Corospondent - July 2021
Coronation Balanced Plus and Coronation Equity funds - July 2021
Balanced Plus returned 1.5% for the second quarter of 2021 (Q2-21), resulting in a return of 23.8% over the last year. Coronation Equity returned -0.4% for the quarter and 30.2% over the last year. Performance benefited from recovering markets, asset allocation decisions, and alpha in the domestic and global equity building blocks. The funds have performed well against their respective peer groups over all meaningful time periods.
Given this considerable strength, Balanced Plus has reduced its holding in global equities to a neutral level, although we see opportunities for stock-picking. High levels of sovereign indebtedness and low yields keep us cautious on global bonds. There is a rising risk of inflation, as economic restrictions ease amidst tight labour markets.
The Equity Fund’s allocation to global equities has benefited the portfolio over time, bolstering returns and improving risk management. The Fund has built a position in AUTO1 Group, which owns the largest consumer-to-business car-buying platform in Europe (the equivalent of South Africa’s [SA] WeBuyCars). The European used car markets are ripe for disruption, given the vast but fragmented market and generally poor customer experiences. AUTO1’s competitive advantage lies in its cost-efficient sourcing of vehicles direct from the consumer, and superior transactional data and pricing, as well as a growing retail business. The business has a long growth runway ahead. The Fund’s exposure to Chinese technology businesses, including Tencent Music Entertainment and JD.com, detracted from performance during the quarter, as these businesses sold off on fears of increasing regulation. Actions by the regulators have focused on anticompetitive practices and data security. We believe these actions are consistent with regulators in many parts of the world where technology companies are having increased social and economic impacts on everyday life, and in many parts are largely unregulated. Having run through a range of regulatory outcomes, we believe share prices are discounting extreme outcomes and believe there is upside at these valuation levels.
In SA, a more resilient domestic economy continued to exceed expectations. Reported first-quarter GDP was up 4.6% quarter on quarter, seasonally adjusted annualised. Constrained power and the poor condition of State-owned enterprises are major headwinds to growth and fiscal sustainability. We note the positive announcements in this regard made during the quarter, enabling greater private power generation and the sale of the government’s majority stake in South African Airways.
These factors are driving increased confidence in the domestic outlook. Local interest rates are expected to remain lower for longer, as inflation remains relatively contained. Balanced Plus added to its position in SA government bonds, given this improving backdrop and the attractive real yields on offer. The buying was funded from cash, taking the Fund to a neutral position.
Having increased exposure to SA equities during 2020, we remain overweight in the asset class, given the breadth of value on offer in resources, domestically listed global stocks and domestic shares. Within SA equities, selective buying of domestic shares further narrowed the domestic underweight. Domestic companies continued to report results ahead of our expectations, due to more resilient economic activity and stringent cost-cutting. This has resulted in strong free cash flow generation.
The portfolios remain overweight resource shares given their attractive valuations. Our investment case is not premised on higher commodity prices (we expect most to trend downwards), but rather on the undemanding multiples and generous free cash flow yields, even after adjusting commodity prices lower. In addition, decarbonisation should support sustained demand for metals. Major diversified holdings continue to include Anglo American, Glencore and Exxaro.
We have built a position in the gold equities, which offer upside and reasonably priced protection. Given the increased risk from stretched sovereign balance sheets and high global market levels, the local gold counters offer a well-priced, diversified investment opportunity. Coronation has not owned gold equities for nearly two decades as they traded at extended valuations, suffering from rapidly rising costs and declining production profiles, and offered poor returns to shareholders. For the two former ‘SA’ gold producers, AngloGold and Gold Fields, the risks have meaningfully changed. Today, these businesses have greater geographical diversification, reduced exposure to SA’s deep, complex gold mines, better cost control, healthier production profiles and restored balance sheets. At spot gold prices, we see a margin of safety in valuations and expect better returns to shareholders going forward. You can read a more detailed analysis in Nicholas Hops’ article in this edition of Corospondent. These positions were funded from selling down platinum group metals shares (currently underweight), which have performed strongly.
The portfolio continues to have considerable exposure to several of the global businesses listed domestically. These are attractive for a variety of stock-specific reasons. Major holdings include Naspers (-15.1% for Q2-21), British American Tobacco (-1.3%), Quilter (-7.0%), Bidcorp (+8.3%), Textainer (+14.8%) and Aspen (+12.3%). The Naspers share price decline reflected underlying price pressure on Tencent as the regulatory environment for technology companies in China intensified, as discussed above. Current areas of Chinese regulatory focus include anticompetitive practices and data security. The Tencent ecosystem is extensive, but we believe this powerful platform is leveraged to the economic benefit of both Tencent and its partners. As a Chinese company, Tencent’s data is retained within China. While we acknowledge the increased regulatory scrutiny, Naspers and Prosus continue to offer exposure to an exciting growth asset in Tencent, which is meaningfully underpriced. The Naspers/Prosus management teams are focused on this discount and aligned with shareholders through their remuneration. The announced share swap deal between Prosus and Naspers is unlikely to be sufficient to unwind the discount, but it is the first step.
Distell rose strongly during the quarter (+43.1%) on the news of a potential offer from Heineken. We have long been admirers of Distell’s quality portfolio of branded beverages and its long runway for growth as it expands on the African continent. As such, we believe a sizeable premium for the business can be justified.
Within the financial sector, banks (9.6%) and property (12.1%) outperformed the life sector (5.8%). The banks raised significant provisions related to Covid-19 during 2020. Actual defaults are proving to be lower than expected, supporting a faster recovery in earnings for the sector. Further, a resumption in dividend payments by the banks improves returns to shareholders. We increased the domestic banks' exposure during the quarter. Life companies continue to face headwinds, both from lower new business volumes and higher mortality risks related to Covid-19 infections. The funds’ major exposure is through Momentum Metropolitan, where the balance sheet is sufficiently strong to withstand these shorter-term headwinds, and the company has highlighted the potential for additional shareholder returns.
Transaction Capital is a new holding in the funds. This entrepreneurially run business recently acquired a controlling stake in WeBuyCars, at what we believe to be a very attractive price. Transaction Capital has demonstrated a strong track record of delivery in its traditional businesses. The addition of WeBuyCars introduces an exciting growth vector going forward. WeBuyCars brings convenience, trust, competitive vehicle pricing (backed by proprietary market transactional data) and scale to a fragmented secondhand car market. This superior offer has enabled WeBuyCars to grow its share of the secondhand vehicle market to 10%. We are excited about the prospects of the business over the long term and expect it to make a meaningful contribution to Transaction Capital.
The domestic property sector remains challenged as reduced demand for both retail and office space threatens future rental tension. This, combined with escalating costs (rates, electricity and water), provides ongoing headwinds. However, a more resilient domestic economy should aid faster deleveraging than our initial expectations, reducing the size of the capital raises required. Exposure in Balanced Plus remains small and is predominantly through the more defensive ‘A’ shares.
While the past 18 months have seen a huge amount of volatility and fluctuating outlooks, our focus remains on seeking out opportunities where the longer-term prospects of assets are mispriced by the market. We continue to believe that this patience will be rewarded.