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Investors who can look beyond extreme sentiment will find opportunity

‘What 2018 showed us is how the pendulum of investor sentiment operates.’

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 Delphine Govender, she’s the co-founder and chief investment officer of the boutique asset management group, Perpetua. Delphine, welcome to the show, let’s start with Jerome Powell, the chairman of the Fed, and on Wednesday he actually surprised the market and adopted a surprisingly dovish tone about the US economy and this sparked a stock market rally and weakened the dollar a bit. Powell hinted that the US may be at the end of a rate cycle and that the Fed may reduce the liquidity in the market a bit faster than was previously expected. What do you make of this and what do you think the impact on South Africa can be?

DELPHINE GOVENDER: Thank you Ryk, thank you for the opportunity. What we have gotten used to, I think particularly from the end of 2017 until today, is living with surprises. This volatility and the shift in the market, particularly in the last 12 to 14 months, are realities that we need to start to learn to live with.

Coming back to your question specifically, I think many market participants saw the year ahead as one where we knew that global growth was going to start to plateau, particularly because the US has come off a fairly decent run and many people are looking more to emerging markets for economic growth, as opposed to developed markets. So as you entered this year with interest rates uncertain in the US but not expecting significantly more to come, there was uncertainty about whether that would happen.

What we have seen is now some clear direction that there will be a pause on interest rate hikes, as long as there is no inflation overshoot, which doesn’t look likely.

The market was probably not expecting to hear as soon as it did. We thought as the quarters unfolded that there would be some direction. At the same time, we are starting to see that the reality of the underlying fundamentals needing to come through is critical, which the US has done.

Now while I think South Africa will benefit in some ways from this direction and just purely because of sentiment moving slightly positive on a global perspective, there is still way too much uncertainty that exists in the world at large, particularly the trade wars, the Brexit issue, emerging markets, the Argentinian debt issue, Italy, Turkey, which haven’t gone away. What has moved at the end of Wednesday night was that the Fed’s interest rate hike impasse is not going to be adding to those uncertainties, so that was probably a positive.

RYK VAN NIEKERK: The market reacted quite positively, the Dow rose by 1.8%, the
S&P 500 by 1.5% and the Nasdaq by 2.2%. This means that the Dow has now gained more than 7% this year so far, the S&P 500 has gained 6.9%, the Nasdaq up 8.3%, so quite a positive reaction this year, as opposed to the dreadful last year.

DELPHINE GOVENDER: Yes, absolutely, bear in mind that we had a shocker in December in global markets, particularly in the US. So we’re coming off quite a low starting point for the beginning of the year.

If the market didn’t have that big leg down in December, we might not see the kind of level of year-to-date returns. The starting point is always important for perspective. But yes, if we were not dealing with all the other uncertainties that I listed earlier we might even have seen a sharper rally. However, given the starting point I think those are decent returns, absolutely.

A year of recalibration

RYK VAN NIEKERK: The local market last year also had a poor year, we are at the end of January currently, do you think we can sustain a positive momentum for the rest of the year?

DELPHINE GOVENDER: We would like to think so. In 2018, I call it the year of recalibrational rebasing, we almost all knew that it was inevitable. I think what was surprising for South Africa particularly is that it happened in the absence of any major crisis that transmitted to our market.

It was just a rebasing year, where we gave up a whole bunch of returns that we had accumulated over the five to seven years prior.

If you look at the extent of Alsi returns, we really saw very high returns from the South African stock market, say from 2009 to around 2013, and then in the last four to five years it’s come back fairly in terms of quantum.

Again, going back to my point that I mentioned earlier, we’ve rebased, so the potential for return is higher from these levels but you’re also dealing with an environment where profits are not very visible, meaning in the next six to 12 months we can’t really get directions. If you see the slew of trading updates coming from many of the consumer-facing companies, many are warning about negative earnings growth for the first time in several years for many of them. So we still have that to work out of the system.

What was important last year was that the negative returns from the South African stock market were really driven by a derating, so P/E multiples coming down after they had been elevated to incredibly high levels and stayed there for many years. That kind of rebasing and recalibration of the P/E multiple is quite important for a sustainable return. We’re more optimistic for the year ahead but I think it’s very much more stock-driven than necessarily market driven.

RYK VAN NIEKERK: Yes, a rebasing in asset management terms roughly translated means opportunities. You manage the Balanced Fund and you’re also one of the managers of the equity fund, the Perpetua Equity Fund, have you changed your approach since last year, are you actually buying currently in the market?

DELPHINE GOVENDER: Last year we were already starting to get a little bit more optimistic on the prospective returns. Again, exactly for the reason you mentioned, which was declining markets. While declining markets are awful to experience as investors, as you see returns evaporate, some of those returns are potentially unsustainable in the first place. So they were a boon, a nice to have, a bit of a free gift, so to speak, and then they evaporate. But declining markets present you with opportunity and that’s exactly what we started to see, hard as they may be to see when you are in them because you are in the momentum of negative sentiment cycle and a negative visibility cycle, meaning visibility is poor on where returns will come from.

As this year has started. we haven’t changed our strategy, we continue to increase our South African equity exposure in the fund.

The balanced fund, as you mentioned, also has the ability to invest in global, so that also is near its maximum in its global exposure. But I think, importantly, within the stocks in the South African equity exposure we’ve started to source opportunities from many more stocks than perhaps three or four years ago when opportunities were concentrated in a very small part of the market, for example like resources.

