Betting on addiction is a sure winner
It is no coincidence that the biggest companies by far on the JSE trade on human weaknesses
Humankind has often been the source of its own progress — and its own downfall. Nowhere is this better illustrated than on the JSE: look for a company with a market cap of a trillion rands, and the three that fit this bill are vast global operations pandering to basic human addictions.
Beer colossus AB inBev (ABI) has a market cap of R1.45-trillion; tobacco giant British American Tobacco (BAT) follows closely at R1.4-trillion; and Naspers’s market cap tipped R1-trillion in May (although it had dropped to R910-billion at time of writing), thanks to its ownership of Chinese Tencent, which derives most of its income from the most modern of dependencies — gaming.
Together, these three are valued on the JSE at R3.85-trillion, almost 30% of its overall R14-trillion market cap.
On the understanding that there’s money to be made out of addiction, here’s my take on whether I would park my cash with these Big Three.
Beer
Recently dissolved home-grown SABMiller has been replaced by ABI on the JSE. SABMiller’s share price went from R792 before the deal to ABI’s current R1 483.
Last year, ABI’s revenue was $43-billion, with that figure postmerger set to rise substantially. The company’s second quarter results this year recorded revenue growth of 3% for the quarter, despite sales volumes dropping by 1.7%.
But in the long-term ABI has a proven track record of value delivery. Its price-to-earnings (PE) ratio has hovered around 20 for the past five years, and today is at about 35, meaning an investor is now willing to pay $35 for one dollar of current earnings, showing faith in future growth.
The company is well known for its strategic mergers and acquisitions, coupled with a lean management style and cost-cutting philosophy. Rewards for shareholders in the medium term are looking attractive.
“Earnings per share growth rates are expected to be mid-double digits in 2017 and 2018,” said John Thompson, an analyst at Investec Asset Management.
“The company’s share price has dropped roughly 15% in euro terms since the deal was announced and, based on long-term value metrics, is looking much more attractive.”
Look out for: We have yet to see how the entire $100-billion merger settles. With several brand takeovers underway and sales yet to be completed, chief executive Carlos Brito has many calls to make in terms of management and consolidation.
In short: South African investors will do better investing in ABI than they did in SABMiller. “SAB shares without the ABI bid would now be well below the share take-out price of £45,” said Thompson. “It’s difficult to guess but, without the offer, the SAB share would be at least down 20%.”
With the share price more reasonable than it was before, now’s the time to get on board.
Tobacco
After listing on the JSE in 2008, British American Tobacco’s share price has risen from R195 to a current R778. This growth, admittedly bolstered by a weakened rand, has outperformed both the JSE all share index and the London Stock Exchange, where BAT holds its primary listing, over the past eight years. It seems surprising — after all, the company’s traditional markets have been losing ground.
Its most recent nine-month interim management statement, released in October, recorded a 2.8% decline in sales in the Asia-Pacific region between this year and last, and a drop of 9.2% in the Americas. Despite this, BAT has a firm grasp on the developing markets, where smoking is still increasing.
“Pricing is at a relatively low level in several of BAT’s key emerging markets,” said Dirk van Vlaanderen, the associate portfolio manager of Kagiso Asset Management.
“As the populations of these markets become more wealthy over time, we believe there is a lot of profit growth potential from higher prices, which will offset slower growth expected out of the more mature markets.”
Overall, cigarette volumes sold by the company increased by 2.2% over the period. Market share was up 40 basis points year to date.
Thompson said this has partly to do with innovation. “E-cigarettes are growing rapidly and might add up to 10% to profits by 2020.”
And, to offset the risk of putting your money into an increasingly unpopular industry that is burdened by taxes of up to 80% of the product price in some markets, BAT is likely to keep paying out dividends that grow by 4% to 5% annually.
Look out for: BAT recently made an offer to acquire United States tobacco giant Reynolds American. The proposed $47-billion deal will give BAT greater access to the lucrative US and “significant presence in high-growth emerging markets”.
In short: BAT is a strong defensive stock and a good rand hedge. Look forward to frequent dividend payouts and decent share price growth in the medium term. The reliability of the stock’s performance appeals to me. Ethics aside, I would be in.
Naspers
Koos Bekker’s gamble on Tencent has done astronomical things for Naspers’s share price. Five years ago, it was R338; today it is R2 087. With a PE of 90.2, the public clearly expects huge things from the company.
Sarine Barnard, an analyst at Investec Asset Management, explained the allure. “There are only four global companies with user bases of more than 800-million — Facebook, Microsoft, Apple and Tencent. We believe this platform provides a very powerful sustained competitive advantage.”
But the company’s greatest selling point also poses its greatest risk. Its share price is dictated by Tencent’s share price, so is subject to fluctuations in the exchange rate between the rand and the Chinese yuan.
In addition, said Barnard, “tech- nology companies are all subject to the risk of new disruptive technologies being introduced by competitors”.
Of course, Naspers also owns a vast array of local and African assets, including pay TV (DStv) in South Africa and Africa; several classifieds businesses in more than 44 countries; and some e-tail businesses in Africa, the Middle East, India and Eastern Europe.
Those who buy the R2000-plus shares are essentially paying for Tencent and gaining exposure to the others for free. Which is fair enough: many of the so-called rump assets are “very early stage assets with low visibility and therefore forecast risk”, she said.
Look out for: Try to see Naspers’s very high PE ratio in perspective. “Naspers is investing in a lot of startup businesses that are not making money at all,” said Barnard. “… In the past six months, the company spent almost $496-million on development spend … Naspers’s earnings would be around 75% higher if one had to add back the ‘drag’ from development spend,” she said.
In short: It’s a gutsy company and, if Bekker’s Tencent gamble is anything to go by, much of the development spend will pay off handsomely. That said, the share price is intimidating. I might buy a few shares, try to forget about them and hope that I get a good surprise in 10 years’ time.