11 April 2018


by Sean Ashton

Executive summary

Following a robust end to 2017, 1Q18 was characterised by significant volatility in equity markets, both domestically and offshore. The principal driver of this has been rising bond yields, pressuring equity valuations via higher discount rates. Growing concerns over a more protectionist approach from the Trump administration also weighed on equity markets. The pressure on valuation multiples associated with normalising interest rates has been felt most acutely in “yield proxies” such as British American Tobacco (down 16% in 1Q18) and AB InBev, which played a part in holding back returns on the JSE, while the strong rand (+4% during the quarter) proved a continued headwind to the sizeable rand-hedge component of the local market. Most notably for the JSE, listed property was a big drag, while Naspers’ discount continued to widen sharply. The Capped SWIX Index ended the quarter down by 5% on a total return basis, with Naspers and the Resilient group of companies (property) accounting for ~60% of the decline.


Listed property a large 1Q18 detractor: a terrible advert for passive investment in SA

The SA-listed property sector is highly bifurcated and demonstrates that passive investment is a bad strategy in this particular sector locally. Despite modest gains from “domestic” bellwether stocks such as Growthpoint (we hold an overweight in our equity mandates) – the Property Index was held back by steep losses from the Resilient Group of companies. This is due to a combination of very high starting valuations (in many cases 2x P/NAV), a business model which relied on continued capital raises at premiums to book value; and well-publicised corporate governance concerns over the economic merits of the Group’s cross-shareholding structures and associated intragroup share trading. Given how steep the losses have been in these shares (~45%-70% down in 1Q18), a detraction of close to 2% from the performance of the Capped SWIX during 1Q18 is perhaps unsurprising. Whilst share prices have begun to more closely reflect valuation reality, we believe corporate governance will continue to prove an overhang on these stocks for some time, hindering the Group’s ability to effect capital raises as in the past. Our positioning in listed property remains focussed on the large liquid counters which will benefit from a decline in the cost of capital in SA, notably Growthpoint and Redefine.

Figure 1: Sharp losses from Resilient group companies in 1Q18

Figure 2: Domestic equities – valuation metrics and total return expectations for the next twelve months

Naspers under pressure to justify its existence outside of Tencent; significant drag on 1Q18 market returns

Following an investor day in New York in late 2017, which failed to allay investors’ concerns about how much value is being created by Naspers’ management outside of its Tencent stake, the Group in late March announced a bookbuild to sell down around 2% of its 33% holding in Tencent to free up capital to deploy into its other e-commerce businesses. Our reaction to this news is mixed: while it is encouraging that the Group has demonstrated a willingness and ability to partially monetise this asset (and hence unlock the discount it trades at on this portion of Tencent), it could also signal that the other e-commerce assets still do not have sufficient scale to self-fund their growth, while investors could suggest that Naspers would be “throwing good money after bad.” We would have preferred to see a larger placement of Tencent stock, with at least a portion of the proceeds being utilised to buy back Naspers shares and hence convincingly reducing the discount to sum-of-the-parts (SoTP). The discount remains unacceptably large at >40% and, while we believe there is reason for it to shrink (as a result of our expectation that ecommerce ex-Tencent losses begin to contract), we don’t expect to see it in the low-30%s due to management’s apparent stubbornness in not pursuing a buy-back, despite many shareholders raising this issue. Furthermore, it should be noted that Tencent’s valuation – despite continued excellent results – is high at a forward 37x multiple, and we believe some share price consolidation is likely, which is what we saw in 1Q18 (albeit with significant volatility). Naspers’ share price declined 16% in 1Q18, exerting significant pressure on overall market returns. We are more sanguine about returns going forward, given the recent underperformance and a very high discount to SoTPs, despite our expectation of a further valuation multiple compression from Tencent.

Figure 3: Naspers SoTP value per share

(*) Includes OLX (Classifieds), e-tailing.

(**) Cash from Tencent placement.

Sectors which witnessed a continuation of the gains of late 2017 included banks and general retailers. This, as investors continued to price in a prospective rise in the earnings and return on equity profile of these companies as a consequence of much higher consumer and business confidence. This has been our logic in rotating our equity positioning into domestic cyclicals as we believe consumer sentiment leads fundamentals. However, much of this has been priced into valuations fairly swiftly (see Figure 4 below; general retailers close to peak ratings, albeit on stilldepressed earnings bases). Thus, while we believe the trend is upward for these companies, we think that a tactical approach is required and we have actively taken profits on certain counters in anticipation of better entry points.

Figure 4: General Retail Index P/E: substantial 1Q18 re-rating

We continue to expect mid- to high-teen annualised returns from SA equities in the next twelve months, with the de-rating in 1Q18 happening faster, and to a greater extent, than we had expected. By our bottom-up estimates, SA equities trade at 13.8x forward earnings and offer a 3.5% dividend yield – we believe this represents fairly attractive value. We also don’t expect a repeat of the deep losses from the Resilient stable which were a material influence on equity market returns at an index level, while rising interest rates in the developed world probably mean that the rand has experienced the bulk of its gains. As a reminder to investors, a strong rand tends to be a net negative for most of the JSE outside of banks, retailers, insurance and listed property.



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