Weekly Market Report

21 November 2023

Global Report

Big Tech Mania.

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Local Report

The Competitive Food Retail Sector.

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Market Indicators

Global and Local Indicators.

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Global Report: Big Tech Mania

By Nick Downing

In last week’s market report, we wrote about the potential for Artificial Intelligence to transform the global economy, with similar effect to the introduction of steam power during the 1700s and electricity in the early 1900s. As AI technology moves across the spectrum from specific AI (designed to complete a specific task), to generative AI (such as ChatGPT) and eventually to general AI (capable of fully simulating human intelligence), there will be significant implications for the economy and financial markets. GDP growth will rise, tax receipts will increase, there will be a boost to productivity growth resulting in higher margins and stronger earnings, while inflation should come down resulting in higher price earnings multiples.

The transformative impact on the economy will be positive for equity markets, especially for the technology sector in the initial years and more specifically for the US technology sector where the AI giants reside. Investor imagination has already perked up, since OpenAI’s launch of ChatGPT in November 2022 and the subsequent announcement in January this year that Microsoft had acquired a significant holding in the company.

The benefits of AI may take many years to filter through, but equity markets are forward-looking, and investors will tend to front load the prospects of higher productivity and faster earnings growth. Since the start of the year, the US Big Tech shares have risen collectively by almost 60%. They comprise over 25% of the S&P 500 index and around 18% of the MSCI All World index. If these shares were excluded, the S&P 500 index would be more or less flat for the year but because of their strong performance and massive weighting, the index is up 18% YTD.

The AI tech giants have the deep pockets and user bases that make them significant beneficiaries. The development of AI Large Language Models (such as ChatGPT) and the computer chips to power them currently cost hundreds of millions of dollars. For the time being, the giants have an almost monopolistic hold on the AI transformation, although as the technology progresses, smaller firms will be involved in workflow integration and development of applications. The rising share prices of the tech giants are supported by solid fundamentals. The graph below prepared by independent research company, Alpine Macro, shows the dramatic increase in their operating margins over the past three years, and their increased weighting in the S&P 500 index.

The share prices of the tech giants are expensive, but nowhere near the bubble proportions of the Dot.com boom or the “Nifty Fifty” leaders in 1972. The table below shows current forward price-earnings multiples versus previous bubble peaks. The technology sector, given the transformational potential of AI, could rise considerably further. In the mid-1990s, Federal Reserve chairman Alan Greenspan warned that the stock market was showing signs of “irrational exuberance”, but the Nadaq surged for 5 more years before the dot.com bubble burst. There has been no such warning yet in today’s technology market, which has risen for just 12 months.

Some economists believe a tech share mania could develop. Alpine Macro references the Kindleberger Framework, which lists four preconditions for an asset price mania to develop. The tech giants qualify on three of them. (1) Fundamental displacement: They dominate their technology segments and have the potential to take advantage of AI-driven innovation. As shown, they have increased margins in absolute terms and relative to the broader market. (2) Difficult to value: Difficulties quantifying the benefits that will immediately accrue from AI will create the conditions for extrapolation and ignoring standard valuation metrics.

(3) Broadening investor participation: Their performance over the past year will strengthen the investor following, especially as they show both “growth” and “defensive” characteristics. Their huge cash balances made them impervious to the regional banking crisis earlier in the year. There is also the potential for forced buying due to their large market weighting. (4) Liquidity: This precondition has not yet been met. The fastest increase in central bank interest rates since 1979 and surge in bond yields has choked off liquidity, but interest rates are expected to fall in 2024 in line with declining inflation. Liquidity expansion may provide the catalyst.

The largest holding in Overberg Asset Management’s global private share portfolios is well positioned to benefit from upside in the tech giants and the broader technology sector. Allianz Technology Trust plc (ATT) has a long and successful track record of investing in quoted technology companies on a worldwide basis. ATT has the competencies to sift through the winners and losers of the AI transformation. It has won several awards and has the highest rating available from Morningstar. ATT is an investment company listed on the London Stock Exchange with a market capitalisation of £1.1 billion and the shares trade at an attractive 13% discount to net asset value. Voya Investment Management, which manages ATT’s underlying investment portfolio, is based in Silicon Valley where the tech giants and the world’s key technology companies are headquartered.

Local Report: The Competitive Food Retail Sector

By Francois Louw

Introduction: In the South African food retail landscape, Shoprite Holdings Ltd, Pick n Pay Stores Ltd, Woolworths Holdings Ltd, and SPAR Group Ltd are the four major players. In the face of a changing consumer landscape, success hinges on innovation and strong leadership. Managing an inflationary environment and a price-conscious consumer, retail companies grapple with the challenge of not passing the entire impact of price hikes onto customers. Striking a balance between stabilising profit margins, coping with rising costs, and handling unforeseen expenditures has turned the local retail sector into a dynamic and forward-thinking environment. Below is a short summary of the performance and strategies of the four leading food retailers.

