07 Dec LEGAE SECURITIES: INVESTORS MONTHLY | DECEMBER 2015

“When there are multiple solutions to a problem, choose the simplest one.”- John C. Bogle

In this edition we review the performance of the local equity market and what to expect in December as well as what Lonmin could signal for other companies. As always, we welcome your feedback and look forward to assisting you with your equity portfolio. The Legae Team

Investors…moderate your expectations

The JSE All Share index ended the month down 4.1% and, as expected, the Resource sector’s torrid performance continued, tunnelling to its bottom. The sector has lost investors 23% Year-To-Date (YTD) and as such we re-iterate our recommendation from previous months. The sector faces headwinds making this an unsuitable play for long term investors. The JSE has returned 3.7% to investors this year and unless December is a strong month, the market looks unlikely to post gains in excess of 2014 returns (7.6%).

Resource stock holders continue to suffer the pains of the sectors plagues. From the OPEC bullies, Saudi Arabia who continue to pump oil into the market at the expense of less well reserved countries who are unable to remain profitable. In addition, industrial metals and resources, like copper and gold have hit 6 year lows. Compounding this is the strong Dollar, which, after the US Federal Reserve raises rates, should seal the fate of commodities as the Dollar is expected to strengthen further which will batter its price.

If one looks at Figure 2 alongside, it may be surprising to see Lonmin (LON) among the top gainers. Before the excitement sets in, lets remember that the share has lost 81% YTD and after hitting an all time low of 25c, its gainer status is merely due to its low base. LON, the black sheep of the platinum family dominated stock market news this month, as it came with its begging bowl to shareholders for $407m in a rights issue. So dire is their state that LON offered shareholders 46 new shares for every 1 held- a 94% discount. Shareholders voted ‘yes’ to the capital raising– however investors exposed to mining stocks should look through LON to the sirens going off, warning investors to steer clear of the sector.

We highlighted the changes in the structural and fundamental environment of the sector last month and let LON be a lesson to all. One needs to look at more than just the share price when deciding to invest. If one looked at LON in 2010, in its hay day, it looked a wonderful investment but when a company over pays its executives, over pays for assets acquired and fails to handle labour relations prudently– i.e. when governance is lax– the consequences are dire when the economic cycle turns.

And this applies not just to resource stocks, MTN and Standard Bank learnt this lesson too. Good governance may not enhance share price performance but it will salvage a company’s under performance. More conservative companies may be the best long term investment.

Figure 1: AllShare Index performance and PE rating

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Figure 2: AllShare best and worst performers for November

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Three’s a crowd…Mediclinic, Netcare & Life Health Care

In this month’s stock feature we relook at the healthcare sector. Interim and full year results have been reported and the diagnosis is clear on who is given the best shot at success amongst the medics in 2016.

Figure 3: MDC,NTC & LHC 2015 performance

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We begin with Netcare (NTC) which may be SA’s and the UK’s largest private healthcare provider. However, markets didn’t approve of the latest full year results. Due to a lack of organic growth, revenue grew inline with the increased capacity. In addition the UK business is facing headwinds that may affect its 16H1 performance.

At first look, NTC full year results look pleasing. Group revenue grew 6.1% to R34bn and HEPS rose close to 13%. They declared a meaty dividend totalling 92cps up 15%, however a few red flags were raised. Firstly, even though the company is evenly split in terms of revenue contribution in its geographical segments; the UK business has incurred large costs and as such contributed a 3% to HEPS. The group has moved to a low cost model and restructured the UK business. The UK business has not grown revenue and had write-offs (R109m) due to financial instruments taken out on leases. In addition, costs of business restructuring dampened operating profits while the growth of the UK private medical insurance remains benign.

When one looks at both the UK and SA healthcare system, the landscapes differ significantly in substance. SA remains an attractive and lucrative market for private healthcare. In contrast the UK market is dominated by NHS which still handles the majority of cases. Regardless of the growing deficit of the NHS fund, politically the UK government cannot afford to pull back funding. Hence NHS remains a risk factor to private health care.

NTC has fallen 5% this year and first half 2016 profit concerns exist. NTC is expecting significant increases to their depreciation charge due to capex spend in the previous year and occupancy levels of the new beds will be affected. However, operational profits should improve in 16H2.

Mediclinic International-top of our script

Interim results from SA’s second in charge MDC was pleasing. They managed to grow HEPS (19%) ahead of revenue (16%). Unlike NTC, they are more geographically diversified. More than half its earnings come from Switzerland with the contribution from the Middle East increasing after its Al Noor deal. A good rand hedge. Since our feature on the two healthcare stocks in September– MDC has out performed NTC by 21% and LHC by 33%.

Life Health Care-priced as a generic but not preferred

It is no surprise that the worst performing of the health care stocks is LHC after HEPS grew by a mere 1.2%. Bottom line seemed to be most impacted by the ramp up in debt as it increased its holding in India’s Max Healthcare. The concern is that LHC is nowhere near as diversified as its peers. 96% of its revenue comes from SA and the remainder from India and Poland. Looking at its long term prospects, the Indian market offers the best value. And with management commenting that the SA market offers no more growth opportunities, growing aboard is their best course of action and they will do so aggressively. However this will take more financing, indicating a possible near term capital raising. MDC and NTC are our favoured stock picks of the healthcare stocks. We would look to pick up MDC at R105 and NTC at R32. On a relative basis LHC may outperform its peers due to it being so bottomed out, but this is a short term view.

Conclusion– December may not be as festive as we expect

December has not started off well for local or international markets. In a market that is flat to moving lower, a good portfolio will make use of the defensive stocks and rand hedges. The sub sectors deemed defensive are telecoms, healthcare and pharmaceuticals and insurance. We would also favour more of the mid cap stocks but be aware that liquidity may be an issue.

Something else to consider is that, in a falling market, for value investors this would be a good opportunity to pick up blue chip stocks at more affordable price levels.

Keeping this Warren Buffet quote front of mind- “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

We wish all our clients a happy and safe festive season and thank you for your continued support throughout the year.

The Legae Team