The in­vest­ment case for Rem­gro, Richemont and Reinet

Finweek English Edition - - FRONT PAGE - By Mar­cia Klein

It must irk Jo­hann Ru­pert to know that the Google search of his name has been cap­tured by wm­, which not only man­aged to se­cure the top search un­der his name, but also al­leges that he owns or con­trols all of South Africa’s banks, au­dit­ing firms and its media.

It goes fur­ther, al­leg­ing that he has a “team of scoundrels” in state in­sti­tu­tions, in­clud­ing the top names at Na­tional Trea­sury and the South African Re­serve Bank.

What this site, which has un­sur­pris­ingly been linked to the Gup­tas, fails to men­tion, are the companies Ru­pert ac­tu­ally owns and con­trols, which cover a broad spec­trum of the South African econ­omy, as well as some sub­stan­tial off­shore as­sets.

Whether he is called one of SA’s best in­vestors or the sym­bol of white monopoly cap­i­tal, the im­pli­ca­tion is that Ru­pert has made ex­cep­tional profit from his in­vest­ments, and var­i­ous rich lists bear this out.

So should you “bank” where Ru­pert banks and invest in Richemont, Rem­gro and Reinet, the companies un­der his con­trol? Or, more specif­i­cally, should you be in­vest­ing in them at this time?

The Ru­pert fam­ily has ac­cu­mu­lated its wealth over decades, and long-term in­vestors have ben­e­fit­ted as he has. The question, how­ever, is whether he has kept these companies rel­e­vant as in­vest­ment propo­si­tions for now, and the fu­ture.

Well ahead of its time, Richemont has, since as long ago as 1988, given South African in­vestors a pure rand hedge op­tion. Not only did it ful­fil this func­tion, but growth in the global lux­ury goods mar­ket in which it was a ma­jor player seemed un­stop­pable.

But Richemont has floun­dered in re­cent years, to the ex­tent that it re­quired a huge shake-up to­wards the end of last year as it failed to adapt to the dig­i­tal watch rev­o­lu­tion and to a clam­p­down on bribery in China, which saw fewer lux­ury gifts be­ing pre­sented to state of­fi­cials.

Richemont has re­sponded to the changes in its en­vi­ron­ment – but per­haps a lit­tle later than it should have.

In the year to March, Richemont’s sales de­creased by 4% to €10.6bn, or by 2% ex­clud­ing the ef­fect of “ex­cep­tional in­ven­tory buy-backs”, where it had to buy back its own stock in or­der to not flood the ex­clu­sive lux­ury goods mar­ket or cause prices to come down. It even went as far as de­stroy­ing some of its prod­ucts to main­tain the ex­clu­siv­ity of its pre­mium brands.

Its sales of jew­ellery, leather goods and writ­ing in­stru­ments in­creased while whole­sale sales de­clined, and growth was strong in main­land China, Korea and in the UK, with the US, its big­gest mar­ket, re­turn­ing to growth. The re­sults show an im­prove­ment in the sec­ond half af­ter dis­as­trous Septem­ber in­terim re­sults.

Nev­er­the­less, op­er­at­ing profit slid 14% for the full year and profit would have dropped 24% ex­clud­ing a one-time gain. But Richemont im­proved its cash po­si­tion (to €5.8bn) and in­creased its div­i­dend by 6%.

CEO Richard Lepeu re­tired in March and was not re­placed, with Ru­pert step­ping in to take on a more ac­tive role as ex­ec­u­tive chairman. Top man­age­ment is now di­vided into op­er­at­ing areas and Ru­pert has said the group will con­tinue to slim down.

Ves­tact port­fo­lio manager Michael Tre­herne says there’s no doubt the watch di­vi­sion has been dis­rupted by dig­i­tal, and the clam­p­down on cor­rup­tion and “gift­ing” in China has had a big ef­fect on Richemont’s business. “So it has been fo­cus­ing on the jew­ellery di­vi­sion and one must not for­get that the num­ber of bil­lion­aires con­tin­ues to in­crease an­nu­ally.

“Will it shoot the lights out? No, not re­ally,” says Tre­herne. “Richemont is about be­ing ex­clu­sive, so it can­not open the flood­gates,” he says. “But it is and re­mains a good storer of wealth.”

It also con­tin­ues to be one of the purest rand hedges for South African in­vestors be­cause of its dual list­ing and tiny pres­ence in SA rel­a­tive to many other rand-hedge coun­ters.

