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Weird and wonderful offshore shares

The main requirements for your new investments would be that the underlying holdings add diversity to your existing portfolio, while offering good value.

Let’s assume you have made the decision to invest offshore, because you know that the JSE’s market cap is less than 1% of listed companies in the world and you should diversify your portfolio. You also know that now is a good time to invest offshore because we are reaping the ‘Ramaphoria’ dividend and the rand is relatively strong.

So what next? The main requirements for your new investments would be that the underlying holdings add diversity to your existing portfolio while offering good value.

Note that this article aims to highlight diverse investment opportunities in the world and is not a view of the future direction of the JSE.

On a macro level there are many useful data points that are useful pointers to finding value. PE ratios (the relationship between a company’s stock price and earnings per share), country valuations (as expressed by total market cap/GDP) and growth projections as predicted by the World Bank or IMF all help to paint a picture.

Overview of the World Economic Outlook projections

 

Estimate

Projections

Different from Oct 2017 WEO projections

 

2016

2017

2018

2019

2018

2019

World

3.2

3.7

3.9

3.9

0.2

0.2

Advanced economies

1.7

2.3

2.3

2.2

0.3

0.4

EM and developing economies

4.4

4.7

4.9

5.0

0

0

US

1.5

2.3

2.7

2.5

0.4

0.6

Euro area

1.8

2.4

2.2

2.0

0.3

0.3

China

6.7

6.9

6.6

6.4

0.1

0.1

India

7.1

6.7

7.4

7.9

0

0

Brazil

-3.5

1.1

1.9

2.1

0.4

0.1

South Africa

0.3

0.9

0.9

0.9

-0.2

-0.7

Source: World Economic Outlook Update, January 2018

For the record, a quick scan of offshore markets at the moment shows that developed markets are generally fully priced with stretched valuations.

Required qualities of new investments

At Rosebank Wealth Group we think that stock-picking skills combined with a ‘top-down’ view has the best chance of long-term outperformance. We like fund managers who choose underlying holdings with following characteristics:

  • Good business models with protection from competitors by way of a ‘durable moat’ and a high degree of sustainability.
  • High-quality management team and business owners. The company must have a history of respectful treatment of minority shareholders and the benefits of structural growth must accrue to all shareholders.
  • The quality of the balance sheet (how cash is used).
  • Good governance.
  • High margin of safety (big gap between the fund manager view of fair value and the current market price).

In our view, the best way to invest offshore is to complement a well-diversified portfolio including passives and global equity portfolios with highly concentrated, high conviction funds.

We actively seek managers who invest beyond the reach of passives and global equities.[1] Our favourite fund managers start with an investment pool of thousands of companies and then whittle them down to a few well-chosen golden nuggets. They work hard to sift through the thousands of shares available to them, in search of those that offer shareholder value.

We asked three offshore managers who manage funds with mandates to invest in China, India and Latin America to name three unusual shares in their portfolios which exploit themes not readily available in South Africa.

Three companies in China

Tong Ren Tang[2] is a Chinese traditional medicine company (TCM) founded in 1669 by the then-doctor to the Qing Emperor and his court. In 1723, Tong Ren Tang was made the sole supplier of traditional Chinese medicine and herbs to the Imperial court. Today it is the number one TCM brand with 99% aided brand awareness. Tong Ren Tang shops (where consumers can buy medicine, see doctors, have treatments like massage and acupuncture) are more like museums and embody the very essence of Chinese culture and history. More recently the company has expanded into new sectors such as spa-like wellness centres as well as skincare products in partnership with a German company. Despite its strong brand and management team, as well as growth in the mid-teens, one can buy this world-class company at 9x pre-tax earnings.  

A second example of a great company trading at a good price in China is Kweichow Moutai. Listed in the domestic ‘A-share’ market, it is the leading distiller of premium baijiu (a strong distilled spirit that is typically consumed during banquets in China) with a household brand name that is over 300 years old. Chinese people have been drinking baijiu for 5 000 years. Moutai is possibly China’s only major luxury brand; a 500ml bottle retails for $150. It also represents far more than just an alcoholic beverage as Chinese leaders from Mao Zedong to Xi Jinping have consumed it in public.

