Jozi, Jozi. 26o 12' 16" S, 28o 2' 44" E. Someone backed up the truck and rode over our feet. It still amazes me that the European situation grips us the same way every time it rears its ugly head, like the threat of six of the best from the housemaster if you don't go to bed on time. I understand that the sovereign debt problems are grave in Europe, but surely not enough to sink us every single time? Sadly yes, the same old fear and the same old ending, stocks sold off 1.2 percent (411 points), with the Jozi all share index closing at 33814 points. Platinum stocks got sold off heavily, Amplats falling three and three quarters of a percent and Implats two and two thirds of a percent as the industry continues to be plagued by the same old issues. Costs rising, productivity might be improving, but it still looks not so good, trickier regulatory environment and labour relations are not that great either. Platinum stocks collectively are down 54 percent over the last five years exactly. Brendan Venter would say, not good, we will have to try harder.
Beijing central. 39o 54' 50" N, 116o 23' 30" E Is it working? I mean, the easing that has been done from the central authorities in China, is it working for the Chinese economy? Well, that is what folks on the box are starting to say this morning. If you have never visited us and you wonder what my view looks like, well here it is below:
That is a fellow from Kenya on the right, Aly-Khan Satchu, who I met once and the woman on the left, Linda Yueh, is a former bank employee who now works as chief economist for Bloomberg in London. Byron is on the right in front of me and Paul is to the left of me. The TV's are in front of me and the gardens behind the Melrose Arch hotel are behind me. A beautiful little patch of lawn and peace and quiet, that you would struggle to find elsewhere I guess. So, the folks on those boxes in front of me are starting to say that that latest HSBC flash PMI release, which was this morning, indicates that "things" are improving. The number came in at 49.5 for the month of July, and is the best since February. So perhaps things are improving out there, we will wait until next week. My feelings on these PMI numbers however is that I never step away convinced one way or another. Darn, I must be getting old, because I am starting to get more sceptical.
Brussels sprouting ideas. 50o 51' 0" N, 4o 21' 0" E This will be the new heading for anything Europe related. After all, if they want the project to work, it will have to work from European headquarters, not so? I am guessing in the affirmative. The single place that I can think would suffer more than any other in Europe, at a city level, if there was a disintegration of the zone, would have to be Brussels. Think of all the hotels and B&B's and conference caterers and facilitators, taxi drivers, big city over-employment relative, that would all vanish overnight. For the record, you have heard us say this many times over, we expect the zone to stay intact and ultimately add more members in the coming years.
Moody's swung to the conclusion that it was time to change their credit rating outlook on Germany, the Netherlands and Luxembourg. And at the same time, the credit ratings agency reaffirmed their rating on Finland. You can read all about it (extra, extra!) right here, from their press release: Global Credit Research - 23 Jul 2012. Huh? Just two major points made, that you could have some fun picking holes in, but it seems like there is nothing new here.
Point 1: "The rising uncertainty regarding the outcome of the euro area debt crisis given the current policy framework, and the increased susceptibility to event risk stemming from the increased likelihood of Greece's exit from the euro area, including the broader impact that such an event would have on euro area members, particularly Spain and Italy." This is mostly I am guessing related to the commentary from the German finance minister over the weekend, and I paraphrase here, if a Greek Euro exit happened, it would not be the horror that it was before. Before you forget, the troika visits Greece with a long snag list that looks pretty much like the last snag list. Err.... guys, please get cracking. Moody's do say that Greece exiting the Euro zone is not their base case, but everyone covers themselves. Our industry talk is pretty much like that of politicians, cover all the bases you know.
Point 2 from in a very bad Moody's press release: "Even if such an event is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required. Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly rated member states if the euro area is to be preserved in its current form." Now this does make sense again and is nothing new. If further funding is needed, which at the moment it looks like it might be, it would impact the financial well being of both Germany and the Netherlands. Luxembourg, well that is just a place to trade options and currencies with all the gearing in the world. You know the old saying, that is like giving monkeys whiskey and shot guns. Some people are good at trading, but the vast majority, well it is hard for them. It is kind of like trying to be a municipality in South Africa and get a clean audit. Ouch, that was a low blow.
