Are these shares the future titans?

Top-performing fund manager discusses his small cap picks

ORAPA – The ClucasGray Future Titans Prescient Fund is an interesting animal. Although it is in the South Africa multi asset flexible category, it is really a mid- and small-cap focused fund.

It’s mandate is to invest predominantly in companies outside of the FTSE/JSE Top 40 index, and similar opportunities in international markets through its 25% offshore capacity.

The fund managers chose to place their fund in the flexible category because of the extra leeway this gives them. The fund currently holds 19% of its assets in cash.

“Historically, the Future Titans Fund has recorded less volatility than the Top40, but we want to have the ability to hold high cash positions when conditions become extreme,” explains fund manager Brendon Hubbard. “For instance when you get a big market dislocation like we did in 2008, small-caps take a bigger hit because liquidity dries up.

“In that kind of scenario we don’t want to be forced to hold positions because of unit trust rules. We are happy to sit in cash and wait for the right opportunities. So we believe we offer a slightly lower risk profile.”

Going by the fund’s performance, this philosophy seems to have its merits. The ClucasGray Future Titans Prescient Fund is the best-performing domestic multi-asset flexible fund over the last year. Over three years it is third behind the 36ONE MET Flexible Opportunity Fund and the Visio MET Actinio Portfolio.

When comparing it to domestic equity small-cap funds, one sees a very similar picture. Over the last year it has outperformed every fund in that category and would be second best behind the Nedgroup Investments Entrepreneur Fund over three years.

This performance is mostly due to identifying under-priced equities that are off the radar screen of most large equity funds. Here are some of the most notable:

Interwaste (Market Cap R436m)

Interwaste is currently the fund’s top holding at over 5% of its total assets. The share price of the integrated waste management business has doubled since the start of 2012, but Hubbard still expects more from it.

“Until last year, Interwase had essentially been a transport business moving industrial waste,” he explains. “But they were taking this to waste disposal facilities run by Enviroserv or municipalities, and in doing so gave up margin.

“In the last financial year they opened their own landfill in Olifantsfontein in Johannesburg. What’s interesting about this is that it will be the last waste disposal site to be built in Gauteng. It’s also the only one built to class B environmental standards, which makes it ahead of legislation.”

Hubbard believes this landfill will be a source of wider margins for the group, and because it is so difficult to obtain a licence to operate one, it adds to the attractiveness of the business.

Interwaste has also invested in new technologies such as using waste removed from Sasol‘s refineries to fuel furnaces in cement manufacturing.

“The company doubled its earnings in the last reporting period, and we anticipate that earnings will be strong for the full year,” Hubbard says. “We also expect that there will be another significant increase next year.”

Metair (Market Cap R5bn)

Due to its exposure to the automotive market, Metair was hammered during the financial crisis. The share price of the auto parts manufacturer dipped as low as R5 a share in 2009. The recovery since then has however been quite spectacular, and it is now trading at around R33 per share.

“The battery business is really where Metair makes its money,” Hubbard says. “If you think that South Africa has eight million vehicles on the road and each of those replaces its battery around every three years, there is obviously volume there.”

And it is in this space that Metair’s future looks particularly bright. New emission standards in the US and the UK require all vehicles to be fitted with stop-start batteries by 2017. Metair is one of the few producers in the world that has perfected this difficult technology.

“The new BMW and Mercedes Benz models launched this year are already using their batteries,” Hubbard says. “Metair bought Rombat in Romania to supply these European auto makers and the after market there and has in effect become a global business.

“Stop-start batteries not only sell at twice the price of current car batteries, but the margins are twice as high as well. So we really see opportunities for Metair to grow its earnings over the next few years. On top of that they have always been cash generative and pay good dividends, so it’s the kind of company that we like.”

Hulamin (Market Cap R1.9bn)

Since 2008 aluminium products manufacturer Hulamin has been under something of a cloud due to the uncertainty over BHP Billiton’s potential closure of the Bayside smelter. Hulamin sources a large portion of its rolling slab from the Bayside smelter and casthouse.

