HANNA BARRY: It’s that time of year again, when annual salary increases come through and you may have a bit of spare cash, and are wondering whether you should commit more of it to the market or contribute a bit extra to paying off your bond or other debt. We are joined in the studio now by Keith McLachlan, fund manager at AlphaWealth, Zwelakhe Mnguni, the chief investment officer of Benguela Global Fund Managers and Craig Gradidge, a certified planner and investment specialist at GM Investments, to discuss this exact topic.
Keith, let’s start with you. Is now a good time to give more money to the market?
KEITH McLACHLAN: Hanna, that’s a really broad question. We have to break it down into sub-categories. The market has a lot of different asset classes. In this case I was talking about equity markets. Equity markets of course have lots of different industries, lots of different stocks, lots of different products, and in fact lots of different exchanges. So let’s zoom it into the JSE, let’s zoom it into the all-share, and the all-share is sitting on a high-teens price/earnings. Now that high-teens price earnings is above historical averages but historical averages aren’t always applicable because you get systemic changes. We are currently going through a very weak South African economy where the US is recovering and the globe is worried about the Europe and China slowdown.
But the JSE itself, the all-share index is up, the JSE is a constituent therein of change. Twenty years ago the JSE was really a resource play. Your Anglo, Billiton dominated that exchange and all the other major resources companies. At this point it is actually being dominated by British American Tobacco and Naspers and a couple of other multinationals – SAB. First of all, none of these, if you look at them, aren’t really cyclical stocks. Second of all, they aren’t hinged on the South African economy. They are often being driven by other things – call it global recoveries or low yields in developed economies that globally are really lifting up valuations.
And then the third part is Naspers, which is of course a big constituent to the index. Naspers’s price/earnings is basically meaningless. It’s an investment-holding company whose underlying is Tencent.
So the all-share’s price/earnings, although it at face value looks very expensive, when you dig a little deeper you start to realise that it’s becoming less and less indicative of where the market is actually sitting from a valuation perspective.
So the long and short of it is I don’t think the market is expensive but I think you’d have to reach very deeply to build an argument to say it’s cheap. I think we are looking at a fairly valued all-share position. That said, equity is still a very attractive asset class, particularly if you are a long-term investor. So I would very seriously consider the risk of missing out. And if you have a long-term time horizon, equity tends to be one of the most attractive asset classes to be in.
HANNA BARRY: Zwelakhe, would you agree with that take? Do you think that there is a risk of missing out on the market if you don’t invest now?
ZWELAKHE MNGUNI: Ja, I would certainly think that one needs to think long term about equity markets. You cannot therefore invest with a short-term view. And, even if the market corrects in the short term – and let’s just be clear – the market is not in a bubble territory, it is not cheap, it’s not in a bubble territory. But if the market was to correct, I would certainly say over the long term it often recovers and all you need is time. So I would certainly agree with Keith that some of the good-quality businesses that comprise our market today are a lot less cyclical than what used to be the major drivers of our market in the past. So I would certainly say that long term you can’t go wrong with equities.
HANNA BARRY: Craig, saving or paying down debt? Now, if you do have a bond, now might be the time to pay it off since interest rates are historically very low and we didn’t see them being raised at the Reserve Bank’s latest Monetary Policy Committee meeting. They might be raised later on in the year. Should someone rather pay off their debt before they look at serious investing?
CRAIG GRADIDGE: I think again it’s a fairly general question. It you are heavily indebted, there is no question. You have to settle debt and get your balance sheet in good order again. It’s pointless investing and earning 10% when maybe you are paying 13, 14% in interest rates, because then from a balance-sheet perspective you are going backwards. But if you are in a sounder financial position, to increase payments on your home loan would be concentrating risk on your balance sheet because you would be just having one major asset class, being your property. For someone like that I would consider either starting up an investment because, if you look two years from now, on your balance sheet you will have your property, but you’ll have this portfolio of unit trusts, of shares or other market securities. So, depending on where you are as an individual, it certainly makes sense, especially if you’ve got expensive debt, tackle that first. But if you are in a good financial position, diversify your balance sheet a bit.
HANNA BARRY: I think that is key – you have to take individual circumstances into account, which of course lots of these questions don’t.
Keith, you are a specialist in small- and mid-cap funds and some of the stocks you mentioned are very large-cap stocks that the average retail investor might not think are affordable. When it comes to some of the smaller stocks that the man on the street can go out and buy, which of those do you particularly like at the moment?
KEITH McLACHLAN: Obviously my starting point is what I hold, so I can be accused of talking my book. But it’s also a case of having conviction and having been in the game. And the nice thing – if you are not looking at an ETF, like a Satrix40 or something like that, and you are starting to look at stock-picking, stock-picking can cut through the cycle. Even in a downturn, even in a falling market, there are really, really good quality companies that can do really, really well.
Some of the ones we are holding at this point are the non-asset-based supply-chain manager Santova, with a potential to grow at 20, 30% year on year for the next 10 or 20 years as it globalises, internationalises the business. At this point it’s earning half of its profits offshore, it’s opening up trade routes, and I’m picking this up at an 11 times multiple with a high-quality management team in my opinion.
