06 Nov LEGAE SECURITIES: INVESTORS MONTHLY | NOVEMBER 2015

“Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth.”-Marcus Aurelius In this edition we review the performance of the local equity market and how changes to the structure of the Chinese economy will influence investment choices going forward and look into the fine that’s hit MTN. As always, we welcome your feedback and look forward to assisting you with your equity portfolio.

Outstanding October- stellar performance for SA equities

Equity investors can breathe a sigh of relief (perhaps temporarily) as the JSE All Share Index ended the month of October on a strongly positive note. The index gained 7.40% to settle at 53 793pts. Year-to-date the SA equity markets have earned an investor 8.08% ( 3.5% above inflation).

Industrials were the star performers (up 8.30%) this month which intuitively corresponds to the changing trends of the Chinese economy. The purpose of this months newsletter, is to offer our clients a perspective change. We take a top down approach to our investment decisions this month and show how changes in the macro economic climate of the worlds second largest economy, have shifted the demand away from resource stocks towards industrials and financials.

China’s once insatiable appetite for commodities, to feed their growing infrastructure, is coming to an end. All the skyscrapers and apartment blocks are built. There is no longer a need for new ports and the environment has been heavily impacted with this robustious expansion. We as the ‘rest of the world’ are beneficiaries of the China led demand, in particular SA, as an emerging market commodity producer.

However, as world renowned economist John M Keynes said: “when the facts change, I change my mind. What do you do sir?” and indeed they have. It’s time investors awaken to this
and adapt accordingly. The global landscape is changing in innumerable ways; namely:
 advance economies have no inflation
 interest rates have reached their zero-bound
 China’s demand for commodities has fallen
 stimulus seems never ending for advanced economies
 social/political unrest is becoming more prevalent

This list is far from exhaustive yet the crux of it is that China’s needs have changed; and if they were the major drivers of growth over the past 2 decades, their demand will be vital to our future global growth. China’s new 5 year plan has among other things outlined that they will move to a consumer lead economy and if logic follows, this will lead to a bigger demand in services. The industrial and financial sectors are set to benefit most. We believe the future of equity investing lies in understanding and accepting this. Resource stocks are unlikely to return to their ’glory days’ and the opportunities lie in the services sector and their ability to meet new Chinese demands.

Figure 1: AllShare Index performance and PE rating

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Figure 2: AllShare best and worst performers for October

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JSE newest listings: excitement, hype and caution

It has been a busy month for the JSE, as investors swoop in to pick up shares of companies coming to the capital markets for the first time.
We have seen the listing of asset managers and health care providers, property and investment holding companies as well as the rumours of more listings to come in the educational ser-vices, alternative energy and special technology industry space.

By far, the darling of the this past months IPO’s has been Sygnia Asset Management. This investment house which differ-entiates itself from traditional asset managers with low cost tracker funds, was 20 times over-subscribed. The share cur-rently trades at R16, which represents a near 100% return– if you were fortunate enough to receive your allocation.

With the demands of IPO shares on the rise, we caution our clients to be aware of getting caught up in the hype. An IPO involves company insiders with detailed and specialised knowledge of the issuing company. They know when the best time to list is and at what price. They are able to forecast earn-ings in a manner the investor cannot, due to the unavailability of public financial records. Investors are in effect placing most of their faith in the management team and their ability to grow the company with the fresh capital raising. Investors need to know the management team and their track record, read the pre-listing statements and think laterally about what the nature of the company is and where their growth will come from.

If we use Sygnia and Anchor Asset Management as an example– let’s analyse why these ‘new to market’ companies are a good investment option. These asset managers offer a product retail investors have been lapping up- low cost tracker funds. With the surge in popularity of tracker funds, due to National Treasury regulating the active management fees charged by pension fund managers – passive is in vogue.

Secondly, the larger fund managers are no longer able to offer their investors the type of returns they once use to. This is due to scale. Their Assets Under Management (AUM) has grown to sizes too large to offer a competitive return. For an asset man-ager that is newer with smaller AUM, this gives them the ability to be nimble in their investment strategy as well as offer inves-tors attractive returns.

The disappointing share price performance of Coronation is a clear signal of the changing trends in the asset management industry. The share price has lost 36% this year and AUM has fallen post the ABIL crisis. This has also prompted a reworking of their fee structure.
If, as an investor, you are looking for stocks in the financial sector and are willing to hold the stock long term, these new-est listing of the JSE offer value.

Tough call on MTN– why the fine may not hold

The announcement of the $5.2bn fine on telecom giant MTN, sent shockwaves through the market. The Nigerian regulator is imposing a fine due to MTN’s disregard for the order to discon-nect subscribers with unregistered SIM cards in Nigeria. The fine represents more than double MTNs estimated 2015 profits in its largest revenue generating region.

Figure 3: MTN share price reacts to fine announcement

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Post the fine announcement, nearly 20% of MTNs market cap was erased in less than a week (see figure 3). However, the market remains baffled by the magnitude of the fine. It is un-derstandable that the regulators must show they mean busi-ness with punitive measures, however it seems coincidental that the magnitude of the fine equals 20% of the Nigerian gov-ernments expenditure and will account for over 60% of its rev-enues (see figure 4).

Figure 4: Funding for government expenditure…

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It is well known that Nigeria’s revenue has been compromised since the fall in the oil price in Q3 2014, coupled with currency restrictions and no apparent finance minister, the government is under pressure to fund their expenditure.

However, the signals that the Nigerian government are sending investors is concerning. The risks of direct investment into the largest African economy has been highlighted and signals a lack of fiscal control by the newly appointed Buhari lead gov-ernment.

Market consensus is that the fine will not hold in its current form. MTN will inevitably pay for this misdemeanour but we believe that Nigeria remains a key region for MTN and they will not pull operations entirely.

For holders of MTN we advise a HOLD position in the near term until further news of the implications of the fine are revealed. At a PE of 10x and a 8.56% dividend yield, among the telco stocks (Telkom and Vodacom) MTN remains the most attractive of the telco defensive counters.

Global markets review

The beginning of the last quarter of 2015 saw global markets rebound sharply. Driving this rebound is the very likely delay of the first US interest rate hike as well as the re-affirmation from the European Central Bank governor to continued stimulus.

Over the month, the NASDAQ was the best performing US in-dex, gaining close to 10%. The star performer in Europe was the German DAX, up 11.94% and the laggard London FTSE, up 4.82% and down YTD –3.23%. Over to Asia and the Chinese Shanghai has recovered over 10%, clawing back some its astounding 2015 bull correction.

 

Final thoughts: what to expect in November

The world still awaits the Federal Reserve lift off of interest rates. Europe remains in a fragile state with stimulus needed. China has changed track and will be driven by consumers de-mand for services.

We hope that investors are able to objectively look at these changes and adapt their view in turn. As a long term investor, the risks to being invested in resource stocks when the trading environment has been changed for the foreseeable future, are on the upside. Returns now lay in being able to foresee where the Chinese consumer will demand services and rotating into these sectors.

Even though we may see churning of share prices in the re-source sector at these low levels, which show short term profit opportunities, we caution our clients to leave that to the day traders and remain focus on acquiring value companies in high demand sectors.