For most of 2017, domestically orientated sectors fared poorly against the FTSE/ JSE All Share Index (ALSI). However, the last few weeks of the year saw a sharp and sudden reversal of this trend. Banks, insurers and retailers all rallied on the back of improving sentiment towards South Africa, and a stronger rand, to regain most, if not more, of all the prior year’s lost ground. The last six weeks of 2017 are a reminder of how quickly perceptions can change. Investors in out-of-favour sectors would have been well placed, at least in the short run. Naspers’ meteoric rise continued, with the stock up 70% for the year. It now constitutes 20% of the ALSI.
Over the course of 2017 the positioning of the Equity Fund has tilted towards a domestic bias as we bought into the laggards. Two positions that have recently crept into the top 10 are Netcare and Life Healthcare.
The companies have a lot in common: Netcare and Life Healthcare are the largest and second-largest private hospital groups in South Africa. Both companies have underperformed the market substantially over the past year. Both companies generate the bulk of their profits in South Africa, a region both companies are actively trying to diversify away from with varying degrees of success.
The combination of a mature healthcare market, poor macroeconomic environment and intensified case management efforts by healthcare funders has resulted in a decline in profitability from South Africa. We believe this is temporary. Given our dual burden of disease and a growing, ageing population, it is not unreasonable to expect case-load growth to resume at some stage. If the hospital operators do a good job on costs, profitability should follow. These are valuable earnings: medical spend is largely non-discretionary, barriers to entry are high, cash conversion is good and the operations are well capitalised.
The prognosis on their foreign operations is less clear. Life Healthcare’s Polish business has performed poorly. Their Indian joint venture might be valuable on paper, but it has hardly contributed to profits. Life Healthcare’s recent acquisition of UK-domiciled Alliance Medical Group did not come cheaply. The performance of this business is encouraging, but it is too early to pass a verdict. Netcare’s foray into the UK, through General Healthcare Group (GHG), has disappointed. GHG’s original structure was flawed and errors have compounded subsequently. On our estimates it is unlikely that capital allocated to the UK operations is recoverable. Fortunately for Netcare shareholders, the value of their South African operations exceeds the value of the company. It is important for the management team to ensure that this value is preserved.
The biggest disposals this quarter were British American Tobacco, Naspers and Standard Bank. The Fund’s offshore exposure is 22% with 2% comprising of pan- African (excluding SA) shares.