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Wood for the Trees | November 2022
15 December 2022

November continued where October left off and reminded us that is it important to remain patient and invested. Over the last 2 months the S&P 500 has rallied 14.5%, while closer to home the JSE All Share was up a whopping 18.3%. As of this writing, the All Share is up for the year while the S&P 500 remains down 17% for 2022.

The catalyst for the follow-on rally was principally due to comments from Jerome Powell that got investors believing the Fed will begin to taper the rate at which they hike rates beginning that their December meeting.

Rate markets quickly adjusted expectations for two further 50 bps hikes in the next two meetings (Dec / Feb), and for rates to peak at 500-525 in June before exiting 2023 at 450-475bps.

Powell’s comments were supported October’s CPI coming in lower than expectations (7.7% vs estimates of 8%). While we will no doubt experience some more volatility going forward, nevertheless, it is nice to have a consistent run.

The trajectory of Inflation is going to be a critical determinant for the path of rate hikes over the next 6 months – in this month’s WFTT we provide you with a look at our thoughts regarding about US inflation over the short term and where we expect it to flush out.

Additionally, we revisit Disney, one of our core holdings after their recent earnings report and CEO shake-up. Our conclusion is that the market continues to significantly undervalue DIS, and we see a solid path to significant potential returns going forward.

On the local front, overly pessimistic sentiment continues to weigh on stock valuations despite operating results to the contrary. We pull apart what current valuations are implying about earnings going forward and believe expectations are way too draconian.

Finally, Property remains one of our most favoured sectors with the opportunity for large potential returns. We lay out our thesis as to why we believe property should be a part of any portfolio.

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By the numbers

November was another great month, showing back-to-back growth as global equity markets rallied. S&P 500 Index was up 4.6%, with a noticeable rally on the last day of November after Fed Chairman Jerome Powell signalled to a potential slowdown in interest rates. The markets reacted positively to the news, with the S&P 500 ticking higher and markets currently expecting a 50-bps increase at the next FOMC meeting. UK & European markets also performed better this month, while staying the course in fighting inflation. Both FTSE 100 (up 6.7%) and JSE ALSI (up 12%) moved into positive territory year-to-date (YTD) as they reversed any losses for the year. Notably in the US, ABIOMED was up nearly 50% after Johnson & Johnson announced an acquisition deal. Cineworld also jumped after agreeing to explore a potential sale of its business. Tesla shares dropped as investors are concerned over possible inattention from Elon Musk, as he focuses on the Twitter acquisition and its transformation. Optimism spiked in markets with Chinese exposure, with significant moves from Chinese companies such as JD.com, Baidu, and Trip.com after Covid polices have become less restrictive and lockdowns have been lifted in major cities in China. In addition, Chinese officials announced plans to support property developers, leading to a bounce in real estate names such as Country Garden and Logan Property Holdings.

Looking into the crystal ball

The surge in inflation has been a dominant theme in 2022 and has directed the Fed to increase interest rates at an unprecedented pace; causing investors to adjust their valuation outlooks. Heading into 2023, inflation will be the primary focus again but this time looking for a slowdown and allowing the Fed to adjust their rate path accordingly. Getting the Fed’s rate path correct will be key for outperformance in 2023.

In determining the potential path of interest rates, we look at the underlying components of inflation. The New York Fed President, John C. Williams, recently likened inflation to a 3-layered onion. The outermost layer consisting of commodity prices, the middle layer made up of goods, and the innermost layer being underlying inflation. This view provides a useful framework on how to think about the Fed’s focal points on inflation.

Peeling back the onion, we will first look at the outermost layer – the price of commodities. Looking specifically at commodities such as lumber, steel, grain, and food oils; these prices have clearly peaked and begin to roll over. In addition to this, with slowing global growth, demand for these products will decrease and potentially lead to a further drop in prices. Going forward, as we start to lap tough comparisons in the first part of 2022, we could see low single digit growth or even negative price growth as we enter 2023.

