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Finding opportunity in unloved shares

Investec’s John Biccard, a ‘rock star’ in the deep value investor club, shares his views on where there’s value at the moment.

RYK VAN NIEKERK: Welcome to this Market Commentator podcast, it’s my weekly podcast where I speak to leading investment professionals. My guest today is John Biccard. He is, of course, the manager of the Investec Value Fund and a rock star in the deep value investor club. John, welcome to the show, the philosophy of deep value investing has always been interesting and we’ve seen many so-called contrarian investors underperform during the past few years. But we’ve seen a lot of sideways volatility in the whole market and a lot of local and international political events created some noise that affected markets. Has your philosophy changed in a material way to also account for these external factors impacting on valuations?

JOHN BICCARD: No, it hasn’t changed at all, I’ve been running the value fund for nearly 20 years now, I think it’s 18 or 19 years, and it’s always been run exactly the same way. All we really do is focus on shares that are totally out of favour but have underperformed the market significantly over a long time period.

Everything in the portfolio we only buy once it’s underperformed for many years and then we do work on it first of all to check its financial position, which is the most important thing. We then spend a lot of time looking at what macroeconomic changes have to happen because most of these companies, why they become really cheap is there has been some macroeconomic event or some macroeconomic factors affecting it, be it interest rates or commodity prices or currencies that get it into this position.

We spend a lot of time thinking about what could change in order to bring that value out. We don’t forecast that change, all we really want is the possibility of that change. The important thing is everything is cheap, everything is underperformed in the fund but the two big hurdles to cross are, one, the balance sheet of the company. If we start with a universal 100 shares we say, what are the cheapest 10 and then we look at the cheapest 10 and we usually throw one of those out, either because the balance sheet can’t support it because value investing is so hard anyway that you’ve got to make sure that you’ve got time on your side for the thing to change.

It’s no good buying a highly leveraged company and you run out of time. The first hurdle to cross is the balance sheet, that it can survive while we wait for things to change and the second hurdle to cross is to check that there isn’t a permanent structural change where you’re buying a buggy whip company and everyone is now driving cars.

That is a rare thing because our view as value investors is that there are very few structural changes in the world.

People often confuse cyclical changes, short-term changes, they say, well, that’s the end of that industry. It’s very rare that industries disappear but obviously it does happen. So if we start with 1 000 shares and we get 50 shares that are really cheap, generally of those 50 shares we’ll probably throw one out because it’s too leveraged and one or two out because there’s a structural change and that leaves us with 47 shares as the core.

No regard for the index

RYK VAN NIEKERK: But you take big positions in some companies, the top 10 biggest shares in your portfolio account for nearly 66% of the total portfolio, is that a strategy?

JOHN BICCARD: We have no regard for the index, we don’t start with the index because that’s never made any sense to me that you would start with the index. When people invest their own money they don’t say the index weight of this… people put the best five or 10 ideas in their portfolio and that is exactly what we do in the value fund, so that means we do take big positions because we’re not worried about the index and if you really like the idea we’ll put 10% of the fund in.

The only thing that constrains what percentage it is, is the size of the company and the liquidity. So if it’s a big liquid company we’ll have 10% and we really like it, we’ll have 10% in and if it’s a tiny small cap we’ll buy as much as we can even if it’s 0.5%. Generally, we land up with very concentrated positions of the stuff we like, which means a lot of volatility in the short term about performance, especially relative to the index because generally our portfolio doesn’t look like the index at all.

RYK VAN NIEKERK: Most definitely not, I see your biggest shareholding is in Impala Platinum, more than 20% of the fund is invested in Impala, and Sibanye Gold also nearly 12%, so nearly a third invested in those two companies. The mining industry currently is being faced by a very unstable electricity supply with Eskom really in big trouble, are you worried about the potential impact this may have on the mining industry and specifically those two counters?

JOHN BICCARD: The reason why they are so big is when they got to the bottom of their performance and to give you an idea of how much these shares fell, Sibanye fell from R45 to R7, and Impala fell from R250 to R16, for Impala that was over a period of 10 years and for Sibanye it was over a period of three years. That’s how much they fell. When they got to those low points of R16 and R7 respectively we made sure that we had 10% of the fund invested by continually buying down. That is very important because as value investors we buy too early and when we buy early and it keeps falling, we keep buying to bring down the average cost.

