vehicle. In its year-end trading update, the company noted that as at the end of January 2024, subscribers exceeded 1.7m and connected devices exceeded 2.0m, and subscriber growth was 12% for consumers and 30% for enterprise (January 2024 compared to January 2023).

The recovery of stolen vehicles and the personal security service is outsourced to a private security company, Rentrak. This company uses vehicles for ground crew to track stolen vehicles, and where difficult to track by road, also has helicopters to track vehicles from the air. Netstar operates its own radio frequency (RF) network in combination with the GSM network to track SVR devices and has a stolen vehicle recovery rate above 90%. Hardware devices are designed by Netstar and manufacturing is outsourced, with Netstar owning the intellectual property (IP).

For the devices paid for on a subscription basis, Netstar owns the devices and includes them on the balance sheet as ‘Capital rental devices’; it also capitalises the device fitment costs in this category. The device and fitment costs are depreciated over three years and charged to cost of sales. The company is reviewing the useful economic life of devices to verify whether this is still appropriate as peers tend to depreciate over a longer period, for example Cartrack over five years and Matrix over five years for its Africa segment. The hardware for the mining collision avoidance systems is paid for upfront and costs at least an order of magnitude more than an SVR device.

The company also capitalises the commission paid to dealers and amortises this over three years, again through cost of sales. In H124, annuity revenues made up 87% of total revenue.

South Africa has a car parc (total number of cars on the road) of c 13m vehicles. The key driver of demand for stolen vehicle recovery services is the high level of crime in South Africa, particularly car hijackings (carjackings). The chart below shows the number and growth rate of carjackings from 2009–23, with 2023 representing the highest year.

In South Africa, Netstar competes mainly with Cartrack (owned by Nasdaq-listed Karooooo) and MiX Telematics (owned by Nasdaq-listed PowerFleet). Cartrack operates across 23 countries and at the end of November 2023 had 1.91m subscribers, with 1.45m in South Africa. MiX Telematics operates across 120 countries and had 1.09m subscribers at the end of September 2023, with 58% of subscription revenue from the Africa segment.

As well as driving revenue growth from increasing the number of subscribers in South Africa and internationally, Netstar is broadening its offering with the following product development:

The business is also working with partners to enhance services. In October 2023, Netstar announced a partnership with the SafeCity initiative powered by Vumacam. Vumacam operates a network of CCTV cameras across Gauteng and Netstar will be able to enhance its surveillance services with data from the CCTV network. This includes automated number plate recognition (ANPR) and AI-powered image analysis of vehicles. The partnership operates as a revenue share of services that leverage Vumacam’s data.

Revenue growth slowed during FY20–22, picking up again from FY23 and reaching 12.1% y-o-y in H124. Over the same period, EBITDA and operating margins declined, with a further decline in FY23 as, among other things, pre-fitment conversion dipped and component costs increased. Since the new management team put in place various measures to improve operational efficiency (driving pre-fitment conversion up, growing the network of fitment centres, establishing an in-house retention team which reduced churn) and has invested in product innovation, revenue growth and margins have started to improve. In the year-end trading update, the company noted that H224 performance was stronger than in H124 and that churn was now at 16% compared to 22% in FY23. We forecast double-digit revenue growth for FY24–26, with operating margins reaching the targeted 16% by FY26.

FinTech provides infrastructure and services for card-based and digital payments. The business was the largest contributor to operating profit in H124 with a 23.9% operating margin. The FinTech business was established in 1993 to supply point of sale (POS) systems in South Africa and has grown to encompass four business lines. In H124, 99% of revenue was generated in South Africa with the remainder from the rest of Africa and annuity revenue made up 69% of total revenue.

Under the NuPay brand, Altron provides a DebiCheck service, enabling companies to debit payments from their clients’ accounts. DebiCheck is the South African debit order payment system created by the Payments Association of South Africa (PASA). When a consumer sets up a DebiCheck mandate for a regular payment, the bank will contact the consumer to confirm the details supplied for the debit order are correct. Once confirmed, the debit order is processed; if rejected, the order will not go through. DebiCheck is similar to the Direct Debit scheme in the UK or SEPA Direct Debit in the EU. Altron works with four sponsor banks to ensure it can offer choice and provide high platform uptime to its customers. The majority of revenue is generated from processing payments and collections for microfinance lenders (see below).

