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Wood for the Trees | February 2021
16 February 2021
We headline this month with perhaps the biggest question facing investors in 2021… will inflation kill the risk asset rally? Liam spends some time looking at both the inflation debate, as well the rotation from growth to value considering rising GDP growth expectations. Are higher rates in response to improving growth expectations really that problematic? He has a quick look.

Locally we have had a lot of results starting to hit the tapes and by and large the numbers have been better than expected on a relative basis. Risk assets remain poised for further upside (nosebleed tech not withstanding) with EM remaining in the limelight as long as US long bond yields do not get materially out of control from current levels of around 1,6.

We hope you enjoy this month’s read. SA equities continue to shine into 2021 and it is pleasing to see meaningful leadership relative to first world peers, not only in percentage improvement terms, but in hard currency as well.

International section

By the Numbers

Another good print for global equities in February, with the All Country World Index posting a bit over 2% in the month despite a softer closing two weeks. At one point equities were heading for 7% higher in Feb but were dragged back by a steepening global yield curve. Caution around inflation saw US 10yr yields close the month north of 1,4%, more than 50 basis points higher that the starting point in January. As can be expected, a fresh bout of bearish predictions on US inflation accompanied the softening in the bond market, which is not uncommon. While we remain cautious that a breakout of US 10yrs would be problematic for risk assets, there is still some way to go before this can be considered as a reasonable prospect. And while we had inflation concerns putting a bit of a lid on things in the second half of the month, progress on the global vaccine rollout is more promising news. At this stage manufacturers have guided to 600 million does being manufactured by June and many countries are making reasonable progress on their rollout strategies. So, while yield curves may be a challenge, vaccines and stimulus are the antidote. The US has been working hard on a USD 1,9 trillion stimulus package, which has subsequently been approved in March, and value stocks continue to respond favourably as a result. No surprise then to see previous losers bouncing back nicely in Feb, with oil companies and cruise liners and airlines top of the pops. On the other side of the same coin, Tech continues to be a laggard this year, barely posting a gain in the month as investors look for a rebound in earings from the “old world”.

Don’t believe the index – the great rotation is real

As investors debate whether inflation is a real concern or not, significant movements are taking place across global markets at individual stock level. Increasing bond yields are putting pressure on the high-flying technology sector that has been trading at nosebleed valuations, justified by ultra-low interest rates which favourably impact the discounting of potential future cash flows. The media has been awash with news that the Nasdaq is negative for the year and the S&P 500 is barely positive causing commentators to question whether we are at the beginning of the end of the market rally we have seen since March last year.

This is very misleading, as below the surface we have seen a rotation into cyclical sectors, something we pointed out at the beginning of the year. The Energy, Financial, Industrial and Material sectors are up significantly year to date and are taking over leadership of the market.

Unfortunately, the issue from an Index level is the fact that the weighting of the Technology Sector has been growing exponentially over time as the sector has continued to jump higher. Exiting 2020, Big Tech (Tech, Communication & Amazon) made up almost 45% of the S&P 500 market cap, while the Energy and Financial sectors made up only 3% and 8%, respectively.
To put this into perspective, Energy and Financials need to perform 4 times better in order to offset any pull back in the Big Tech sector.

As GDP growth begins its bounce back from the global pandemic induced recessions in 2020, it is becoming more ubiquitous, and investors appear unwilling to pay the handsome premiums of the past. The focus has now switched to value names and those that will benefit the most from a strong economic up cycle. Growth Investing has trumped Value Investing for the last 10 years and while we have seen some large outperformance from the Value Sectors of late, the trade still has a long way to play out.

This trend is supported by increasing evidence of the global economy bouncing back nicely, further supported by continued stimulus and numerous instances of economic data surprising on the upside. Rising yields appear to be reflecting the strength in the underlying economy, rather than just fear over inflation pressures. It is disingenuous to call the end of the stock market rally due to the poor performance of the S&P 500 index to date. The underlying cyclical sectors are outperforming, as they should be in an improving economy, and have delivered very attractive returns in 2021 so far. One thing for certain is that you need to be in the appropriate sectors and stocks to benefit from the rotation from Growth to Value.

The inflation debate

Currently the major topic on all market participants’ lips is whether inflation is going to be an issue in the near term and whether the US Fed will be forced to raise interest rates sooner than expected.

Recently US 10-year treasury yields have risen to 12 months highs as the market begins to discount the potential for rising inflation.

