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Unloved and Under-Owned.
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Overberg Asset Management Big Five Holdings.
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Global Report: Unloved and Under-Owned
By Nick Downing
There was much fanfare when China lifted its hard Covid lockdowns in December last year. China’s equity markets rallied hard on expectations of a post-Covid economic rebound. However, all the gains made by China’s Shanghai and Shenzhen CSI 300 index in December and January have been given back due to disappointment over the strength of the economic recovery. Purchasing managers’ indices (PMIs) have slowed, exports have fallen back, the property market remains in the doldrums and the latest second quarter (Q2) GDP figure was weaker than expected.
The official manufacturing PMI was below the key 50 level in June for the third straight month, signalling contraction. The new exports sub-index fell to a five-month low of 46.4. The official service sector PMI fared better, above 50 at 52.8 in June but at its lowest since December. Exports fell in June by 12.4% year-on-year in dollar terms, the largest decline since the start of the Covid pandemic. Imports also fell, by 6.8% on the year comparted with a 4.5% decline in May.
Q2 GDP figures released on 17th July were disappointing. Although GDP growth increased from 4.5% on the year in Q1 to 6.3% in Q2 this was far below the consensus forecast of 7.0% and largely reflects the especially weak base in Q2 2022 when Shanghai and other cities were under full lockdown. In quarter-on-quarter terms, GDP growth slowed from 2.2% in Q1 to 0.8% in Q2. However, the June monthly data makes for interesting reading as it shows the slowdown may have stabilised. Fixed investment spending, infrastructure investment and manufacturing appear to have turned the corner in June.
Despite tentative prospects of improved economic momentum in the second half of the year, a step-up in policy stimulus is expected soon, possibly as soon as this month at the meeting of the government’s politburo. The threat of deflation and rising unemployment will lend a sense of urgency to upcoming stimulus. Premier Li Qiang has added to the recent government chorus, assuring executives of large technology companies that the regulatory clampdown of the past two years is now over.
Consumer price inflation (CPI) fell in June to 0.0% year-on-year. The month-on-month rate declined from 0.2% in May to 0.0% in June. Core CPI went negative, falling in June to -0.1% on the month. Producer price deflation deepened in June to -5.4% on the year compared with -4.6% in May. The authorities will be anxious to avoid deflation becoming entrenched in business and consumer expectations, as this will cause companies to hold back on investment and households to hold back on spending. Youth unemployment, among those aged 16-24 is still rising, increasing from 20.8% in May to a record 21.3% in June, raising the threat of social unrest, which government will want to avoid at all costs.
The unwelcome news is most likely already reflected in equity prices. The CSI 300 index is trading well below average valuations of the past 15 years. The trailing 12-month price-earnings multiple is 11.73x versus the average of 13.41x. The price-to-book ratio is 1.32x compared with the average of 1.62x. (figures from CEIC).
Despite an ageing population and increasing geopolitical isolation, the long-term outlook for the world’s second largest economy remains exciting. GDP growth is expected to slow to an average pace of 3.8% over the next 10 years compared with 6.7% growth over the past 10 years, according to MRB Partners, but by the end of this forecast period per-capita GDP will still only be 22% of the US level, indicating considerable catch-up potential over coming decades. Labour productivity has moderated but remains high by global standards. Over the next decade China’s share of world GDP is expected to continue rising, from 18% in 2022 to 23% in 2032. The country is not yet fully urbanised. The United Nations forecasts that people living in cities with populations exceeding five million will increase from 208 million in 2020 to 280 million in 2030, bringing numerous economic spinoffs and considerable relief to the over-extended property sector.
Cheap valuations are no guarantee of strong returns, especially over a short-term horizon. However, over a longer investment period, the current cheap entry levels on offer assure outperformance. China’s equity market is unloved by foreign investors and is under-owned. The Citigroup Economic Surprise Index is at its lows, reflecting the fact that economic data has been consistently below consensus forecast in recent months. As the economy stabilises and government adds fiscal stimulus, economic data are likely to exceed now-depressed forecasts, which should act as a catalyst for the equity market’s re-rating. Meanwhile, earnings growth will continue to motor along even if GDP growth slips to 5%. Now would be as good a time as any to enter China’s equity market, while expectations are low enough to be beaten, valuations cheap and stimulus around the corner.
