We couldn’t lead a January review without making mention of the alarming events witnessed on Capitol Hill in the first week of January. By now you will have all read ad nauseum about what happened and why, but this surely must be one of the lowest points in recent US political history. It has been bookended by the second impeachment of former President Trump during his presidency, another first in US history.
January was to mark the end of a tumultuous period in US politics, with former President Trump tearing up the playbook for most of his term. As we wave him goodbye, his departure has been followed by a collective sigh of relief from many of the US’s trading partners. This has been reflected in market movements as well, as investors position themselves for a broadly weaker dollar and a re-emergence of relative performance from the rest of the world, rather than the fairly narrow leadership of the US markets in the more recent past. January also saw the Senate majority transfer to the Democrats as they flipped two crucial seats in the state of Georgia to finally given them control of both the House and the Senate (the blue wave).
Despite the drama unfolding in Washington during the month, the ticker tape was largely unchanged for the first month of 2021. Small losses in US equities, with Europe down more significantly as 2nd wave lockdowns start to take their toll. Stand out performance from EM equities and China in particular, with the Hang Seng jumping around 6% for the month, with our faithful JSE delivering close to 3% in USD as well.
Most people had never heard of hedges, GameStop or “Short Squeezes”, but we all got a quick crash course in January as GameStop (a bricks & mortar retailer selling video games and computer hardware) returned in excess of 1600% in the month! While the devastation that took place in certain hedge funds is no laughing matter, this explanation of what happened on twitter is a must watch. It’s just over 2 mins and has been viewed more than 17 million times (even Elon Musk has commented on it). For a more informed view, scroll down to the Retail investor riot section where Mandy unpacks what went on in a bit more detail.
In this month’s edition we also take a quick look at the bounce expected in offshore earnings in 2021, reflect on what US consumers might do with excess savings and then dive into updates from several South African companies.
We hope you enjoy the read as we look forward to a 2021 that begins the process of rebuilding from the devastation of COVID-19 in 2020.
By the Numbers
An End to the US Earnings Recession
We believe it is generally accepted that given the continued uncertainty surrounding the impact of the pandemic, CEOs are not incentivised to be too optimistic with their outlook comments and guidance. This conservativism, along with the change of momentum in global GDP driven by massive stimulus, means 2021 and 2022 EPS estimates have significant room to move higher.
Currently 2021 & 2022 EPS growth expectations are for 23.4% Y/Y & 16.40% Y/Y respectively. 2021 EPS expectations of $173.43 is higher than pre-pandemic 2019 levels of $163.
It is this risk to the upside that will continue to provide the grease to keep stocks and equity markets moving higher.
The Consumer Has Never Been Healthier
“This was the only downturn in my professional career in which disposable income actually went up in a deep recession, and a lot of that has been saved.” – FED Vice Chairman Richard Clarida
Given the enormous amounts of stimulus being injected into the global economy to defend against pandemic driven lockdowns, consumers find themselves in an unusually well-off predicament. Driven by the unemployed benefits, one of cheques and social transfers coupled with the inability to spend on typical monthly purchases, consumer savings ratios across the world are at record levels.
Big Tech Still in the Sweetspot
APPLE, GOOGLE and MICROSOFT delivered revenue growth of 21%, 23.5%, 17 % and earnings growth of 35%, 68% and 34% respectively in the reporting period. All showed significant momentum as clients/customers position themselves to better cope with the changing environment. Once analysts estimated one PC/Laptop per household with this now changing to 1 PC/Laptop per individual, a significant difference.
Apple saw iPhones sales increase 17% driven by new 5G units. They surpassed 1bln active devices in the quarter, while iPad and Mac books sales continue to grow at extremely strong rates (iPad sales are increasing at 40% + for the last 3 quarters whiles MacBook’s are up 20-30% over the same time frame). Active Apple devices now tally over 1.65bln, as individuals upgrade devices adopting the “work for home” culture. This compounding installed base played right into Apple’s wearables and services segments. Both divisions are generating S&P 500 type revenues.
For businesses like Google, the conditioned adoption by businesses and consumers of online advertising and ecommerce are supportive tailwinds. Alphabet noted that retail searches increased 3-fold in the quarter, while their merchant community increased by 80%, driven by Small and Medium sized businesses. YouTube Ad revenues, up 46% Y/Y, continue to benefit from the shift to video ads/branding and YouTube Shorts (basically YouTube’s version of TikTok, getting 3.5bln daily views). Google Cloud has benefitted from the shift to the renting Software as a service model rather than buying outright, with revenue growth continuing to be in the 50% area.
Microsoft remains the doyen in the industry. All its product areas are tailored directly into digital transformation, sweeping across every company and industry. From Productivity products, to Azure and cloud services, to Gaming, Microsoft continues to drive 20% plus growth rates.