Those two stocks have got so large in the fund because over the last six months they have had a recovery. But a very small recovery, so to give you an idea, Impala fell from R250 to R16 and it’s now tripled to R46 but it’s still R46 versus a high of R250. That’s why they got so big.

To get back to your question, the Eskom situation is bad news for everything in South Africa and it is bad news for miners. The only thing I would say is mining, ironically, is not as badly affected as a lot of manufacturing operations in South Africa and, in fact, may not even be as badly affected as retail. Shops are actually having to shut, mainly because the miners are generally the last people to have the lights turned off because they are big users and the government is very aware of their importance in the economy, so they are the last people to get turned off and they’re the first people to know when the load shedding is coming so that they can schedule their operations around that.

Very importantly, mining is not batch processing, they can actually stop hoisting for a period of the day and then continue on with operations like batch processing, and manufacturing is worse affected when the power goes out and you have whole batches of things going off. So it’s not good news but we’ve lived through it before.

Read: Cheesecake tossed as SA blackouts cripple businesses

The last point is, very importantly, that both these companies are platinum companies or PGM metal companies and so it’s very important that if there was a real problem in South Africa with electricity it would obviously be bad for them but at least they would be somewhat offset by high metal prices because South Africa is the primary producer of those metals. It doesn’t help if you’re an iron ore producer in South Africa and you stop producing, the iron ore price doesn’t go up because you only produce 1% but when you’re South African platinum and you’re 70% of the market our production really does matter in the price.

Impala Platinum’s share price performance

RYK VAN NIEKERK: But Impala Platinum, I’m looking at the share price performance over the last few years, it’s down 63% over the last five years but over the past six months it’s up nearly 170%, and year-to-date nearly 30%. When do you start looking at taking the profits on this stellar performance?

JOHN BICCARD: As you say, it’s one of those crazy shares where it’s down 70% of its all-time high but it’s up three times off the bottom. You’ve got to look at the long-term graph to get where it is and you’ve got to look at what the stock is worth. We have consistently said and I think if you go back to any of our presentations we have said over the last three, four years – because we’ve now been invested in Impala for three or four years – increasing the weighting consistently as it continued to fall, we’ve said it’s worth a minimum of R75, and that was when the share was R50 and we were buying it and then when the share was R16 we were buying it.

Obviously when it was R16, people said you’re absolutely crazy but that is our valuation based on what we think to be reasonable PGM prices. All that’s changed is the PGM prices have moved a little bit, well, five of them, with the exception of platinum, have moved a lot, platinum hasn’t moved at all. But the basket as a whole has moved up from unsustainably low levels to more reasonable levels and the new management team has done a better job in controlling costs and improving production and those two things have resulted in a company turning from a loss to a profit.

Even though the shares are now R46 and not R16 we still think that it’s undervalued. We’re thinking that at this basket price, where the rand is today and where all the metals are today, we think that Impala could earn R5 or R6/share, which will put the share on eight or nine times earnings and its major rival, Amplats, trades on 22 times earnings, so there’s still a big discount and we see the debt being paid down and we can’t understand how Amplats is worth R170 billion and Impala is only worth R30 billion.

The answer is when metal prices and where the area was nine months ago, the company was losing money and had debt and today it’s making money and paying the debt down quickly, and it’s gone from an asset where you thought you just couldn’t invest in, to an asset that you could invest in. Very importantly, if the basket price continues to go up, which we think it will because there is a shortage of five of the six metals in the PGM basket, all five of them, except for platinum, are in a deficit position and we think the rand is vulnerable and it’s unlikely to strengthen from here.

So we think the basket price will keep going up. So we’re saying that at spot net you’ll maybe be paying at eight times earnings, if the basket goes up another 10% that eight P/E becomes a four P/E very quickly. So Impala still trades at one-seventh of its replacement cost, which is a very important thing. Despite the share tripling it still would cost seven times as much as the share price to rebuild those platinum mines. So we see the share significantly undervalued. 

