Corospondent - April 2019
2019 Quarter in Review* - April 2019
The broad-based asset class declines experienced in 2018 reversed dramatically in the first quarter of 2019. The MSCI All Country World Index ended the quarter up 12.2% in US dollar terms, despite a deteriorating macroeconomic environment in which central banks have become meaningfully more dovish than they were late last year. Developed market equity, and in particular the US, performed strongly and recorded their best quarter in nearly 20 years. The portfolio has benefitted from its large exposure to global equities and our overweight position in emerging market equities contributed meaningfully to performance during the quarter.
The Citigroup World Government Bond Index appreciated by 1.7% in US dollars for the quarter. Bond yields fell, with investors buying up debt as a haven amid mounting evidence of a global economic slowdown, continued political uncertainty and a more dovish outlook among global central bankers. This shift has seen the US Federal Reserve (Fed) signalling that rates will remain on hold for the rest of this year and announcing that the bank will end its balance sheet run-off programme.
In addition, the European Central Bank announced future stimulus measures and that it too will leave rates on hold until the end of 2019. At the end of March 2019, the amount of global government debt with negative yields rose above the $10 trillion mark, and European corporates such as Moët Hennessy Louis Vuitton (LVMH) and Sanofi were even raising debt at sub-zero rates (meaning you have to pay for the privilege to lend to these companies). The extent to which central banks continue to distort debt markets is concerning and we remain cautious on the outlook for global bonds.
The All Bond Index ended the quarter strongly (+3.8%) as the market started to price in potential interest rate cuts later this year. We believe the high real yields on offer are a reasonably attractive investment opportunity. Given recent global monetary policy developments and the South African Reserve Bank’s benign inflation outlook, coupled with weak economic growth, we expect policy rates to remain on hold for an extended period of time. The property sector underperformed during the quarter on broad-based weakness. Distribution growth rates are increasingly at risk given negative rent reversions in certain sectors and nodes, high vacancy rates in the office sector and leveraged balance sheets. The portfolio’s property exposure, which is focused on the higher-quality portfolios such as Redefine and Investec, together with our exposure to the A property shares, should weather the storm better than peers.
Overall, the JSE had a good quarter, with the FTSE/JSE Capped Shareholder Weighted All Share Index appreciating 3.9%. Resources had another very strong quarter and were up 17.8% – bringing the sector’s rolling 12-month total return up to a whopping 41.6%. Platinum stocks in particular had a very strong quarter on the back of a rising platinum group metals (PGM) basket price.
During the quarter, all mining companies reported their annual or interim results for the period to end-December 2018. These results were characterised by a strong performance from the bulk metals (iron ore, coking coal, thermal coal and manganese). The theme of strong cash flow, deleveraging and capital returns to shareholders continues. Shares reacted positively to financial results announcements and a strong commodity price environment, driven by tight supply/demand balances and an abatement of China-US trade war fears. Our large exposure to Anglo American (+22%) contributed to performance.
After a long and frustrating wait, PGM shares have finally begun to rally strongly, with our holdings in Northam Platinum (+47%), Anglo American Platinum (+38%) and Impala Platinum (+66%), as well as our position in the Palladium Exchange-Traded Fund (ETF) (+12% in US dollars) all contributing meaningfully to returns for the quarter (refer to Nicholas Hops’ article, The dangers of headline investing for more insight into PGMs).
After a challenging 2018, it was also particularly encouraging to see that a number of the portfolio’s other high-conviction ideas recovered well. These included Naspers, British American Tobacco and Quilter.
Naspers (+19%) benefitted from a strong recovery in the Tencent share price as sentiment towards China shifted positively on the back of a reduction in trade war fears and a resumption in the licensing approval process of online games by the Chinese authorities. Naspers also surprised the market in March by announcing the offshore listing and part unbundling of its offshore internet portfolio (i.e. Tencent, Mail.ru, OLX, its food delivery businesses, et al.) in an effort to reduce the discount at which it trades relative to its underlying intrinsic value. While this is certainly no ‘silver bullet’ that will immediately remove the entire discount, we nevertheless view it as a marginally positive step in the evolution of the group into a global consumer internet powerhouse and will allow it access a wider investor base.
The British American Tobacco share price (+27%) recovered strongly during the quarter on the back of reporting good results, which allayed market fears around US volume declines, its debt levels and the outlook for its next-generation products. It also appears that investor anxiety towards the regulatory headwinds faced by the US business is abating and sentiment is finally starting to turn positive on the stock. Even after this short-term price rally, British American Tobacco is still trading on only 9.5 times one-year forward earnings and a 7% dividend yield. We still believe this to be very attractive for a stock of this quality and it remains the second biggest position in the portfolio.