Given the secular growth we continue to see within the technology space and the growth rates that these big tech companies are able to display, in addition to their extremely healthy balance sheets and cash piles, we remain constructively positioned within our portfolios. Forward valuations approaching 30x (essentially 1x growth) are a reasonable price to pay for companies leading us into the next technology evolution.
Retail Investor Riot
We may only be a few weeks into 2021 but so far it has already been filled with surprises for the market. One particular market event which is being described as a “David versus Goliath” battle has seen the coordinated trading by millions of retail investors to make significant gains at the expense of various Wall Street hedge funds.
To understand how this all unfolded its best to start with a basic explanation of the mechanics behind the trading involved. At NVest we are long term fundamental investors. We buy and hold shares in companies that we feel will grow earnings over time providing share price return along the way. We buy shares now with the intention to sell them at a higher price many years from now. We are seen as being “long” in a particular stock. On the flip side, investors can also “short” companies if they believe its operating performance will weaken leading to a weaker share price over time. Short sellers sell stock now with the intention to buy it back later at a lower price. In order to short sell, you have to hold the share to sell it, so short sellers borrow the share from other investors, sell them now and when they purchase the share back at a lower price in the future the shares are returned to the lender and the short seller banks the profit.
Short selling does not happen for free, when borrowing the stock, the short seller is required to hold cash in a margin account in line with the lender’s requirements. If the share price increases by too much, the short seller receives a margin call which requires a further cash deposit or the delivery of the shares to clear the position.
Critics of short selling often argue that it incentivises Hedge Funds to push share prices lower through controversial means which may include spreading negative rumours about a company’s prospects. This is where the GameStop story gets interesting…
GameStop is a video game, consumer electronics and gaming merchandise retailer with over 5,000 retail stores. The shift to online games sales through online stores gathered steam as the pandemic took hold and had big investors anticipating pressure on GameStop’s sales and a resultant decline in their share price. They took large short positions as a result. This short selling angered many retail investors who saw it as another move by Wall Street “fat cats” to make money at the expense of the company. Millions of retail investors were rallied together through online Reddit forum r/WallStreetBets calling on members to buy GameStop shares to create a “short squeeze” on the Hedge Funds. As millions of investors bought up the penny stock the sudden spike in its share price triggered margins calls on short sellers. They were forced to either inject millions of dollars of cash or buy back the stock at astronomical prices to close the position. The increased buy back further increased GameStop’s share price which between the start of 2021 and the 27th of January 2021 gained over 1,700%.
Needless to say the retail crowd based attack shocked the market leading to tremendous losses by some, significant gains by others and general awe by the greater investment community. Gamestock has largely lost all its initial gains but the crowd based idea of trading has gathered steam with a number of other shares gaining in a similar fashion.
By the Numbers
Room for a Rate Cut
So far Biden has been given the benefit of the doubt as far as markets are concerned and has had for some time. The perceived impact of higher stimulus is viewed as outweighing any potential negative impacts of mooted higher corporate taxes and regulation under his administration. We view market participants as likely correct in this regard, which dovetails nicely with our belief that monetary policy is also likely to remain loose for the foreseeable future.
In South Africa, the SA Reserve Bank’s monetary policy committee (MPC) was split by a single vote in favour of keeping interest rates on hold for a third meeting in a row in January. Reserve Bank Governor Lesetja Kganyago rejected suggestions that the Bank had been too cautious in its approach so far. In his view it had actually been “very aggressive”, with 300 basis points of interest rate reductions during 2020 yet to be felt in real economic activity, as monetary policy action usually takes between 12 and 18 months to filter down.
After inflation averaged just 3.3% in 2020, the lowest level since 2004, as the pandemic weighed on demand, the Bank now sees it averaging 4% in 2021 and 4.4% in 2022. The Bank, however, was more upbeat about growth, revising its forecasts for GDP growth in 2021 to 3.6% and predicting an expansion of 2.4% in 2022. In our view there appears to be room for more easing as the current economic shock has kept demand in the economy very low, and as a result inflation will likely remain anchored below the midpoint of the target band.
Stimulus hopes, the possibility of inflation somewhere over the horizon and a slowing virus infection rate will continue to be a positive for markets. And in South Africa, to the extent that there is a third wave that could hit its economic activity, we have got the monetary policy scope to respond and provide more stimulus if need be. A further catalyst for our local market to continue higher along with the rest of the world.
Woolworths released a first half trading update in January showing an incredibly strong performance given the uncertain trading environment. Earnings surpassed consensus expectations by almost double, coming in at an anticipated increase of 17-22% or between R1.89-R1.98, with consensus anticipating R2.10 for the full year. Group sales increased by 5.3% compared to last year with improved trading momentum across all businesses in the final six weeks of the period.
