The maze of short-term helicopter views put out by investment commentators i s i nvariably both tiresome and confusing for investors, but one specialist house that is robustly bottom-up and proudly so is Old Mutual Investment Group’s Electus Boutique.
“Sure, we take note of macro developments but ultimately we are bottom-up,” says Boutique head Neil Brown.
With over R30bn under management and a limited equity capacity to R60bn in today’s money, Electus does not focus exclusively on the JSE Top 40, but also invests in South African mid- and smallcap shares. Equity research is owned, managed and driven by it.
The most i mportant tenets i n its analyses are return on capital exceeding cost of capital, quality business models, proven management teams with strong capital allocation skills, strong earnings and dividend growth rates, cogent cash f lows, and high margins of safety in fundamental valuations.
“We always strive to buy into highquality businesses at prices that are low compared to their long-term investment valuation,” says Brown.
A fund that strongly ref lects the Electus house view in the large-midcap category is the Old Mutual Top Companies Fund which boasts an excellent long-term performance record and is currently wellpositioned for future excess returns.
Brown estimates that the upside to portfolio fair value is 21.1% compared with the JSE SWIX benchmark -0.1%. The earnings per share growth during the next 12 months is put at 20.4% compared with the benchmark 15.9%. The rolling dividend yield is in line with the JSE SWIX, while the, price/ book ratio and price/cash f low ratio are all cheaper than the benchmark figures.
Recent changes in the portfolio ref lect much of where Brown and co-manager Richard Hasson are going.
Though wary of banks in general because of the South African slowdown and interest rate cycle, they’ve topped up on Investec, Barclays Africa and Standard Bank which they believe offer good value at present. Their prize choice otherwise would be FirstRand, but they believe that it is slightly pricey. They had exposure to Nedbank via Old Mutual but sold out six months ago and haven’t gone back into it again.
Brown and Hasson believe t hat Investec with its good asset management, corporate f inance and South African banking capabilities is worth R90/share against its present R75/share.
They’ve also purchased Clientele which they consider a good business all round, has boasted spectacular growth, and doesn’t have a legacy of high cost structures. In fact, the business was recently slowed down to improve its quality.
On resources, they’ve bought Northam Platinum and Anglo American, sold down Sasol, and off loaded Gold f ields entirely.
“We l ike platinum in general and Lonmin and Northam in particular”, says Brown. “Platinum is still the best resource industry in South Africa, providing 70% of new supply. And Lonmin and Northam are the best operations in the industry, with Lonmin’s improved operating performance and Northam’s excellent management and Booysendal expansion”.
He points out that Electus is well-disposed towards Lonmin, in spite of Marikana. “Management is doing the basics properly; it’s getting production back from 680 000 ounces a year ago to 750 000800 000, and in doing that doesn’t need too much capex.
“In November 2102 it had a big capital squeeze, followed by a big rights offer, and we followed our rights at effectively R20 a share and the post-rights price was about R38. Now it is 50% above that. Currently trading at R60/share, we think that it’s worth about R80/share”
Brown says that his team dumped Gold Fields at R59 to avoid the value trap that it posed and because the group didn’t meet three conditions it (Electus) thought necessary. These were maintenance of its dividend policy; no acquisitions; and upholding its commitment of 700 000 ounces of gold from its South Deep operation by 2016.
“We said that if it didn’t deliver on these, we’d kick for touch. In the end Gold Fields bought three mines from Barrick; paid no dividend, and backtracked on the 700 000 ounces.”
Among industrials, the f und purchased Sun International, Aspen, and Reunert, but recently sold Netcare and Telkom. Sun International’s appeal is that the new CE Graham Stephens is looking to lower the high-cost structure and retrench a huge infrastructure of non-income generating staff. This could include 1 700 people.
Both Netcare and Telkom did well for it and they took money off the table.
Purchases among i ndustrial rand hedges have been BAT, Steinhoff and Reinet Investments, but Brown and Hasson have sold down MTN and Trencor.
Brown a nd Hasson have been impressed with Steinhoff ’s restructuring in Europe, particularly its consolidation of new businesses, centralised sourcing and potential for significantly higher profit margins. They’re not overly concerned about local furniture retailer JD Group’s latest poor results which they point to being a small part of the overall business.
BAT and Reinet are considered qualitative and reliable defensive plays. Besides, BAT is at the right entry price at present and Reinet trades at a 30% discount to net asset value. Brown is not alarmed on a 10-year view about the growing bias against smoking.