WHERE FUND MANAGERS ARE INVESTING
ashrinking economy, stubbornly high unemployment, rising interest rates and target-busting inflation are putting pressure on South African consumers and businesses. Due to the unique nature of the stock market, with multinational companies that earn the bulk of their revenue outside the country dominating the local exchange, fund managers have the opportunity to structure their unit trusts defensively to benefit from a weakening rand and economic growth abroad.
Some of the largest equity fund managers are utilising a substantial part of their offshore allocations, capped at 25% by government regulations, to diversify returns to geographies with less gloomy economic prospects. Others are deriving the same benefits through buying so-called rand hedge stocks, or rather companies that earn in foreign currencies and translate them back to a weakening rand in order to defend their capital bases against losses.
The South African economy shrank by 1.2% quarter-on-quarter during the first three months of the year, according to Stats SA. Consumer price inflation, mainly driven by rising food prices due to a drought and more expensive food imports, breached the Reserve Bank’s upper target of 6% for the fifth consecutive month in May when it was recorded at 6.1%.
“We’re in an environment where capital preservation is more important than seeking aggressive growth,” says Errol Shear, manager of the Absa Select Equity Fund with R3.3bn under management. “We’re seeing economic headwinds not only in SA, but in the whole world.”
Active fund managers, as opposed to passive tracker funds, which usually buy an index, have a so-called bottom-up approach to stock selection and are loath to comment on certain sectors. They analyse specific stocks and take their investment decisions based on this research. Value investors, for example, buy stocks at cheap valuations – using metrics such as price-toearnings ratios (P/Es) among others – and sell when they deem the stock expensive.
There are, however, certain sectors that are distinguishable on the JSE, notably financial stocks, consumer goods, consumer services, industrials, healthcare, telecommunications, basic materials (resource stocks), technology and a small balance of other stocks.
CONSUMER GOODS AND SERVICES
Some of the most prominent stocks on the JSE fall into this sector, notably British American Tobacco (BAT), Naspers*, Steinhoff International, SABMiller and to an extent Remgro, with its holdings in Unilever SA and RCL Foods.
The bulk of BAT, Naspers, Steinhoff and SABMiller’s revenues are generated abroad, making them hedges against a weakening rand as their rand-translated earnings increase when the local currency slides.
BAT, which has a large emerging-market presence, returned 39.9% to rand-based investors and 23.4% to those invested in its London-listed stocks over the past year. The company suffered from the slump in commodity-producing emerging markets over the past two years and, with regard to profits, didn’t perform as well as its developed market peers, notably Japan Tobacco Inc, explains Rhynhardt Roodt, co-manager
of the Investec Equity Fund with R9.3bn under management.
“In hindsight, we didn’t have enough BAT stocks over the past two years as we didn’t foresee the rand weakening as much as it has,” he says. “But we now have a strong preference for BAT against other SA rand hedges. Commodity-producing currencies seem to have stabilised, which in turn should favour BAT.”
The stock, which now does constitute one of the fund’s top 10 holdings, has been actively bought by the fund over the last few months, Roodt adds.
SABMiller, which will likely be taken over by Anheuser-Busch InBev at some point this year, has been a consistent performer over the years, says Absa’s Shear.
“The stock is still trading at a discount for what is going to be paid for it,” he explains.
The stock has returned 47% to rand-based investors over the past 12 months and 31% in pounds.
Naspers, with its 34% stake in Hong Kong-listed Tencent Holdings, owner of Chinese instant messaging service QQ and English peer WeChat, has returned 18% to investors over the past 12 months. Aside from its holding in Tencent, the company’s holdings include the pay-television service MultiChoice, online shopping websites in a number of countries as well as online and print media titles.
“The market is still underestimating the underlying platform of Tencent,” explains Peter Linley, manager of the R2.1bn Old Mutual Top Companies Fund. “WeChat, for example, is becoming more dominant in people’s and businesses’ lives. It is becoming a platform itself.”
With more than 800m users in China, Linley says that Tencent has taken on a defensive nature as stock. In addition the company has more opportunities to monetise this large platform, or sell online services to customers, according to him.
“How many people just leave Facebook, for example, after they’ve joined?” he asks.
Naspers’s businesses, excluding its Tencent holding, are trading at a negative value of around R278 per share, says Linley. The stock constituted more than 16% of the Old Mutual Top Companies Fund at the end of March.
“Over the next two years we believe the market will
begin to see the real value of the unlisted businesses in the rump, which we expect will drive further outperformance of Naspers,” he explains.
“We have added to our Naspers holdings as the holding company discount widened over the last year,” says Ruan Stander, co-manager of the Allan Gray
Equity Fund. “Valuing the rump at R800 per share means you are paying less than 20 times earnings for Tencent. An attractive price given that this is a cashgenerative business with a great track record and good growth prospects.”
