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Market gloom opens attractive buys

Difficult local conditions have led to a material de-rating in equity valuations.

The tough local environment is a challenge for most companies, and many local investors are feeling the pain after a somewhat demoralising third quarter.

Despite a bumper start to the year for local markets, South Africa’s stop-start economic growth, and mixed signals from government on policy reform saw business confidence hit an all-time low in August, while the JSE All Share Index ended September in the red for the third consecutive month.

Then, further compounding the general mood of despondency, negative sentiment, policy uncertainty and Eskom-related anxiety saw the World Bank cut its 2019 growth forecast for South Africa by half a percentage point to 0.8%.

However, in some good news for investors, difficult local conditions have led to a material de-rating in equity valuations, creating several enticing opportunities in higher-quality companies that were previously expensive, or were trading on historically demanding multiples.

While local industries will likely continue to be challenged by the weak environment, select companies that are supported by higher quality or defensive attributes are also set to fare relatively better as we inch towards a brighter setting in the economic cycle. These attributes include stable business models, above-average returns on invested capital (ROIC), industry prominence, balance sheet strength and high cash generation, amongst other factors.

In our view, some of the attractive companies on offer include:

RMB Holdings (RMH)

Source: Iress, 2019

Since its listing in 1993, RMH has provided shareholders with a vehicle to co-invest with the founders of FirstRand (which makes up 99.3% of RMH’s intrinsic value). RMH’s discount to net asset value (NAV) is currently around 11%, thus offering an attractive investment into FirstRand. This compares to the three- and seven-year average discounts to intrinsic value of 6.8% and 3.3% respectively. With quality management behind the group, the business’ strategy to deliver superior earnings, dividend growth and sustained long-term capital growth will also appeal to many investors.

The primary asset, FirstRand, is a high-quality banking and financial services operation that has historically traded at a material premium to its peers. FirstRand has momentum behind its franchise, and its strong core operating performance looks set to continue, albeit at a lower level of growth. Return on equity (ROE) is likely to moderate from the current level (22%), but we believe that ROE can be supported within management’s target range of 18%-22%. And, while the group continues to trade at a premium to peers, the stock has de-rated, providing an attractive entry point.

The current price-earnings (P/E) multiple is 12.8 times, with an attractive dividend yield of 4.6%. This is made further enticing through RMH’s discount to NAV.

Given the structural nature of South Africa’s challenges, companies will have to execute appropriate strategies in order to produce growth, and we believe that RMH should be able to deliver on this promise with its current portfolio.

MultiChoice Group

The MultiChoice Group (MCG) is a pay-TV operator with 15 million subscribers, a 30-year track record and a presence in 50 countries across Africa. The MCG group comprises:

·         A South African pay-TV asset (67% of revenue), which has a relatively mature growth profile and a strong track record of free cash flow generation;

·         A loss-making, but high potential rest-of-Africa pay-TV portfolio (28% of revenue); and

·         Irdeto, a platform for digital security.

The share price has recently come under pressure, mainly due to headline risks around its rest-of-Africa strategy, premium subscriber erosion in South Africa and concerns over its broad-based black economic empowerment (B-BBEE) transaction.

MCG announced the details of the “flip-up” transaction prior to its listing, and as such, this transaction is not a surprise. Phuthuma Nathi (PN) shareholders (who currently own 25% of MultiChoice South Africa) are being offered shares in MCG at an exchange ratio of 0.97. The price MCG is offering PN shareholders is significantly below what we would consider to be fair value.

In our opinion, however, the recent sell-off is overdone, and the price (R120 per share) offers an attractive entry point into this high-quality investment. The group has operational leverage thanks to several cost-optimisation strategies, as well as the ability to grow market share in the middle and mass markets.

Mr Price

Source: Iress, 2019

Mr Price (MRP), a former market darling, has experienced soft sales and margin pressure in an increasingly competitive sector, but part of the retail group’s challenges was self-inflicted owing to an inappropriate product mix. Additionally, like most South African companies, MRP is at the mercy of low economic growth, indebted consumers and rising unemployment. The share has de-rated considerably (shedding 30% within a year), as deteriorating earnings and growth expectations are priced in.

Consequently, we believe the current valuation is now attractive, with a P/E multiple of 13.3 times and dividend yield of 4.6% – as compared to its historical five- and ten-year average P/E multiples of 21 and 20 respectively. And while the company may still experience challenges over the short term, this business is a high-quality asset, with net cash of R3.1 billion on its balance sheet, and some of the highest ROIC in the sector.

AVI

Source: Iress, 2019

Retail specialist AVI is home to a diverse range of businesses and recognised FMCG brands, which produce goods from sweet and savoury snacks, hot beverages and frozen foods to personal care products, cosmetics, clothing and footwear.

AVI’s trading environment is expected to remain difficult as a result of constrained consumer spending, and the company is likely to experience low or even negative growth rates until there is a meaningful improvement in the economy.

Notwithstanding this, all AVI’s businesses are targeting profit growth in the next financial year, and it represents a well-managed company with a resilient business model. Furthermore, with a P/E multiple of 15 times and a dividend yield of 5%, it is currently trading on the most attractive valuation multiple we have seen in the past five years, given its average P/E multiple of 20 times.

Samantha Steyn is the Chief Investment Officer at Cannon Asset Managers

“The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.” is locked
 
The views and opinions shared in this article belong to their author, cannot be construed as financial advice, and do not necessarily mirror the views and opinions of Moneyweb.

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Followed Cannon Asset Managers for years, arguably some of the worst performance in the biz. Wowzers, they still have AUM? These companies are quoted are the very DEFINITION of mature businesses, especially Multi-choice, those PEs are still damn high. Best of luck, can find cheaper and better alternatives offshore at those PE with same risk.

Dr Saville must have some great marketing skills.
Looking at the performance of the SuperDogs fund over the last 10 years is just sad – it has fallen short of its benchmark since 2012.
Hummingbird which seems to have a similar strategy and objectives fares only slightly better in that it’s ahead of benchmark for those investors who were there at inception…but that might be due to its lower fees and charges, more than anything else.

Wow another Asset Manager who consistently under performs, but still feels the need to punt individual stocks. Let me remind you Samantha, South Africa’s Q1 GDP fell the most in a decade, down 3.2%. So with this in the back of your mind you punt MP, RMB and MCG……wow. I punt the MSCI World Index, I wager you a kg of good coffee, my prediction will outperforms yours over the next 5 and 10 years in real monetary terms, ($, Pound or Euro), you choose.

Aye but remember the asset manager’s job is not really to grow the assets but rather maximise the fees payable. Which do Cannon do?

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