Graph showing the price of commodities

The middle layer consists of goods such as vehicles, appliances, and household goods. All of which experienced both strong demand and severe supply chain disruptions. Demand continues to outstrip supply, but with easing global supply chain pressures, deflation in used car prices, and the incremental supply of new vehicles; inflation pressures should ease in these core goods and won’t be a concern on the Fed’s radar if current trends continue.

Graph showing good inflation year on year: comparing new vehicle sales, used vehicle sales and household goods

Fed member Williams also referenced the Global Supply Chain Pressure Index, which shows that global supply chain pressures are falling back in line with historical levels as supplier delivery times shorten substantially and shipping costs normalize – further exerting downward pressure on overall inflation in coming months.

Global Supply Chain Pressure Index from January to September

Source: Federal Reserve Bank of New York

Lastly and most importantly, the inner layer which is underlying inflation. Ongoing imbalances in shelter, services, and labour market, have led to broad-based inflation which could take longer to suppress. Williams noted that the innermost layer is critical to bringing inflation back down to the Fed’s 2% inflation target.

Housing and Shelter forms the largest component in the inflation equation, accounting for circa 33%, and hence will be a major contributor to any pullback in inflation. Even though Shelter inflation continues to rise, there are a few positive points that we have seen. As mortgage rates increase, we have seen a slowdown in the US housing market that is beginning to pressure rentals and house prices. While house price growth is still elevated on a Y/Y basis, we are starting to see it roll over. We would expect housing inflation to begin falling sometime next year.

Graph: Shelter inflation year on year growth

Looking at the services sector; unlike goods inflation, services inflation has continued to rise. Wage growth is a determining factor in the cost of services and ultimately, the Fed needs to apply some pressure to the labour market in order to cool wage inflation. The unemployment rate remains top on our watchlist and will have to increase further for inflation to soften. Williams expects U.S. unemployment to rise to 4.5%-5% by the end of next year; currently the unemployment rate is 3.7%, up from September’s record low of 3.5%.

As inflation growth slows, it will lead to a downshifting in potential Fed rate increases which will be a positive factor for equity markets globally. As we head into the first half of 2023, we forecast the major inflation components will begin to soften. This will lead to a pullback in headline inflation; our expectations are for inflation to fall below 5% before mid-year 2023.

Graph: Inflation

Currently, it looks like the Fed funds rate could peak at 500-525bps in June 2023, before exiting 2023 at 450-475bps. We still have some way to go before we reach target inflation rate of 2%, however the market will look past this as the pathway to the target becomes clear – at which point it will begin to price in the next stage of the economic cycle.

Aforementioned, John C. Williams, concluded that, “Tighter monetary policy has begun to cool demand and reduce inflationary pressures.” He acknowledged that it would take some time, but he is fully confident that we will return to a sustained period of price stability. Looking into the crystal ball we can take comfort seeing that inflation relief is on its way as we lap base effects from the corresponding period last year.

Don’t ignore mickey just yet

Disney shares have had a tough time this year – they are currently down more than 40% year-to-date compared to the S&P 500, which is down 17.4%.

Operationally you cannot fault Disney’s execution. Its Parks, Experiences & Products business saw revenue growth of 73% in FY22. Revenues are now above pre-covid levels even though Disney Shanghai has been closed for a large portion of the year. What has been most impressive has been the profitability of the division; operating margins are currently 27.7%, significantly above all prior periods.

In the Direct-to-Consumer (DTC) division, Disney continues to move forward with its plans targeting 240mln Disney + subscribers by 2024. In the most recent quarter (Oct Q), Disney added 12mln Disney + subs to end the quarter with 164.2mln.