Another South African company that expanded aggressively abroad, and notably in Europe, is Steinhoff. The company, headed by CEO Markus Jooste, bought French retailer Conforama and UK-based Harveys and Bensons for Beds a few years ago, among others. The company shifted its main listing to the Frankfurt Stock Exchange in December.
“Steinhoff is a self-help story that we like,” says Patrice Rassou, co-manager of the Sanlam Investment Management General Equity Fund with R7.8bn under management. “They created a platform with the listing and benefits from low funding costs in Europe to grow the company further.”
The stock has returned 21% to rand-based shareholders over the past 12 months. Since December the German-listed stock rose 2.5% in euro terms.
“We have a high degree of confidence in the commercial acumen of Steinhoff’s CEO and management team,” says Anthony Sedgwick, fund manager at Abax Investments who part oversees Nedgroup Investments’ R15.9bn Rainmaker Fund. “We will always give them the benefit of the doubt.”
Steinhoff’s latest acquisition target is British lowcost retailer Poundland. However, it is not a foregone conclusion that Steinhoff will purchase the company, according to Sedgwick. Poundland does seem to be a good fit with Steinhoff’s Pepkor unit, which it bought from Brait at the start of last year for R62bn, he explains. Steinhoff constitutes 7.3% of the Rainmaker Fund and 7.7% of the SIM General Equity Fund.
Locally-facing consumer stocks are not, however, as favoured as their peers with international exposure. The South African consumer, who is dealing with a plethora of economic woes, doesn’t stoke investors’ confidence. In addition, especially local retail stocks are considered expensive by fund managers.
Shoprite Holdings, the continent’s largest grocer, trades at a historic P/E of 20 and has returned 3% to investors over the past 12 months. Pick n Pay Stores are trading at a ratio of almost 32 times profit and returned 26% to investors. Massmart Holdings, majority-owned by Walmart Inc, trades at almost 24 times earnings and lost investors 16% over the last year.
When analysing local consumer-facing stocks at their current valuations, managers such as Old Mutual’s Linley would rather opt to buy banking shares.
“Banks’ price-to-earnings multiples are as attractive relative to the market as we have seen over the past 20 years,” says Allan Gray Equity Fund’s Stander. The Allan Gray Equity Fund has R40.9bn under management. “Given strong capital levels, prudent provisions, sluggish loan growth and more sustainable commission income the downside risk is much lower than during previous economic downturns.”
The fund, which counts Standard Bank, Africa’s largest lender, as its largest financial holding and second-biggest overall holding, is buying a number of financial services stocks, he says.
“In the short term Standard Bank faces headwinds in Africa but in the medium term the investment into their African franchise should reap benefits that are not priced into the share,” he says.
The stock is trading at 8.8 times historic earnings at a gross dividend yield of 5.5%. It lost investors 15% over the past 12 months.
Barclays Africa Group, which is being sold by its parent, London-based Barclays Group, is trading at a historic P/E of 8.6 and at a gross dividend yield of 6.8%. The stock lost investors 10% over the past 12 months.
FirstRand, owner of First National Bank, is trading at 11.4 times historic earnings and at a gross dividend yield of 5%. It lost investors 9.3% over 12 months.
Nedbank, owned by Old Mutual, is trading at the lowest multiple, 7.9 times historic earnings, and at a gross dividend yield of 6%. The stock lost investors 16.5%, the most among the four traditional commercial banks, over the past 12 months. The lender relies heavily on corporate deals, such as mergers and acquisitions, for non-interest revenue.
A number of factors played into the banks’ share price performance over the past few months in addition to the fate of former finance minister Nhlanhla Nene. The risk of a sovereign downgrade by credit-rating agencies Standard & Poor’s and Fitch reared its head early in the year, according to Suvasha Kander,
co-manager of Ashburton’s SA Equity Fund with R1.3bn in assets. Fears about how the upcoming local elections will play out as well as the results of Britain’s referendum to leave the EU also contributed to uncertainty for the local banks, she explains.
Says Investec’s Roodt: “We have been heavy sellers of financial stocks in the second and third quarter of last year. People thought 12 months ago that banks would continue delivering double-digit growth in 12 months’ time. We thought it would be much lower.”
Going into the December rout that hit local banking shares following President Jacob Zuma’s sacking of Nene and replacing him with little-known David van Rooyen, Investec’s Equity Fund had little exposure to banking stocks, explains Roodt.
“More recently we’ve been buying back into banks
as earnings expectations and valuation levels are more reasonable than a year ago,” says Roodt.
Abax’s Sedgwick says they are very bullish on banks. “We know about the headwinds.”
The Rainmaker Fund’s fourth-largest holding is FirstRand at 7.1% of the underlying assets, followed by Old Mutual at 5.3% and Barclays Africa Group lower down at 2.9%.