At a sector level, as can be expected, the highest growth is likely to come from the cyclical sectors that were hardest hit in the height of lockdowns last year, such as Energy, Industrials, Materials, Consumer Discretionary and Financials. The opportunity for big earnings beats also lie with these sectors.
The 10-year Breakeven Inflation rate (Difference between 10-year treasury yields and Inflation Protection Treasuries) continues to edge closer to 2.5%, levels last seen in 2013.
Inflation is inherently a bullish phenomenon as it suggests the economy is growing at a healthy pace. However, if left unattended at unhealthy levels can cause great destruction as central backs have to increase interest rates to slow down growth to control the risk of hyperinflation. Most recessions have been caused by central banks raising interest rates too rapidly.

Enormous pandemic driven stimulus packages, ultra-low interest rates and accommodative central banks policies have seen monetary supply growth increased by more than 20%

This coupled with pent up consumer demand, a fast pace of vaccine roll outs across the US and a Fed that has suggested it is prepared to tolerate Inflation at higher than its 2% target rate for a prolonged period of time, is driving the market view that doubts the Fed has the ability to control inflation and will be forced to increase rates sooner than expected.

Analysts who disagree that Inflation will be a problem note that inflation will spike in the short term as we lap easy comparisons between March and July last year when global lockdowns were in full swing and Oil prices collapsed.

They believe short term inflation will be transitory and ultimately the main driver of inflation is wages (wages typically drive 75% of inflation). Given that over 9mln people in the US are still unemployed versus pre-covid employment levels, wages will not be a problem for several years as we edge towards full employment levels again.
Currently the Forward Rate markets are pricing in an increase in US rates in the next 12-15 months, while the latest Fed Dot plot suggests no rate hikes until after 2023. Clearly the rates markets are calling the Fed’s bluff.
The bottom line is that Inflation suggests economic growth which is positive for the cyclical sectors in the market but is not as supportive for growth stocks that are trading at record high valuations. Until we get consensus on where the trajectory on inflation will go, we continue to expect volatility in the stock market.

Local section

By the Numbers

Another big month for SA Inc, with the equally weighted top 40 pushing for 5% in February. The repair in locally listed stocks continued in line with the EM trend around the world. As investors consider alternatives to a relatively expensive US stock market in an environment where the US dollar has been weakening, South Africa has begun to screen quite favourably once again. Of course, our prospects weren’t hurt in February by a few positive surprises in the budget presented by Minister Mboweni in the month, with VAT receipts and corporate taxes surprising to the upside, to the tune of R100bln. This gave a bit of breathing space to the fiscus and ensured that no further tax rate hikes were pushed through this year. Our market was led higher in February by resource counters, with Platinum having another good run and Sasol surprising investors for the right reasons this time, with a dilutive rights issue now taken off the table by the Sasol Board. With a sigh of relief, the stock climbed a further 14% in February, capping off 40% gains for the stock YTD. A pleasing move from the likes of MTN and Bidvest in February, with the listed property sector also moving higher this year as some degree of normality begins to return to the sector. No surprises again in this environment that gold would be the funding mechanism for the long SA trade, with all gold miner returns solidly negative for the month, with the index itself down 12% YTD to the end of February.

The budget balancing act

President Cyril Ramaphosa’s 2021 State of the Nation Address (SONA) on 11 February sought to balance immediate challenges from the pandemic with the difficult task of reviving an economy that was already in dire straits going into the crisis. On balance he probably exceeded the nation’s modest expectations by announcing further energy reforms and extending income and wage support for those hit hardest by the pandemic.

Rather than reiterate the long list of reforms required to change the economic trajectory, the speech focused on the four most critical economic reform priorities. While the focus was welcomed, execution remains the key demand from stakeholders. For business, the bottom line is whether the SONA signals the start of a bolder undertaking by the government to lift growth-enhancing reforms out of the bog of bureaucratic inertia.

Naturally and most pressing, more information on the vaccine procurement and rollouts were high on everyone’s priority list, with questions of how these would be funded.

The 2021 National Budget delivered by Finance Minister Tito Mboweni on 24 February walked an equally tight rope, balancing the need to support while demonstrating fiscal prudence. A combination of higher commodity prices and a decent economic recovery over the latter half of 2020, left him with about R100bn of additional revenues relative to the Medium-Term Budget estimates.