Kumba’s spectacular recovery

RYK VAN NIEKERK: Kumba was another share that actually fell extremely far around five years ago but since then has recovered spectacularly, even more so than Impala. Obviously hindsight doesn’t help you at all, how do you look at the performances of companies such as Kumba, companies that have performed better than the ones you have chosen?

JOHN BICCARD: It’s a good question, it’s interesting you chose Kumba because actually a year ago that was a comparison we did in one of our presentations, where we build the case that Impala was going to be the next Kumba. So exactly what you’re saying, Kumba was one R600 share and the iron ore price was US$200, then Kumba was a R30 share and the iron ore price was $40. We didn’t buy Kumba mainly because we didn’t see a deficit in the iron ore price. 

The deficit in iron ore but for whatever reasons which are – you don’t have to go into all of them – but the iron ore price then, Kumba was R30/share and the iron ore price was $40. The iron ore price then went from $40 to about $75 unexpectedly and I have to say I did not foresee that at all with the iron ore price and obviously the market didn’t. That rise in the iron ore price drove Kumba from R30 to R400, which you have alluded to, and actually last year Kumba made R30/share.

So here was a share that was trading at R30 and no one wanted it and then two years later it actually made R30/share. That’s why the share went up 10 or 12 times. Our argument is that exactly the same thing is going to happen to Impala, where the share has dropped 90%, the share was trading at R16 and I can show you a scenario, and a scenario that’s not far from today’s prices of the rand and metal prices, where Impala made R16/share.

I would say, just off the top of my head, if the rand PGM basket rose 20% from today’s level, which is not that much, all we need is palladium to go up another 10%, 15% and the rand to weaken 10%, both of which are very possible, Impala could earn R16/share and earn the share price that is was. So your point is right, these things happen in mining all the time and we didn’t, as it happened, buy Kumba, although we knew Kumba was really cheap at R30, at the time I didn’t think there was a case for the iron ore price to go up and it did. So we’re seeing the same thing with Impala and I can build you a strong case on why the PGM prices should go up and that’s mainly because there’s a shortage of metal in the world, so we’re happy to stick to that. So we think Impala is on the same road as what Kumba was over that period.

RYK VAN NIEKERK: Just lastly, the local market really took a beating last year, especially in the mid-cap sector, are you buying in the sector at the moment because it seems like there are many well-managed and good, solid companies that seem to be oversold.

JOHN BICCARD: Yes, so the summary of the fund’s positions is we’ve got one-third in platinum, one-third offshore in the global value fund and one-third in mid and small cap South African shares. We actually have not one share in the Alsi 40, which is quite an extreme position but we do not see any value in large cap banks, retailers, large cap miners.

So that’s where we’re positioned and we think mid- and small-caps in South Africa are priced like South Africa is Zimbabwe, which is a debatable point but at least they’re trading on the equivalent of five times earnings. So we see lots of value there.

SA retailers are still priced way too high, even though they’ve come down a lot, they’re still trading on 18 times earnings, which we think is a ridiculously high valuation, given the outlook for the domestic economy in South Africa. So we’re not interested in the retailers, and the banks are cheaper than the retailers but they’re at best fair value, they’re probably slightly overvalued on ten, eleven times earnings. So we’ve got none of the large caps and we find a lot of value.

We put our money in Mediclinic, which has fallen from R200 to R50 and trades on eight times earnings. We’ve put our money in Nampak, which is the same price as 25 years ago and trades on seven times earnings. Also shares like Tongaat and Hulamin, we think that’s where the value is in South Africa and at least those valuations have discounted a worst case outcome for the domestic economy, whereas a lot of the bigger shares are still priced for a very, very favourable outcome in South Africa.

RYK VAN NIEKERK: We’ll have to leave it there. Thank you, John. That was John Biccard, he is the manager of the Investec Value Fund.

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Good interview. Thanks.

Problem with these funds are going in too early. And investors like me, investing in this fund too early.

Not sure what you mean by this comment but it could mean you are ‘timing’ the fund, which in my opinion is a complete loser’s game. You are either a value investor, who aligns with Biccard’s value investing methods, or you are not. Investor’s destroy more value through behavioural errors and biases than any other means and that includes costs.

“However beautiful the strategy, you should occasionally look at the results.” -Petrolpumporacle

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