RYK VAN NIEKERK: We are talking markets again, and today in addition to the podcast we are also shooting a video of the discussion. So please let me know what you think about the video below:
My guest today is Hannes van den Berg, the co-head of SA Equity & Multi-Asset within the 4Factor team at Ninety One. Hannes has been with Ninety One for four-and-a-half-years, and before that he was at Fairtree Capital for nearly a decade. He is a CA and also a CFA Charterholder.
Hannes, thank you so much for joining me. First of all, who and what is the 4Factor team?
HANNES VAN DEN BERG: Hi, Ryk. Thanks for the opportunity and nice to talk to you today. 4Factor is a style that Ninety One, previously Investec Asset Management, embraces to identify stocks on a global scale. So they analyse stocks according to the quality or the strategy of the business, the valuation of the business, the earnings profile, earnings revision, and then also technicals. They use that on a global scale to filter through the huge universe of stock opportunities and to identify a list of stocks that they then do research on, and then obviously include in their funds.
In South Africa we tend to highlight or emphasise two factors more strongly, which are earnings revisions on the one hand and then reasonable valuation. We’ve found that over time we’ve analysed markets and what contributes to returns specifically for the South Africa market. And then earnings at a reasonable valuation are [what] we believe drives share price outperformance in the South African market.
RYK VAN NIEKERK: But is that the case currently?
HANNES VAN DEN BERG: Yes, it’s a good question, Ryk. If you look at the South African market, Covid-19 has reset a lot of earnings expectations for companies in South Africa. So we are seeing a lot of very positive revisions, especially on the SA Inc side in South Africa. Commodity prices have been very supportive of resource counters, so we’ve also seen a lot of positive revisions and changing sentiment and expectations for the resource counters. So, to answer your question, yes, we are finding quite a lot of buying opportunities on the South African exchange at the moment.
RYK VAN NIEKERK: I’ve spoken to several of your peers at Allan Gray and Coronation in recent weeks, and they are pretty bullish about the local market. They also see a lot of value, they also see a lot of buying opportunities. What is your feeling about the temperature of the local market?
HANNES VAN DEN BERG: Obviously, if you sort of take a top-down view globally where are we in the cycle, it is that of a massive recession. Out of the recession you have first your recovery phase which, as you know, delivered quite handsome returns over the last 12 months for equity investors.
We do think we now are going through the growth or expansion phase post the recovery phase – also the next part of the cycle. In this part of the cycle we expect markets to be more trending, rather than the strong growth that we’ve had.
But from a bottom-up perspective, yes, we agree that we are finding quite a lot of buy opportunities.
Yes, maybe there’s a bit of stabilisation and volatility over the short term, but if you take a 12-month view over the medium- to longer term, [there are] lots of buying opportunities on the South African exchange.
On the SA Inc side we would agree with our peers, also on the resources side. More recently we’ve seen a bit of a pull-back in the last few weeks, and that creates a fantastic opportunity to position yourself correctly going into 2022.
RYK VAN NIEKERK: But if you look at what happened between 2010 and 2021 – if we can take that period – we’ve underperformed most international markets, especially the US market. But then last year after the crash, we saw a very strong rebound of local stocks, and it pretty much correlated with what we saw elsewhere.
But over the past few weeks, as you’ve just said, it seems like we’ve lost steam a bit. Are you concerned about this, or do you think it’s just a short-term thing? Do you think we can close the gap again and be better correlated to especially what we’re seeing in the US, where we see records every second week?
HANNES VAN DEN BERG: Ryk, your first point about the previous decade from 2010 – I think it was easier to have everything offshore. SA Inc stocks – we know about the political environment, we know about the New Growth environment, corruption. Our sort of ideal trade was to have your money offshore to benefit from a weaker rand and the bigger-universe stocks that you could invest in on the offshore side.
What happened during the pandemic or the crisis was that the earnings expectations for some of the SA stocks got reset 40%, 50% lower than maybe where they were in 2019. The stocks reacted with those lower earnings expectations and reset in earnings expectations, and a lot of our analysts started indicating to us that the market has overshot on the downside for the SA Inc stocks. Take a bank that had to do non-performing loans provisions in the third quarter of last year under Level 4 lockdown, these provisions were done very conservatively.
People weren’t expecting the consumer to recover as consumers had not been as [badly affected] as feared. People didn’t expect the savings rates to be as healthy – globally and in South Africa. That created a lot of pent-up demand and gave the opportunity for the trade to go slightly the other way again, and to find some of these SA Inc opportunities.