Quilter (+28%) performed very well over the period. Its maiden full-year results materially exceeded market expectations. Quilter provided medium-term guidance on their profit-before-tax-margin aspirations. At 34%, this too exceeded expectations. The long-term outlook for integrated wealth managers with advice forces at scale remains very attractive. This positive outlook is driven by a decline in advisers following the UK’s adoption of the Retail Distribution Review, ‘pension freedom’ boosting demand for advice and opening up the post-retirement market to wealth managers, and a shift away from defined benefit funds to defined contribution funds.
Stocks exposed to the domestic economy came under significant pressure during the quarter as the realities of operating in a ‘no-growth’ economic environment filtered through into corporate earnings. The quarter kicked off with a string of profit warnings from the domestic retailers, and the likes of Mr. Price (-23%), Massmart (-22%), Truworths (-18.5%) and Dischem (-16%) all ended the period materially lower. Fortunately, the portfolio had no exposure to any of these stocks. Eskom remained in the headlines as it hit Stage 4 load shedding in the middle of March. Years of underinvestment and alleged mismanagement and corruption are finally coming home to roost. Although for now we appear to have received a temporary reprieve from the worst of load shedding, it has become clear that we are only starting to understand the true extent of the power utility’s problems and that its numerous issues could indeed take years to rectify.
Unfortunately, if persistent load shedding becomes the norm over the next few years, the impact on consumer sentiment, business confidence and GDP growth will be devastating. We therefore continue to remain cautious on stocks that are heavily exposed to the domestic economy and our preferred exposures are through high-quality domestic defensive businesses that should weather the challenging environment better than their weaker, economically sensitive peers.
Notwithstanding the uncertainties that abound, our objective remains building diversified portfolios that can absorb unanticipated shocks. We are happy with the current portfolio positioning and excited about future return prospects. We remain focused on valuation and will seek to take advantage of attractive opportunities the market may present to us, and in so doing generate inflation-beating returns for our investors over the long term.
GLOBAL EMERGING MARKETS
The Coronation Global Emerging Markets Strategy had a very good quarter, returning +23.4% compared to the MSCI Emerging Markets Index return of +9.9% and in doing so outperformed the market by 13.5%. This made it the Strategy’s best quarter of outperformance since inception almost 11 years ago. Its previous best quarter was the one to end-June 2009 (12.1% outperformance), which was the period that signalled the bottom of the market post the 2008 Global Financial Crisis (GFC) decline.
During the quarter to end-March 2019 there were a number of stocks that contributed positively, with all of the 15 largest positive stock contributors appreciating by more than c. 20% in US dollars. At the top of the list was Wuliangye Yibin (+91%, 2.0% contribution), followed by New Oriental Education (+64%, 1.4% contribution), JD.com (+44%, 0.9% contribution), YES Bank (+52%, 0.8% contribution), British American Tobacco (+29%, 0.8% contribution), Ctrip (+60%, 0.7% contribution) and Philip Morris (+33%, 0.7% contribution). A number of these stocks were poor performers in 2018 (specifically in the last few months of the year) and so the Strategy’s strong performance to date in 2019 is partly a reversal of a poor 2018. JD.com, YES Bank, British American Tobacco, Philip Morris and Ctrip would all fall into this category.
In addition, a few of the new buys in late 2018 were strong performers, most notably Wuliangye Yibin and New Oriental Education. Lastly, a number of long-held positions contributed positively, including Airbus (+38%, 0.6% contribution), 58.com (+21%, 0.5% contribution) and Ping An Insurance (+27%, 0.4% contribution). At the same time there were few large negative contributors with no detractors of more than 0.5%. Since inception almost 11 years ago, the Strategy has outperformed the market by 4.0% per annum and over the last 10 years has outperformed by 3.5% per annum.
There were five new buys during the quarter. The two largest new buys were that of Jiangsu Yanghe Brewery (1.8% position) and LVMH (1.9% position). The three other buys were small: a 0.7% position in NetEase (no.2 online gaming company in China after Tencent), a 0.6% position in BM&F Bovespa (Brazil’s dominant vertically integrated multi-asset [equity, bonds, derivatives] exchange) and a 0.4% position in Eastern Tobacco (Egypt’s monopoly cigarette manufacturer). In total, the five new buys represent 5.5% of the Strategy. There were two outright sells during the quarter: that of Baidu (no.1 search engine in China) and Marisa (a Brazilian clothing retailer). In the case of Baidu (a 1.3% position at the start of the year), we had become increasingly worried about the core search business, as well as the uncertain future return from the numerous other areas where the group is investing significant capital.
In the case of Marisa (a small 0.3% position at the start of the year) there was still not much sign of a turnaround in the business, and we felt the funds were better invested elsewhere. In terms of other portfolio activity, we reduced the positions in New Oriental Education, Ctrip, Noah, Li-Ning and Adidas (all on strong share price performance and resultant less upside to our estimate of fair value) as well as Indiabulls (largely due to a reduction in our fair value and a less attractive risk/return profile). From a buying point of view, most of the activity was in the five aforementioned new buys, but we also added to the existing positions in HDFC Bank and Pão de Açúcar.
