Weekly Market Report

20 September 2022

Global Report

European Energy Crisis.

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Local Report

Naspers and Prosus.

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Global Report

By Carel La Cock

The European energy crisis has been years in the making and a confluence of factors have brought it to a crescendo this winter. European leaders are feverishly trying to find solutions to secure their energy sectors after years of neglect.

Europe has been spearheading the drive for cleaner energy and leaders decided a decade ago that gas was going to be the bridge technology between the dirty fossil fuels, such as coal and oil, and the future of clean renewables. Burning gas halves CO2 emissions compared to coal and it became central in achieving emission goals. Around the same time nuclear power stations were being decommissioned around the world, following the Fukushima disaster of 2011.

Europe imported increasingly cheap oil and gas from Russia, laying pipelines to feed directly into storage facilities often owned by Gazprom, Russia’s state-owned multinational energy corporation. Industries were built around cheap energy imports. Europe wilfully became ever more reliant on Russian oil and gas, emboldening the Kremlin. Warning signs were ignored when Russia annexed Crimea and by the time Russian tanks rolled into Ukraine it was too late.

The crippling sanctions on Russia, following the invasion of Ukraine, placed European gas supply at the mercy of the Kremlin. During the summer months when gas demand was low, Gazprom ran down the levels of its gas storage in Europe, mostly unnoticed. At the end of August Putin shut the Nordstrom 1 pipeline, restricting a third of Russian gas supply to Europe, until sanctions are lifted. Last year Europe imported 155bn cubic meters of Russian gas via pipelines, accounting for nearly 40% of its total supply. Since the closure of Nordstrom 1, that figure has fallen to 9% causing a major shortfall. As a result, gas prices have increased 10-fold compared to the average over the last decade.

Some European nations have it worse than others. It all depends on the energy mix and how your government has come to the rescue. The UK for instance derives 40% of its electricity from gas. Although the UK is not linked to Russian gas directly, it is still affected by the wholesale price of gas causing electricity prices to spike in the last year. In comparison, households are paying 30% more for electricity in the UK than Italy, the European nation with the costliest electricity. The UK government has recently announced some mitigating initiatives. It will cap the typical household bill for energy at £2,500 a year, for the next two years. However, support for businesses will only last for 6 months after which they will reassess and support only key industries. Furthermore, a provision will be made for a £40bn liquidity facility to assist power producers coming under increasing strain to provide margin in the futures market where they secure their energy pricing. The hit to the UK fiscus is estimated at £150bn.

France on the other hand, has a much lower reliance on gas. It has been Europe’s nuclear champion since the seventies and has amassed a total of 56 reactors, many of which were earmarked for mothballing. Putting energy security front and centre, French president, Emmanuel Macron, is doing an about turn, talking of expanding and replacing the current fleet of reactors with next generation reactors. Macron has also called for aging reactors to be operated beyond their 40-year lifespan. However, an unprecedented number of reactors have been taken out of service for maintenance this year, exacerbating the energy crisis. There are also doubts that the French still have the skills to build new reactors, evident from the last reactor commissioned that is a decade late and four times over budget, mostly due to staff and skill shortage and regulatory blockages. In the meantime, the French government announced it will be capping electricity and gas price hikes at 15%, while also giving the most vulnerable of society energy cheques of between €100 and €200. The cost to the fiscus of €16bn will be partly offset by mechanisms built into contracts with renewable energy producers which allows the government to recoup funds once prices hit a certain level.

European leaders have proposed a similar windfall tax on non-gas energy producers which have been benefiting from record energy prices. The member states are expected to raise as much as €140bn, which will go some way to soften the blow this winter. Leaders will meet at the end of the month to agree on the proposal, knowing that there is a real threat that Putin could shut off all remaining gas flows to Europe this winter.

Local Report

By Gielie Fourie

INTRODUCTION: Tencent is the driving force behind Naspers and Prosus. Prosus owns 27.99% of Tencent. Any move in the price of Tencent will affect both Prosus and Naspers. Year-To-Date (YTD) Tencent is down 33%. Naspers is down 6%, while Prosus is down 23%. The drop is a result of the Chinese crackdown on technology companies. In 2021 Chinese regulators froze all licensing activities for new computer games. Now, a year later, good news is coming out. Last week Tencent received its first game approval, “Défense of Health” since regulators froze licensing activities. Game approvals resumed in April, but Tencent and NetEase (a Chinese internet company) only featured in the fifth batch of games approved in September.

The drop in Tencent’s price is not due to anything internally wrong at Tencent. If Tencent had internal problems, it would have been a red flag and a signal to sell the share. But Tencent is still a brilliant company. It is the biggest company in China. The drop in Prosus is also partly the result of the Russian invasion of Ukraine. Prosus acted quickly and decisively. It has ceased all its Russian operations. It is set to write down a $700 million (R10.7 billion) stake in Russia’s biggest internet firm, VK Group. Prosus has also cut ties with its star classified Russian business, Avito.ru. Avito is the second biggest classifieds business site in the world.

KOOS BEKKER AND TENCENT: Koos Bekker, chairperson of Naspers and Prosus, has experienced tough times in China before, and he survived. He invested $32 million in Tencent in 2001. The rest is history. Tencent became the biggest company in China. Tencent was well on its way to become the first trillion-dollar company in China. A clampdown on technology companies put a stop to that. Today the market capitalisation of Tencent is around $360 billion. Prosus owns 27.99% ($100 billion or R1.7 trillion) of that. It makes up 85% of the market capitalisation of Prosus.

BUY OR SELL: The question investors often ask is: “Do I sell Prosus and Naspers, or do I buy more”? There are occasional media “attacks” on Tencent. On 14 March 2022, the Wall Street Journal (one of the world’s leading financial newspapers) reported that Tencent could face a “record fine for violating anti-money laundering rules”. Tencent shares fell nearly 10% on the news but recovered quickly. It is now six months later, and nothing has happened. It seems to be a case of fake news. There are no internal issues at Tencent. We rate Prosus and Naspers a buy.

GEOGRAPHICAL DIVERSIFICATION: Prosus has built a world-class, global portfolio of attractive assets. Prosus is globally diversified – it now serves more than two billion users globally. The four core divisions are Food Delivery, Fintech (PayU and BillDesk in India), Classifieds (OLX) and Education Technology (distance learning). In the event of political turmoil (like Russia and Ukraine), or economic turmoil (in China), Prosus is sufficiently geographically diversified to minimise the negative effects of most issues. It is also diversified around four big asset classes.

VALUATION: The drop in the YTD market prices of Naspers is -6% and Prosus -23%. The net asset value of Prosus is R1,721.30 per share. Prosus is currently trading at around R1,000.00 per share. This relates to a discount to NAV of 41.9%. Prosus is a smart way to buy Tencent. Naspers is trading at a historical average discount to NAV of 49.6%. There is a big margin of safety – the downside risk is limited.

BOTTOM LINE: We feel Prosus, and Naspers, are undervalued. They still have robust growth potential. They are victims of setbacks outside their control – like regulatory clampdowns and Russia’s invasion of Ukraine. There is nothing internally wrong with the companies. China regulators are perhaps doing the right thing and are ahead of the curve. It is possible that other countries can follow the lead set by China. We are not selling our Naspers and Prosus shares.

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The Bottom Line: Innovation and the Magic of Compounding

By Carel La Cock

The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.

Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.

After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.

Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.

As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.

Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.

Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.

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