Av­er­age on the cheap

Finweek English Edition - - INVESTMENT -

Ig­nor­ing the JSE’s cur­rent high valu­a­tions and sim­ply buy­ing into ‘qual­ity’ busi­nesses will not give you great re­turns five to ten years down the line, warns Jan van Niek­erk, chief ex­ec­u­tive of­fi­cer of Cape Town-based as­set man­age­ment house RECM.

“Buy­ing good busi­nesses is no guar­an­tee for good re­turns,” he says.

Take an out­stand­ing busi­ness like SABMiller, which trades at a high priceto-earn­ings ra­tio of 26 times. It re­cently re­leased a trad­ing up­date for the f irst quar­ter of this year. “To only see growth of 4% in sales vol­ume for such a price tag is dis­ap­point­ing,” Van Niek­erk says.

The trick is to do all your home­work and wait for the right time to buy. A case in point is global phar­ma­ceu­ti­cal be­he­moth John­son & John­son, a qual­ity com- pany but one that RECM did not own be­tween 2000 and 2010 when it was a mar­ket dar­ling. It was then trad­ing at a price-to-book value of 7.8. It grew its div­i­dend rate by 13% in that pe­riod, while earn­ings per share grew 11%. Still, the share price re­mained f lat through­out the pe­riod, only ris­ing by 2%.

From 2010 to 2013 the com­pany be­came cheap, trad­ing at a price-to-book value of 2.9 and achiev­ing a share price rise of 14%. “It is not enough to just buy a good com­pany, one must buy it at the right price, and nowa­days it is very dif­fi­cult to find a good com­pany cheap, there­fore it is bet­ter to buy an av­er­age com­pany at a cheap price rather than buy a good busi­ness at a high price,” Van Niek­erk ex­plains.

In­cluded in RECM’s f lag­ship Global Flex­i­ble Fund are what Van Niek­erk de­scribes as av­er­age com­pa­nies in min­ing and other cycli­cal in­dus­tries, in­clud­ing the high­est al­lo­ca­tion (5.7%) in An­glo Amer­i­can Plat­inum. Other com­pa­nies in which Van Niek­erk sees value at a cheap price in­clude steel pro­ducer ArcelorMit­tal, which he says is al­most priced as if it wouldn’t sur­vive but has plenty of uptick po­ten­tial, as well as di­ver­si­fied re­tail and con­sumer fi­nance busi­ness JD Group.

The re­tail sec­tor has come down to earth some­what from its ex­pen­sive lev­els in 2012, but many an­a­lysts be­lieve the sec­tor is still not cheap. Says Rhyn­hardt Roodt, port­fo­lio man­ager at In­vestec As­set Man­age­ment: “Re­tail­ers, and credit re­tail­ers in par­tic­u­lar, have un­der­per­formed the broader mar­ket since the begin­ning of 2013. As a re­sult the val­u­a­tion rat­ings of these com­pa­nies are per­haps more palat­able than be­fore, but we would still not clas­sify the sec­tor as be­ing cheap when tak­ing into ac­count the chal­leng­ing growth out­look. We also think the trad­ing en­vi­ron­ment for re­tail­ers is very com­pet­i­tive at the mo­ment.”

Threats to the sec­tor in­clude the weak rand, ris­ing trans­porta­tion costs, in­dus­trial ac­tion in the min­ing and man­u­fac­tur­ing sec­tors, a lack of job cre­ation and a slow­down in credit ex­ten­sion that has a neg­a­tive im­pact on con­sumers.

El­ton Oliver, eq­uity re­search an­a­lyst at Mo­men­tum As­set Man­age­ment, be­lieves that stock-pick­ing op­por­tu­ni­ties are begin­ning to present them­selves, but cau­tions that the sec­tor may con­tinue to un­der­per­form due to the head­winds con­sumers are faced with. “Our pick is Fos­chini as we be­lieve it of­fers a bet­ter fashion of­fer­ing for the price, and the com­pany is mak­ing im­prove­ments to its sup­ply chain which will in­crease eff icien­cies. Its re­turn on eq­uity will also be boosted thanks to the planned share re­pur­chase pro­gramme us­ing the pro­ceeds from the sale of RCS,” Oliver points out.

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