Delter designs and supplies software for the unsecured microfinance lending market. The software supports lenders over the entire lifecycle of a loan, including file capture; e-signatures; fingerprint capture; credit bureau, interest and affordability calculations; fee structures; disbursement of funds and repayments. The software is available for on premise or cloud deployment. Lenders can disburse funds direct to bank accounts via electronic funds transfer (EFT) or can load the cash onto a NuCard, a Mastercard-branded debit card that can be used at ATMs and retailers. Altron only works with lenders that can prove they are certified by the National Credit Regulator (NCR) and has c 2,700 customers, which it estimates make up c 65% of the NCR market. There is a link to the Collections & Payments part of the business, which processes the debit orders for borrowers receiving and repaying their loans.

Altron operates in two main areas: supplying payment acceptance devices and processing payments (financial transaction switch):

This is predominantly a hardware business; Altron resells machines from ENTRUST that are used to personalise and issue debit, credit, access and identity cards. It operates in the following areas:

South Africa has a large informal economy, which according to a Mastercard white paper, includes c 3.3m micro and informal businesses primarily using cash to make and receive payments. Altron FinTech’s credit management software helps microfinance lenders service this market in a regulated manner and promotes financial inclusion for all.

The division benefits from the shift from cash to card payments, although South Africa is behind countries such as the US and the UK when it comes to debit and credit card ownership. According to the World Bank’s Global Findex report in 2021, 60% of people in South Africa aged 15 and over held either a debit or credit card in 2021, up from 46% in 2011. This compares to 97% in the UK and 91% in the US. Bank account ownership is also slightly behind the UK and the US, at 84% compared to 100% and 95% respectively. As more citizens gain access to bank accounts and the ability to pay by card, this supports growth in digital payments. According to Statista estimates, digital payments worth $19.8bn were made in South Africa in 2023 and this is expected to rise at a CAGR of 9.2% pa to $30.8bn by 2028.

In the P&I business, Altron is considering how to manage the shift from physical to digital cards. Digital cards, for example, cards held within wallets such as Apple Pay and Google Pay, require a virtual token on the phone. ENTRUST can provide software tokens and related back office and verification services. Altron is considering dual issuance (ie a physical card plus a digital card on the mobile phone). In our view, consumers are unlikely to shift to using only digital cards in the near term, as this presents too much risk if there is unreliable internet access or a phone is not working.

The FinTech business saw strong revenue growth in FY23 (22%) as it saw a higher-than-normal level of hardware purchases. Hardware purchases remained high in H124, with revenue growth of 1.8% reported. We expect growth of 5% in H224, which results in FY24 revenue growth of 3.4%. In the year-end trading update, the company noted that H224 performance was similar to H124. We expect hardware purchases to normalise in FY25 resulting in a lower level of revenue growth of 1.9%, rising to 8% in FY26 based on growth in annuity revenues. We expect margins to remain relatively stable over this period.

Altron HealthTech was founded around 30 years ago and in 2016, its MedeMass, MediSwitch and MedeServe offerings were consolidated. In H124, 53% of revenue was from software licensing, 43% from claims processing (c 100m claims processed per annum) and 4% from services. Annuity revenue made up 93% of revenue. 99% of revenue is generated in South Africa, with the remaining 1% from other African countries. Altron HealthTech provides technology solutions in three main areas:

Altron HealthTech targets the privately insured healthcare market. Solutions include:

Altron HealthTech works with corporates in two areas:

While strictly adhering to POPIA, the business has built new solutions from its practice and claims switching data. The data is being augmented to improve its relevance to industries such as insurance, financial and retail. Recent offerings in this space include:

In FY23 HealthTech launched four new offerings and is currently focused on growing its occupational health business. Revenue from enterprise customers for its occupational health solution grew 19% y-o-y in H124 to 25% of revenue. We note that profitability has been supressed over the last few years as the business has expensed investment in its cloud offerings. This had the effect of reducing EBITDA margins by 0.6pp in FY22, 3.4pp in FY23 and 2.6pp in H124. We understand this investment in broadly complete.

In the year-end trading update, the company noted that H224 performance was similar to H124. We forecast revenue growth of 7–8% for FY24 and FY25 with stable margins.