Pick n Pay: Pick n Pay is facing a challenging 2024 financial year, reporting its first pre-tax net loss of R873 million in the interim financial year results for the period ended 27 August, a stark contrast to the previous year’s profit of R588 million. Newly re-appointed CEO Sean Summers attributed a significant portion of the loss to one-off unforeseen expenses related to retrenchment, load shedding, and a distribution centre transition (from 60% ownership to renting). The group’s debt increased by 171%, reaching R3.8 billion for the half year, and interest payable has become a point of concern. Returning after Pieter Boone’s tenure, Summers, with a proven track record, aims to revitalise Pick n Pay, acknowledging the opportunity to honour the legacy of founder Raymond Ackerman.

Shoprite: In the first quarter of its 2024 financial year, Shoprite exhibited notable growth, launching 81 new stores as part of its strategic plan to open a total of 314 new stores by June 2024. The company’s capital expenditure (capex) is particularly noteworthy. Capex rose from R5.4 billion to R6.8 billion in 2023, and projections anticipate a peak of R8.5 billion in 2024, reflecting a 25% anticipated increase. This underscores Shoprite’s commitment to maintaining its market dominance. Since Pieter Engelbrecht assumed the role of CEO in 2017, his leadership has been characterized by strategic execution and innovation, with Shoprite now the largest retailer in the country.

Woolworths: Woolworths produced a robust financial performance for the 52 weeks ended 25 June 2023, with a 29.5% increase in pre-tax profit to R6.7 billion from a 7% rise in total turnover to R85.7 billion. The core food business was the driving force behind its success. Shareholders benefited from a noteworthy 36.4% dividend increase to R3.13 per share. However, Woolworths has struggled to adapt to the New Zealand and Australian markets, with its clothing business Country Road experiencing an 8.1% decline in sales. Appointed as new CEO in 2020, Roy Bagattini initiated strategic moves, including selling David Jones clothing company, addressing minimum wage concerns, and elevating transparency by disclosing hourly wage levels.

Spar: In the 6 months ended 31 March 2023, SPAR saw a 5.6% growth in total turnover, primarily driven by a 7.9% increase in the grocery wholesale business. However, TOPS at SPAR experienced a 1.9% decline in liquor sales due to high previous period sales during eased lockdown restrictions. Challenges also emerged in KZN during the implementation of a new SAP software system, resulting in distribution issues and an estimated loss of R1.42 billion for the 47 weeks ended 30 August 2023. Angelo Swartz, with 16 years of Spar experience, assumed the role of CEO on October 1 of this year, succeeding Brett Botten. The group also appointed a new COO to help increase profitability. The new COO, Megan Pydigadu, is well-known for her anti-corruption efforts at her previous employer (IT company EOH).

Delivery Wars: There has been a noticeable shift toward online shopping among local consumers. Shoprite witnessed an impressive 82% surge in Sixty60 deliveries in the first half its 2023 financial year, expanding services to 466 locations. Pick n Pay responded by improving its asap! application, now offering 25,000 products. With a robust 76% growth in online sales, Pick n Pay now provides delivery services to 400 locations. In its 2023 financial year, Woolworths experienced a 28.5% increase in online sales due to its online shopping service – Woolies Dash. Spar joined the trend in 2022 with the launch of Spar2U, now delivering parcels with eco-friendly vehicles.

In a market where budget-conscious consumers prioritise price, a recent case study by BusinessTech compared the pricing of four delivery platforms across 15 everyday consumables, including 10 food items and 5 non-food items of house brand goods (Table 1). The case study revealed that, overall, Checkers Sixty60 emerged as the most cost-effective option (R641.85) compared to its counterparts. Specifically, when examining two distinct baskets, Checkers Sixty60 proved to be the cheapest for 5 non-food items (R228.95), while Spar2U offered the best prices for the 10 food items (R396.90). Conversely, Woolies Dash ranked as the most expensive across both categories (and in total), although it did provide the most competitive pricing for a 2kg bag of white sugar (R57.99). This study supports the notion that most consumers prioritise price, with Checkers Sixty60 being the biggest platform amongst its peers.

Bottom Line: South Africa’s major retailers have recently undergone significant leadership changes, with some bringing back experienced leaders and others introducing new faces to influence operational strategies. Consumer loyalty varies, with some exclusively favouring one retailer, while others choose based on factors like location, convenience, and promotions. The retail sector is directly impacted by key economic factors such as inflation, unemployment, and low GDP growth and success lies in the ability to rise above these. Those who introduce new ideas, whilst staying true to their brand identity, are likely to thrive amid economic challenges and changing consumer preferences.

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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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