While the deficit and debt ratios are still well in excess of comfortable levels, the outcome of the National Budget was better than the market expected and allowed the funding of vaccines and extended COVID relief measures without additional direct taxes outside of the usual increases in the fuel levy and excise duties. The Rand and local markets gained in the aftermath

Stock Comments

FirstRand Interim Results

FirstRand released their interim results for their first half ended 31 December 2020. As the first big bank to report the market enthusiastically awaited an update on how the banking sector had fared over the past few months given the COVID-19 pandemic and resultant economic pressure it created.

FirstRand did not disappoint showing a robust performance despite the tough operating environment. Normalised diluted earnings per share were down 21% YoY largely in line with market analyst expectations, impairments increased 59% YoY but decreased 46% compared to 2H20, and pre-provision operating profit was flat YoY and up 8% comparing the 2H20 to the 1H21. Focussing on topline revenues, performance was resilient with net interest income flat YoY and operational non-interest revenue down 1% YoY. It is important to bear in mind the comparative periods when looking at YoY figures as 1H20 was a pre-pandemic operating environment. This is further evidenced in the divisional normalised earnings performance. While from a YoY perspective, performance on the surface is weak, when compared to 2H20 the start of a recovery is clear.

The credit loss ratio (CLR) remains elevated on a YoY basis at 1.46% but has improved considerably versus the FY20 12-month CLR of 1.91% (2.87% represents the rolling 6-month CLR for 2H20).
The balance sheet remains robust despite the increase in impairments being primarily attributed to an increase in new non-performing loans. Stage 3 loans increased to 4.8% of advances from 3.6% in Dec 19 and 4.4% in June 20. This increase reflects the expiration of COVID-19 relief and a decline in advances.

The standout result was the announcement of an interim dividend. A figure of R1.10 per share at the bottom end of their target pay-out ratio of 1.8-2.2 times and coming in ahead of analyst expectations was welcomed by the market. The South African Reserve Bank has previously advised banks against dividend payments given the uncertain pandemic environment and only recently relaxed its view.

This is based on net bad debt levels of 15% of gross debtors for both FY22 and FY23, and an allowance for doubtful debts as a % of gross debtor levels of 23% and 22% for FY 22 and FY23, respectively. We consider these levels to be quite conservative, seeing that the average net bad debts as a % of gross receivables is 14% and allowance for doubtful debt is 19% (having gone up to 30% in Jun-20 from 20% in Dec-19).
FirstRand anticipates FY21 EPS to exceed that of FY20. Despite this, the earnings achieved in the second half are anticipated to be less than those seen in the first. The three main reasons behind this include cost normalisation, credit loss provisions to remain in line with current figures (in other words, they are not anticipated to be written back) and largely the delayed recovery in SA given the expectations of a slow vaccine rollout. Despite the strong performance seen in their 1h21 results, management remain cautious of economic risks. At current levels FirstRand is trading on a forward PE of around 12x with a forecast FY divi yield around 3%. We are buyers of FirstRand on appropriate portfolios.

Bidvest (BVT) – HY 2021 Results

BVT reported interim results recently which were a mixed bag at a divisional level, but which nevertheless provided some encouragement for shareholders for the road ahead. Their focus was on expense and balance sheet management while delivering efficiently into market demand.
Trading profit increased by 3.5%, enhanced by the consolidation of PHS for the full reporting period. Normalised HEPS from continuing operations came in at 651.6c per share, 6.1% higher and the group declared an interim dividend of 290c per share, up 2.8%. Cash generated by operations almost doubled to R6.2bn while free cash flow totalled R3.1bn. This allowed Net debt/EBITDA at the reporting date to decline to 1.7x versus 2.1x as of 30 June 2020.

BVT have optimised their cost base and improved efficiencies. They completed the sale of its 6.75% stake in Mumbai International Airport for R1bn and the cash proceeds received earlier this calendar year. They have also signed an agreement for the sale of its airports ground handling business, Bidair and is in the process of disposing of its Bidvest Car Rental business.

Following restructuring efforts in the prior period and these disposals of non-core assets more recently, together with the commissioning of the R1bn liquid petroleum gas storage facility in Richard’s Bay last October BVT appears well positioned for the reopening of the economy. Their businesses are future-fit and their operating models scalable, well placed for growth.
Given the unprecedented trading environment, management can be forgiven for serving up a commendable but not flawless result for the period. With BVT trading on a forward PE of 13x and a forward yield above 3% we remain buyers in our relevant portfolios.