If you look at our banks’ indices, they are up more than 20%. Our retail index went up more than 30%. Those kinds of returns you don’t often find.
The trade has been the other way round for the past 12 to 18 months, to bring some of that capital back from offshore to South Africa and to invest in some of the SA Inc opportunities. We tend to think that that trade has still got some legs. We tend to think the opportunity continues into 2022, and we can talk about some of the stocks and opportunities.
We recently engaged a lot of the companies. We still think there’s upside to the earnings expectations for some of those SA Inc stocks. So we would agree with the thesis that you’ve mentioned.
RYK VAN NIEKERK: Let’s talk about the SA Inc stocks because in many ways I also think the local market has been distorted with the poor performance of Prosus and Naspers in recent months, because that dragged down the JSE Alsi significantly while many other SA Inc stocks have actually performed really, really well.
Which stocks are you looking at, which stocks are you currently buying?
HANNES VAN DEN BERG: You are right, Ryk. If you look at Naspers and Prosus they are down here today relative to the index that’s in the green. So a lot of the sort of value attracted negative returns from those two big stocks in our index. Currently the banks still have been a very attractive sector for us.
When we speak to these banks, retail advances inside the corporate and business lending practices that they’ve got, it’s going better than expected.
As I’ve mentioned, non-performing loans, the provisions that they’ve made – those non-performing loans are behaving better than the banks thought. And non-interest income or revenue, transactional activity, exceeding expectations. So that’s really a very attractive sector.
Insurance companies as well had to make provisions for the first and second and third wave. We think we’ve reached the point where they’ve also adequately provided. It’s interesting that people fear that the insurance market, because of persistency, would struggle because the consumer would be in a bad space. And we’ve recently spoken to Sanlam and Old Mutual, and persistently levels are better than expected.
So maybe a pandemic like we’ve had makes people look into insurance, and maybe it will also help insurance in a more positive way.
And therefore you would like to get your basis covered. So the insurance sector – stocks like Old Mutual and Sanlam are looking interesting.
And then on the retail side, I’ve mentioned a stock that we think has got tailwinds – Shoprite repositioning themselves quite well. They’ve addressed their balance-sheet concerns, exited some of the businesses in Africa, and they are repositioning themselves on the fresh side. Some of some of the shops are seeing capital spending and refurbishment. They’ve got new systems – a SAP system that they’re rolling out. So therefore their GP [gross profit] margins are starting to benefit and opening up. Checkers is trading incredibly well.
Checkers is actually trading at margins at the same level or even better than Woolworths Food is trading. That’s been the darling of the food market for quite a while.
We also like the credit retailers. They’ve got two levers that they can pull. They can either hold back on credit, and therefore have a better default experience, therefore their credit experience is better, and they can be too conservatively provided; or they can use that credit lever to drive revenue on the top line and grow their top line by extending credit to the consumer. You don’t often find that they hold back on credit and have a bad debt experience. The market penalises them for both. And that exactly was the opportunity.
So we quite like the likes of Shoprite, Truworths and Foschini.
Pepkor is benefiting from a lot of grants, grants being extended into next year; also people trading down into the value segment.
We tend to think they’re in a good position. They’ve addressed their balance sheet concerns. There’s a lot less debt on the balance sheet. You’ve got a better high free cash flow profile from Pepkor.
Another stock that’s trading quite well is Motus. I remember in 2007/2008, when we went through the financial crisis, these companies struggled to control their fixed costs, and there was negative operating leverage. This time around Motus came through their crisis, managing their working capital and their fixed costs exceptionally well. Also the 300-basis-points lower interest rates helped the vehicle market. And we also saw that on the banking side vehicle advances that they give to consumers have been very strong and therefore Motus has benefitted from that.
RYK VAN NIEKERK: Are you selling anything aggressively?
HANNES VAN DEN BERG: Ryk, we are underweight rand-hedge stocks, defensive industrial rand-hedge stocks. We don’t own the likes of Anheuser and British American Tobacco for specific company reasons. We feel the upside or the potential return potential of some of the SA Inc stocks and also on some of the resources stocks exceed those rand-hedge stocks. So we see them as funders.
RYK VAN NIEKERK: I’m looking at the fact sheets of two of the funds where you are involved with the management – the Ninety One Equity Fund, which is a Regulation 28 fund, and the Ninety One SA Equity Fund, which is 100% invested in local assets.
It’s very interesting to see that the SA Equity Fund has slightly outperformed the Regulation 28 fund, which has about a 25% foreign exposure. How did this come about, because that is probably contrary to the perception or expectation.
