Allan Gray Equity comment - Sep 17 - Fund Manager Comment17 Nov 2017
Despite the high price-to-earnings (PE) ratio of the FTSE/JSE All Share Index (ALSI), our bottom-up investment process is finding attractive opportunities that offer good returns without taking substantial risk. The companies come from different industries and trade at different multiples of current accounting earnings, but the one common denominator is a requirement for patience.
Sasol is one of the most analysed shares in our stock market. Efficient market theory would not expect a company like this to be undervalued at any point in time, yet it is trading at a PE multiple of only 9 times the earnings one would expect at the current rand oil price. For many years the company has invested in expansion projects around the world, including R100 billion into an ethane cracker in the USA (context: the market values Sasol at R250 billion); none of the benefits of these investments reflect in the earnings yet. If one includes the present value of future earnings on these projects, the PE multiple falls to 6.5. Investors may be tempted to wait for oil price uncertainty to subside or the projects to contribute to earnings, but, unfortunately, at that point the PE multiple won’t be 6.5; it is likely to be substantially higher.
Naspers is another widely followed share in our stock market that is extensively covered by sell-side analysts. The company boasts a superb long-term track record of growing intrinsic value per share and yet it trades at an estimated holding company discount of over 40%. Many investors are frustrated by the fact that the company has underperformed its largest holding, Chinese internet company Tencent, as start-up losses have mounted in new ventures. The guidance around these ventures has been clearly communicated over time and the latest guidance indicated a profitable result for the online classifieds business in the upcoming results. Once an online business crosses into profitability, operational leverage ensures attractive future profit growth - one is currently paying a big negative price for these assets when buying Naspers.
Various other local financial and industrial companies have also traded down to the point where inflationary growth offers attractive total returns to investors, since the dividend yields are above 5%.
With low expectations priced into our portfolio of shares, we are optimistic about the potential for future real returns for our clients.
During the quarter, our top three purchases were Remgro, Woolworths and Nedbank and our top three sales were Naspers, Standard Bank and Mr Price.
Commentary contributed by Ruan Stander
Allan Gray Equity comment - Jun 17 - Fund Manager Comment11 Aug 2017
Sentiment towards South Africa generally, and the equity markets in particular, is sinking steadily lower. Economic growth has slowed with the end of the commodity boom and government policy uncertainty is discouraging both local and foreign investors. The local equity market has remained basically unchanged over the past three years, despite Naspers adding 10% to the index return, as earnings have generally undershot expectations. The multiple investors are willing to pay for the JSE earnings stream has fallen along with deteriorating sentiment and lower expectations for future earnings growth. Three years ago the FTSE/JSE All Share Index traded on 23 times our estimate of trendline earnings. This rating has now fallen to 18.
A lower market rating indicates better future returns and our bottom-up research concurs. For the first time in many years, we are beginning to find opportunities in certain domestic consumer businesses outside financial services. Clothing retailers, for example, were previously generating well above normal operating margins and investors were expecting these high margins to continue so they assigned very high PE multiples to the sector. Margins have now begun to decline along with the deteriorating consumer environment and the market has subsequently cut the PE multiples. As a result, we have begun to find value and invest in selected South African retailers.
Globally, one of the few sectors that looks reasonably valued is the resources sector and we have started to invest in certain mining companies. The risk in this sector is that Chinese demand plateaus or declines. Fortunately, the underlying commodity prices are in many cases not particularly high and the company valuations are pricing in further commodity price declines.
The strengthening of the rand is somewhat surprising given the ramp up in political risk and falling commodity prices. The weak economy and thus low domestic demand helps to narrow the current account deficit. Another important factor is the positive sentiment towards emerging market bonds, which has lead foreigners to buy a net R38bn of South African bonds year to date. We have taken the opportunity of the rand moving back below R13/US$ to increase the Fund’s exposure to international equities.
Commentary contributed by Andrew Lapping.
Allan Gray Equity comment - Mar 17 - Fund Manager Comment01 Jun 2017
During the quarter, the Equity Fund’s most significant purchases were Naspers, Life Healthcare and Netcare. The most significant sales were Standard Bank, Capitec and Murray & Roberts.
We think that a disciplined bottom-up research process, combined with rational decision making, can add value to our clients over time as illustrated by the example below.
One of the shares in the top 10 that could catch a casual observer by surprise is KAP Industrial (KAP). KAP was formed in 2012 when Steinhoff merged its industrial assets with those of the listed entity KAP International. At the time, it was easy to avoid this company since 1) KAP’s original industrial assets had underperformed the market substantially over the prior decade, 2) Steinhoff was willing to sell a portion of its assets since it owned less than 70% of the new KAP and 3) A free float of only R2.6 billion made the absolute upside seem small relative to the effort of researching a company that was not extensively covered by stock brokers.
Our disciplined bottom-up research process identified 1) An exceptional CEO in Jo Grové; 2) Industrial operations in a strong competitive position in logistics company Unitrans, timber company PG Bison and PET manufacturer Hosaf; with 3) Strong cash flows and various opportunities to re-allocate capital from poor quality businesses (the original KAP businesses) to improve and expand the high quality businesses.
Given this assessment, we were delighted at the opportunity to buy two substantial lines of shares in the company on behalf of our clients at R2.82 in June 2013 and R3.85 in June 2014 to build a stake in excess of 20%. The company has delivered on its potential by growing headline earnings per share by 18% p.a. from 2012 to 2016 in a tough economic environment. Including dividends and a re-rating of the valuation multiple, our two significant investments yielded an annualised total return of approximately 40% p.a. for our clients.
We are impressed with the new group CEO Gary Chaplin’s role in turning around subsidiary PG Bison, as well as his contribution to capital allocation decisions. We also supported the recent acquisition of plastics manufacturer Safripol by participating in the rights issue. Going forward, we expect this acquisition, as well as various other organic growth projects, to maintain the momentum in growing the business in a shareholder-friendly way.
Commentary contributed by Ruan Stander