Sanlam Private Wealth’s stock picks for 2018
CAPE TOWN - This year has been one of extremes for South African equities. Alwyn van der Merwe, the director of investments at Sanlam Private Wealth, says that, among the top 40 shares on the JSE, the winners performed spectacularly – Naspers, for instance, gained 87.4% from December 1, 2016. The losers, on the other hand, performed “diabolically” – Netcare bringing up the rear with a decline of 27%.
Only 11 of the top 40 shares outperformed the average of the FTSE/JSE Top 40 Index.
Van der Merwe and his colleagues at Sanlam Private Wealth have picked South African companies they believe will do well for their shareholders in 2018.
“Over the past few years, I’ve followed a process of picking from a universe of shares that have underperformed in the preceding three years, that show value based on a number of valuation criteria, and are starting to show recovery in earnings expectations,” Van der Merwe says.
• Tongaat-Hulett (sugar production and property investments): Tongaat is an exciting recovery story, underpinned by organic capacity growth. The company’s results declined over the past three years because of an extended drought in its cane-growing areas, exacerbated over the past year by high maize prices for its starch business.
Over the next three years, we expect sugar volumes to recover and prices to return to more normal levels. Tongaat continues to monetise its extensive land portfolio successfully.
• EOH (technology services): EOH is a market darling that has fallen from grace. The group’s 17-year history of reporting earnings growth in excess of 20% came to an end in the 2017 financial year, when growth fell to 16%. In light of this slowdown, multiple concerns around the business’s stability have arisen, from the retirement of founding chief executive Asher Bohbot (he returned this week to focus on strategy and stakeholder management) to unproven and subsequently retracted media allegations of impropriety in winning government business.
But most concerning is that working capital has risen ahead of revenue recently, creating a gap between accounting profits and cash flows. This should begin to reverse. In our view, the market has punished the share price far too severely for the above issues.
• Metair (automotive components and battery manufacturer): The one-off retooling of Metair’s South African manufacturing facility and struggling European operations weighed on the share price in 2017, despite better-than-expected earnings in the first half of the year.
The company remains on a path to rebalance the business towards batteries, which have a higher profit margin and are less cyclical than auto components.
It has, however, suffered from negative news about its South African manufacturing exposure, its business in Turkey, and the assumption that lead-acid batteries will be displaced by electric vehicles. We believe investors will change their minds on these factors over time, or when the results prove these concerns unfounded. Uncertainty regarding the impact of electric vehicles is likely to linger longer, however.
• Invicta: As an importer and distributor of agricultural and construction equipment, and a leading distributor of engineering consumables and provider of engineering solutions, Invicta is often at the mercy of the strength of general economic activity, particularly within the primary sectors of mining and agriculture. One can therefore understand investors’ current scepticism when “rating” the company.
In our view, investors are being overly cautious, and patient investors are likely to be rewarded for the risk they take to invest in this share.
• Coronation Fund Managers (asset manager): Coronation’s profitability is mainly driven by its assets under management and its fee margin. Both of these were under pressure over the past three years but are expected to improve over the next year. The recent rise in the South African equity market after a three-year consolidation should start having a positive impact on Coronation’s earnings in the new financial year. Despite suffering large investment outflows over the past three years, the momentum seems to be turning, driven by activity in the institutional space and a recovery in its investment performance.
Altaf and Emile’s picks
Altaf Rooknoodeen and Emile Fourie, portfolio managers at Sanlam Private Wealth in Johannesburg and Pretoria, have selected the following shares as their picks for 2018:
• BHP Billiton (mining company): The share price doesn’t fully reflect the recent rally in commodity prices. This important point, along with the knowledge that you’re buying into high-quality assets with strong margins, should provide investors with comfort when investing in this cyclical stock. The stubbornly high iron-ore price and the recent resurgence in the oil price because of production cuts and tensions in the Middle East bode well for the company.
• Woolworths (retailer): With its successful high-end food offering (26% of operating profit) and strong Australian presence through Country Road and David Jones (41% of operating profit), it’s difficult to compare Woolies with other local retailers. Although the short-term economic environment is expected to remain tough for consumers in both South Africa and Australia, we see this as an opportune time to invest in a quality company with a highly respected management team.
• Remgro (investment holding company): Remgro has underperformed over the past few years because of its investment in Mediclinic (down 52% from its high), and exposure to locally based businesses such as First Rand and Rand Merchant Insurance (RMI).
We believe that Mediclinic’s Al Noor business in the Middle East is turning the corner and will be able to grow earnings over the longer term off the current low base. Additionally, First Rand and RMI look attractive at current price levels. At the current share price, one is buying a basket of above-average quality assets at an attractive level.
• Impala Platinum (platinum miner): As with other mining industries, the platinum industry is cyclical. Platinum-group metal prices are currently very low and below what we would consider to be the normal prices required to sustain the industry. Competitors in the sector will find it increasingly difficult to survive this trying period. Impala Platinum (Implats) has the important advantage of a strong balance sheet to operate through the low-price environment.
Carl’s rand hedges
Carl Schoeman, wealth manager at Sanlam Private Wealth in Cape Town, has selected the following two stocks as offering good protection against a potentially weak rand.
• Sasol (oil-from-coal producer): With its product priced in dollars, Sasol offers investors an attractive hedge against a depreciating rand and a rising oil price. The stock currently trades at a discount to intrinsic value because of a depressed global oil price and massive capital expenditure.
There are also questions about management’s ability to allocate capital and its hedging strategies (buying protection against fluctuations in the oil price and dollar price of the rand).
The factors favouring a rise in the share price include a depreciating rand and firming global oil prices, its Lake Charles project starting to produce revenue in the second half of 2018 and a decline in its capital expenditure.
• PPC (cement producer): In addition to the construction slowdown in South Africa, PPC has faced several headwinds, including a downgrade of its debt. Other challenges have been a public spat between the company’s former chief executive and its board, falling cement prices, and concerns over the economic viability of operations in the Democratic Republic of the Congo (DRC). The company was also subject to a merger offer in September.
PPC’s share price has reacted to the offer, almost doubling from its lows (which were too cheap). However, we believe there’s still some headroom for the price to appreciate. Potential positive earnings catalysts include PPC’s DRC and Ethiopia projects becoming cash generative, and the fact that import duties in South Africa have resulted in a decrease in imports, resulting in local cement prices stabilising.
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