Q3: Coronation Smaller Companies

This commentary is for the retail class of the fund.

PERFORMANCE

This has been a flat quarter for the Fund, returning -0.9%. This is not too dissimilar from the Mid and Small Cap Indices, which declined -0.7% and -0.8%, respectively. Our three-year compound annual return remains strong at 16.3%, placing the Fund first in its peer group.

Our investment universe, the SA Mid and Small Cap Indices, is dominated by companies that are exposed to the SA economy. That is a hard place to invest right now, with our economy not growing fast enough to make doing business here easy for the average company (Real GDP growth for the past 10 years has averaged only 0.7% per year). This, combined with high fuel costs, increasing interest rates making debt servicing more expensive, and an unfavourable job market, means that the average consumer is under pressure. This is very much evident when reading the results of most consumer-facing businesses.

HOW DO WE INVEST IN SUCH AN ENVIRONMENT?

Firstly, we try to identify businesses that are taking market share and are thriving despite the tough economy. Companies such as Advtech, Shoprite and PSG Financial Services are good examples.

Secondly, we think it’s important for the Fund to take advantage of the change in its mandate (effective since January 2025), allowing 20% of the Fund to be invested in large caps. The Fund has fully utilised this opportunity, and owns large caps Naspers/Prosus, Bidcorp, Mondi and Shoprite. All of these holdings (except Shoprite) diversify the Fund’s exposure to SA Inc.

And thirdly, we invest a portion of the Fund in businesses whose fortunes are not tied to the SA economy, such as Northam Platinum and South32.

We live in a world that is changing rapidly. A high-quality business today might not be that in the future. Businesses are being disrupted by technology, changing consumer habits, and new competition. As an example, the share price of Nike, the global sporting goods brand, is down close to 80% in the past five years. In managing the Fund, we try to stay paranoid and prepared to change our minds, while also valuing diversification.

PORTFOLIO ACTIVITY

Two of the largest buys during the quarter were Reinet and Exxaro. Reinet is an interesting opportunity. The share price is some 35% below net asset value, 85% of which is cash. And the company is buying back shares – effectively buying cash at a 35% discount. Yes, there is an intention to deploy this cash, which introduces risk, but we think this is more than priced in.

The Exxaro investment case for us is simple. It offers an 8% or 9% dividend yield, and we think it can grow earnings over the medium term by mid-single digits. Absent any re-rating (from the very modest current multiple of 5 or 6), a return of 13%-14% p.a. is what we expect. Yes, there are coal and iron ore price risks, but these commodity prices are not high today, meaning there is as much upside risk as downside.

Two of the largest sells during the quarter were Kap Limited and Brait.

We sold out of Kap during the quarter. Kap owns a portfolio of mostly challenged businesses, but the share price has nearly doubled in the past year off a very low base. We took the opportunity to sell out of what we think is a low-quality business.

Our Brait sell was a trimming of a large position. The Fund has done well from its holding in Brait and the investment case has now become simpler with debt largely paid down and two main assets remaining – Premier Group and Virgin Active. Returns from here will largely depend on the performance of Virgin Active and its potential listing.

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