This division contains four businesses: Altron Security, Altron Managed Solutions (AMS), Altron Systems Integration (ASI) and Altron Karabina. The table below summarises the historical performance and our forecasts for each business.

Altron decided to enter the identity security market in FY20 and Altron Security was created from the acquisition of two businesses: Ubusha in FY21 and Lawtrust in FY22. Ubusha was founded 20 years ago to provide identity management services to enterprises, automating user management, reducing attack surfaces and aiding regulatory compliance. Lawtrust was founded in 2006 and is Africa’s leading Trust Centre, security integrator and security solutions developer. The business now provides cryptography, signing, identity, fraud prevention and compliance solutions to banks, telecom operators, insurance companies and manufacturers in South Africa

In H124, 94.7% of revenue was generated from South Africa, 1.8% from the rest of Africa, 0.7% from Europe and 2.8% from the rest of the world. Annuity revenue made up 83% of total revenue.

The goal of the business is to provide preventative controls to companies with regulatory requirements to automate their compliance. Altron Security operates across two main areas:

Altron Security provides encryption solutions, for example securing GSM networks and enabling the South African national smart identity card (where it works in conjunction with Altron FinTech). It sells TLS certificates to consumers, providing the majority of certificates in the South African market. A TLS certificate is a digital certificate that authenticates a website’s identity and enables an encrypted connection. A website needs a TLS certificate to be able to keep user data secure, verify ownership of the website, and prevent attackers from creating a fake version of the site. Altron Security also provides the security element for the South African identity card (managed by the Department of Home Affairs). The business resells software from ENTRUST, Ascertia and Venafi.

Altron Security is one of a limited number of companies certified to issue Advanced Electronic Signatures (defined by the Electronic Communications and Transactions Act as high assurance digital signatures) and offers its own SaaS-based digital signing platform called SigningHub, which enables users to sign documents electronically. It is similar to DocuSign but is locally hosted by Altron, offered to the South African market as a public cloud offering, priced in rand and can offer high level assurance. High level assurance requires face-to-face verification, which can either be performed in an enrolment centre or by a team sent to the customer. Altron Security’s digital signatures are also approved by the Adobe Approved Trust List. Altron is increasingly integrating SigningHub with customer applications.

Altron provides solutions and managed services for identity access management, identity governance and privileged access management, working with software partners such as CyberArk, OneTrust, Ping Identity and SailPoint. Altron’s Biotrust solutions use multi-factor authentication (MFA) to secure transactions, including the option to use biometric security based on fingerprints. For compliance reporting and data governance, Altron helps companies to comply with POPIA (Protection of Personal Information Act) and with non-financial reporting such as ESG, cybersecurity and governance. Fraud prevention is the smallest part of the business and the company is working to develop its offering.

The business generates revenue in five ways:

The business generates around one-third of revenue from its own platforms. Most customers use cloud-based solutions although a few prefer to use on-premise software (eg banks). All software is sold on a subscription basis, even if deployed on-premise. Customers tend to prefer to pay using an opex model rather than capex and pay for software licences on an annual basis, although many third-party software vendors are moving to three-year terms. Altron Security’s own platform is charged for on an annual basis paid upfront. In H124, annuity revenue made up 83% of total revenue.

Altron Security operates in the growing market for regulatory technology (RegTech), designed to automate regulatory compliance as additional regulations are introduced.

Cross-selling is a key growth strategy for Altron Security. With its focus on supporting smaller businesses to access the same level of security as enterprises, it looks at ways to sell additional services to customers using SigningHub. There is also scope to team up with Altron Digital for shared opportunities. While Altron Security currently sells projects and software, it is shifting to selling access to its platforms and growing managed services, which should improve gross margins.

From a product perspective, the business is aiming to widen identity verification to citizens who are not South African, although this is only realistic in countries with well-established identity databases. The business sees an opportunity to support other African countries that are implementing public key infrastructure (PKI).

The company would consider making bolt-on acquisitions to accelerate growth. Countries/regions under consideration include South Africa, South-East Asia, Belgium, the Netherlands and the UK. Targets would ideally have at least 70% annuity revenues.

In the longer term, the emergence of quantum computing is likely to make current encryption techniques obsolete as encryption algorithms are cracked. We expect the industry to develop quantum-proof encryption methods, which should ultimately drive an upgrade cycle.

