Finweek English Edition - - FRONT PAGE - By Jaco Visser

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.


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

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