In good spirits
Jiangsu Yanghe Brewery is the largest premium brand baijiu (the dominant white spirit in China) company, in contrast to the main ultra-premium (very high end) baijiu companies Kweichow Moutai (not owned in the Strategy) and Wuliangye Yibin (a 3.9% position in the Strategy). We bought a position in Wuliangye Yibin late last year and subsequently continued to do additional work on the industry, including a week’s trip to China solely focused on the baijiu industry, which led us to Jiangsu Yanghe.
Over the past decade, Jiangsu Yanghe has grown sales by 27% per annum, making it the fastest-growing baijiu company over this period. Both net profit and free cash flow have grown by 35% per annum over the past 10 years and today the company generates over $1 billion of free cash flow. The company is a beneficiary of the premiumisation of baijiu (their main premium brand, ‘Dream Blue’ series, has gone from being 2% of sales a decade ago to contributing over 20% of sales today) and we expect this to continue, together with further expansion to regions outside of its home base, Jiangsu (which today still contributes 53% of sales). A unique feature of Jiangsu Yanghe that also attracts us is the fact that management own c. 21% of the company. Just like Kweichow Moutai and Wuliangye Yibin, the financial metrics of Jiangsu Yanghe are impressive, with operating margins of c. 45%, return on capital of c. 20% and high free cash flow conversion (over 100% of net profit in the past three years has been converted into free cash flow). The share trades on c. 18.5 times forward earnings with a 3% dividend yield, which we believe is attractive given the company’s long-term prospects.
The wealth effect drives luxury goods
The other new buy of note was a 1.9% position in LVMH, which we have covered for several years and have owned in the Strategy in the past. LVMH is the largest global luxury goods company and the owner of the Louis Vuitton brand (c. 50% of group profits) and many other global brands, including Moët & Chandon, Hennessy, Christian Dior, Fendi, Bulgari and Tag Heuer. Over 40% of sales come from emerging markets and the Chinese consumer alone (purchasing at home as well as while travelling) is responsible for well over 50% of incremental growth.
LVMH has an enviable track record (over the past 20 years, earnings per share has compounded at
c. 12% per annum) and today is well placed to be a key beneficiary of the growing emerging market middle and upper class and the wealth effect. The barriers to entry possessed by the true global luxury brands (Hermès, Louis Vuitton and Gucci) are amongst the highest in any industry in our view: in the case of Louis Vuitton, a 150-year history and investment in the brand for a start. The resilience (of both the top-line and profitability) of the Louis Vuitton brand, in particular in tough economic periods is also unparalleled: in 2009 (post the GFC), sales of the Fashion & Leather Goods division of LVMH (with Louis Vuitton making up the lion’s share of this division) grew by 2% and earnings before interest and taxes (EBIT) grew by 3%. In 2002 (post September 11), the Fashion & Leather Goods division experienced 16% sales growth (and this after double-digit sales growth in 2001 as well) and 5% EBIT growth. The Strategy bought LVMH on c. 20 times forward earnings and a 2% dividend yield, which we think is attractive for what we would consider to be one of the best businesses in the world.
Members of the Global Emerging Markets team continue to travel extensively to enhance our understanding of the businesses we own in the Strategy, their competitors and the countries in which they operate, as well as to find potential new ideas. In this regard, over the past two years we have done detailed work (modelling, fair value and research reports) on 51 new companies, 18 of which have made it into the portfolio over this period, representing 32% of the Strategy today. In the first quarter, there were two trips to China and two to India. The coming months will see a further trip to China, as well as one to Brazil. The Strategy’s weighted average upside to fair value at the end of March was c. 40%, which we feel is compelling. We would also consider the overall quality of the stocks held in the Strategy currently to be above average when compared with other points in the Strategy’s 11-year history.
Global Frontier Markets
Markets have started 2019 brightly, with the MSCI Frontier Markets Index (up 6.9%) recovering nicely after a tough end to 2018. As the Strategy significantly outperformed the market in 2018, it has unsurprisingly lagged the market recovery in the first quarter of 2019 (Q1-19), with a return of 3.5%. While we are certainly never happy with relative underperformance, when viewed over a more appropriate time period, we remain satisfied with the performance. Over the one- and three-year periods to end-March 2019, the Strategy has returned -11.7% and 10.5% per annum, respectively, while the Index was down 15.0% and up 6.9% per annum over the same periods.
The quarter saw positive returns across most markets, with Egypt (+16.9%), Kenya (+13.6%), Vietnam (+9.8%) and Kazakhstan (+7.2%) all seeing strong gains. Argentina (-3.9%), Pakistan (-0.6%) and Bangladesh (+1.5%) were more muted. The Strategy’s largest exposures are Egypt (18.3%) and Jordan (10.4%). As always, country weights are a function of the attractiveness of the individual companies in each market rather than being based on a macroeconomic or index view.
