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Wood for the Trees | April 2021
16 April 2021
No surprise this month that we’ve led with US Q1 earnings season in our headline graphic. After such strong price moves higher from the COVID market lows in late March 2020, market participants were looking to make sure that these higher stock prices would indeed be matched by significantly higher year on year earnings. I’m pleased to report that this was indeed the case, with Q1 earnings largely behind us by the end of April. How much better were they? I’ll leave you to have a look at the update a little further down in this month’s newsletter. We also touch on a few key company updates offshore this month and then spend a little time reflecting on where things stand in SA listed property. A sector of the market that has taken considerable pressure for 3 years, it is good to see capital values rebuild rapidly as portfolios stabilise and the sector begins to resume income distributions again.

Proper numbers posted by MTN in the month, surprising for all the right reasons. Now if it could just get some of its trapped earnings out of Nigeria as dividends, we could really be off to the races. The SA narrative continues to gain momentum as higher prices have begun to attract foreign interest in the media (although YTD foreigners are talking more with their mouths than their money, with net foreign purchase of SA equities disappointingly still negative YTD to the end of April). On the local political front, rumours and murmuring bubbling under the surface in April, have spectacularly burst into full view in May, with the battle for the ANC and the country exposed in full view. We will spend some time addressing the implications of this in next month’s edition, but for now the signs are certainly positive. Enjoy April’s read

International section

By the Numbers

A stellar April saw the All Country World index post 4% for the month. Sentiment remains on a firmly upward trajectory as strong economic numbers, as well as blowout Q1 earnings numbers from the S&P500, lifted investor confidence.

We spoke previously about high global savings rate following the pandemic, and this combined with fresh rounds of stimulus cheques and a vaccine rollout gaining daily momentum, was more than enough to send the bulls to the “buy” button. So far, the US has vaccinated about 45% of its population, with the UK doing well too (just north of 51%) and this is providing confidence that the reopening trade remains firmly on course.

A slight rotation from the Value trade this month, as Growth stocks managed to gain ground on a relative basis in April, gaining almost 2 to 1 in the month, a change from Value, which has really been enjoying its time in the sun this year.

In the US some big moves from stocks like Equifax (data analytics and technology company – at least its PE is only 50x 🙂 ). Not surprising to see tech companies in most of the top 5 in the S&P500, given our earlier commentary that Growth led Value in April. But they couldn’t do enough to completely eclipse some of the “old world” companies, with Harley Davidson holding its own (up 20% in the month and 36% for the year). Have to love their ticker code, “HOG”, for those who would like to follow it.

Japan still lagging for the month and looking very poor YTD, the only index we follow showing negative returns this year so far.

The UK also trying to make a proper fist of it, with Intermediate Capital (a UK based alternative asset manager – think much smaller Blackstone as reference) up 20%, with Smith & Nephew posting mid teens as well in April.

A reflection on Q1 earnings season

Earnings growth rocketing ahead

A couple of months ago, in anticipation of the start of the 1Q21 earnings season in the US, we wrote that expectations going into the reporting season was high with estimates for earnings growth having increased a record 6 percentage points to 24.5% Y/Y from the prior quarter. Additionally, we noted market fundamentals were currently pricing in a 2022 EPS number of $223/shr for the S&P 500 versus current estimates of $202.

As we come to the end of 1Q21 earnings season, it turns out that analysts have significantly underestimated the strength of the current earnings recovery. To date, 88% of S&P 500 companies have reported results, with a record 86% of companies beating estimates. Even more impressive is the amount by which companies have exceeded estimates. On aggregate reported earnings have beaten estimates by 22.1% to deliver 1Q21 earnings growth of 49.5%, way ahead of the 24.5% expected, as we entered the reporting period.

As the market is a forward pricing mechanism, and taking into consideration the already high degree of optimism currently priced into equities, it was interesting to see that the market did reward the companies that beat estimates, by pushing prices up almost 1% on aggregate, while at the same time punishing the misses less than is ordinarily the case (see graph below). This gives you a sense that companies continue to surprise already optimistic expectations on aggregate in this first reporting period of the year.

While 1Q21 earnings delivered a huge beat, we have seen very little follow through into the upcoming quarterly expectations, which may suggest estimates will continue to move up and the final 2021 EPS number could well turn out to be substantially higher than the current $187/shr estimate. As more economies begin to open and return to normal, we expect pent up demand to drive numbers higher.

