RYK VAN NIEKERK: We are talking markets again and my guest today is Piet Viljoen of RECM. He’s of course one of South Africa’s most dedicated contrarian investors. Piet, welcome to the show.
We are living in an extremely interesting and volatile time, not only politically but in markets too. What is your take on valuations at the moment? Let’s start in the US and Europe and then work our way back to Johannesburg.
PIET VILJOEN: Hi Ryk, thank you. …well let me take a step back and just say that we cannot say too much about politics and economics and all those things that people love talking about because those are, on the one hand, very difficult to forecast [correctly] and on the [other] hand, even if you can forecast what’s going to happen, to take the correct investment decisions based on that forecast is very hard.
Take Brexit for example. If one had forecast that Britain would vote to exit Europe, you would be very nervous and you would probably have sold all your UK exposure. Yet if you look now, a month later, those UK stocks have done generally fantastically well, with the exception of possibly property and one or two others. But by and large, UK-based stocks have actually done fantastically well….
So we try and avoid forecasting at all times and we think that being able to forecast or think we are able to forecast, gives you a false sense of security. The only security you can get is from the margin of safety in the event in the price you pay for the assets you acquire. So if you pay a low enough price, that gives you a marginal safety and a comfort that whatever happens in the future, your low price will take care of that.
RYK VAN NIEKERK: But don’t you think that political events, such as Brexit, are more profound – the impact is more profound – on equities than [they were], say, ten, 20 years ago?
PIET VILJOEN: No. I think if you go back in history there’s always stuff happening… that comes out of the blue, that you don’t expect and it has positive and negative implications. And it’s just so hard to forecast these things and it’s so hard to forecast or to take account of the second-order effect of these things, so we try and stay away from that and we find that other times, if you pay a low enough price for the assets you acquire, that protects you against the vagaries of the market and politics and economics and all those sort of things.
So if you want to talk about the economics of what going on, or the politics of what’s going on, I’m probably the wrong person to speak to, but we can talk about values and where we see good value and where we see bad value, that I’m more than happy to talk about.
RYK VAN NIEKERK: Let’s look at the US market and valuations there. You know the world is not the healthiest place economically currently, but yet we see really high valuations in the US market. What are your views there?
PIET VILJOEN: I think one of the drivers of the market, especially of developed markets and indices which owns good quality businesses with steady dividend income and good business models, have become very, very expensive in the past few years as interest rates have been manipulated downwards by central banks. So they’re telling themselves it’s hard to get yield in the interest rate market, let me rather take a bit more risk and buy the equity of a business [that] pays steady dividends, a good quality business.
And in that process, they bid up the price of those businesses to very, very high levels and that search for yield generally tends to end badly and we think this one will be no exception.
SA value stocks
RYK VAN NIEKERK: And if you look at the South African market, few stocks have performed really well, but many of the other stocks have not performed as well. Where do you see value here?
PIET VILJOEN: You know, the South African market is a microcosm of the global market – if you look at what’s performed well here it’s …generally the sort of stocks like SABMiller or AB InBev. In the future, there’s brewing companies, tobacco companies, high-quality businesses paying steady dividends. But we think the market is paying far too high a price for those businesses based on artificially-low interest rates. So we think those are high-quality businesses but very risky investments.
On the other hand, we’re seeing increasingly better investments in lower quality businesses in say: SA industrial manufacturing and those sorts of areas. That is where we are seeing more and more value. It’s not hand over fist at this point in time, but it’s increasingly going that way, so that’s where we’re looking, and moving towards.
RYK VAN NIEKERK: If you take a company like Naspers for example: if a fund manager held Naspers the performance would have been great, if you didn’t then the performance is a lot worse. Do you think they differentiate fund managers? Is it luck? Is it foresight? Because at the end of the day, those short-term differences in valuation or performances actually affect investment decisions.
PIET VILJOEN: Yeah, look, you’ve got to take this commentary from whence it comes. It comes from a fund manager who didn’t hold Naspers and still doesn’t hold Naspers and so I find it hard to think that one is either a genius or a fool based on whether you hold Naspers or not. But right now, there’s a strong contingent out there in the market that all the smart investors hold Naspers and all the dumb ones don’t.
So we’re probably one of the dumb ones, but we just can’t get that valuation: we’ve struggle to think that the price you’re paying for Naspers shares today will give you good investment returns in the next five or ten years.
Deep value, contrarian investing
RYK VAN NIEKERK: Again, you know you are a deep value investor, contrarian investor. You look at a set number of factors in your investment model. Do you think in the long term if we look back at the last few years, [we will see that] earnings from companies have not really been the main driver of valuations…?