HANNES VAN DEN BERG: Yes, Ryk. That’s a very good point you make there. It’s not often that you find – we also highlight this in the balanced or multi-asset space – domestic balanced funds outperforming global balanced funds.
The point you’re making here is that a domestic equity fund is outperforming a fund that’s got global exposure. There are lots of ways to look at this.
The common belief out there is that South Africa as an equity market is smaller than 1% of global market capitalisation, so you have to find more opportunities in the global space than you would potentially find in the 60 to 70 or 80 stocks that form part of our investible universe in South Africa. So yes, there are lots of sectors, a semiconductor sector, there are lots more tobacco companies, lots more luxury goods companies, more oil and gas companies, more tech companies that you can follow and all sorts of stuff. So there’s a much bigger universe from a stock-selection perspective.
The rand has been much stronger over the last 12 months. In the middle of the crisis we also got a debt downgrade. The rand was at R18.19 to the dollar. As it stands today, it’s at R14.15 to the dollar.
So any offshore exposure has been fighting that stronger rand trend.
So over the medium to long term having some money offshore and some offshore exposure is probably the right thing – to have better opportunities, greater growth rates, companies that do quite well gaining from market share, operating and financial leverage – that’s positive.
In the short term, as I said, South African earnings and equity and prices got smashed quite hard, and that was the exact opportunity over the last 12 months. The return profile of some of these SA Inc stocks over the last 12 months have exceeded what you would have seen as returns in rand terms from some of the offshore stocks. So ‘local is lekker’ is a phrase that we often use in our team. Local stocks have done incredibly well relative to having money offshore over the shorter term.
RYK VAN NIEKERK: It’s also obviously a stock-picker’s market because we have challenges and that affects certain sectors. But I think if you select wisely you can get these type of returns.
If I look at the top holdings of the respective funds, they are pretty similar. Your biggest holding is in Naspers. I’m looking at the July fact sheet of both funds. Did you, or didn’t I, do one exercise – the swap with Prosus?
HANNES VAN DEN BERG: Yes, Ryk, we did. It was obviously first about Prosus on the Prosus transaction, about which we engaged extensively with the company. We talked about the voting and management alignment and remuneration and share buybacks. A lot of work and effort has gone into that. You would have obviously known that across the South African industry there was an industry collaboration, working together with regard to this transaction. But now, post the transaction, yes – we did sell our Naspers shares. So, as it stands today, we hold just short of 8% in Prosus. We held 3% in Naspers, but we topped up a little bit on the Naspers side, collectively about 12% in the Prosus/Naspers combination.
RYK VAN NIEKERK: Are you concerned about that, because there are significant concerns about the future of IT and tech companies in China, especially in the market where Tencent operates, which is in some of the gaming and communication markets.
HANNES VAN DEN BERG: Ryk, if you had to ask me what are the two biggest concerns, what are the two things that we lie awake at night about, one would be the tightening cycle policy changes we’ve seen globally. When we work with our global colleagues in London we’ve got this phrase that we’ve seen the peak in policy stimulus or accommodation, that the risk is that tightening happens faster than the market is pricing in.
At the moment, we’ve got very high housing prices globally. Central bankers often worry about when that happens.
So the risk is that inflation is more sticky than everybody thinks, and therefore we have a faster tightening cycle than the market is currently pricing in.
And then you’ve highlighted the other big risk, which is China. You highlighted it specifically from the internet sector. We tend to think it’s broader than just the internet sector. It’s a bigger political agenda around regulation, not only in the internet space, which we recently saw in the gaming space with certain Macau companies, also regulation being introduced in the food and drug sector. There’s a lot of regulation, maybe a backlog of regulation that’s now being addressed from a Chinese perspective – maybe because they’ve had such a strong recovery. They came out of Covid faster than the rest of the world. They got a bit of a window of opportunity to address these regulatory concerns.
But to answer your question, we saw this in 2018 when they addressed the gaming regulation issue, worried about addiction, they were worried about minor gaming and children spending too much time in front of screens and specifically gaming. We think it’s short-term pain, but there is medium- to longer-term upside.
If you had to ask me today with a blank sheet of paper whether we’d be buying Naspers and Prosus, I think we’re going to look back in 12 to 24 months and see this as a fantastic buying opportunity for these stocks.
So we don’t think these companies are broken. We think they are an introduction of regulation – and we speak to our Chinese colleagues almost on a weekly basis. People on the ground will help us to understand the Western view of this, the Western world view versus the Eastern or the Chinese view, and what’s actually happening on the ground. And I must say, I think from where we sitting, looking outward into China, it seems like a lot more of a hostile in a volatile environment versus how they are experiencing it on the ground. So we remain constructive. We think Tencent is a fantastic business. If you buy Naspers and Prosus that’s what you are buying. Gaming is about a third or 30% of the business as it stands today, not the two-thirds it was a few years ago. Therefore we think this is a fantastic buying opportunity.