36One As­set Man­age­ment in­vest­ment an­a­lyst Cobus Cil­liers says: “Look­ing at the re-or­gan­i­sa­tion, it has pro­vided a much eas­ier com­mu­ni­ca­tion line to Ru­pert.

“Essen­tially it has been di­vided up into four pil­lars, with the most im­por­tant seg­ment with re­gard to sales and profit be­ing Cartier.”

Asked if Richemont has done enough, he says: “We view this as hav­ing done enough for now. Given the early ac­tions that Richemont took with the watch in­ven­tory buy-backs, we see this as pro­vid­ing ev­i­dence the re-or­gan­i­sa­tion is not just for show, but that there is real pos­i­tive change and that the ef­fects in­vestors are hop­ing for from Ru­pert will ma­te­ri­alise.”

Cil­liers says, how­ever, that there are bet­ter rand-hedge in­vest­ments around if you look at the fun­da­men­tals, given the cur­rent share price. But Richemont is com­ing off a trough in earn­ings and it is geared for growth. “If an in­vestor can hold onto it for the long run (three to five years) and get a good en­try price, it would make an in­ter­est­ing in­vest­ment.”

Richemont con­tin­ues to be one of the purest rand hedges for South African in­vestors be­cause of its dual list­ing and tiny pres­ence in SA rel­a­tive to many other rand-hedge coun­ters.

Look­ing at Rem­gro’s port­fo­lio now, it is easy to for­get how much it has changed over the years. Ini­tially in­vested in wine and spir­its as well as to­ba­coo, Rem­gro ex­panded into bank­ing and fi­nan­cial ser­vices, min­ing, print­ing and pack­ag­ing, med­i­cal ser­vices, engineering and food.

It still holds many of these in­vest­ments, but it has, since the 1980s, helped start and then sold Vo­da­com, got out of tobacco (although Bri­tish Amer­i­can Tobacco is still held through Reinet), largely di­ver­si­fied out of min­ing, and in­vested heav­ily in health­care (through Medi­clinic) and fi­nan­cial ser­vices.

Its in­vest­ments are still, how­ever, in a broad range of companies across the South African econ­omy, and its re­sults re­flect the state of the econ­omy to some ex­tent.

In the six months to De­cem­ber, head­line earn­ings grew 29.7% to R4.7bn. Ex­clud­ing one­off items, head­line earn­ings grew 7.5%, or 4.3% per share.

There was a 24% de­crease in the con­tri­bu­tion to earn­ings of food, liquor and home­care in­ter­ests. RCL Foods was one of the ma­jor cul­prits, mainly due to the chicken business, a long-term non-per­former, off­set slightly by a good per­for­mance from sugar in­ter­ests. RCL is a typ­i­cal ex­am­ple of Rem­gro ex­e­cut­ing its long-term strat­egy, although af­ter so many years of chal­lenges, in­vestors may won­der why it per­sists.

Unilever also turned in a poor per­for­mance, with its con­tri­bu­tion drop­ping 14%, while Dis­tell marginally in­creased its con­tri­bu­tion.

Bank­ing (FirstRand and RMB Hold­ings), the big­gest con­trib­u­tor to earn­ings, did well while Medi­clinic’s con­tri­bu­tion was up, mainly due to Rem­gro’s in­creased stake, the in­clu­sion of the re­sults of Medi­clinic’s off­shore as­sets Al Noor and Spire Health­care Group and a strong per­for­mance in Switzerland, as well as good or­ganic growth in South­ern Africa. Health­care has been edg­ing up and is now the sec­ond­largest con­trib­u­tor to earn­ings.

Rem­gro’s net as­set value (NAV) de­creased by 15.9% to R257.79 per share at end De­cem­ber from R306.44 at end June, mainly due to a 38.7% drop in the mar­ket value of the Medi­clinic in­vest­ment, and the di­lu­tive ef­fect of its rights is­sue. Rem­gro’s clos­ing share price of R223.05 at end De­cem­ber rep­re­sents a dis­count of 13.5% to NAV.

An­a­lysts have of­ten com­mented that any­one can invest in Rem­gro’s listed in­vest­ments them­selves. It is the un­listed in­vest­ments that should add value to the share price.

Among them, Unilever and To­tal fared poorly while Air Prod­ucts, Kag­iso Tiso Hold­ings, PGSI, Wis­peco and Dark Fi­bre Africa did rel­a­tively well, but none shot the lights out.