PIET VILJOEN: No. It’s been declining interest rates and higher multiples on, or higher PE ratios that the market’s prepared to pay on good-quality businesses and businesses that are showing some sort of growth, like Naspers for instance. So those valuations have been driving markets, not underlying fundamentals like earnings and those sort of things.
Whereas for us, as value investors, we look at underlying fundamentals and not the momentum of where prices are going in certain assets. And we think the volatility that you spoke about earlier on in our discussion – that volatility creates exactly the sort of environment where value managers, value investors such as ourselves, start to do well, and if you look at our year to date numbers, we’re top of the pops. So I think what’s happening fundamentally on the ground is sort of corroborating our investment philosophy.
RYK VAN NIEKERK: You did say you are seeing value in the industrials, but I just want to go back one year. In your equity fund and your balanced fund, in June last year, you were heavily invested in Anglo American, Anglo Platinum and Impala Platinum, and that was a big play on the resources sector. We’ve seen a big bounce in those counters. What is your view on this sector going forward?
PIET VILJOEN: We still think the sector is cheap. We’re not wedded to resource stocks, we are not wedded to any type of stock. We like investing in cheap stocks. So about two to three years ago, we started investing in resource stocks and increased our investment as they declined, and they reached the peak of their decline probably in the second half last year, and that was the peak of our exposure. So then a stock like Anglo, has quadrupled, those had gone up by a factor of three or four times; Amplats have gone up by a factor of three times and so on and so forth. So a lot of these stocks have shot the lights out and we have correspondingly reduced our exposure somewhat. We’ve not sold out but we have reduced our exposure somewhat.
RYK VAN NIEKERK: But for the commodity sector there doesn’t seem to be any real upturn in demand in the short term. Do you think the increase in valuations, like we’ve seen, can be sustained over the next few years?
PIET VILJOEN: Generally these stocks tend to go up in advance of anything positive happening and they tend to go down in advance when negative things are happening. So if you want to wait until you see high commodity prices and good global growth and so on and so forth, it’s going to be too late and you’re going to be buying at the end of the good performance not at the beginning of the good performance. So generally we take our cue from the price to value relationship, in other words, when the price of the stock is far below its intrinsic value regardless of the immediate outlook for the companies, we will buy. And when the price to value relationship narrows, in other words, when the price goes up, and remember the value or intrinsic value of the business is a pretty stable number, it doesn’t jump around… so when the prices quadruple, like in the case of Anglos, that means your margin of safety has declined and that means you take the money off the table, regardless of the immediate outlook. We do not know where commodity prices will go and we don’t have a view on that.
RYK VAN NIEKERK: Let’s look in industrials – you say you see value there. Which companies are standing out for you?
PIET VILJOEN: There’s a whole host of them. As I said earlier on it isn’t hand over fist yet, it’s not where you can say that you can just stick your hand out and grab them. But increasingly we’re seeing good industrial companies, companies like Invicta, Hudaco, some trading on single bid PEs which we haven’t seen for a very long time. So those are the ones we are starting to look at; we haven’t taken any big positions there yet. Metair is another one that comes to mind. We’ve got the Turkish exposure which the market hates at the moment, and it loved that exposure a year ago before anything bad happened in Turkey. Now the bad stuff’s happening, now the market started to hate it. But these things come and go.
So those are interesting sort of companies, but our biggest exposure in industrial South Africa is in a company called HCI. Its main interest is in Tsogo Sun which is the hotel group which we think is highly undervalued. With the weak rand, returns are coming in and the hotel occupancy seems to be going up, so we’ll see what the earnings look like in the next two years.
Banking, financial services sector
RYK VAN NIEKERK: One sector which many fund managers are looking at is the banking sector and the financial services sector. What is your view on that sector?
PIET VILJOEN: …we think the banks are – the prices are attractive but we’re sort of standing back a bit because we think the regulatory environment is not conducive to generating good profits in the financial sector. The regulatory burden, the compliance burden is massive. My business is in the financial sector so I see first-hand what’s happening on that side of things and it’s massive. I can only think what it is like for a bank like Standard Bank or Nedbank or FirstRand – what compliance burden they have to face and they’ve increased the cost of doing business and it also reduces the business opportunities.
So we think the finance sector is being regulated to a point where it will be very difficult to achieve past levels of profitability. So today, prices in that sector, relative to historical profits, look low but possibly not that low relative to sustainable future profits.