RYK VAN NIEKERK: So are you accumulating shares at these prices?
HANNES VAN DEN BERG: We have been buying over the last few weeks, yes, Ryk. Subsequent to the transaction we bought some Naspers and we’ve also bought some Prosus. So yes, we are buying. Prosus is also doing a share buy-back at the moment so also allocating capital towards that. We tend to think that the investment phase that Tencent currently is in – they’ve announced to the market that they they’re using some of the revenue that they’re generating to invest [in] additional engineers in development, additional advertising positioning the business correctly. What we saw in the previous cycle is that that initial phase leads to lower margins, but then after that it leads to stronger revenue. So this investment phase we tend to think will bear fruit over the medium to longer term. So yes, we are accumulating.
RYK VAN NIEKERK: Naspers I see [is] 22% down, so it’s the beginning of a significant opportunity or a signal. I don’t know which one we will see in a few years’ time.
But just lastly, in both funds you have significant exposure to the basic materials sector, the commodities, and in the top holdings table you publish with your fact sheets I see Anglo American, Impala Platinum; Sasol is there, BHP Billiton, Sibanye-Stillwater – big South African commodity counters. Do you think the commodity cycle may be close to a top? How do you approach it?
HANNES VAN DEN BERG: Ryk, A lot of words, like a supercycle and so on, have been thrown around over the last few months. I don’t think it’s a supercycle. Like I said earlier on, we think that we go from a strong recovery into a growth and expansion phase of the cycle. Given where real rates are globally, we don’t think a recession is imminent. So we therefore think that global growth stays at or above an average level. So if you have that kind of environment where you have above-average drug levels, globally emerging markets tend to do well. Yes, there’s been a few sort of announcements and a bit of volatility inside China with regard to steel production, and in the housing market, a bit of a slowdown, total social financing being unbearable that a lot of people focus on – which is around loans and supply of money into China.
So yes, there’s a bit of slowdown. But if you look at commodity markets in general, we tend to think supply-demand dynamics are very supportive for the likes of PGM metals – palladium, rhodium and platinum. Yes, there’s a big chip shortage that’s causing a bit of a delay in production, and therefore demand being pushed out to 2022. I think the market got a bit caught off-guard by that.
There’s a lot of supply chain disruption around. If you look at global shipping tariffs, they are at an incredibly high levels. The reason for that is that there’s a shortage of supply. We tend to think that because we’ve had the global financial crisis, because we’ve had labour disruption, because we’ve had Covid-19, not a lot of investment has gone into the supply of, for example, PGMs [platinum group metals] or iron ore production, copper production. New supply coming online has been very slow.
And we think that demand curve has been flatter and a bit longer, so the demand being pushed out to 2022 is still constructive. And therefore a lot of these commodities are in a tight position, if you look at supply-demand dynamics, and quite supportive for the revenue line and also for the earnings lines of some of the companies that we hold.
We also think that the balance sheets of these businesses look materially different from what they did over the last five years. They don’t have a lot of debt. Some of them are in a net cash-positive position. Hollard just announced that they’re going to target to sort of R20 billion worth of cash. That means if commodity prices stay constructive, the free-cash flow profiles to shareholders are in double digits. Even with spot prices post this pull-back that we’ve recently seen, these companies are trading at 20 to 25% free cash flow profiles, which means you get your money back over a four- to five-year time period.
So yes, we are still very constructive on some of these commodity counters, and we tend to think that from an earnings perspective and from a price-earnings ratio perspective that shareholders will benefit from these returns.
RYK VAN NIEKERK: And you must be smiling about the dividends flowing in?
HANNES VAN DEN BERG: Yes, we are. It’s nice to get the free cash flow. I must say in the last month or so the movement in these commodity prices has not been easy – a lot of them because of the chip shortage, as I’ve mentioned. The rhodium and palladium prices have pulled back. The iron ore price is not at $200 anymore. It’s, as you said, at $125. So we’ve seen that in the share price actions, but we think it’s an opportunity to accumulate. So therefore this pull-back is in our view, like I said upfront, an opportunity to position yourself appropriately going into 2022.
RYK VAN NIEKERK: Hannes, thank you so much for your time today. That was Hannes van den Berg. He’s the co-head of SA Equity and Multi-Asset within the 4Factor team at Ninety One.buy