Local Report: Overberg Asset Management Big Five Holdings
By Gielie Fourie
INTRODUCTION: The top five holdings in Overberg Asset Management’s Local Growth portfolios comprise 33.86% of the real weighting of the model local growth portfolio. Our top five holdings have two things in common. Firstly, all five companies are big companies, and secondly, all five have considerable offshore exposure. Two of the big five, FirstRand and Investec, are banks, with a combined portfolio weighting of 15.13%, two, Prosus and Naspers, are technology companies with a combined portfolio weighting of 13.12%, and the last one, Reinet, is an investment company of the Anton Rupert Descendants Trust, with a portfolio weight of 5.61%. This report provides a brief overview of these five winning shares and the motivation for their continued inclusion in the portfolio.
FIRSTRAND is our biggest holding with a current portfolio weighting of 8.80%. FirstRand operates in various markets including South Africa, sub-Saharan Africa, the UK, and India. The company has a diverse portfolio of integrated financial services businesses that offer a broad range of products and services. FirstRand has a strong track record of delivering superior returns to its shareholders. FirstRand’s target is to generate a return on equity (ROE) of between 18% and 22%. For the first half of the year to 31 Dec 2022, its ROE was 21.8%, 170bps higher year-on-year. HEPS was up 15% and the dividend was up 20%. An increase in the pay-out ratio is a strong signal that management is happy with the current situation at the bank. Performance varied across the different segments, with WesBank up just 6% and Rand Merchant Bank (RMB) jumping by 28%. FNB is the largest contributor of group earnings (61% of the total) and grew by 17%.
In terms of outlook, FirstRand expects earnings growth in the second half of the year to be in line with that of the first half. The company has achieved this by employing a combination of strategies such as organic growth, acquisitions, innovation, and the creation of entirely new businesses. FirstRand has focused on growing its customer base, increasing market share, and expanding its product offerings to drive organic growth. In addition to organic growth, FirstRand has pursued a strategy of acquisitions. The company has selectively acquired other financial services businesses to strengthen its market position, expand its geographic reach, and enhance its product capabilities. These acquisitions have allowed FirstRand to enter new markets and diversify its revenue streams. Innovation is another key element of FirstRand’s success. The company has embraced technology and digital transformation to enhance its customer experience, streamline operations, and introduce new products and services. FirstRand has invested in fintech initiatives, data analytics, and digital platforms to stay ahead of industry trends and meet evolving customer needs. The company’s diversified presence across different markets and its focus on adaptability and customer-centricity have contributed to its success.
PROSUS AND NASPERS are our second and third biggest holdings – Naspers has a portfolio weighting of 6.77%; Prosus has a portfolio weighting of 6.35%. Naspers and Prosus are in the process of removing the crossholdings between them. After the removal of the crossholdings, Naspers will hold 43% of Prosus. Prosus is a global consumer internet group and one of the largest technology investors globally. It owns 25.99% of Tencent, the biggest gaming company in the world and the biggest company by market capitalisation in China. Prosus operates and invests in various markets with the aim of capitalising on long-term growth potential. Prosus focuses on building and nurturing leading consumer internet companies that have the potential to empower individuals and enrich communities. The company’s primary areas of interest include online classifieds, food delivery, payments and fintech, and education technology sectors. It actively seeks opportunities in markets like India and Brazil, which are known for their significant growth potential in the consumer internet space. In addition to its core focus areas, Prosus also has a ventures team that invests in various sectors, including health, logistics, blockchain, and social commerce. This diversification allows them to explore emerging technologies and industries with the potential for disruptive innovation. Prosus emphasises collaboration and partnership with exceptional entrepreneurs who are leveraging technology to improve people’s everyday lives. By providing support, expertise, and investment, Prosus aims to foster the growth and success of these ventures. Prosus has a strong balance sheet. Naspers is trading at a 44% discount to net asset value. Prosus is trading at a 31% discount to net asset value. These margins are too wide for two quality companies. The balance sheets are strong. When they need cash, Prosus sells 2% of its portfolio of Tencent shares, now worth R2 trillion. They use the cash to buy back their own shares. Prosus and Naspers could benefit substantially with the arrival of Artificial Intelligence (AI). CEO Bob van Dijk told Business Day: “AI has been a top three or four priority for the past five years. Now it is our top one priority for the last year at both Prosus and Naspers.” When Chat GPT launched in November 2022, it reached one million users faster than any other social media platform. It now has 100+ million users. Van Dijk says Prosus and Naspers will not be left behind. Tencent’s CEO, Pony Ma, said that AI would be “the core driving force” for the company’s growth.