Micky Mouse version of Iron man
graph: Number of Disney+ subscribers worldwide from 1st quarter 2020 to 4th quarter of 2022

The DTC business reported an operating loss of $1.4bln in the 4th quarter, taking its loss for the full year to $4bln. Investors were disappointed at the extent of the loss. Despite this, Management is sticking to their goal to reach profitability in the DTC division in 2024. Another further issue disappointing investors in their quarterly results, was the drop in Linear Network (think TV networks) revenues, which dropped 5% due to a slowdown in ad spend. The problem here is that Linear Networks – while growing slowly – is Disney’s most profitable division, which is essentially funding the ramp-up of the DTC business. The fact the revenues are slowing, while at the same time the DTC losses are increasing, is causing concern for investors.

While it cannot be ignored that the US economy is beginning to slowdown, Disney continues to do a good job across all their divisions, and some bumps in the road can be expected.

As we have seen with some companies (namely Netflix, Meta, Amazon), investors are no longer prepared to tolerate infinitely growing expenses that generate little to no return. Unfortunately, Disney’s DTC business has not escaped investors ire in this respect. So-much-so, that the board grew disgruntled, ousting its current CEO, Bob Chapek, and bringing back long time Disney veteran Bob Iger. We expect Iger to restructure the Disney Media & Entertainment Distribution (DMED) business, which includes DTC, as well as rein in business costs. To date the market has cheered the return of Iger, if he is successful at accelerating a path to profitability at the DTC business, the stock could move significantly higher.

At a current share price of $92.29, valuation is extremely undemanding. On the surface, Disney currently trades on a forward PE of ~20x. However, this includes the big loss for the DTC business. If we use a Sum-of-the-Parts valuation, looking at Disney excluding DTC (old DIS) and DTC as a stand-alone, we get a fair value for DIS in the range of $175-$200/shr. Old DIS will generate $6/shr in FY23; putting that on a historical average PE of 18x, gets you a value of $108/shr. For the DTC business we use a blend of P/Sub and P/Sales (Netflix trades at a P/Sub of >$600 and a P/Sales of 5x) to give us a value to between $60-$75/shr.

Refreshed energy in the Executive suite, continued strong growth in Disney + subs, a new Ad subscription tier driving profitability, strong Parks momentum with Shanghai Disney hopefully reopening soon, and more conscientious content spending; it feels like the market is missing the Wood for the Trees on this one.

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By the numbers

The local markets rebounded strongly in November, up 12.3%, as the JSE ALSI recorded its best monthly performance since April 2020. The Resource sector outperformed, posting a return of 16% for the month. SA Industrials also posted a strong return of 14% over the month with all the groups within the sector, except Healthcare, posting positive returns. Aspen returned a loss of 6.2% in November. Technology names rallied, following underperformance in the previous month, with Naspers and Prosus posting sizeable returns of 38.7% and 39%, respectively, benefitting from the massive rally in Tencent (up 30%). Another strong performer was Richemont, which returned 22.4% for the month after releasing interim results that highlighted strong operational performance. Financials and Property returned 5.5% and 5.2% for the month, respectively. SA Banks released strong operational updates and Property sector operating metrics continued to improve. Retailers showed the least amount of return, returning 2.8% for the month. Spar finished down 14.5% and The Foschini Group (TFG) down 7% for the month despite a positive operational update. The Rand strengthened 5.5% during November, finished the month below R17/$, the first time it has broken these levels since September.


SA Retail holding its own

The current market consensus is that the SA consumer is under significant pressure as inflation remains high and the interest rate hiking cycle continues. Additionally, intensified load shedding has also pressured sentiment.

This negative sentiment is being reflected in historically low valuations across the SA retail sector, specifically within the apparel names. However, the underlying operating performance of these retailers does not reflect a weak consumer environment, as evidenced by the strong trading updates released in November.

Shoprite (SHP) continues to be a star performer amongst the food retailers, reporting double-digit sales growth of 19.9% for their first quarter ended September 2022. Its competitors have also seen improving sales growth over the past 12-months.

Graph: WHL SA food sales growth relative to peers

Management teams have done a great job in managing costs and continue their efforts to keep internal price inflation in single digits; below the current CPI food inflation of 12%.

Apparel retailers’ sales growth momentum also continued, with Woolworths (WHL), Truworths (TRU) and The Foschini Group (TFG) reporting double digit sales growth that averaged 13.8% for the quarter ended September, coming in ahead of market expectations.

