Hannes van den Berg discusses the current challenges being faced in the South African investment landscape and what that means for ‘SA Inc’.
Lindsay Williams: We know about the state of the nation, we know about the state of the economy but what about the state of the JSE? With me now is Hannes van den Berg, who is a Portfolio Manager at Investec Asset Management in Cape Town.
Hannes, I was thinking about it long and hard over the weekend and I thought to myself the scandals keep on coming. We have had Steinhoff; we have had EOH; we have had Resilient; we have had MTN; latest we have had is Aspen – and it suddenly dawned on me that South African companies are consistently giving us things to worry about. Never mind that, let’s have a look at South African companies that mainly ply their trade within the borders of South Africa. Is it a time to buy or is it a chance to flee? That is my big question to you.
Hannes van den Berg: Good day, Lindsay. Yes, we have had this discussion before. I tend to always say when you generate good ideas and you want to allocate capital to ideas, you can allocate capital to emerging markets and the resources space where South Africa, we have got listed companies that give us that exposure, you can allocate to global rand hedge companies and then you can allocate to the SA Inc. space, our banks and our retailers and our property companies.
Over the last few weeks or months, you have tried to avoid the potholes (as you rightly mentioned), some of the companies that have disappointed and some of the disappointing results and events that we have seen but it is incredibly, incredibly difficult to allocate capital at the moment to the (call it) SA Inc. space.
Lindsay Williams: Is that because of the companies’ valuations? Is that because of the South African economy? Is it because of the elevated state of the developed world markets? Is it because of all of those things? Why is it so difficult at the moment?
Hannes van den Berg: It’s probably a combination of all of that, Lindsay. I think we are in a process where globally central banks, especially the Federal Reserve in the US, are withdrawing liquidity and, you know, what does that mean for emerging markets and the growth outlook? If you have got rhetoric like trade wars and protectionism going on in that environment where you are also withdrawing liquidity, the threat of slowing global growth is not great for emerging markets.
I tend to look at it from a bottom-up perspective and what we hear in South Africa is that companies are really struggling. Apart from the fact that we are technically in a recession, the Reserve Bank needs to make a decision this week about interest rates. When they previously met, the rand was around 13.40/13.50 where today it’s at R15.00.
So what does that mean for the inflation outlook? From a bottom-up perspective, as I said, when we had a call with one of the big food producers last week, telling us that there is just no volume, no activity coming through from the demand side, from the South African consumer. Maybe it’s confidence; maybe it’s the VAT hike; maybe it’s the additional increase in the petrol price that we have recently seen, all of that and then there is a threat of – as I said, with the rand blowing out, a threat of inflation coming down the track. So how does that play out over the next few months for the SA Inc. space?
Lindsay Williams: Yeah, it doesn’t sound like a particularly good picture but, as I said in my introduction, the big question now is: is it a time to buy or is there still a chance to flee because valuations, PE valuations, for example, are still relatively high? How do you view it at Investec Asset Management and from a personal point of view as an asset manager?
Hannes van den Berg: Valuations are at levels where they were pre the December ANC electoral conference. So, from a valuation perspective, you have to ask yourself is this the opportunity? We tend to believe that we need to combine earnings expectations and the valuation together to form the share price and we need that expectation of earnings to at least bottom and start turning positive and we prefer to invest in companies where those earnings expectations are being revised higher, the consensus expectations and our own expectations.
At the moment, those companies are far and few. You think the valuation is looking interesting and, you know, it’s at the level where it was pre the conference but the environment might still be deteriorating and therefore the stock is not cheap enough yet. So for us at the moment, trying to stick to the more quality businesses in the South African space (and we can talk to those) but try and stick to those where the management teams have got levers to pull and, through that, they can actually navigate the very difficult environment that we are in at the moment.
So it is not just a valuation argument, to answer your question. You also have to look for the businesses where margin and top-line can lead to a healthy bottom-line earnings expectation. It provides the right opportunity for you.
Lindsay Williams: When you come in in the morning, Hannes, do you say to yourself: well, my potential universe is therefore shrinking – because I know at Investec Asset Management, and this has been drilled into me over the years from interviewing people like yourself and your colleagues, that this upward revised earnings expectation story is one that you hang your hat on but that is just not happening. So it must be very, very difficult indeed for you to come in every day and say right, I like this one and therefore I am going to build a case for buying this stock or increasing my stock in this stock (if you see what I mean). How difficult is it compared to previous years for you?
