Long view and ability to identify potential key for equity investing
• Fund managers should not be so quick to dismiss firms that do not scream instant returns
As a fund manager I am often asked about the recent poor performance of equities. Increased political risks, low investor confidence and a likely further credit ratings downgrade have left investors concerned they will no longer get the return from equities they have experienced over the past five years.
As investing in equities is my favourite pastime, and we as a team spend numerous hours with the management teams of SA’s top companies, I can talk about this for hours.
The JSE all share index’s (Alsi’s) average annual growth rate over the past two and a half years has been a mere 2.3%, well below consumer inflation of 5.5% over the same period.
In contrast, over the past five years the Alsi has risen by an annual average of 10.1%, excluding dividend receipts, or 14% including dividends. This more than beats inflation of 5.7% over this period.
The recent underperformance of the domestic market does not mean investors should flock offshore or into other asset classes. There are still opportunities to make money in locally listed equity.
By carefully looking at the long-term fundamentals, we identify companies whose potential to grow is not being seen by the market.
Investors’ behavioural biases lead to the mispricing of longterm growth companies. By investing in these firms it has been possible for active fund managers to outperform the Alsi in recent years.
Active fund managers have numerous tools for generating investor returns.
While they can focus on a company’s financial statements, we believe one gains far deeper insights through a good understanding of a company’s production process, management style, marketing budget, product development pipeline and strategic initiatives.
Identifying the unique differentiators that will ultimately drive a company’s growth is time-consuming and resourceintensive. But it has helped my team identify opportunities in companies that offer superior earnings growth over time.
As an example, AVI, a fastmoving consumer goods company with more than 50 brands, including Five Roses tea, Zoo biscuits, Romany Creams, Marie Biscuits, Salticrax and Cheese Curls, is a clear winner.
Its competitive advantage centres on having a clear understanding of the economics between volume and price. Additionally, the company relentlessly focuses on quality, which affects all processes from manufacturing and distribution to packaging and arrangement on shop shelves.
Much of AVI’s success can be attributed to its CEO, Simon Crutchley, who joined in 1999, first in business development, then as chief operating officer before taking the helm in 2005.
We have met him regularly over the years, since he headed glass manufacturer Consol in the late 1990s and turned that business around.
Under his leadership, AVI’s profit has increased more than fourfold, from R315m in the 2005 financial year to R1.4bn in 2016. At every turn when investors have been doubtful of the firm’s ability to continue generating solid earnings it has surprised with yet more growth. Crutchley’s role is absolutely critical to AVI’s success. Its price:earnings ratio is 20.11 and in the past five years its share price has risen nearly 70% from R57.10 to R96.98.
While we identify growth companies by their competitive advantage, operational leverage and strong management teams, as is the case with AVI, others might impress us with their production capabilities, such as Kumba Iron Ore.
Out of favour recently with many investors, the company has made key shifts to change its mine plan design. From being a high-cost producer it has an opportunity to reduce costs and increase mine lifespan by lowering the production targets of its Sishen mine, which has had difficulty reaching its installed capacity of 42-million tonnes.
Sishen is based near the town of Kathu in the Northern Cape. At 14km, it is one of the largest open-pit mines in the world and has sufficient reserves to sustain a 19-year lifespan. In recent years Kumba has increased its use of technology to improve the efficiency of mines by extracting greater iron content from particles.
In a typical display of market behavioural biases, investors reacted when Kumba failed to declare a dividend in February, even though its largest shareholder, Anglo American, had announced the intention not to do so. The share lost 7% in the week after the release of its great 2016 results.
We felt this reaction was excessive and unsupported by the company’s fundamentals. Our view on Kumba Iron Ore remains positive based on the company’s ability to generate greater efficiencies through the use of new technology.
A growth company may also be identified by its ability to respond to socioeconomic trends, such as Curro, the country’s fastest-growing private education specialist.
Middle-class South Africans who can’t afford to send their children to traditional private schools but want to ensure they have a good education are increasingly looking for more cost-effective options.
PSG Group-controlled Curro charges about R40,000 a year, a more affordable level than the R100,000-plus charged by some private schools. It now has 110 schools across every province in the country and has the potential to reach 500 schools by 2030.
Having listed on the JSE in 2011, the group has a market capitalisation of about R17.5bn. The company holds a key position in our equity portfolios because of its ability to innovate and respond to a growing socioeconomic need.
It also has the opportunity to potentially replicate its success in nursery, primary and high schools, and in tertiary education. Its teacher education specialist, Embury, offers accredited degrees in various subjects and in 2016 acquired a 50% stake in BA Isago University in Botswana, which could be its entry point to building a tertiary education platform.
Investing in equities requires a long-term horizon. You may have heard this time and again, but it does hold true.
Asset managers must watch where the business cycle is going next to determine growth opportunities. The ability to look beyond current noise to find the real-world investing opportunities that grow investors’ portfolios is fundamental.
Van Velze is head of Stanlib Equities.