Pioneer, Tiger Brands, Woolies and BAT

RYK VAN NIEKERK: Can you name a few?

DELPHINE GOVENDER: Sure, some of the shares we’ve been adding to in the last several months, shares like the food producers, Pioneer, Tiger Brands, both those stocks have fallen. Pioneer has come all the way down from R200 about a year-and-a-half ago and is now trading in the 80s. Tiger, equally, was trading above R400 last year, if we were speaking this time, and now it’s at the R260, R270 level. Part of that was self-inflicted; we know there were the listeriosis issues in the first part of last year. Both of these stocks we didn’t own in size, Tiger we had zero holding a year ago, Pioneer we had a small holding, sold some and then bought it back when we saw how much it has come back.

Both of them have fallen as much as they have because it’s really tough trading conditions and the biggest issue facing many of the South African consumer companies was on the manufacturing, producing and selling leg has been very low food inflation particularly. So what we’ve seen is the ability to grow topline, retailers need inflation because inflation is what helps them put prices up. When inflation is negative that means you are starting with your revenue being negative from the get-go.

The food producers have it even worse because they have rising input costs, so they’re paying more for the product but they can’t pass that price across, so their margins get squeezed. That’s a classic cyclical situation and that’s exactly what happened to both of those companies. So now we think pretty good quality business, which has fallen on tough cyclical times are being sold down as if they are poor quality. On the retail side as well we’ve been adding a little bit to the likes of Woolies.

RYK VAN NIEKERK: Looking at the top 10 equity holdings of both your balanced fund and the equity fund, right at the top is British American Tobacco, that lost more than 40% last year, and Woolies as well, which was also under immense pressure, when did you buy those counters?

DELPHINE GOVENDER: Woolies is a stock that we started buying in about 2017 in size but remember, Woolies was over R100 in 2016 and then it fell to at first R80 and then R70 and by the end of 2017 it was in the 60s, and then through last year it really had that next leg down from R60 to I think as low as the high 40s and it’s trading around the high 40 level at the moment.

British American Tobacco has traded probably between R650, R750 for most of last year, we had a fair value above that and obviously with the news in December about the potential banning of menthol cigarettes the shares fell all the way from R600 down to R450, where it’s been trading, I think it touched as low as R430 earlier this week and has bounced from that.

Both of these stocks are slightly different situations. With the benefit of hindsight we might have entered those stocks early,

One of the important things to remember with investing is what matters is not whether the share price is falling or rising, it’s what is the business worth.

For both those examples we think the share prices are completely undervaluing the worth of the business, even with new information and the British American Tobacco example, where potential profit will be evaporated should the menthol banning go through or effectively hit. So we think that the fair value for British American Tobacco even in a scenario where menthol cigarettes are banned in a few years’ time, which will affect their US profits, the business is still worth significantly more than the current share price, less than we might have thought it was worth a year ago when menthol banning was not mentioned but still significantly higher and I think that’s the importance of when you’re investing, invest with a margin of safety because events that you don’t expect to happen can happen.

RYK VAN NIEKERK: The current P/E of British American Tobacco is under 4% and the forward P/E is under 9%, 8.4% according to Profile Media, and a dividend yield of nearly 8%, it does seem to be very attractive.

DELPHINE GOVENDER: The problem with the “market” is often individuals believe that if they’re trading a stock today at R450, that is the value because that’s what a willing buyer is prepared to pay but it’s not. The value is higher but you’re also dealing in a period of uncertainty and what investors in the market fear the most [is] poor, short-term visibility because that gives them no ability to figure out where a price might settle, believing that price’s value. This creates opportunities for investors like us who are willing to look through the extreme sentiment in the market.

What 2018 really showed us is how that pendulum of investor sentiment operates.

If we were speaking three years ago and we spoke about Woolies, BTI and Tiger being in our top 10 and some of the other stocks that are there now, you wouldn’t have asked any questions about those shares because they were popular shares to own; good quality businesses whose share prices, in many instances, would have been 60%, 70%, 80% higher than they currently are now. That’s the irony. After a lot of these stocks have fallen, albeit with some new information, people are surprised to see them in the top 10, despite the fact that they are way more attractive now than they ever were in the last three years.

RYK VAN NIEKERK: On the short-term horizon for South Africa, we will see an election and we’ve already seen some populist comments from various political parties. It will be a tough election to fight for many parties, do you think that will affect markets at all?

DELPHINE GOVENDER: I think it will, it’s natural if you look at the geopolitical impact that we’ve been experiencing in the world over the last five to seven years and how that’s really transmitted into markets globally. What we’re finding with South Africa is that it becomes what we call range-bound in nature, where markets struggle to really go through a level because there’s this broader uncertainty about potential policy changes, broader uncertainty about who will lead, the fiscal constraints that we’re operating with in in this country… As important as the election is, equally important is next month’s budget and where the money is for things like Eskom and the other important foundations that we need in our economy over and above political stability.

RYK VAN NIEKERK: We live in interesting times indeed. We’ll have to leave it there. Thank you, Delphine. That was Delphine Govender, she’s the co-founder and chief investment officer of the boutique asset management group, Perpetua.


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” the year of recalibrational rebasing”. A new phrase for poor performance? Why not just say that the market estimates that future cash flows from firms in South Africa will be lower than previously thought?

Recalibrate and rebase mean the same thing, so “recalibrational rebasing” is gobbledygook. She’s trying to sound intelligent without actually saying anything intelligent. That’s how you underperform your benchmark by 5% p.a. since inception.

End of comments.





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