The local equity market had a strong quarter, breaking out to new highs despite all the negative news headlines. Many investors forget that the FTSE/JSE All Share Index (ALSI) has been range-bound for around three years and the average stock performed even worse given the large positive contribution of Naspers and SABMiller over that period.
As we have previously written, we have been finding increasing value in local equities over the past 18 months as valuations have come back to more attractive levels. This has been driven by investor pessimism towards domestic-orientated stocks given the poor political and economic backdrop.
There is substance to the pessimism as the poorly managed, poorly performing South African economy has finally caught up with corporate earnings after years of defying gravity. This has provided opportunities: if companies have reported down earnings for cyclical reasons, prices may overreact on the downside; if companies have expanded offshore and overpaid for acquisitions, they may have underperformed.
As a result, the Fund has a greater weighting towards domestically orientated stocks. However, it still maintains a significant weighting to stocks listed on the JSE that have large offshore operations, such as British American Tobacco and Naspers, in addition to the 25% the Fund can invest offshore. We don’t believe it is wise to invest solely on the basis of trying to predict what can be seen as an almost binary outcome in South African politics.
Remgro is a good example of a share that we are currently finding attractive. The share has underperformed as a result of its listed hospital subsidiary Mediclinic overpaying for Al Noor, a hospital group in Abu Dhabi (i.e. offshore expansion), and its exposure to the local economy through its stakes in companies such as FirstRand, Rand Merchant Insurance (RMI) and Unilever (i.e. cyclical earnings pressure).
We believe that Mediclinic is trading far closer to fair value following its significant underperformance. Many of the other companies in the Remgro portfolio, such as FirstRand, RMI, Distell and RCL foods, are listed. If we sum the market value of these listed subsidiaries and add our valuation for the unlisted companies, such as Unilever, we find that Remgro is trading at a historically high (18%) discount to its intrinsic value. In addition, we find the underlying holdings, FirstRand and RMI, attractive on a standalone basis.
From current levels, long-term investors in Remgro should benefit not only from growth in the intrinsic value of the underlying holdings, but also from a closing of the discount to its intrinsic value as pessimism subsides.
The Fund benefited from the strong absolute performance of Naspers during the quarter as a result of the significant increase in the share price of its Hong Kong-listed associate, Tencent. On the negative side, British American Tobacco detracted from performance after regulators in the US announced potential changes to regulations. Other than the continued active increase in exposure to domestic-focused stocks, there were no material changes over the quarter.