With so many of its in­vest­ments – from RCL Foods to Dis­tell, Medi­clinic and FirstRand – be­ing read­ily avail­able as in­vest­ments them­selves, the value added by the non-listed in­vest­ments is not that ev­i­dent.

Health­care has been edg­ing up and is now the sec­ond-largest con­trib­u­tor to earn­ings.

Whether Rem­gro is a good in­vest­ment de­pends on where you draw the line in the sand, says Tre­herne. If you bought the share re­cently, you might not be happy, but if you are a longterm in­vestor, it has paid good div­i­dends, and is a good storer of wealth, he says. There are going to be pe­ri­ods of neg­a­tive growth, but it pays div­i­dends and ap­pre­ci­ates over time.

Ru­pert has un­der­stood the long term, Tre­herne says. “Rem­gro piv­oted out of min­ing as­sets and moved to health­care and fi­nan­cial – it was early on that, as it was with min­ing; it an­tic­i­pated the fu­ture and sold at the top.”

Reinet, formed in 2008 with Richemont’s in­ter­est in Bri­tish Amer­i­can Tobacco (BAT), gave early in­vestors hope that as it sold down BAT over time, it would buy the kind of high­growth as­sets that are not ev­i­dent in Rem­gro’s port­fo­lio.

Af­ter nearly 10 years, the BAT in­vest­ment still com­prises over 70% of Reinet’s net as­set value (NAV) which, at end March, was just over €6bn, a 15% in­crease over March 2016. Reinet di­rec­tors point out that it has de­liv­ered a com­pound re­turn, in­clud­ing div­i­dends, of 16% a year in euro terms since March 2009.

The in­crease over the past year re­flects the in­crease in value of its in­vest­ments in BAT and the UK-based Pen­sion Cor­po­ra­tion, its two ma­jor as­sets, off­set to some de­gree by the weak­en­ing of ster­ling against the euro.

BAT’s higher share price, due to strong earn­ings and its pro­posal to buy the 57.8% of Reynolds Amer­i­can that it did not al­ready own, meant it grew to 70.8% of Reinet’s NAV from 67.3% a year ago.

Reinet’s man­age­ment said the de­ci­sion to hold on to BAT over the past year rather than sell any shares proved cor­rect. In fact, ac­cord­ing to an­a­lysts, BAT re­mains a strong-grow­ing de­fen­sive in­vest­ment de­spite fears that tobacco con­sump­tion is drop­ping, a trend not as ev­i­dent in de­vel­op­ing as in de­vel­oped coun­tries.

In­vest­ments since 2008 to­talled over €2bn at year-end, with fur­ther com­mit­ments of €288m.

The BAT in­vest­ment re­mains con­tin­u­ally un­der re­view but be­tween its good re­sults and gen­er­ous div­i­dend (with 3.7% of BAT, Reinet re­ceived div­i­dends of €127m), Reinet has held tight over the past year.

The big question is whether any fire­works are ex­pected from its other in­vest­ments.

These in­clude nu­mer­ous part­ner­ships with other in­vest­ment fund man­agers, which may make some in­vestors won­der what value Reinet man­age­ment it­self adds and re­ceives fees for.

Reinet is in­vested in SPDR Gold shares, a gold ex­change-traded fund (ETF), and US-listed Selecta Bio­sciences, a bio­phar­ma­ceu­ti­cal com­pany. Among un­listed in­vest­ments is Pen­sion Insurance Cor­po­ra­tion in the UK, which has done well in a chal­leng­ing en­vi­ron­ment in the UK.

Reinet’s part­ner­ships with fund man­agers in­cludes Tri­lan­tic Cap­i­tal Part­ners, 36 South Cap­i­tal Ad­vi­sors, Mile­stone China Op­por­tu­ni­ties funds, Pre­scient China Bal­anced Fund, Van­terra Flex In­vest­ments, NanoDi­men­sion, Foun­tain­head Ex­pert Fund, Snow Phipps Group, JPS Credit Op­por­tu­ni­ties Fund and the GAM Real Es­tate Fi­nance Fund.

In SA, it has in­vested in two projects – one which ex­tracts di­a­monds from the waste tail­ings of min­ing op­er­a­tions at Jagers­fontein in the Free State and an­other that has the rights to mine di­a­monds on a pre­vi­ously un­ex­ploited site at Rooipoort near Kim­ber­ley. Nei­ther ap­pears to be of­fer­ing the high growth po­ten­tial in­vestors were hop­ing for.