We added to our position in Egypt’s monopoly tobacco company, Eastern Tobacco (Eastern), over Q1-19. Egypt is one of the most attractive tobacco markets globally, with high prevalence rates, growing volumes and good affordability. The company is in the process of moving from being regulated as a state-owned entity to a private company. During Q1-19, the government sold down a 4.5% stake in the business to facilitate this change, and on 1 April 2019 shareholders officially approved the move. Being regulated as a private company should result in numerous benefits for the business, and we expect vast improvements in production efficiency, marketing, investor engagement and capital allocation. Eastern remains the Strategy’s largest position.
The Strategy exited its position in Citadel Capital in Q1-19. Citadel is an Egyptian investment company with interests in energy, cement, agrifoods, logistics and mining. By far the largest part of the business is their 17% stake in Egyptian Refining Company (ERC). With commissioning of ERC expected in Q4-19, market sentiment has turned very optimistic, which has seen the share move through our estimate of fair value. We thus exited on valuation grounds.
The largest contributors for the quarter were Vostok New Ventures and Zimplats, while the largest detractors were British American Tobacco Kenya and Al Eqbal Tobacco. Vostok New Ventures received $540 million through the sale of its stake in Avito to Naspers. In turn, Vostok used the proceeds to buy back shares, pay a special dividend and settle some bonds. Zimplats benefitted from higher palladium prices, and a change in its mining licence (from a special mining licence to a normal one). This change resulted in a simplification of and reduction in tax payable, and gives Zimplats increased mining rights over the remaining 45-year lease.
British American Tobacco Kenya ended 2018 strongly, but declined over Q1-19 despite a strong set of results which followed two tough years. Al Eqbal Tobacco is in the process of taking a significant part of its distribution in-house, which has seen a number of nonrecurring charges causing a slowdown in growth. Management has focused on bedding down these changes and took a step back from investor engagement. While this decision is the right one, it has left the market a bit surprised by the results and its share has come under pressure. We recently met the new CEO in Dubai and toured the production facility in Ajman, and returned even more positive on the long-term opportunity despite the likely disruptions in the short term. Al Eqbal is the largest position in the Strategy.
African Frontier Markets
African frontier markets also enjoyed a good start to the year, with the FTSE/JSE All Africa ex-South Africa 30 Index (up 6.4%) recovering nicely after a tough end to 2018. The quarter saw positive returns in Egypt (+16.9%) and Kenya (+13.6%), while Nigeria (-0.6%) and Morocco (-5.3%) were negative. Egypt benefitted from a surprise 100 basis points (bps) rate cut and a strengthening in the currency as the government’s reform strategy continues to bear fruit. In a recent meeting, the CEO of one of Egypt’s most successful banks commented that the economy has seen tourism arrivals up 41%, tourism receipts were up 77%, remittances increased to $26 billion, and the Zohr gas field came online, while Suez Canal revenues increased by 15%. Much has changed over the past year. Egypt (at 32.9% of Strategy) remains the portfolio’s largest exposure and we continue to be excited about the businesses we own in the country. As previously mentioned, country weights are a function of the attractiveness of individual companies in each market rather than a macroeconomic or index view.
We made similar additions and exits to those in the Global Frontiers Strategy during the quarter, adding to our position in Egypt’s monopoly tobacco company, Eastern Tobacco (Eastern) during the quarter, and exiting Citadel Capital.
The largest contributors for the quarter were Eastern and Zimplats, the reasons for which have been detailed under Global Frontiers above; while the largest detractors were British American Tobacco (BAT) Kenya and Egyptian International Pharmaceuticals Industries (EIPICO). BAT Kenya ended 2018 strongly, but declined over Q1-19, despite a strong set of results that followed two tough years. EIPICO had enjoyed a period of cheap raw materials purchased before the floatation of the Egyptian pound. This saw margins expand significantly in 2017. Calendar 2018 saw a normalisation and margins came under pressure. Coupled with sales lagging the market, this resulted in a share price decline for EIPICO. We have since spoken to the new CEO, who communicated a number of positive initiatives, and saw the parent company increase its stake in EIPICO, both of which are positive in our view.
The Global Frontier Markets team travelled to Vietnam and Bangladesh as part of small investor group trips and to Dubai to attend the largest Global Frontiers conference in the world. We also met a number of African corporates at two separate conferences in Cape Town. We continue to believe that both of our strategies have a number of very attractive opportunities across countries and sectors. While these businesses are compelling in their own right, the valuations at which we can buy them make for an even more compelling investment case. Over the long term, this should result in attractive returns for our investors.
We thank you for your ongoing support.