Kweichow Moutai has a virtual monopoly with 55% share of China’s premium spirits market, and highly attractive economics (above 70% operating margin, a 25% return on investment capital and strong free cash flow). The company’s share price has doubled over the last two years, but it still trades at a relatively modest 18x EV/EBIT (2017), which is half of what it has averaged over the past decade. While Moutai may no longer be the ‘steal’ it was two years ago, its investment case remains compelling.

Dong-E-E-Jiao is a TCM company which was founded in 1951, although its brand has a history that stretches back 2 500 years. It manufactures TCM products from the gelatinous layer underneath the skin of donkeys. The company’s products are mostly used by women to nourish ‘Yin’ (as opposed to ‘Yang’) and treat conditions such as anaemia, dizziness and insomnia.

Dong E-E-Jiao has a strong ‘brand moat’. It has 70% market share and its products are synonymous with e-jiao (in the same way that consumers often refer to all vacuum cleaners as a ‘Hoover’). This has led to favourable economics with ROIC and ROE in the mid-20s, gross margins over 60%, a net cash balance sheet, and earnings growth of 25% p.a. over the past decade.

The pricing power of the company has been spectacular; prices have risen 7x over the past seven years and are currently trading at a 70% premium to those of its peers. While historic growth is unlikely to be repeated, mid-teen growth should be achievable for the next five years or more. At 12x next year’s pre-tax earnings, it is simply too attractive to resist.

Three companies in India

Godrej Agrovet[3] is an agri-business firm which listed in 2017. The company has a leading market position in poultry processing, animal feeds, oil palm plantations and agri-inputs. The parent company of Godrej Agrovet is Godrej Industries which has been trading since 1897. The agri-business sector in India is highly fragmented and has many disorganised small companies. Godrej Agrovet is well placed to benefit from the consumption of more protein and processed foods in an increasingly formalised economy.

The company has invested in research and development, has good distribution channels and has a well stablished supply chain. The Godrej brand is like royalty in India and the company has pristine corporate governance, a strong management team and a dynamic leader.

Endurance Technology is an auto part manufacturing company that was listed in October 2016 and is arguably the best way to play the structural growth of two wheelers (motorbikes and scooters) in India. The auto and 2W space is one of the few areas of genuine world class manufacturing in India, which is a major beneficiary of government focus to ‘Make in India’.

As the largest 2W auto component player in India it has unmatched scale advantages and has consistently outperformed the underlying industry. It has used its strong research and development division to focus on increasing its share of proprietary engine parts including suspension, brakes and transmission. It is diversified across geography and product. In short, this company is a one-stop-shop for the major manufacturers. Endurance Technology is also a prime beneficiary of a tougher regulatory environment in India, as new regulations are forcing a structural increase in local content per bike.

This stock also plays into the growth of consumption and ‘premiumisation’ (making a brand or product appeal to consumers by emphasising its superior quality and exclusivity) in India. It has a top-quality management team and majority owners who have been around for a long time.

HDFC (Housing & Development Finance Corporation) is India’s premier financier in mortgage lending with a market share of about 16%. About 69% of its loan book comprises retail loans, the balance being commercial real estate loans and lease rental discounting. It is a mega cap company and is one of the largest listed stocks in India.

Usually the large index-heavy names have seen the best years of growth behind them and turn primarily into defensive companies protecting their market share and turf, but not in this case. In India there is a chronic shortage of housing, as population growth has consistently outstripped house construction. This is not a new problem but government policy which previously viewed housing as ‘consumption’ with a high capital/output ratio now sees housing as a driver of economic growth. Recent reforms have focused on reducing housing costs and increasing mortgage financing options for consumers. This accelerates housing capex and creates jobs (important with an election next year).

HDFC has consistently strengthened its market position, despite rising competition. It is the dominant player in the industry; no other competitor has the scale, brand, cost competitiveness and industry leading risk management processes that HDFC has.