Another one is Calgro M3. They really provide integrated housing solutions. View it as one those on the hierarchy of needs at the bottom rung; one of the most basic needs is shelter, and these guys, as a risk-adjusted model are really market leaders in this. And of course we know that the demand for quality affordable housing on all walks of life, even up at higher LSMs, is basically infinite in South Africa and definitely infinite in Africa. Everyone wants one. And with about a R19bn project pipeline Calgro is trading on I think approaching a R2bn market cap. And of course they are adiing more and more and more to this project pipeline. Once again, top-qiality management and I’m picking it up on about a 14, 15 times price/earnings.
We are also sitting holding AdapIT. It’s a software company application development. So the tech sector in South Africa is growing above GDP. So just that sector itself is a growth sector. Then, within the tech sector you get some that are growing faster than others. Something like hardware is getting commoditised, But software and applications within the tech sector are actually the faster-growing. So you are in the growth sector, in the growth niche within that sector. The AdaptIT is of course quite smart at putting together acquisitions. They grow a very strong platform and about half of their income is annuity-based and they’ve got a negative working capital cycle. If you think about the way you pay for software, we all interact with software all day long. And think about the way you pay for it. You tend to pay for it up front and on an ongoing basis. And view that from a software company’s perspective – they actually get paid at, call it, the start of the month, start of the period, start of the year, and then they pay their salaried employees in arrears. So you are generating more cash than accounting allows you to show as profit, because of the accrual principle. So a highly, highly cash-generative business. It’s sitting on a 21, 22 times price/earnings. It may sound expensive; understand that multiple is actually based in IFRS earnings. If you look at it on what they call a cash-based price/earnings, it’s suddenly a lot cheaper when you compare it to, once again, a 20, 30 sometimes even 35 going on 40% year-on-year growth because you are in a growing industry with a very strong platform, getting returns to scale and with a smart acquisitional tool bringing in some very valuable intellectual property into the business.
So those are three examples of stocks we hold. And you can see a common theme between them – they are all fast-growing, high quality. You can see how these guys can grow these businesses also irrespective of the economic cycle, and [you are] not paying a lot for them in the market. There really are some attractive stocks out there if you just dig a little deeper and pick them.
HANNA BARRY: And it’s absolutely a challenge to get those that can grow, despite a weak GDP growth number that we have at the moment. That certainly is something I guess to invest in. So Calgro M3, Santova and Adapt IT. Those three.
Zwelakhe, are you a fan of those stocks or can you perhaps add stocks that you think there are opportunities in?
ZWELAKHE MNGUNI: I would definitely say that AdaptIT and Calgro are very good businesses. I’d agree with Keith on that. Recently it’s actually quite interesting if you look at the market size segments, you would struggle to find a lot of value in the high end of the market. So the large-caps seem to be quite highly priced relative to the smaller and mid-caps. So definitely I’ll agree with Keith on that.
We have also recently acquired a company like Afrimat. The sector is out of favour and it is a good-qiality business in a sector that is very cyclical sometimes. It is a business that has aggregates, so they mine different types of stones and supply to people in the construction sector. That business is actually very defensive because once you’ve got the quarry in a certain area, the government doesn’t allow people to own quarries in a lot of areas. So their business is quite interesting.
There more recently a business that we’ve also taken an interest in – Datatec in the tech sector. A very good business, well balanced, with exposure to the Americas, Asia and Africa. We quite like that business as well.
Overall we also think the banking space – I think the banks are still quite attractive. Their earnings are probably relatively more predictable than many other companies in the market. They are trading on price multiples of between, say, 10 and 15. If you look – with the exception of FirstRand and Capitec – obviously the price to books are what are normally used in the industry, but even on a price/earnings basis the companies are not that expensive. FirstRand is probably on about four times, Standard Bank and Nedbank are probably on about two times price to book, or just under that. So relatively speaking predictable earnings and stable business models. Reasonable good-qiality businesses that can continue generating returns for investors. So that’s where we are kind of finding value at the moment.
HANNA BARRY: Craig, let’s talk about debt to end off, since it is quite a serious issue in South Africa. If I am completely I over my head, completely over-indebted, don’t know where to start to get myself out of debt, what should I do?
CRAIG GRADIDGE: Ja. In the first place, you would probably need to go and see a debt counsellor and just make sure that a debt review is probably going to be the option if you are really in over your head and there is no way out. The thing with debt is understanding if you want to get rid of it on a sustainable basis, it is understanding what is creating that debt, And if you look at the reasons people borrow money, five of the top seven reasons are consumption-based, consumption-related. So we are paying for food, clothes, educating the kids, and at the end you’ve got a pile of debt and nothing to show for it. And very often it is expensive debt associated with that.
However, if you are buying assets, then typically if you are in a tough space and you’ve got something to show for that debt, so you sell the asset, get rid of the debt and perhaps start again, which is a better option than going into debt review. So again it comes to why are people in debt. People often have no sense of how much their debt is costing them. There is a saying about compounding – if you understand compounding you earn it, and if you don’t understand it you pay it. And expensive debt just compounds and it keeps you poor.
HANNA BARRY: I think that’s brilliant. If you understand compounding you earn it; if you don’t then you will pay dearly for it. There you go – on paying down debt and investing in the stock market, that was Keith McLachlan, fund manager at AlphaWealth, Craig Gradidge, certified financial planner and investment specialist at GM Investments, and Zwelakhe Mnguni the chief investment officer at Benguela Global Fund Managers.