Hannes van den Berg: I think, as I said at the beginning, if you look at the resources space, we are still seeing a lot of positive earnings revisions coming through there and I just read a note this morning again stating that the next cycle of positive revisions coming through in the resources space has potentially only started now. So we still see companies like Sasol and Anglo American and South32 more recently, these companies are seeing very strong positive earnings revisions because of a good supply-demand dynamic that is currently in place in the resources space.
Obviously, your industrial rand hedge stocks will, with the rand blowing out, as I said, that leads to a lot of positive revisions and those companies are in a good space and you can actually include some of the paper stocks in there, stocks like Mondi and Sappi (in my mind, they are more industrial companies than they are resource companies) but, if you look at the SA Inc. space, you don’t see a lot of positive revisions coming through there. Therefore a company like FirstRand stands out to me. I mean FNB’s results in their last results presentation were phenomenal, close to 16% up on their earnings. Credit loss ratios also – in some of the banks and a bank like FirstRand especially, the credit loss ratios don’t look that bad.
So my take on that is that the balance sheet of the South African consumer is actually looking a lot more healthy. They just don’t want to spend. They don’t have the confidence to go and spend on discretionary spending or the big ticket items like a new vehicle or, with the land reform issue, investing and taking that step to buy a new house or a piece of land.
Then, in the retail space, a company like Mr Price and say, for example, Foschini, these companies – I know Mr Price is on a 16 multiple and Foschini is on a 12 forward multiple – these companies are more client-centric focussed and they are – I mean Foschini reported seeing 4% like-for-like sales, increase of sales. These companies are navigating the environment quite well.
So to answer your question, yes, it is more difficult. You have to be more selective about which stocks you pick and why you pick those specific stocks. To end it off, in the SA Inc. space I think it is incredibly difficult to invest in the property sector at this stage. It has been a darling sector for a number of years because of the fantastic stable dividend yield and then a constant growth in that dividend and then the earnings of those companies but, speaking to some of the businesses, not only the property businesses but the retailers who are the tenants of these properties, that environment is incredibly tough. So do we have too much square metres in South Africa? Is that too big and is this market getting saturated? Some of the companies are telling us that they are negotiating their leases downwards. One of the food producers actually said that he negotiated to half his rental agreement.
That just shows you how tough it is underlying and you have to be selective about which stocks do you invest in and which stocks – should there come a cyclical uptick going into 2019 and confidence comes back let’s say closer to election and after election, which are the guys that you want to invest in to get that exposure to a recovery should that come through into 2019?
Lindsay Williams: So what you are saying is that there are opportunities out there but they are becoming fewer and further apart and that we should just be patient and are you confident that perhaps this is the bottoming of the market and the bottoming of the lack of opportunities (if you see what my clumsy phraseology says) or do we will still have some more pain to endure?
Hannes van den Berg: Well, I think, Lindsay, you have to understand that the business confidence and consumer confidence at this stage is still very low. We need more clarity going into the election next year what exactly the rhetoric around land reform will be. I recently attended a meeting where the CEO of the business said to me that no farmer is spending any capital or any capex at this stage on his farm. He is not building new roads or planting more. So there are a lot of question marks and you saw the agricultural number in our recent GDP number was a big disappointment.
So we need confidence to come back in, we need to lending to come back into the economy so that the consumer has access to more capital or more cash and then we need inflation to stay under control. As I said, with the rand blowing out recently, that is definitely not helping. That puts the Reserve Bank in a very tough position about how do they manage this temporary breach of the upper-end 6% limit and inflation over the next 12 months? Do they believe that that will come under control and they don’t have to hike now or do they react because a lot of other emerging markets – you saw Turkey hiking with 625 bps. India and a lot of the other emerging markets have also increased their interest rates. Does that put our Reserve Bank under the same kind of pressure? It is an incredibly difficult decision for them to make because technically we are also in a recession.
So do I think that, going to 2019, confidence can potentially come back? I hope so. I hope that we can stabilise the rhetoric in South Africa. If you look at the global backdrop, the US is still growing very strongly and potentially we can see more of a recovery in Europe coming through and China is still growing at 6% plus.
So if we can go back to a synchronised, fundamental growth profile that we saw at the beginning of the year, that should be good for emerging markets and it should be good for us. If we can get that tailwind back, potentially confidence can lead us to identifying more South African-specific opportunities into next year but at the moment it is very difficult.
Lindsay Williams: Hannes, we will leave it on that sobering note. Thanks very much for your time. That is Hannes van den Berg, who is a Portfolio Manager at Investec Asset Management in Cape Town.
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