RYK VAN NIEKERK: But still they offer, some offer really attractive dividend yields which in [the] short to medium term shouldn’t change. Is it maybe not a safer bet just to park money for the short term, while we go through this current volatile period?
PIET VILJOEN: I still have to meet the person who can tell me what is going to happen in the short term with a consistent level of success. So if you say the dividend yield is attractive in the short term, remember when you buy a stock, when you buy the equity of a business, the stock, you’re buying an asset with a growth of 40 years. So that dividend might look attractive today, but you don’t know what happens in the future.
Take PPC for instance, I mean that was a dividend-yielding stock par excellence a few years ago. Everybody who wanted dividends owned that stock and today that company has lost almost 80% of its price, it declined more than 80%. It’s not paying a dividend any more, in fact it’s in debt, it can’t pay a dividend. Things change quite quickly and if you are relying on a dividend yield for the next five to ten years, you’d better be sure that the company’s intrinsic value is still intact and will be for the long term.
RYK VAN NIEKERK: An interesting trend that has changed in recent times was the inflow of foreign money into South Africa. For the first six months of the year we saw a sharp outflow from foreign investors, but we seem to have turned the corner, we’re the flavour of the month again. We saw a lot of money flowing in the past six weeks. How do you read this?
PIET VILJOEN: We think the rand is massively undervalued and in our local balanced fund, we brought money back from offshore as well. We brought a significant amount of money back from offshore at R15 to the dollar and better. We think that with the rand at that sort of level, things have got just dirt, dirt cheap. So we think South Africa, from an offshore investor’s perspective has to be looking very attractive. So we’re not surprised that there’s money coming into the country.
And remember investments are at the most attractive when the short term fundamentals look at their worst, and right now, one can’t argue that South Africa’s fundamentals look great, in fact they look pretty poor, but that’s why it’s cheap and we think that increasingly foreign investors will recognise that, will recognise the bargains that are on the table and start taking advantage of that and I think we’re seeing the start of that now.
You can go back in history and every time the rand has been weak like it is its created a buying opportunity for the smart foreign investors and the local investors still don’t want to invest and only when the rand strengthens again do people want to invest in the country. And I think one should again, as you said be contrarian, not for the sake of being contrarian but contrarian opportunities are where the value is and that’s where we’re seeing value today. In South African assets, the rand is cheap and currencies like the dollar is very expensive.
RYK VAN NIEKERK: There are some pretty well-known financial advisors who are still beating the drum ‘take your money out of the country, the rand can quickly devalue to levels around R16, R17, R18 against the dollar’. Do you think there’s more money to be made now in South Africa than offshore and can that dynamic change quite quickly?
PIET VILJOEN: Yeah, I think the opportunity is where no-one wants to be, where there’s less competition. Where there’s more competition, the returns are generally lower because lots of smart people are running around trying to eke out a return for their assets. So where there’s less competition, in places like South Africa which are a bit smelly … it’s easier to make money in South Africa today than it is maybe in America or in Europe, or a couple of other places. So that’s where we think the opportunity is, longer term of course, and of course, in the short term anything can happen. Those advisors might be right that the rand could go back up to R16 or R17, but if you ask me where the rand is going to be in three or four years’ time, I guess it’s going to be stronger than that.
RYK VAN NIEKERK: Investors currently, South African investors, are very emotional. I think they sometimes over react. When the rand is weak, you take out money, when it’s very strong…
PIET VILJOEN: When it’s strong nobody wants to take out money.
RYK VAN NIEKERK: If you look at your funds, they haven’t performed well over the last three or four years, but there has been quite a good bounce with the upturn in the commodity stocks. What advice would you have for investors looking at this volatile period [on] how to invest your money and be confident to leave it there for five to ten years?
PIET VILJOEN: Look I think the most important thing is, as an investor is you need to find out what sort of investment approach resonates with you. Not everybody can be a value investor because sometimes you need to sit through long periods of underperformance. You know, performance periods where you look dumb…. But if you are a value investor, and that sort of approach resonates with you, then you need to sit it out and not move your money around the whole time, just as, if you are a momentum or a growth investor, and things start looking poor for the growth and momentum environment, you need to sit it through because not all styles are always in fashion and always do well. These things are cyclical and they come and go.
We think that over time, value investing outperforms most other styles of investing and the numbers prove it, so you know, that’s why value investing resonates with us and that’s why we’re sticking to our knitting. But the important thing is to be consistent in your actions and not flip-flop around.
RYK VAN NIEKERK: Thank you Piet. That was Piet Viljoen of RECM.