Discovery Interim results ended 31 December 2020

Discovery’s interim results showed resilient performance over the first six months of their 2021 year despite the headwinds the COVID-19 pandemic created. Operating performance was robust, and the group reported a 19% increase in normalised profit from operations. Established businesses, being the main contributor to operating profit, showed a strong performance (+10%) while emerging businesses continued to gather steam (up over 80%).

Looking at operating performance from the underlying composites. The SA Composite held its ground with SA Health +6% YoY despite reduced total health lives as retrenchments increased. SA Life increased 3% being impacted by a 6% decline in new business from a deterioration in face-to-face sales activity and elevated group live claims. Discovery Invest saw a 3% decline in operating profits in part from prior year once offs in addition to a 3% decline in new business. Discovery Insure benefitted from reduced vehicle mobility increasing its operating profits by 43% YoY. Lastly Discovery Bank, while still small continues to show promise with retail deposits now at R5.7bn and advances largely stable at R3.8bn reflecting a conservative lending strategy over the period. The UK Composite delivered a strong performance +36% YoY in GBP and +56% in ZAR. Similarly, the partner composite which includes Ping An Health had a strong operating performance up +65% with total Revenue +62% and new business premiums +31%.

COVID-19 provisions remained unchanged at R3.4bn on a net basis despite further mortality provisions being recognised for the SA Life business. Discovery found the impact of the second wave in SA to have a much more significant impact on their target market when compared to the first wave.
Despite the strong operating performance HEPS decreased 10% while normalised HEPS decreased 1% as earnings were impacted by market volatility (interest and exchange rates). Given the uncertain environment no interim dividend was declared which came in line with market expectations. Discovery’s resilient performance throughout the pandemic shows the effectiveness of their shared-value model. Their established businesses held their ground effectively while the emerging businesses continue to scale up and create value. At NVest we find their innovative approach attractive and their underlying performance robust. Discovery trades on a forward PE of 18x and we are long term holders on appropriate growth focused portfolios.
AB InBev (ANH) – 4Q & FY 2020 Results

ANH reported their fourth quarter and full year 2020 results on 25 February. They posted a decline in underlying EPS for FY20 of 30.8% to 251 US cents per share. The results were mainly driven by the negative impact of COVID-19 restrictions. While the full year results were discouraging, we note positive signs of a recovery as restrictions are eased across its markets.

EBITDA fell 2.4% to $5.07bn in Q4 above an average market forecast of $4.8bn but was boosted by a tax credit in Brazil. Excluding this, the profit fall was worse than the average 1.0% decline expectations. Organic volumes and organic sales reflect a strong Q4 period where volume grew 1.6%. In Brazil, the company sold 11.9% more beer in Q4 than a year earlier. But in Europe, the Middle East and Africa, beer volumes fell 6% due to lockdowns, though ANH said it did increase market share in France, Germany, and the Netherlands. China grew only marginally, and the US market declined due to a COVID resurgence.

The geographically uneven nature of the rebound and the muted outlook on margins suggest limited upgrades, however, the world’s largest brewer forecast “meaningfully” better 2021 earnings predicting increased drinking and higher prices as countries emerge from the COVID pandemic.
We view ANH as the best in class and a leader in global beer market which offers investors access to high quality, defensive and globally diversified income streams. They benefit from having a broader portfolio in wider markets, better innovative and distribution capabilities compared to its peers. ANH is operated by a highly experienced management team, with a good track record of value creation. The debt reduction initiatives combined with innovation and costs management should support future earnings growth for this business.

Based on our forecasts, ANH is trading on a normalised PE of 15x and a target price of R1 250 is well within range and continues to attract a BUY recommendation for appropriate portfolios.

Closing Comments

We signed off last month saying things were looking just a little bit rosier on the southern most top of Africa as we closed out the first trading month of the year. With another month in the bag, we might even venture to say that it is looking brighter still. Corporate South Africa has continued to hold up better than expected, retailers are generating more cash as a percentage of EPS than they have for some time, the banking sector is pointing to recovery with the resumption of dividends in some cases and our finance minister appears to have been able to hold the wolves at the door, at least in this budget speech.

With the vaccine rollout gaining momentum across the globe, there are glimmers of hope that 2021 may well turn out to be a significant improvement on the hardships many faced in 2020. The first peg is in the ground from a South African investment case perspective, reasonable results. Next stop structural reform and some “light” (pardon the pun) at the end of the tunnel from the rolling challenges facing our SOEs in general and Eskom specifically.