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Webinar: Dr Adrian Enthoven – Positioning for a recovery: Anchor answers your questions (Peter Armitage)

29 April 2020

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by Peter Armitage, CEO

  1. Global equities and the rand strengthening: You spoke about both the upside return potential as a result of a recovery in global equities, as well as the reversion of the rand back down to fair value. How do you approach the offsetting nature of a global equity recovery with the local currency strengthening? Given their offsetting nature, coupled with the volatility on both fronts, would it not be better to capitalise on the weaker rand and high local bond yields in the short term, while we wait out some stability before re-entering global equity markets? Also, where do local rand hedge stocks fall in this equation?

We are currently not advocating that investors take money out of SA en masse. Although we see many opportunities in global markets, as we have highlighted in our presentation, we agree that the rand, which can be viewed as a risk asset, is extremely undervalued at current levels. The Anchor Recovery Portfolio is best suited for those investors that have already taken cash offshore. It is also important to re-emphasise that our Anchor Recovery Portfolio should not replace a quality core portfolio but is only there to supplement such a well-constructed portfolio.

For those local investors who wish to get some exposure to the Anchor Recovery Portfolio, the decision process is trickier. Although we view the balance of probabilities as being slightly favourable to the SA economy recovering, and with that we should see significant rand appreciation, there is a scenario where the local economy will continue to lag the global economy significantly over the next few years. In such a scenario, we believe that the rand should still appreciate, but the potential return of the Anchor Recovery Portfolio will then be more than offset by this rand appreciation. We will therefore continue to advocate a balanced approach for SA investors. It is our view that local investors should continue to diversify their portfolios on a moderate, but continual, basis. Trying to time the rand’s movements is, to our mind, a fool’s errand.

While hedging the currency is indeed an option for some investors, the costs are onerous for small portfolios. We are currently in the process of investigating ways to pool assets and then hedge the currency on a more cost-effective basis. We will keep investors updated once an optimal solution has been found.

  1. Resources: The resources sector sits at the centre of the JSE’s recovery from current lows, particularly at prevailing commodity prices and with the exchange rate where it is. What is your view on the resources sector in the short- and medium-term and, in particular, regarding gold stocks and Sasol?

We have been very surprised by the resilience of the iron ore price throughout this period of extreme volatility. Iron ore is down c. 8% YTD compared with oil that has plummeted by c. 70%, copper that is down c. 17% (from already depressed levels in 2019) and the Bloomberg Commodity Index which is c. 25% lower YTD (admittedly, oil is the most significant weighting in this basket) . Commodity prices are driven by economic activity and, given what has happened to the global economy over the past few months, it is difficult to understand how iron ore has remained so resilient over the period. We will therefore be extremely cautious of the diversified miners that are very reliant on iron ore (ala BHP).

We remain reasonably constructive on platinum group metals (PGMs), but we are keeping a very close eye on the recovery of global vehicle sales post the worldwide lockdowns. We believe that the PGM market is still reasonably balanced even after the slump in global vehicle sales. This is very much due to the fire at AngloPlatinum’s refinery and the consequent force majeure on PGM supply from that refinery. While we are reluctant to take a significant position in this sector, we still see it as offering reasonable value.

Gold is always the most difficult commodity to forecast as demand/supply dynamics have no bearing on the price. We thus cannot advocate that we are in any way in a better position to predict the gold price from any other market participant. But, taking a more macro view, it is very difficult to imagine a world more suited to a gold price rally. With central banks printing money at unprecedented levels and governments stepping forward with significant fiscal stimulus, global markets will be awash with liquidity. Yet, corporates may grapple with liquidity issues as they struggle to generate top-line sales during and after the various lockdowns. Financial market liquidity will thus have to find a home, and equities may not be the preferred asset class. That will leave bonds and physical assets. The poor state of global economies and, consequently, worlds governments, may force investors to clamour into the few liquid physical assets available.

While it is difficult to imagine a better scenario for gold (or physical assets), it is almost impossible to imagine a worse scenario for Sasol. The company was already under pressure going into this crisis due to massive cost overruns at its Lake Charles Chemical Project (LCCP) and the strain that this caused on the company’s balance sheet. The silver lining for Sasol was always that it can generate strong free cash flow and once the LCCP was completed it should have been able to quite quickly start to deleverage its strained balance sheet. However, now with oil hovering below $30/bbl and the global chemicals market under pressure due to poor economic conditions, that strong free cash flow is also questionable. Nevertheless, we highlight that the current share price is already pricing in a very negative outlook for the company. So, should the global economy improve, oil prices revert to their longer-term norm of c. $50/bbl to $60/bbl and Sasol’s financiers be willing to relax the Group’s debt covenants for a short period, we see significant upside in the share price. The risks are, however, extremely high, and investors should be prepared to follow a rights issue (if that was to be announced).

  1. Leverage: The relative leverage on the balance sheets of local companies is going to be fundamental to their resilience through this recession. Those companies that do survive with strong balance sheets intact are going to be faced with significant opportunities in a more open market (assuming some corporate failures as a result of the recession) when SA emerges from this downcycle. What are your favourite stocks which you believe are well positioned both to weather the current storm and to best capitalise on a recovery thereafter?

We cannot agree more with this assertion. Balance sheet strength is one of the key variables to us in these uncertain times. In terms of our favourite counters, four companies come to mind that have entered the current crisis with a very strong balance sheet. They are, however, all facing significant headwinds due to the lockdowns and we are expecting some very depressed earnings numbers from all four of these businesses over the short- to medium-term. Nevertheless, over the longer term, we believe that these companies are extremely well placed to take advantage of an improvement in the operating environment, either by acquiring quality businesses at depressed prices or by getting their operations up and running faster than their competitors.

AVI: AVI has always been a strong cash generator. It entered the current crisis with a strong balance sheet with its net debt to EBITDA at less than 1x. Over the past few years, AVI has suffered from increased competition in some of its key categories such as tea, coffee and biscuits but, we believe, that this crisis will wash out many of the Group’s competitors.

Mr Price: Mr Price entered the COVID-19-crisis with a net cash position. In fact, at the time of writing, Mr Price’s cash pile was equivalent to c. 10% of its market cap. Although we do not believe that Mr Price will be too keen on acquiring another business in SA, it is very well placed to emerge from this crisis in a stronger position than many of its competitors.

Bidvest: Again, it will be difficult for Bidvest to make significant acquisitions in SA, and with the rand at c. R19 vs the dollar, it will also be difficult for it to acquire a business offshore. But again, in our view, Bidvest is well-positioned to survive this crisis and should be able to grow its already considerable market share in SA.

BidCorp: BidCorp’s strategy has always been to buy independent food services companies and bring these under the BidCorp banner. This has allowed entrepreneurs to remain reasonably independent while benefiting from BidCorp’s corporate muscle (branding, logistics and balance sheet). In the past, the Group’s biggest challenge in acquiring these independent businesses was to convince their owners to sell. However, we think that this crisis will prove to be very persuasive to such business owners.

 

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