I agree with the reasons that Moody's have put forward, but what almost nobody has seen, is the ability for governments to enact real change on the current situation. Either way the Euro exercise turns out, someone is going to have to pay for the situation, and that somebody is Germany and France, well at least they have the greatest resources to deal with the situation. The German and Spanish finance ministers are going to meet today. What do you think that they are going to say? We will have to wait and see a little later today. It just seems all too much over and over again, but that is just the uncertainty and resulting volatility that we are going to have to put up with. But inside of that is always an opportunity. The carnage across equity markets in Europe did little for confidence yesterday, the German Dax shed over three percent, the Spanish were getting a beating, down over five percent before the authorities decided to ban short selling for a while. It ended down just over a percent. Pity the Greeks though, the Athens bourse sank more than 7 percent. Time to call on Zeus and the gang to lend the mortals a hand.
Meanwhile the yield curve continues to flatten out, and just today the respective bonds (2 year, five year, ten year and 30 year) in Spain reached Euro level highs. And we are starting to get closer to a point where you see an inverted yield curve. The borrowing costs at the shorter end of the curve become more expensive, and this is happening. Right now, just moments ago, Spain raised money with both two and three year maturities, and paid more for the two year than the three year. Crazy! And inverted yield curves are sure signs of recessions, but we know that already. That meeting between the Spanish and Germans can't happen quicker.
Byron's beats was struggling to come up with a topic this morning, but then came up with this beauty.
- There has been a lot of speculation about whether there is a micro-lending bubble in South Africa. Through the likes of African Bank, Capitec and the big four Banks, the rate of unsecured lending has increased far above the historical rate in the country. In fact according to the latest African Bank report who cite the Credit Bureau there are now 67.5 million credit accounts in SA. With a population of just over 50 million you can see that there is comfortably over 1 account per person. Of these, 75% are in good standing meaning that they have been financed within the last 3 months.
What spurred me to talk about this topic was the following article from the WSJ which looks at micro-lending in Africa. According to the article 80% (326 million) of Africa's adult population remain unbanked. This is because the majority of them fall within the informal sector. I'm sure you are well aware how difficult it could be to open a bank account without formal employment, a proof of address or legitimate identification. These people still have the capacity to lend money however and still receive an income be it from the informal sector.
The article goes on to talk about Equity Bank Group, a Kenyan bank which is taking advantage of this gap in the market. How's this for in interesting line from the article. "Godfrey Chege is one such customer: He received a loan for almost $1,200 from Equity to expand his chicken-selling business. He and his wife pledged their bed as collateral."
What I am trying to get at here is that there is still room for growth in South Africa. According to Adcorp the informal sector represents 32.8% of our workforce or 6.2 million people. Don't be fooled by the 67.5 million credit accounts in SA. That will include your Truworths account, and 3 credit cards. I know individuals who could contribute to at least 7 accounts so this number is inflated.
African Bank have a total of 2.6 million customers who of course are not all part of the informal sector. The industry is competitive but the margins are good and as I mentioned earlier many of these people only have micro-lending to turn to. People often think that micro-lenders are greedy institutions taking advantage of the poor but in reality they provide financing to people for education, small business start ups and home improvements when no one else will. We continue to invest in this theme via African Bank who look cheaper than Capitec and don't get involved in all the shenanigans that the big banks get up to.
New York, New York. 40o 43' 0" N, 74o 0' 0" W. Different time zone, different markets, same result. The anxiety around the Spanish bond yields and the regional governments in Spain running short of money meant that it was another case of selling first and asking questions later. It was rather a heroic come back from the bottom however, stocks rallied from 10am in New York all the way through to the close, but it still looked grubby at the end, the broader market S&P 500 closed off 0.9 percent to 1350. There were of course results streaming in, Halliburton as well as Eaton with a beat, Texas instruments with a low level beat, but the one that we were most focussed on was McDonald's, which reported decent enough numbers, but missed expectations.
The full release is available via this link, and the headline pretty much sums up a tough quarter: McDonald's Second Quarter Reflects Solid Top-Line Results, Economic Headwinds And Strategic Investments. There is clearly an impact from the stronger US Dollar, sales increased five percent in constant currency but was flat in their reporting currency, Dollars of course. You could not get more American than McDonald's and Coca-Cola. Maybe, but you know what I mean. The same happened of course with earnings, up 3 percent in constant currencies, but down 2 percent in Dollars to register 1.32 per share. Europe. Yip, whilst sales in Europe are strong in local currencies, suggesting that perhaps the trade down is taking place, this does not help when you translate back to Dollars.