Three companies in Latin America

Arcos Dorados (Golden Arches)[4] is the largest McDonald’s franchisee in the world in terms of system-wide sales and number of restaurants (2 000 stores) and the largest quick service restaurant of fast food chain in Latin America. It has exclusive rights to own and operate McDonald’s restaurants throughout Latin America, with Brazil representing 50% of revenue.

The company listed in New York at $17 per share in 2011 with the stock tumbling thereafter due to the recession in Brazil and weakening currencies in Latin America. It now trades at $10 per share with a market cap of US$ 2billion.

The headwinds turn to tailwinds when currencies such as the Brazilian real appreciate strongly, given that 20% of the costs are in dollars. As Brazil has emerged from the recession, inflation has fallen, along with wages and the price of raw materials. The Brazil minimum wage is linked to inflation.

This is leading to margin recovery and, with the stock trading at 7.5x EBITDA versus Latin American and US peers trading between 10x to 20x, the stock is the most attractively valued quick service (fast food) restaurant in the world.

Magazine Luiza is a Brazilian retailer that has transformed itself from a bricks and mortar electronics and white goods retailer to the leading omni-channel operator in the country. It has also launched a market place offering third party products on its website and provides the logistics and warehousing to service these clients. 

Management has converted the original store foot print of 850 stores to ‘shop-able distribution centres’. ‘Click and collect’ is a large driver of the increase in e-commerce sales. Much like South Africa, logistics within Brazil are challenging due to poor infrastructure. The traffic is congested and the post office is slow and unreliable.

A large store and distribution centre footprint for click and collect that is already served frequently and cost effectively with daily truck delivery to stores, at zero incremental cost through the logistics network, offers a compelling competitive advantage.

The company has launched a mobile app which now represents 20% of ecommerce sales, with one third of app sales being click and collect. This digital transformation resulted in the company growing net income over 300% in 2017. With ecommerce sales in Brazil representing less than 5% of total retail sales and growing at an expected CAGR of 15% to 20% for the next five years, there is a strong opportunity for ecommerce players, especially incumbents that have cost-effective logistics.

The company has a market cap of US$4.6bn and trades at 12x EBITDA and is in a net cash position.

Gerdau is a major producer of steel in the Americas, with a dominant position in Brazilian long steel used in construction. After the worst recession in memory, Brazilian construction activity fell dramatically in recent years. As the economy starts to recover, Gerdau is very well positioned to take advantage of rising construction expenditure, particularly as global steel prices are rising on China’s production cutbacks on environmental concerns.

Gerdau also has smaller operations in other Latin American markets such as Argentina, as well as the US where the steel industry is expected to improve significantly in the coming years on increased infrastructure spending. The company trades at 1.0x price to book value, with expectations of strong returns in the coming years.

This article is not intended as investment advice, but to underline the fact that there are many weird, wonderful and well-managed companies out there which would add a bit of zing to any portfolio.  

Disclaimer: Investors should take cognisance of the fact that there are risks involved in buying or selling any financial product. Past performance of a financial product is not necessarily indicative of future performance. The value of financial products can increase as well as decrease over time, depending on the value of the underlying securities and market conditions. Illustrations, forecasts or hypothetical data are not guaranteed and are provided for illustrative purposes only. This document does not constitute a solicitation, invitation or investment recommendation. Prior to selecting a financial product or fund it is recommended that investors seek specialised financial, legal and tax advice. Rosebank Wealth Group (Pty) Ltd is an authorised financial services provider in terms of the Financial Advisory and Intermediary Services Act (Act No. 37 of 2002).FSP 41005. The laws of the Republic of South Africa shall govern any claim relating to or arising from the contents of this document.

[1] There are about 430 foreign denominated funds, including ETFs, approved under Section 65 of the Collective Investment Schemes and Control Act, by the FSB for marketing in South Africa. Management companies that have registered these funds may market the funds to potential South African investors. However, South African investors are at liberty to research and invest in funds not on this list.

[2] Source for statistics on Chinese companies: Cederberg Capital

[3] Source for statistics on Indian companies: Ashburton Investments

[4] Source for statistics on Latin American companies: Sagil Capital

ADVISOR PROFILE

Peter Nurcombe-Thorne

Rosebank Wealth Group (Pty) Ltd

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