Graph: TFG Africa 3mma sales growth relative to peers

Despite the strong operating performance, market sentiment towards the apparel retailers remains negative and this is reflected in the low valuations.

To determine what the market is pricing at current valuation levels, we performed a reverse engineering analysis for TFG to solve for the market implied revenue growth and margins for the 2023 financial year (FY23). Based on the closing price of R104.19 on 5 December 2022 and the average 10-year PE of 12.85x, we calculated an implied earnings per share (EPS) of R8.11.

The FY23 revenue implied is for a 4.8% year-on-year decrease. This suggests that the second half (2H23) revenue will decrease by 25.3% compared to the same period last year. Given the momentum in sales growth and the fact that 2H23 period includes Black Friday, festive season, and back-to-school promotions, we think it is unlikely that revenue for the 2H23 would decline by this magnitude.

Table 1: Impact on sales based on 1H23 margins:

FY22 1H23 2H23 FY23
Revenue 43,370 23494.5 17,797 41,292
31.6% 23.5% -25.3% -4.8%
Gross Profit 21,027 11,592 8,781 20,372
Gross Margin 48.5% 49.3% 49.3% 49.3%


Operating income 4,872 2,619 1,984 4,603
Operating Margin 4,872 11.23% 11.15% 11.15%
Net Profit 2,969 1,488 1,127 2,615
Net profit margin 6.85% 6.33% 6.33% 6.33%


Keeping our projected 16.6% sales growth estimate for FY23, and solving for the implied EPS, our model suggests a gross-, operating-, and net-profit margin of 47.1%, 9.4% and 5.2% respectively. As a result, the implied 2H23 margins will be depressed compared to FY23 levels.

Table 2: Impact on margins based on our revenue projections:

FY22 1H23 2H23 FY23
Revenue 43,370 23,495 27,07 50,566
23.5% 11.2% 16.6%
Gross Profit 21,027 11,592 12,236 23,827
Gross Margin 48.48% 49.34% 45.2% 47.1%

Looking at the historical average margins over a 5-year and 10-year period, including the covid impact 2021, it is evident that the implied margins are too low.

Table 3: Historical average margins:

Including 2021 5-Year Average 10-Year Average 2021 Margin
Gross Margin 50.3% 48.6% 45.5%
Operating Margin 11.2% 14.5% -2.2%
Net Profit Margin 5.7% 8.4% -5.7%
Excluding 2021 5-Year Average 10-Year Average
Gross Margin 51.4% 48.9%
Operating Margin 13.8% 16.2%
Net Profit Margin 7.9% 9.9%


As management continues to increase sales at above average rates and effectively manage costs, it is unlikely that margins will drop to these low levels. As a result, it is our opinion that the market is implying too harsh a criterion on TFG’s valuation.

Although the consumer environment remains challenging, it is always important to understand what is being reflected in the current share price. We believe that the TFG valuation is too depressed and that the apparel retailers will continue to deliver operating results that will beat the low expectations, resulting in opportunities for significant upside.


SA Listed Property: strength to strength

 SA Listed Property remains one of our most favoured sectors. Large discounts to underlying NAV’s remain, dividend yields are high and balance sheets continue to strengthen. Results since the lows of the pandemic indicate an environment not represented in current market pricing. On average across the sector, we have seen net property income growth return, vacancies decline and demand for space resurface. All indicators point to a sector much improved, and the market is starting to take notice.

In our opinion SA listed property offers significant value at current levels and results across the sector attest to this. We take a look into the most recent price movement addressing the key points of interest.

Closing comments

As we head into December and the final Fed meeting of the year, there is still a lot that can happen in 2022. 2023 should pose an interesting year with the markets currently pricing in expectations for a recession; we should begin to look through any economic downturn and focus on the growth that lies ahead. With lots of money sitting on the sidelines waiting to re-enter global equity markets, we have big hopes for 2023.