It is interesting to note the surprise announcements made by several market ‘darlings’ over the course of the third quarter of 2016. Mr Price revealed negative unit sales growth and cautioned investors that its next reported profits are unlikely to exceed those of the previous year. Aspen’s recently reported earnings were impacted by currency volatility and a disappointing performance of its South African business. Steinhoff’s core business – excluding acquisitions – is growing slower than many expected. Mediclinic is struggling with the integration of its Middle East businesses. Richemont is experiencing a sharp slowdown in sales and expects profits to be down 45% when it next reports results. These are only a few examples.
In all instances the shares sold off quite sharply in absolute terms and also relative to the market. There have been one or two missteps – a supply chain issue here, a slow response to a competitor there – but share price weakness cannot be attributed exclusively to management. In some cases the companies did what they could in response to rapidly changing conditions.
The bigger problem was one of unreasonable expectations. The price-to-earnings (PE) multiples that these companies traded on were in the twenties and thirties. Profit margins in some cases rose to unsustainable levels. Lofty valuations provide little margin for error and a high degree of continued future success was priced in already.
Expectations for the future prospects of many of the Equity Fund’s top holdings are far more modest. Sasol, Standard Bank and Nedbank trade on PEs of less than 10. Old Mutual and Investec’s PEs are in the low teens. The conglomerates – Reinet, Remgro and even Naspers – trade at discounts of between 15% and 30% to their sum-of-parts values. British American Tobacco’s current valuation relative to the FTSE/JSE All Share Index is lower than its average since listing on the JSE in 2008.
The outlook does not appear rosy for all the Fund’s holdings, with some facing meaningful challenges. Fortunately, a rosy outlook is no prerequisite for a good investment. The future merely has to be a little better than what is implied by share prices today.
Changes to the Fund over the quarter
Netcare, Naspers and Investec were the most significant additions to the Fund this quarter, funded by disposals of SABMiller and selected gold shares. The foreign portion of the Fund, invested in the Orbis Global Equity Fund, has increased from 10.8% at the end of the second quarter to 13.5% at end of the third quarter.