Continuing trade war worries, a widely expected US Federal Reserve (Fed’s) 25-bpt rate hike and a more hawkish tone to the Fed’s outlook in the post-meeting statement took their toll on the SA market. It was red across the board on the JSE for September, with the FTSE JSE All Share Index (J203) closing Friday 5.0% lower MoM (down 6.4% YTD) at 55,708.5- well below the 60,000-point mark it crossed on 28 August. Disappointing MoM performances from large constituents such as BHP Billiton (-1.8%), British American Tobacco (-6.3%), Naspers (-6.6%) and Richemont (-11.1%) conspired to drag the JSE lower. While some large mining majors (BHP Billiton) weighed on the resources sector, good performances from the likes of Glencore (+2.1% MoM), Anglo American (+7.8% MoM), Kumba Iron Ore (+21.1%) and especially Impala Platinum (+53.6% MoM) managed to stymie Resi-20 losses (-1.1% MoM). Overall, industrial counters were the worst impacted with the Indi-25 dropping 8.6% (-13.2% YTD), while financials declined by 3.7% MoM (-7.3% YTD).
Gold remained on the back foot as a strong greenback and Fed indications that it will pursue tighter monetary policy weighed on the yellow metal (higher US rates boost the dollar, pushing bond yields higher and putting pressure on the gold price). Gold is down c. 13% from its April high, dropping for a sixth-straight month (-0.9%) to end September at $1,190.88/oz, largely due to a rampant dollar. Platinum was c. 4.0% higher MoM, at around $822/oz, while the benchmark iron ore spot price rose c. 3.0% MoM to end September at the $68 level.
While EM currencies remained under pressure there was some degree of a rebound which the rand traced fairly closely. A refinanced loan by Turkey’s second-largest listed bank allayed concern of a debt crisis in that country, while Argentina was promised extra money and faster payments from the IMF, which expanded an already record bailout to $57bn over three years. The rand got a respite, rebounding 3.7% in September after a 10.6% drop in August, but the currency is still down 14.7% YTD.
On the macro front, SA entered a technical recession (the first since 2009) as GDP data showed that the economy shrank for a second consecutive quarter. According to Stats SA, the local economy shrank 0.7% in 2Q18, following a revised 2.6% contraction in 1Q18. August CPI slowed unexpectedly following three successive monthly increases, with headline CPI decelerating to 4.9% YoY in August from 5.1% in July and contracting by 0.1% MoM after July’s 0.8% MoM rise. Core inflation, excluding the volatile food, beverages, energy etc. categories, declined to 4.2% YoY vs 4.3% in July. Meanwhile, the SA Reserve Bank’s (SARB’s) Monetary Policy Committee (MPC) left the repo rate unchanged (6.5%) at its September meeting, citing an expected increase in inflation later this year and a weak economic growth environment.
In politics, President Cyril Ramaphosa continued his uphill battle to revive the SA economy in the face of many headwinds, including a lack of business confidence, sizeable fuel price and VAT increases dampening consumer spending and fiscal difficulties, which are expected to remain a constraint on the economy for the foreseeable future. Nevertheless, Ramaphosa announced a R50bn stimulus package in September and while many criticised it for being largely different spending rather than new money, others saw it as a good start. Mineral Resources Minister Gwede Mantashe published the latest revisions to the Mining Charter with the few changes made mostly well received and likely to be viewed as positive by the mining industry.
Aspen under pressure
Aspen Pharmacare came under significant pressure in September following the release of disappointing FY18 results and concern over the company’s debt. In addition, the market seemingly took a dim view of the $860mn Aspen received from the sale of its baby formula business to Lascalis. The Aspen share price closed September 42% lower MoM.
The share price reaction can be attributed to the following:
- Debt increasing to R46bn, which is optically high (its net debt to EBITDA is lofty at just below 4x). This is before applying the Lascalis cash proceeds.
- The sale of the company’s infant milk business at a price lower than the $1bn-$1.5bn the market had expected (although we note that the net R11bn proceeds will help reduce debt).
- Low organic growth in the second half (+/-3%), with significant declines in parts of the business offsetting growth areas (notably China).