However Hubbard believes that there is likely to be a resolution to this soon. The IDC, which owns 30% of Hulamin and also has a big stake in BHP Billiton has been negotiating to maintain the supply and he expects an announcement to be made in the next few months about a final decision on Bayside. Speculation is that Hulamin will buy the Bayside casthouse.

“The smelter was built in 1971, so it’s quite old technology,” Hubbard says. “But what it has that Hulamin really needs is the casthouse and we believe that is going to stay open although the smelter is still likely to close.”

Eskom wants the electricity supply to Bayside smelter cancelled and Portnet wants the land to build a new coal terminal. ClucasGray believes that if it is negotiated rationally the outcome would be a win for all parties.

With that in mind, there are a number of positives for Hulamin in the pipeline. The company has gone through a massive expansion programme and when this is complete by 2014 its prospects could be very positive.

“Hulamin is massively geared to the exchange rate, so they really struggled through the period of rand strength,” Hubbard says. “But the weaker rand is going to benefit them in a huge way.

“The other kicker is that Nampak is now moving into using aluminium cans. It’s cheaper than steel and more environmentally friendly, but it’s a very complex metal to produce because it is so thin and Hulamin has the advantage in that market.

“On top of that, the cans will come back to them as scrap and aluminium as a waste has much higher value than many other metals. So they will be able to use that scrap at a much lower cost than if they bought it from BHP Billiton.”

Grindrod (Market Cap R15bn)

Shipping and freight logistics company Grindrod has been one of the stars of the JSE over the last 12 months. Its share price has gained nearly 75% since October 2012. But even at a P/E of 21x, Hubbard still sees opportunity in the counter.

“Port operations are typically high P/E businesses,” he says. “There are high barriers to entry and they need intensive capital expenditure. And nature isn’t creating too many more natural ports.

“So with the capacity that they are building, and the potential for exports to ramp up, there could be big additional volume going through their port facilities.”

He also believes that Grindrod’s shipping business is showing signs of recovery.

“In its heyday the shipping business made about R800m. Last year, it lost R100m. But we think we’re at the bottom of the shipping cycle and the business could be earning R300m to R400m again in the next two to three years.”

Sirius Real Esate (London listed under code SRE.LN)

One of the reasons many analysts are getting excited about the coming listing of Attacq (formerly Atterbury Investment Holdings) is its international assets. Through the Karoo Investment Fund, it has a 25% interest in German flexible property company Sirius Real Estate.

ClucasGray is however not waiting to access this opportunity through Attacq. It has bought into Sirius directly.

“What really interested us in this business is that after Atterbury bought its 25% it blocked two attempted liquidations by US asset manager Weiss,” Hubbard says. “Because Sirius is trading at about a 50% discount to NAV, Weiss wanted to sell of the assets to realise a profit.

“But Atterbury saw more value in building the business long-term. It spent a lot of money getting rid of the old management company and there has been a big clean up in the business.”

With the counter trading at such a big discount, Hubbard believes Atterbury’s intervention will have two big positives in the near future.

“Within two years it could be trading at NAV or even at a premium to NAV like Atterbury’s other international vehicle MAS. On top of that, it should soon be able to pay a dividend and we could be looking at a yield just shy of 10% in Euros in the next year or so.”

New Europe Property Investments (R14.2bn)

Another counter in the European property space is New Europe Property Investments (Nepi), which holds a portfolio of Romanian property assets.

“The big thing for me about Romania is that it sits within the EU with all its laws and standards, but is essentially an emerging market,” says Hubbard. “There are no big local brands, so Nepi is developing malls where big European retailers are taking ten year leases in Euros in an emerging market where retail sales are growing even faster than in South Africa.

“This is a good company with good management operating in a strong legal environment within a growing economy. It’s been a fantastic performer and we don’t see that changing.”

Over the last 12 months, Nepi’s share price on the JSE has gained over 60%.

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