“It is not often that you get the chance to buy the banks at a price where future price-to-earnings ratios are equal to their dividend yields,” says Sedgwick.
Financial stocks offer better value than their industrial and resource peers, says Ashburton’s Kander.
Following the 2008 financial crisis, local banks strengthened their capital bases and tightened up lending, she says. Local banks’ limited exposure to foreign economies also stood them in good stead. “Local banks are locally focused,” Kander explains. Banking shares have been pricing in the downgrade risk and although the country wasn’t downgraded earlier this month, uncertainty is likely to persist until the December round of rating agency reviews, Craig Butters, co-manager of the R2.8bn Prudential Equity Fund, comments in a note to clients.
“So we see limited scope for the banks’ valuations to rebound back to historical levels anytime soon,” he says.
Old Mutual is a favourite among the 13 funds analysed, featuring among the top 10 holdings of nine of the funds. After luring Bruce Hemphill, former CEO of competitor Liberty Life, to its top post last year, Old Mutual has announced upcoming structural changes, including splitting the group into its four underlying businesses, namely Old Mutual Emerging Markets, Nedbank, Old Mutual Wealth plc (UK) and Old Mutual Asset Management (US).
“Old Mutual’s current structure has a lot of inefficiencies,” says Allan Gray’s Stander. “This could be unlocked by the proposed restructure.”
Following the 2008 financial crisis and primarily driven by Old Mutual’s US business, a lot of value was destroyed, explains Stander.
“The company is now well run,” he says.
Resource stocks have been hard-hit by the slowdown in the Chinese economy, which has traditionally been driven by mineral beneficiation and manufacturing. Add to that a glut in steel production, and it won’t come as a surprise that especially basic metals, such as iron ore, chrome and aluminium, underperformed over the past two years. “There remain headwinds for infrastructure-linked commodities such as iron ore with China’s debt-fuelled construction boom coming to an end,” says Stander.
Following the year-to-date rally, Investec has continued to reduce its exposure to China-linked commodity producers, adds Roodt. The outlook for economic growth in China remains poor, according to him.
Despite this, many mining conglomerates worked their balance sheets over the last two years, notably Anglo American and Glencore. Since the start of this year, commodity prices have stopped their slump.
“The balance sheets of companies look better,” says Ashburton’s Kander. “They have reduced their cash costs, reduced their capital expenditure and are selling off inefficient mines.”
Allan Gray’s Equity Fund started seeing some value returning to large diversified miners such as Anglo American and Glencore in the first quarter of this year, according to Stander.
“But prices rebounded quickly and unfortunately this is no longer the case for the sector as a whole,” he says.
Old Mutual’s Linley bought Glencore when the stock traded below R20 late last year.
“But we remain unconvincend this is the beginning of a commodity bull market,” he adds. “China remains a challenge.”
On the other hand, the prospects of precious metals, such as gold and platinum, are a little better.
“Gold and platinum have been good performers, although off a very low base,” says Kander.
“It is not often that you get the chance to buy the banks at a price where future price-to-earnings ratios are equal to their dividend yields.” “Gold and platinum have been good performers, although off a very low base.”
Among the 13 fund managers analysed, Mediclinic stands out as the preferred healthcare share to hold. The company bought UK-based Al Noor Hospitals Group earlier this year through a reverse acquisition that saw Mediclinic being listed on the London Stock Exchange.
“Mediclinic has been a fantastic performer for us,” says Abax’s Sedgwick. A number of factors play into the hand of the private hospital group, including an ageing population, an increased disease burden and, locally, a non-participative public healthcare system, according to him.
“The company’s balance sheet is prudently managed,” he says. “In the long term, this is a share you can own for another 20 years plus.”
Ashburton’s Kander says the stock was added to their fund last year. They especially liked the diversified global exposure of Mediclinic and its footprint in the UK, Switzerland and the UAE, she says.
“In excess of 70% of earnings are generated outside of South Africa exposing investors to hard currency,” she says. “Mediclinic has become an international company with a highly rated management team.”
Another healthcare share that the Ashburton fund prefers, and counting under its top 10 holdings, is Aspen Pharmacare. The stock returned 1.6% over the past 12 months.
“We bought Aspen a couple of years ago,” Kander says. “We like how the company has grown through mergers and acquisitions and that it has a global footprint today.”
Some of Aspen’s share price underperformance can be attributed to GlaxoSmithKline (GSK) reducing its stake in the company and a subsequent oversupply of the shares in the market, she explains, adding that GSK sold off its holding to use the cash for another acquisition.
Errol Shear Manager of the Absa Select Equity Fund
Rhynhardt Roodt Co-manager of the Investec Equity Fund
Suvasha Kander Co-manager of Ashburton’s SA Equity Fund
Ruan Stander Co-manager of the Allan Gray Equity Fund