As mentioned on prior occasions, while the current S&P 500 forward PE at 21.5x is higher than 5-year average levels of 18x, we believe the market is currently pricing in a 2022 EPS number closer to $222 (versus current $207), which represent a forward PE closer to 18.5x and more in line with fair value. Time will tell, but for now the earnings trajectory is lining up well.

Stock Comments

Apple continues to benefit from the “Work from Home” trend as consumers upgrade their home offices and mobile working capacity. Not so long ago it was thought that it was sufficient for each household to have one PC / Laptop. It is now clear that every individual in the household may require a personal computing device. Apple generated $89bln in revenue in the March quarter, up 54% Y/Y and easily beating estimates. On top of this, margins continue to expand and earnings growth exceeded 100%, coming in at double the 70c/shr expected.

Product growth has ramped, as Apple is benefiting for the secular shift in mobility.

Apple’s high margin services business continues to go from strength to strength. It added 40mln new paying subscriptions in the quarter and now has over 660mln paid subscriptions across their platform. This provides a very powerful annuity-based income stream.

Alphabet reported a blowout quarter powered by much higher margins on the strength of its core search advertising business, reflecting elevated consumer activity online and broad-based growth in advertiser revenue as customers begin to restore marketing budgets. Revenues jumped a healthy 34% Y/Y to $55.3B, easily clearing analysts’ bar, and operating income more than doubled to $16.4B.

Operating margin jumped to 30% from a year-ago 19%, driving net income up 162%, to $17.9B.

Google Cloud saw revenues up 45% Y/Y to $4.0bln in the quarter reflecting strength and opportunity in both GCP and Workspace.

YouTube continues to grow, with ad revenues increasing 49% Y/Y during the quarter, generating revenues of $6bln.

All eyes were on the big US diversified financials to get some insight into how the economy in general and the consumer in particular were doing. They did not disappoint. All delivered big beats with those with large capital markets businesses (JP Morgan, Goldman’s, Morgan Stanley) posting the biggest upsides, driven by record Investment banking and debt underwriting divisions. The banks in general benefitted from large reserve releases as the US consumer is a better position than previously accounted for, with bad debts running at a significantly lower run-rate as a consequence.

On the negative side, loan demand remains soft with most banks showing low to negative growth in this area. This is primarily a function of the consumer using a portion of the stimulus cheques to pay down existing debt and a lack of confidence in the strength of the job market which is causing the consumer to hold back on credit spending. Lower net interest margins also hurt Net Interest Income revenues. All in all though, the banks’ balance sheets remain healthy from a capital perspective and strong non lending businesses are driving up return of equity.

Philip Morris delivered a strong set of 1Q21 numbers despite the soft duty-free market due to international travel restrictions. 1Q revenues grew 2.9%, as Heat Treated Unit (HTU) volumes increased 29.93% offsetting the 7% decline in traditional tobacco products. Philip Morris’ pricing power continues to be impressive with net revenue per unit up 6.9%. Operating margins expanded 590 bps driving EPS up 21.5%. On top on this, management lifted full year guidance for both revenue growth and EPS growth.

We continue to have a positive view on Philip Morris as they drive penetration of their higher margin Heat Treat Unit. HTUs currently make up 13% of volumes but 28% of Revenues. Philip Morris remains on target to achieve its goal of selling 250mln HTU units (30% volume share) and 50% of revenues.

Additionally, Philip Morris pays an attractive dividend yield of 5% on top of these strong growth dynamics.

Local section

By the Numbers

Another positive return number for the Equally Weighted Top 40 as the local market continued to march higher this year, April posting just short of 2%. Gains were led by property, with a stellar 10% bounce in April. 3yrs of pain finally starting to unwind as sentiment towards the sector begins to improve. We’re still a long way away from 2017 highs, but it is encouraging to see the discounts to tangible NAV beginning to claw their way back.

Resources best of the rest (up around 3% or so) with Sasol leading the pack convincingly, up 15% in the month. This month caps a 75% capital return in 2021 so far for the company. The macro environment remains constructive for Sasol, with a higher oil price, higher ethelyne prices and lower debt a powerful recipe for what we expect to be a very strong results announcement in August.

A nice bounce also this month from Investec (a move from very cheap to just cheap) while its counterparts, in SA’s big 4 banks, struggled during April, with most in the red for the month.