In FY22 and FY23 the company worked to integrate the two acquisitions and invested in headcount to drive growth, with FY23 the first full year after the two acquisitions. Revenue grew 5.6% y-o-y in H124 and we expect limited growth in H224 (as per the year-end trading update) – FY24 forecast revenue growth of 3.4% reflects a digestion phase after customers upgraded to meet regulatory requirements in previous years. We expect growth to accelerate from FY25 as cross-selling increases. Management pointed to a small drop in profitability in FY24 and we forecast a lower operating margin of 16.0% compared to 17.0% in FY23. We expect a recovery from FY25 as revenue growth reaccelerates.

From 1 March 2024, Altron Managed Solutions, ASI and Altron Karabina were combined to create Altron Digital Business (although these businesses will be reported separately for FY24 results in May). These three businesses service the same customers and have similar competitors. Management has already restructured the individual businesses to optimise their cost bases so that the focus when combining the businesses can be on driving growth. The businesses, with a combined headcount of 2,100, will be collocated with the aim of limiting disruption during the integration process. The new operating model will seek growth from cross-selling and improved service delivery.

The changes to the operating model that have been made to drive growth include:

Measures to drive margin expansion include:

The three businesses operate across two main areas:

According to Statista, the South African IT services market was worth $6.14bn/ZAR113.3bn in 2023 and is forecast to grow at a CAGR of 12.1% to 2028. The table below shows the relative size of the sub-segments of the market and forecast growth.

With revenue of ZAR4.2bn in FY23, Altron has a relatively small market share. The South African economy is relatively stagnant (the IMF forecasts 0.9% real GDP growth in 2024), leading to customers seeking ways to use technology to grow revenue, become more efficient and reduce costs. We discuss each of the individual businesses in more detail below.

Exhibit 15 shows the geographic spread of revenues and the level of annuity revenue in each business.

Roughly 40% of ASI revenue comes from IT outsourcing, where customers buy IT infrastructure from Altron combined with managed services, covering areas such as unified communications, network switching and routing, managed cloud, managed security, storage and enterprise architecture. The main OEMs that ASI resells are Cisco, Huawei and Microsoft.

The remaining 60% of revenue comes from its professional services business, covering:

From 1 October 2023, the Huawei networking and enterprise services business that was in Nexus was transferred into ASI.

AMS provides technology solutions with related managed services. It is focused on the retail market, which includes petrol station forecourts. Its largest customer is MassMart in South Africa where it provides end user support for head office and stores, POS support and support for the digital workplace. There is some overlap between ASI and AMS, and management believes that AMS’s service delivery skills will be valuable in the combined Digital Business as it has expertise supporting large-scale customers and supply chain management. On 1 July 2023, Altron sold the ATM hardware business within AMS for proceeds of ZAR13m and an additional ZAR119m received from retained trade receivables. This has not been treated as a discontinued operation; the company provided data on revenue and EBITDA excluding the sold business.

Altron Karabina, originally founded around 20 years ago, was acquired five years ago. Karabina specialises in systems integration for Microsoft solutions. It provides licensing advisory services, Microsoft 365 managed services, cloud migration, cloud infrastructure, business application implementation and data and AI services. The data and AI practice has won the Microsoft South Africa Data & Analytics Partner of the Year award every year for the last 17 years.

The business has already made good progress in improving the performance of ASI, with H124 operating profit of ZAR31m, which was 80% of the cumulative operating profit over FY21–23. We forecast mid-single-digit revenue growth for each of the three businesses in FY24, excluding the disposed ATM business within AMS. In the year-end trading update, the company noted that the performance of ASI and AMS (adjusted for the ATM disposal) was better in H224 than H124. Karabina’s H224 performance was in line with H124. We forecast relatively flat margins for AMS and Karabina in FY25 and FY26, while we forecast margin expansion for ASI over the same period. We forecast the entire IT Services division to reach the 7% operating margin target in FY26.

Altron Arrow is a distributor of electronic components in sub-Saharan Africa. In H124 it generated 10% of group revenue and 10% of operating profit.

Altron Arrow is a 50/50 joint venture between Altron and Arrow Electronics (NYSE-listed). Altron Arrow is consolidated in Altron’s accounts, with the 50% stake owned by Arrow treated as a minority interest.