If you were in at the be­gin­ning, you now own an as­set that is di­ver­si­fy­ing it­self out of tobacco and your in­vest­ment has done well over the years, says Tre­herne. “There are some very clever peo­ple there, us­ing the money to di­ver­sify. BAT is slowly be­com­ing less and less of NAV and the long-term plan for BAT is that it will be­come in­signif­i­cant.” In the mean­time, BAT pays a good div­i­dend, and you get value gains, so you are do­ing quite well.

Cil­liers says af­ter BAT (70% of NAV) and Pen­sion Insurance Cor­po­ra­tion (18%), the rest of the NAV is in­vested in pri­vate eq­uity and other in­vest­ments, and while “there might be a start per­former some­where here […] given this is such a small com­po­nent, it needs to grow a lot be­fore it makes a mean­ing­ful impact.”

The out­look for BAT is good rel­a­tive to the other tobacco stocks, Cil­liers says. “EPS is set to grow for the full year, it pays a good div­i­dend and the Reynolds deal will be EPS ac­cre­tive. This is a good de­fen­sive stock with enough in­no­va­tion [like ‘glo’ smoke­less tobacco] to keep its cus­tomers com­ing back.”

The Ru­pert ef­fect

All three in­vest­ments do, to a large ex­tent, re­flect Ru­pert him­self – fairly con­ser­va­tive and geared to­wards a long-term strat­egy.

In­vestors wel­come the fact that he is in­volved in his in­vest­ments and has a long-term and re­al­is­tic out­look.

“What is nice about own­ing these companies, is that Ru­pert is straight and blunt and says it like it is be­cause he has noth­ing to prove. He tells you, ‘This is how it is,’ and ‘This is what’s chang­ing.’ With CEOs whose jobs are on the line, there is far more sugar-coat­ing,” says Tre­herne.

Cil­liers says Ru­pert has built and in­vested in companies with good cash flow-gen­er­at­ing abil­i­ties, strong bal­ance sheets and good business mod­els. “These companies of­fer prod­ucts or ser­vices to clients that of­fer unique value propo­si­tions to those clients.

“Ru­pert’s skill in build­ing busi­nesses and al­lo­cat­ing cap­i­tal ef­fec­tively is one rea­son why he has been so suc­cess­ful.” He iden­ti­fies good busi­nesses and does not over­pay.

Ru­pert’s port­fo­lio of as­sets pro­vides good di­ver­si­fi­ca­tion, which in turn pro­vides a more con­ser­va­tive port­fo­lio than one sin­gle share, but each has it own risk, ex­plains Cil­liers.

He says Richemont is run in a fi­nan­cially con­ser­va­tive man­ner, as it has sig­nif­i­cant amounts of ex­cess cash on the bal­ance sheet, “but this is pru­dent – some would ar­gue over-con­ser­va­tive – given that Richemont is subject to more volatil­ity in de­mand for its prod­ucts than most other companies.”

Rem­gro too, he says, has a con­ser­va­tive di­ver­si­fi­ca­tion ap­proach across a va­ri­ety of sectors with companies like Medi­clinic and fi­nan­cial ser­vices in­vest­ments mak­ing up a large por­tion of its NAV.

But if you look at the share price per­for­mance and NAV growth of his companies, the past few years don’t in­di­cate high-per­form­ing companies.

Whether they are at­trac­tive de­pends on the in­vestor’s time hori­zon, says Cil­liers.

Reinet of­fers a mar­gin of safety, as it is pro­vid­ing shareholders a dis­counted en­try price to BAT, he says.

BAT is still tak­ing away mar­ket share from its com­peti­tors and the Reynolds deal is set to close end of July. “The debt side of this deal has been fi­nanced at a very low in­ter­est rate, and it will be ac­cre­tive to EPS.” He ex­pects Richemont to re­turn to growth. No doubt in­vestors who want to fol­low Ru­pert need to have his out­look and ex­pect a slow and steady per­for­mance over the long term. Any po­ten­tial in­vest­ment that shoots the lights out is a bonus, but should not be ex­pected.

Cartier bracelets

Richard Lepeu Re­tired CEO, Richemont

Rem­gro is heav­ily in­vested in the health­care sec­tor through its in­vest­ment in Medi­clinic.

Michael Tre­herne Port­fo­lio manager at Ves­tact

Cobus Cil­liers In­vest­ment an­a­lyst at 36One As­set Man­age­ment

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