Aspen’s current historic PE is 11x following last month’s share price decline. However, having said that, the earnings growth outlook is rather muted. FY19 guidance is for 1%-4% YoY organic turnover growth for commercial pharma (accounting for 83% of turnover) and turnover going backwards in manufacturing (17% of turnover). This suggests constant currency earnings growth of low to mid-single digits (0%-5%).
Given that the majority of the firm’s earnings is from outside SA, there could well be a big positive currency impact on earnings if current spot rates are sustained. This growth outlook is a step down from the market’s expectations of 10%-15% sustainable growth prior to the release of its results last month. The combination of the muted growth outlook, high debt load and declining return on equity is concerning the market at present. It might well be premature to decide on a more positive view on the company.
Peter Armitage, Chief Executive Officer
MTN: Nigeria déjà vu
Once again MTN has been in the news recently for all the wrong reasons, with Nigerian authorities making two demands in quick succession: (1) that MTN return $8.1bn of dividends allegedly illegally repatriated between 2007 and 2015; and (2) that an additional $1.3bn in taxes, allegedly underpaid by MTN on equipment imported, be paid. MTN management has strenuously denied any wrongdoing on both counts and has pledged to defend MTN Nigeria’s position.
Prior to the emergence of these allegations, our investment thesis on MTN was that it was emerging from a perfect storm of macroeconomic headwinds in key markets (thanks in no small part to the recovery in the oil price), aggressive price competition, negative regulatory interventions and strategic missteps of its own. In the wise words of Winston Churchill, “never let a good crisis go to waste”. Despite the considerable financial pain it has caused shareholders, this perfect storm has been the catalyst for extensive senior management changes and, for an organisation seen as arrogant and weak on execution, acted as a lightning rod for cultural change. Furthermore, restricted investment by international mobile operators in their African operations leaves MTN’s main competitors with more limited network capacity with which to initiate further aggressive price competition going forward. As a top-2 market share operator across all its markets, and with those markets collectively still representing one of very few basic telco growth stories left in the world, the stars are aligning for an operational turnaround. We expect MTN to deliver a three-year revenue CAGR of c. 10% with efficiency initiatives driving margin expansion and translating into double-digit profit growth. With capital intensity expected to moderate after three years of elevated spend, we anticipate free cash flow to grow at close to a 20% CAGR over the next three years, with the dividend growing at a similar clip.
The Nigerian government’s demand to return $8.1bn in dividends to the country is theoretically not a complete loss for MTN, as these funds should be returned to MTN Nigeria. However, the problem is the government’s insistence that this be done at the same exchange rate at which they were externalised in the first place – $1/NGN160 then vs an exchange rate of $1/NGN364 currently. The implied exchange loss here equates to c. $4.5bn. Add to that the tax claim of $1.3bn and MTN’s potential loss stands at $5.8bn. At the time the Nigerian authorities made these demands, this translated into a potential loss of c. R88.5bn. This equates to 44% of MTN’s market capitalisation prior to these demands being announced!
We estimate the value of MTN’s 78% stake in MTN Nigeria at c. $4bn (R55bn-R60bn depending on the exchange rate). Ignoring, for a moment, the validity of the Nigerian authorities’ claims or MTN’s ability to raise the cash to meet these demands, this presents the very real question as to whether MTN would be better off to walk away from its investment in Nigeria altogether! Indeed, with these figures in mind, it is not hard to make the logical deduction that these demands were the first step in a ploy to expropriate MTN’s business in Nigeria. In the two weeks following the disclosure of these demands, MTN’s share price fell from R107/share to R70/share, wiping R70bn off its market value, and implying that the market had reached exactly this conclusion – entirely writing off the value of MTN Nigeria.
Subsequently, comments from the Nigerian authorities that they were reviewing further information provided and implying a softening in their position has seen about R36bn of value written back. With MTN remaining resolute that it has committed no wrong in Nigeria and potentially able to defend its position legally in The Hague in terms of a bilateral investment treaty between Nigeria and South Africa, the market has begun to price in the probability of a favourable resolution for MTN. The complicated politics that lie behind regulatory interventions such as this in Nigeria, mean investors should be cautious about assuming that these matters will be resolved easily or quickly. However, if they are resolved in MTN’s favour, this will likely still prove to have been an attractive entry point to gain exposure to MTN’s operational recovery over the next few years.
Mike Gresty, RCI – Chief Investment Officer