The main areas in which AA operates are:

The business has access to more than 140 electronic component suppliers in South Africa and more than 600 through Arrow Europe. Altron has a 4,000m2 warehouse in Johannesburg that holds approximately 32,000 line items while also having access to more than one million product lines held at Arrow Electronics EMEA warehouse based in the Netherlands.

The Altron Arrow engineering team specialises in helping customers with their specific electronic component needs, ensuring the optimal solution for their requirements. Through careful analysis and expertise, they provide specific recommendations ensuring efficiency, cost optimisation and effectiveness.

Altron Arrow saw strong revenue growth from FY22–23 as the component supply chain started to ease up after COVID disruption and the business pursued new opportunities. Demand remained strong in H124 (revenue up 32.1% y-o-y) but we expect demand to moderate now that supply chain issues have eased. The business reported an operating margin of 7.4% in FY23 and 8.7% in H124, impressively high for a distribution business. We expect the margin to be maintained at this level in FY25 and FY26 even as demand moderates.

In addition to the usual competition and technology risks, our forecasts and the share price will be sensitive to the following factors:

In the recent year-end trading update, the company disclosed the following expectations for FY24 EPS. Our forecasts are at the lower end of these ranges.

We forecast group operating profit of ZAR1.0bn by FY26, which is just below the company target of ZAR1.1bn. We expect Netstar to have the biggest impact on operating profit growth (+ZAR244m FY23 to FY26e), followed by ASI (+ZAR164m FY23 to FY26e).

Within discontinued operations, we have modelled continued ownership of ADS and Altron Nexus. We note that the large loss that we forecast for discontinued operations in FY24 includes c ZAR392m of one-off write-downs that were made in H124. In the FY24 year-end trading update, the company confirmed that ADS had returned to profitability in H224 although would be loss-making for the full year. We assume ADS is profitable in FY25 whereas we continue to model losses for Altron Nexus. The company noted in the trading update that it is managing both entities for value and is currently in negotiations with potential buyers of ADS.

The company targets a dividend payout ratio of 50% of headline EPS from continuing operations.

Altron’s capex includes:

We forecast that depreciation and amortisation from the items above as well as depreciation of right of use assets (c ZAR130m pa) and amortisation of acquired intangible assets (ZAR22m pa) will total ZAR783m in FY24.

The company reported net debt of ZAR558m at the end of H124 (continuing and discontinued operations combined). Discontinued operations included debt of ZAR412m relating to rental finance advances for which the corresponding receivable was recorded in finance lease assets. For gearing calculations, net debt at the end of H124 was ZAR164m (it excludes the back-to-back financing described above) and net debt/EBITDA was 0.23x, leaving plenty of headroom for M&A.

As the group consists of six businesses with varied business models, we use a sum-of-the-parts (SOTP) valuation to reflect the different dynamics within the group. In Exhibit 19, we summarise the peers used for each business. There is a limited number of peers listed in South Africa so we have expanded our peer group to incorporate European and US companies. We have grouped Altron Managed Solutions, ASI and Altron Karabina together as Digital Business, as they have similar operating characteristics and are now operating as one unit. We do not assign any value to the discontinued operations. Exhibit 20 shows forecast growth and margins for each peer group as well as revenue and EBITDA/EBIT multiples, and the same for each Altron division. Exhibit 21 shows the SOTP valuation. We have applied a 30% discount to reflect a holding discount and the higher risk from the South African market. We have used our forecast for continuing operations net debt at the end of FY24.

In the table below, we have assigned multiples to each division based on its performance versus its peer group. In our SOTP calculation, we have averaged the valuations across FY24 and FY25 and across the three multiples. This results in a per-share valuation of ZAR21.0, 84% above the current share price. In our view, evidence of margin progression towards the group’s medium-term targets should reduce the discount to fair value. We have not included any value for discontinued operations. Businesses held for sale had a net book value of ZAR935m at the end of H124. If sold for this amount, the proceeds would be worth ZAR2.5 per share.

We have also performed a reverse discounted cash flow analysis, using a WACC of 14% and a long-term growth rate of 3%. Using our forecasts to FY26, we estimate that the current share price is factoring in revenue growth of 3.2% pa FY27–33 and EBITDA margin expansion of 1.25pp over the same period from the 21.5% we are forecasting in FY26. In our view, this appears conservative considering that Altron is operating in structural growth markets and is focused on optimising profitability.