The Southern African operations saw Woolworths Food remain resilient, growing sales by 10.9% over the 26-week period and up 12% in the last six weeks alone. The expansion of their click and collect offering and the trial of an on-demand delivery service helped push up online sales by 158.5%, contributing 2.2% to overall sales. Woolworths Fashion, Beauty and Home, on the other hand, continued to feel the pressure of the constrained environment declining 11.2% over the period. A significant drop in Black Friday sales and a reduction in the formalwear trade contributing to this. Online sales saw a 118.8% increase contributing 4.0% to SA sales.
Australia and New Zealand saw an improved performance over the period with the negative impact of the 12-week lockdown in the state of Victoria being offset by the extended JobKeeper relief, a successful Black Friday and Cyber Monday campaign and further growth in online sales.
David Jones and the Country Road Group saw sales decline by 8.8% and 5.2% over the first half, largely impacted by lockdown restrictions. Both saw an over 50% increase in online sales.
The better than anticipated performance was well received by the market, with Woolworths ending the day 5.2% stronger following a surge of more than 13% in early trade. The announcement adds to the positive sentiment being seen across South African retailers including Mr Price and The Foschini Group who similarly saw their share prices soar on the back of healthier than anticipated retail performance. NVest are currently holders of Woolworths on appropriate portfolios.
Despite the pandemic, a sharp decline in crude oil prices, softer chemical product prices and numerous hurricanes impacting production, Sasol is expecting to deliver a strong set of results for their first half ended 31 December 2020. In their latest trading statement Sasol has guided to EPS and HEPS between R22.76-R24.07 and R18.59-R19.78 respectively, both an increase of over 100% and coming in ahead of market expectations. Core headline earnings are anticipated to be between R6.94 and R8.79 which are close to market expectations for full year Core HEPS. To clarify, what the market was anticipating over the full year, Sasol has delivered in the first half. Management attributed the better than anticipated result to strong cost performance supported by delivery towards the $1billion integrated crisis response plan commitment.
In December we provided an update on the progress of Sasol’s debt reduction strategy. They were ahead of expectations on asset sales and given the potential for a more stable market environment following Biden’s presidential win and worldwide COVID vaccine rollout supporting the oil price, their prospects were looking up. The latest trading statement is further supportive of this notation and with the price of oil and chemical products continuing to trend up, the prospects for strong performance ultimately assisting in debt reduction over time continue to improve.
Sales forecasts remain conservative in an improving environment
Given TRU has a June Year-End, the last 2 years have been impacted by various degrees of lockdowns driven by the pandemic. As we enter a more normalized environment, we model sales against 2019 revenues.
- We assume SA revenue for 1H22 will increase by 3% from 1H20 and increase 3% in 2H22 from 2H19. This will result in total revenue for FY22 growing 4.55%, from a FY19 base (15.27% from FY21 revenue).
- The UK business has been under significant pressure over the last 3 years. Going forward we assume Office stabilizes and improves as management has been able to remove an enormous amount of costs. We forecast revenue for 1H22 to be at 1H20 level, and 2H22 to be at 2H19 level as conditions in the UK return to normal. This equates to FY22 revenue increase of 40.78% from FY21 (2.25% decrease from FY19 base).
- Total group revenue for FY22 is forecasted to be up 20.52% from a Covid impacted FY21. A mere 2.83% growth from FY19 revenue levels. FY23 revenue is forecasted to grow at 6% from FY22 levels. Our revenue growth assumptions are conservative compared to the current sales growth levels of 8%.
- Margins are forecasted to move closer to pre-Covid averages of 23-25%, with FY22 OM estimated to be 21.5%, and FY23 OM at 23%.
APN and JNJ seal the deal
Aspen Pharmacare (APN) could start production of Johnson & Johnson (J&J) Covid-19 vaccines in South Africa by late March or early April if all approvals are in place. They have current capacity to manufacture up to 300 million doses of the vaccine. All the vaccines produced will be exported to J&J and will be part of its global supply inventory.
Results of its clinical trials at the end of January impressed. Protection from J&J’s vaccine was 72% in the US, 66% in Latin America and 57% in South Africa, 28 days after a single shot. It is important to emphasise that their vaccines showed protection against severe disease. South Africa’s government is in talks with J&J to secure some of this product for its own consumption.
APN itself has gone into consolidation mode of late, focussing on organic growth and looking to benefit from past capex by increasing throughput through manufacturing facilities as they ramp up production over the next three years. APN has already invested more than R3bn in the sterile facility in Port Elizabeth where the vaccine will now be manufactured. Clearly APN will now start to enjoy the fruits of their labour as capex is appropriately matched with new revenue.
The bounce from the October lows on the JSE has been stellar, in many cases well above 20%. With valuations in most cases still well off their previous peaks, our market still has legs to move higher. With vaccine rollouts globally gaining traction, monetary and fiscal policy remaining accommodative and a constructive view from global allocators of capital to emerging market equities generally, things are starting to appear just a little brighter on the southernmost tip of Africa.