Financial Mail - Investors Monthly
Who to watch in 2015
Low growth hurting
China’s growth is slowing down after decades of rapid expansion. That’s bad news for commodity-producing countries — and mining and energy companies that have been feeding its insatiable hunger for metals like iron ore and copper — as well as oil. The slowdown is reflected in commodity prices. Iron ore has fallen more than 40% this year and US banking group Citi believes it has further to go. Oil prices have fallen sharply to a four-year low below $80, with the US’s move towards energy independence adding pressure.
Despite slowing growth, Chinese consumers are shopping up a storm. One of their preferred methods is online, as was evidenced when recently listed Chinese e-commerce giant Alibaba sold goods worth more than $9bn on November 11 during its annual Singles’ Day Sale.
Unsurprisingly, China will be one of the main determinants of which stocks will do well next year. So don’t expect too much from your resources portfolio in the year to come, but hold on to those Naspers shares. Investors may also have to look beyond SA’s borders to find anything worth buying. Fund managers are finding little value in South African equities.
Independent analyst Ian Cruickshanks says he remains bearish on the prospects for the JSE next year because weak growth is expected and valuations are already high. With the Reserve Bank forecasting 1.4% growth for 2014 — or less — he says growth next year is unlikely to be higher than 2%-2.5%. The International Monetary Fund has also revised downwards its forecasts for global growth.
“The outlook for the market as a whole really depends on the outlook for the economy,” Cruickshanks says. “Where we have always looked for rescue — our resources sector — is not
likely to help much because demand for commodities is limited and the cost of South African production is rocketing.”
Given increasingly unreliable electricity supply, an unstable labour force and questionable security of assets, one large and influential global fund manager says it is “unlikely to attempt to influence any foreign capital inflow” into SA. These factors could make it increasingly difficult for the country to balance its current account.
“So, is this a market in which you should be a buyer?” says Cruickshanks. “In the long run we are going to get some sort of growth, albeit at a low level, and there are some companies that can take advantage of the situation.”
There’s no disagreement from Claudius Rostoll, a portfolio manager at AG Capital.
“Apart from domestic challenges, rising US rates could pose some of the biggest challenges to our market next year,” he says. “If our political leaders continue to take a lethargic stance on foreign direct investment, we’re not making a case for attractive investment. We will continue to keep a keen eye on China’s growth as it grapples with the 7% level. This has a massive direct impact on our resources sector in particular.”
From a macro perspective, Rostoll says he would limit his domestic exposure to sectors not exposed to lower discretionary spend. Companies with significant offshore exposure are preferable, he says.
“Of the highest-ranking geographies, I quite like the potential that the US and Eastern Europe offer, given the level of risk,” he says.
“The US market seems to be performing well throughout the tapering cycle and I would like to see a continuation of this performance with the training wheels off for another year.”
Less central bank intervention means volatility should increase and normalise off the current historically low levels, which presents a great opportunity in itself should the US economy remain robust in the face of the new year’s challenges, Rostoll says.
“But I’m not mortgaging my house just yet to go all-in on equities,” he says.
There’s only one JSE-listed share on 36One Asset Management analyst Jean Pierre Verster’s watch list for 2015: Naspers, owner of a 34% stake in Chinese Internet giant Tencent.
While third-quarter results from Tencent earlier this month may have disappointed investors at face value, Verster says this was due to a temporary slowdown in revenue growth at its mobile gaming unit.
“Our outlook for Naspers and Tencent is still intact,” says Verster. “The premise of Naspers for us is not just about Tencent, although that is the most crucial element as the Tencent stake is worth roughly the same as Naspers’s entire market capitalisation.”
The market is effectively ignoring all other parts of Naspers, including MultiChoice, which includes DStv in SA and the satellite operations across the continent. This area of the business generates cash strongly, yet the market is effectively valuing it at zero, says Verster.
“We are also very bullish on Naspers’s e-classifieds and e-retail sub-divisions,” Verster says. “CEO Bob van Dijk comes with a background in e-commerce so we think there will be an increased focus on this.”
A deal this month with Singapore Press Holdings and Norway’s Schibsted and Telenor, which will create joint ventures for their online classifieds businesses in Brazil, Indonesia, Thailand and Bangladesh, will decrease Naspers’s R&D spend and accelerate profits in these markets. It’s a significantly positive move forward, Verster says. In Brazil, Naspers has been spending more than R1bn a year on R&D and this will now be curtailed, he says.
Though Naspers is the sole SA-listed share on Verster’s list, Cruickshanks and Rostoll have identified a number of local shares they would invest in — at the right price.
“Most of the stocks I’m looking at are relatively expensive, which is why I don’t advise rushing into any opportunity until the potential upside suits the risk of the investor at that entry price,” says Rostoll. “Steinhoff is probably the only stock I’d buy at current levels. The stock is virtually a European household goods retailer, with continental Europe alone accounting for more than 60% of its revenue.”
According to Rostoll, Steinhoff continues to make inroads in market share with its value offering internationally and will probably continue to do so as it increases its Eastern European footprint with the Quattro Mobili brand.
“Once the much-awaited Frankfurt listing is finalised, we expect a re-rating in the valuation to match its European peers as a kicker,” he says.
Areas that Cruickshanks has identified for investment in 2015 include food, pharmaceuticals and the low end of the retail market. Any signs of corporate activity could also present a buying opportunity, he says.
In the food sector, he says Tongaat Hulett is one of the few companies that have successfully partnered with local producers to improve productivity to the extent that they are increasing employment and producing a higher-grade product.
Zeder is also on Cruickshanks’ radar. It is expensive, trading on 18 times reported earnings, but he says food production is an absolute essential. Zeder also has operations in southern Africa outside SA, where growth prospects and margins may be higher.