On the Industrials side, some good moves from both Aspen (11%) and Anheuser Busch (+10%). We’re particularly pleased with the move from AB Inbev as the stronger rand had provided us with what we felt was a good entry point into a quality business earlier in the year. The market has finally taken a liking to the large EM exposure in their portfolio, with growth starting to come through even while the company focuses on reducing debt. The changing of the batton from Carlos Brito to the new CEO, Michel Doukeris (currently AB Inbev North American President), was also well received by the market with little disruption so far.

First prize for best monthly return in the ALSI went to none other than Vukile property fund, adding back almost a third in April (+29%).

SA Listed Property Update

South African listed property began to stage a recovery towards the end of last year, seeing significant improvement from November towards the end of 2020. This trend has largely continued in 2021 with April’s performance in particular, showing a change in appetite for the downbeat sector. Over the last 12 months the SAPY has gained over 30%, while YTD the index is up around 13%.

Year to date, the sector as a whole has been one of the best performers, with the SAPY (Purple) the second-best, behind Resources (Blue).

While this short-term performance may have some cautious of further upside, underlying fundamentals still point to a significantly undervalued sector. As a whole the sector trades at a discount to NAV of around 30%, with the majority of SA focussed names showing more considerable discounts.

REIT distributions have largely returned, with the exception of one or two names, and on average we are anticipating a forward dividend yield of around 9% on a full property portfolio.

While the property sector is not without its challenges, results are starting to show improvement in balance sheets and operating metrics. Loan to values on average remain elevated, but have improved from 43% in June 2020 to 42%. It is expected to take time for gearing to improve, but it remains a priority of the property companies. We are of the opinion that this sector still has room to recover from here, as a return to normalcy has the potential to trigger a significant rerating in the sector.

Stock Comments

MTN released quarterly results for the period ended 31 March 2021, which showed a solid performance from the mobile operator. Organic service revenue grew by 17.8% y/y in 1Q21 in constant currency and 8.8% y/y on a reported basis due to ZAR strength in the quarter. All segmental revenue streams (voice, data, fintech, digital and wholesale) saw improvements versus FY20 with some assistance from easier comps. EBITDA improved +21.3% y/y with Nigeria, South Africa and Ghana in particular contributing to the strong performance. In constant currency terms, MTN’s EBITDA margin improved to 44.2% in 1Q21, broadly in line with the previous quarter.
MTN saw strong EBITDA margin expansion from the majority of their operating companies with those lagging being the Ivory Coast, parts of West and Central African and the Middle East and North African (MENA). MTN’s exit from the MENA markets should reduce this dilutive effect over time.

MTN South Africa delivered a solid performance with service revenue +11.8% YoY and sustained growth at all core business units. Total subscribers increased 95,000 in Q1 to 32.1 million. The market loves to hate Nigeria and often places little value on its operations despite building on its growth momentum and delivering service revenue growth of 17.2% supported by growth in data and voice revenue. Subscribers declined by 5 million to 71.5 million primarily on the back of regulatory restrictions on new SIM sales and activations. The MTN Group has an estimated R5bn-R7.5bn in dividends due from MTN Nigeria which would be a catalyst for the share price at a time when repatriation is possible.

MTN currently trades at a discount of around 30% to its 5yr average forward EV/EBITDA based on Reuters. In addition, it trades at a significant discount to Vodacom on consolidated EV/EBITDA multiples. We are buyers of MTN and have been pleased with its performance over the past few months. Year to date, MTN is up 57%.

Closing Comments

It looks like we’ve now posted 6 straight positive months on the local bourse and continue to lead our global peers on a total return basis year to date. What a positive change it has been. There remains much to be done locally, but each month seems to end with another brick put back into the broken South African wall.

Internationally, a willingness to support higher prices, combined with a constructive monetary policy stance and floods of stimulus being proposed in the US Senate, provide a reasonable backdrop for equity prices as they continue to push higher this year. It’s not to say of course that markets cannot wobble from here, but rather that if you have the correct capital committed to risk assets, any sustained downside appears likely to get support at this stage as dormant cash is enticed from the sidelines to hit the offers in the market. If we’ve learnt anything in the last 18 months, it’s that being an equity investor requires a strong stomach, but that’s if you’re able to stay the course, the capital values of quality companies have an ability to stand the test of time.