Chantal Marx picks three undervalued stocks

Chantal Marx, the investment research head at FNB Wealth and Investments, identified her top three stock picks during a recent JSE SA Stock Picks event – Master Drilling, Capital Appreciation, and Lewis. 

Marx was instrumental in launching FNB Securities’ in-house research platform and plays a key role in the content and research teams at FirstRand.

She holds a BSc in Mathematics and Economics, a BCom Honours in Investment Management, a CFA charter, and a Master’s degree in Finance.

Describing herself as a “boring, long-term investor”, Marx seeks companies with stable management, a large and growing market, a strong balance sheet, and solid fundamentals.

She regularly comments on market trends on platforms like Business Day TV, Newzroom Afrika, The Money Show, and SABC.

Two of Marx’s stock picks, Master Drilling and Capital Appreciation, are ones she has previously highlighted at a JSE Stock Picks event.

This JSE event focussed specifically on small-cap stocks, which Marx loves, with many of her past stock picks falling into this category.  

Marx explained that there is a nice rule of thumb when it comes to screening smaller-cap stocks.

Compare the company’s dividend yield and the price-to-earnings (PE) ratio, and usually, when its dividend yield is higher than its forward PE ratio, it’s worthwhile to have a second look at the company.

“Sometimes it’s a value trap, but a lot of times it’s actually a really nice signal that the market is mispricing a stock that is cash generative but not necessarily getting the rating that it’s supposed to.”

Each of the stocks she selected shares this characteristic: their forward dividend yield for the coming 12 months is higher than their forward PE ratio, which can often indicate solid value for investors seeking income-generating options in the small-cap segment.

Below is an overview of the stocks Marx picked. 

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Master Drilling

Chantal Marx’s first stock pick is Master Drilling, a company in the mining sector specialising in large-scale drilling services, and has a market cap of R2.07 billion. 

Known for its expertise, Master Drilling operates with a significant advantage in the industry due to its extensive proprietary technology, which it has developed over the last 40 years. 

This technology and the high level of skill involved in operating their machinery make it challenging for competitors to replicate their services and give Master Drilling a strong market position.

While Master Drilling has a strong presence in South Africa, it is actively expanding internationally, with a growing footprint in regions such as South America, North America, Australia, Southeast Asia, and, more recently, the Middle East. 

The company’s services have also extended beyond mining into broader construction, offering opportunities in new markets.

Master Drilling is exposed to the ups and downs of the commodity cycle and naturally, its performance is impacted when commodity prices fall or when mining companies reduce capital expenditure, as seen recently. 

“But the reality is that we’ve seen massive underinvestment in supply in many commodity types over the last decade or so,” Marx said. 

“The expectation is that we will eventually have to start seeing that capex being spent in order for us to meet future demand, particularly for critical metals like copper – and master drilling will benefit from that.”

The stock’s forward P/E ratio is currently 4.5, which is “exceptionally cheap”, and it offers a dividend yield of 5%, making it a strong option for value-oriented investors. 

Over the past year, Master Drilling delivered a total return of approximately 12%, with a 6% return year to date, though it has slightly underperformed the broader market. 

Marx explained that the company’s strong balance sheet, high cash generation, and solid management team make it a reliable long-term investment.

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Capital Appreciation

Marx’s second stock pick was Capital Appreciation, a fintech company specialising in payment solutions with a market cap of R2.27 billion. 

Using her screening rule, Marx said this stock is “really, really attractive”, with a forward P/E ratio of 7.6 and a forward dividend yield of 8.6%. 

Capital Appreciation operates primarily in the payments sector, with a focus on the supply chain for payment terminals – the card machines that allow customers to swipe or tap. 

The company sources, upgrades, develops software for, and distributes these terminals, positioning itself as one of South Africa’s market leaders. 

Capital Appreciation’s business is currently growing rapidly, in part due to the demand for upgrades from older 2G and 3G technologies to 5G-compliant terminals. 

This necessary upgrade cycle is boosting sales in its terminal business.

The company’s software division, which operates on a subscription model, offers annuity-style income, contributing further to the stock’s appeal. 

Besides payment solutions, Capital Appreciation also develops software for other areas within the fintech space, expanding its reach.

Marx expects the company to deliver robust earnings growth, potentially around 30% per annum over the next few years. 

Although the stock recently saw a re-rating, its valuation at a forward P/E of 7.5 remains attractive, suggesting more growth potential ahead.

“So a seven and a half times forward P/E is still very cheap, even though we have more recently seen a really nice re-rating in the stock.”

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Lewis

Marx’s final stock pick was Lewis, a South African furniture retailer with a market cap of R3.93 billion. 

Although Lewis is more sensitive to economic cycles, Marx explained that it remains well-positioned, even with interest rate shifts. 

“Lewis has shown us that they can do quite well regardless of where we are in the interest rate cycle.” 

“We’ve also started seeing some green shoots from a consumer confidence perspective, and we have started seeing furniture and homeware sales increase, not only for Lewis but for other players in the market as well.”

Marx noted that Lewis has made significant progress in its cost management, reducing unnecessary expenses from its income statement. 

The company has also improved its cash generation and enhanced its debt collection processes, and as a result, its books look a lot healthier than they did in previous years. 

A recent trading statement from Lewis indicated that its headline earnings per share are expected to increase by over 45% this year, which points to their very solid performance. 

With the potential for further interest rate cuts and a positive consumer outlook, Marx said that she sees continued growth for Lewis. 

The stock is currently trading at a forward P/E ratio of 5.8, which she considers undervalued relative to its growth prospects. 

Lewis also offers a forward dividend yield of 8.7%, “a really attractive dividend yield on any measure”.