Average on the cheap
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.