"For the quarter, Europe delivered comparable sales growth of 3.8% while operating income decreased 3% (increased 8% in constant currencies). Ongoing strength in the U.K. and Russia led the segment's comparable sales and constant currency operating income growth, with France and Germany also contributing. Reinvigorated everyday affordability options, ongoing premium product innovation and restaurant reimaging were key sales drivers for the quarter." See, sales are good, they are more profitable than last year, you will see this hacked graph from Yahoo! Finance that will show what the problem has been over the last year. Yahoo finance? Well, the graph came out better, you can find it here: EUR/USD (EURUSD=X).
This means that whatever McDonald's (or any American company operating there) have been selling in Europe a year ago in Euros, versus today, you are getting nearly 16 percent less in Dollar terms. Our local exporters and importers know this currency volatility all too well. Around three eights of all McDonald's profits come from Europe. So, this is even worse for every big Mac, smoothie, coffee, muffin, a Salade Chèvre Croustillant in France or a Pannkakor (Pancake) in Sweden. Whatever the menu item, tweaked for the geography, it does not help McDonald's when the Dollar strengthens too much. What normally might help them would be that the soft commodity prices might decrease, as the Dollar strengthens, but if you have been paying attention you would have seen soft commodity prices like corn and soya beans going through the roof. All as a result of a bad drought in the USA.
But these fancy menu items tell me nothing about the immediate future or the long term profitability and continued success of the brand and the company. Personally I must eat at a McDonald's three to four times a year, which is just awful! I should, in the words of Brendan Venter, try harder. The reason for having being in the stock in the past is clear, the company, although in the restaurant industry (depends who you are, restaurant might be generous) is seen to be defensive in nature. The company has managed to grow earnings by 6 to 7 percent (in same currencies) year in and year out, but for the first time is reporting sales slowing across their geographies. If our thesis is right, the "situation" could be close to bottoming. And if the Europeans come up with a central plan, well that might be good for the Dollar sales of McDonald's. But the couple of analyst notes that I have seen so far are turning neutral on the stock.
The dividend payment ratio is always around half of earnings and one of the main attractions. Expectations this year are around 2.80 USD (Q2 of 70 cents was declared the other day), whilst next year the quarterly dividend is expected to ratchet up to 77 or 78 cents a quarter. The year after the expectations are for roughly 85 cents a quarter. So, if you were to hold the stock for the next three years (and buy it today at 89 Dollars a share) you average yield would be three and a half percent. And if you needed reminding US ten year debt yields less than one and a half percent currently. I know which one I would rather be owning. Expectations are for the company to make 6 Dollars worth of earnings per share next year, so at 15 times forward earnings for a company of this size and scale, I would hardly say expensive. But, as Byron pointed out to me this morning, it is possibly the Europe "thing" that is holding the stock back, because earnings are missing what have become very lofty expectations. We continue to buy the company on weakness.
There are of course anxieties about the service offering at McDonald's. In the same way that countries are starting to lean on the tobacco and liquor companies products, taxing it more just before it lands in the end users hands, McDonald's products could face the same pressures. There is increasingly the realisation in the developed world that you can't have the same health benefits and not have a say in what people consume. Over the last decade or so, McDonald's have tweaked their menu to offer folks what they want, balancing fast, affordable with healthy, being a relative term. The first salad was only introduced in late 1987. Tweaked en masse in 2003. The menu changes for each region and if people demand a specific menu item, I have no doubt that McDonald's will get that on the list. In their slow and laboured way. Check out the menu releases: McDonald's History. Nice. Byron and I are trying to become racing snakes, so perhaps we wont be eating any of these items any time soon.
Currencies and commodities corner. Dr. Copper is slightly higher at 335 US cents per pound, the gold price is flat at 1576 Dollars per fine ounce, whilst the platinum price is lower again, at 1389 Dollars per fine ounce. The oil price is last at 88.52 Dollars per barrel, that is for Nymex WTI. The Rand is steady, I guess, 8.47 to the US Dollar, 13.13 to the Pound Sterling and 10.30 to the Euro. We are catching up here this morning, and have started better notwithstanding news from Europe this morning. Apple reports afterhours tonight, that is possibly the single biggest company event on any earnings calendar.
Sasha Naryshkine and Byron Lotter
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