“Looking at the retail sector, I think some of the ratios are way too high, especially among the credit retailers,” he says. “We are already seeing increasing consumer debt and an increasing inability to service that debt.”
That’s why Cruickshanks prefers cash retailers, such as Mr Price. The affordable clothing and household goods group has established itself firmly at the lower end of the value market and is picking up business from customers who can no longer afford the more expensive credit retailers, he says.
Another low-end retailer Cruickshanks likes is Pepkor, which investors can access through investment holding company Brait.
“Pepkor makes up 70% of Brait’s assets at the moment and that’s where Christo Wiese has parked a lot of cash,” he says. “It’s one I would look at and buy if its price came down a little. Wiese is a natural deal maker and has a great record.”
Defensive healthcare companies appear on both Cruickshanks’ and Rostoll’s lists.
Cruickshanks would be a buyer of Aspen, but only if its price:earnings ratio fell back from a lofty 39 times reported earnings. “It’s a great company and is becoming a strong foreign exchange earner,” he says. “It is also strong in the area of cheaper generic medicines and from an African perspective I think that’s a very important thing to have.”
Mediclinic also stands out. The company has recognised the global move away from state-provided medical care, building a strong presence in Switzerland and the United Arab Emirates, where it doesn’t face a lot of competition. With well over half of its revenue coming from outside SA, it also provides a hedge against a weakening rand.
“Both companies have top-notch management with phenomenal track records,” Rostoll says. “These two in particular are on my buying list on a market pullback. It won’t be that easy, though, because the reluctance in the share price to drop earlier in October illustrated the extent to which investors are falling over their feet to gain entry into the hospital and pharmaceutical space.”
A surprise entrant in Cruickshanks’ list of stocks to watch next year is paper and packaging group Mondi.
“Mondi is important because more and more goods are being sold packaged rather than loose these days and I think it is well situated for that — it has shown a terrific ability to stay in the forefront of marketing and packaging,” he says. “And of course there’s the foreign currency earnings. I think it’s something you have to look out for.”
Banks are going to have an increasingly difficult time as they battle with cash-strapped consumers in a rising interest rate environment, while facing tighter rules and regulation domestically and internationally.
“Business and consumer confidence are also low, but PSG, which owns a chunk of Capitec, may be worth considering,” Cruickshanks says. “Chairman Jannie Mouton is buying stock in his own company and that’s a good sign — he’s not called ‘Slim Jannie’ for nothing.”
PSG has consistently picked winners. It has recently listed financial services group PSG Konsult and education group Curro, and Cruickshanks believes there could be more to come.
“You are paying a fairly hefty price, but if you want some financial sector exposure, then PSG might be the way to go,” he says.
While Rostoll sees challenges for SA shares next year due to weak growth, rising interest rates and weak demand for our commodities, he says if rand weakness abates Imperial could be a stock worth watching.
“If you take the view that the rand will be stable, the oil price will remain depressed and there is no or little risk of contagion as a result of higher US rates, Imperial is the ugly duckling I would back to morph into that beautiful swan,” he says. “Oil is our biggest import and if this dreamy scenario of stable or stronger rand and lower oil price materialises, Imperial will see the effect directly on its margins, coupled with healthier domestic demand.”
Apart from Naspers, Verster finds little value in South African equities. With the rand vulnerable to further weakness against the dollar and other currencies of developed markets, 36One prefers exposure to companies that generate foreign currency earnings with exposure to fast-growing markets.
So, while Richemont has long been a favourite of many investors, Verster would rather invest in a business like Michael Kors, a US-based affordable luxury goods group. The retailer is positioned in a segment of the market that is resilient thanks to rising affluence in the markets it targets. It recently reported strong like-for-like sales at its US stores and is expanding internationally.
“It stacks up better on a valuation basis,” he says. “They are not strictly comparable as Richemont is high-end luxury, while Michael Kors is affordable luxury, but it is growing faster, has higher returns and is trading at a lower multiple than Richemont.”
Alibaba is another global stock Verster is watching going into the new year.
He says the record Singles’ Day sales illustrate the buying
power of the Chinese consumer.
“Alibaba has a dominant position in the business-tobusiness and the business-toconsumer market in China,” Verster says. “Increasingly we are seeing international retailers that want to enter the Chinese market realising they need a strong Internet strategy as well as a bricks-and-mortar presence. Rather than building their own e-commerce sites they would rather partner with Alibaba and offer their products through its consumer site, Tmall.com.”
Infant nutrition group Mead Johnson is another on Verster’s list for 2014. Following the scandals when baby milk formula produced in China was found to contain melamine, Chinese parents prefer international milk formula brands.
“Mead Johnson is one of the leading international players in milk formula so it can command a premium in China,” he says. “With the one-child policy being done away with, we expect China’s population growth to pick up slightly, which means more children who will need formula. We are looking at pricing and volume growth for Mead.”
Also on Verster’s global list is The Priceline Group, which owns travel and hotel-booking website Booking.com, a service with a dominant position in Europe and the US and expanding in Asia through acquisitions and partnerships.
“It has a competitive advantage in the market because as its gets bigger, adding more hotels and destinations to the site, other hotels feel they have to join as Booking.com becomes the go-to site for travellers,” he says. “This virtuous cycle has entrenched the company in the high-growth market of online travel.”
Putting together a portfolio of South African stocks does come with a caveat in what may be a hostile investment climate in 2015, however. Cruickshanks suggests buying a couple of put options on the market in case there is a significant pull back.
“I think it is prudent at the moment to have a little bit of insurance in case the market takes a knock,” he says.