THE RUPERT EFFECT
The investment case for Remgro, Richemont and Reinet
It must irk Johann Rupert to know that the Google search of his name has been captured by wmcleaks.com, 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.
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