INVESTEC PLC is our fourth biggest holding with a portfolio weighting of 6.33%. Investec PLC is the offshore division of Investec. Investec Ltd is the SA division. Investec is a niche private bank and wealth manager that operates in South Africa, the United Kingdom, and other selected countries. The company provides a range of financial services to a diverse client base, including private individuals, institutional investors, and corporate entities. In the United Kingdom, Investec has a significant presence. The company focuses on delivering specialist banking solutions, including private banking, corporate and institutional banking, investment management, and asset finance. Investec’s international footprint extends beyond South Africa and the UK, with a presence in other countries such as Australia, Ireland, Switzerland, and Mauritius. The company leverages its expertise and network to cater to the unique financial needs of its clients in these markets. Overall, Investec aims to be a trusted partner for its clients, delivering tailored financial solutions and investment opportunities across its key markets and beyond. In April, this year the Rathbones Group agreed to buy the UK wealth management business of Investec in an all-share deal valued at £839 million. Investec will be a minority shareholder in the enlarged Rathbones entity, with a 41.25% stake. The outlook for Investec has improved over the past three years.
Three years ago, Investec was regarded as a deep value investment. That viewpoint has changed. The new team at Investec represents a much more attractive investment case and their impressive performance is rewarded. Over the last three years the share price is up 222% – a spectacular performance. The board took note of this, and handsomely compensated its CEO, Fani Titi, and his team. Titi scored a 73% increase in his remuneration for the 2023 financial year that came to £7.501m (R179.8m).
REINET INVESTMENTS S.C.A. commonly known as Reinet, is our fifth biggest holding with a portfolio weighting of 5.61%. Of our top five holdings, Reinet is the top performer with a gain of 48% over the last year. Reinet is the investment vehicle of the Rupert family, which owns 25% of Reinet. Reinet’s investment portfolio is diverse and spans various sectors and asset classes. The company primarily focuses on two main areas: listed and unlisted investments. Listed investments include holdings in publicly traded companies, while unlisted investments refer to private equity. Reinet’s largest investment is a 50% stake in Pension Insurance Corporation plc (PIC) located in London. Reinet’s second largest and most well-known investment is its stake in British American Tobacco (BATS), a leading international tobacco company. BATS has operations in more than 180 countries and is known for its portfolio of well-known tobacco brands, such as Dunhill, Lucky Strike, and Pall Mall. Apart from its holdings in BATS, Reinet has also invested in other companies across various industries. These investments have included sectors such as financial services, consumer goods, technology, and renewable energy. As an investment company, Reinet aims to generate sustainable, long-term value for its shareholders. It achieves this through active portfolio management, strategic investments, and seeking opportunities that align with its investment objectives. Reinet has a strong balance sheet and is cash flush. When it needs funds, it sells a tranche of its BATS portfolio. That is on top of a generous annual BATS dividend of 7.27%. Reinet is trading at a discount to NAV of 32%, lower than the 42%+ earlier this year – a very wide margin for a share of this quality. By buying Reinet you indirectly acquire BATS at a 32% discount to NAV – it provides a cheap entry into BATS. Despite some analysts’ negative sentiments on Reinet, buying Reinet is a “no-brainer.” Marc Hasenfuss of the Financial Mail confessed last month: “Reinet is not such a dog after all.” And an award-winning analyst said: “Reinet is the best share on the JSE.”
In conclusion, please use this information as a reference only, rather than as a basis for making investment decisions. We are experiencing tough times in South Africa. To take the emotion out of equity analysis, you are welcome to contact one of our friendly consultants for a free consultation. The JSE is resilient and still offers value.
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Reference: Capital Economics – Historical bond and equity return data.
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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