Money with a dash of Funny: July 2014

Thursday 31 July 2014

BATS not exactly lighting it up

"When allocating your capital to a business you can choose whether or not you want to fall into a category of responsible investing or not. Again, most investors just have one objective and that is to obtain superior returns from their investment manager. I suspect that this is personal to each individual."

To market, to market to buy a fat pig. It was a down day for Mr. Market yesterday, the Rand weakened during the course of the day, the unemployment numbers have looked awful. There was also locally a credit report released with the health of the consumer in South Africa continuing to look more than a little average. Not great, many of the big banks looking average on the day, in fairness many of them are trading near their all time highs along with the rest of the market participants.

There were also numbers from Barclays Africa, the stock of the company that is 62.3 percent owned by Barclays Plc. is trading nearing all time highs. An interim dividend of 400 cents per share (14 percent increase) was declared on EPS of 727.6 cents (10 percent increase), the stock trades on a forward multiple of 11.3 times and a dividend yield before tax of 5.1 percent.

With earnings growth rates expected to be muted for the time being I suspect that the stock is about fair value at these levels. It was an interesting set of numbers to trawl through, the mortgages business might be a massive part of their loan book, it is not anywhere near the most profitable. Banks make big money from add on products and initiation fees associated with advances of all sorts, obviously the more risk the bank takes the greater the charge and interest rates.

I do not have a problem with the bank making any money of any sorts, they offer a great service to broader society, not quite Gods work as Lloyd Blankfein, the CEO of Goldman Sachs once said, without finance you are struggling. If you think that your bank charges you too much for your borrowings, then save up the money and buy that house or motor vehicle cash.

Business could not or would not be able to operate without access to credit, the bank takes on enormous risks. Don’t get me wrong, much of the financial crisis is due to excesses of both humans and financial institutions, governments were only too happy to have higher home ownerships and rising receipts as a result of juiced up company revenues. It is only when it all goes pear shaped that law makers start pointing fingers, something that they are good at, blaming someone else all of the time.

Back to Barclays Africa quickly, I think that structurally the company is obviously best placed to cement their footprint as the leading bank on the continent, the brand is nothing short of superb. It is important to note that the continent possesses many frontier markets, ones that you can enter where many fear to tread. South Africa is not Somalia and Nigeria is not Niger, Kenya is not the DRC.

When many talk about the prospects for the African continent as an investment destination, I believe them. There are many opportunities, equally there are many hurdles. On balance we are not likely to be investing in banks and financials, a fine a week at a global level points to great regulatory overreach, greater public scrutiny and higher shareholder anxiety around executive pay, all in all leading to lower profits as a result of lower risk taking. More utility like in the end.

There were also numbers from British America Tobacco, currency headwinds denting earnings when compared to the prior comparable reporting period. You know that we do not like tobacco as an investment, their product is likely to attract more scrutiny from public healthcare and also be seen as a soft target for national treasuries under pressure.

Make no mistake, their product kills people, not to be too precious about it, too many Nestle chocolates will no doubt do that to you too. It is the preventable deaths that the authorities are looking to cut down on. There are many places where the costs of cigarettes are being pushed higher (as a result of higher excise duties) that is leading to lost revenues for governments as a result of illicit cigarettes. The balance for the tax authorities is key here, almost a golden goose type scenario.

I believe in freedom of choice, obviously not at the expense of others however. There are some products that are far worse in broader civil society however, the abuse of liquor over cigarettes has worse consequences for communities. South Africa is a not so great example of that, the impact on poorer societies in terms of abuse of all sorts of substances leaves those most vulnerable worse off.

When allocating your capital to a business you can choose whether or not you want to fall into a category of responsible investing or not. Again, most investors just have one objective and that is to obtain superior returns from their investment manager. I suspect that this is personal to each individual, with a business like ours we can tailor make portfolios to fit each and every need.

Back to the business of the cigarettes producer, for me lower volumes are the biggest problem. I do not care whether you sell chocolates or watches, if you keep selling fewer every single year this has an impact eventually. In their case volumes were marginally lower, 0.4 percent from this time last year. Western Europe trending lower and lower, each and every year, Asia-Pacific making good gains, not enough to offset the lower European volumes however. The margins at this business are fabulous, operating margins were 39.2 percent. There are plenty of costs to cut which should see that high margin remain there.

Earnings and subsequently the superior dividend should be maintained in the very short term. Consumption trends seem in the wrong direction, that worries me the most about this business, how can a company with lower volumes over the years trade on a 17 times earnings multiple? It is because the yield in Pound terms is 4.13 percent, I think therein lies the answer. I would say avoid, I would again go a step further and reckon that in the next three to four years you should start to see the tipping point of whether or not it is a longer term hold. Methinks not. Not for us.

Home again, home again, jiggety-jog. The Fed boosted the economic outlook and hinted that rates could rise sooner rather than later, nothing wrong with that. I am always bemused when people want the Fed to do X or Y and shout that they are behind the curve, if that is the basis of your investment thesis best you give the money back to the clients. Markets are lower today. Remember the big number tomorrow! Non farm payrolls. It will help take our minds off the absolute retirement of South Africa’s favourite cricketing son. The two best players in one, a third if you include the catches. We will miss Jacques Kallis, thanks for the amazing memories. Sad.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Wednesday 30 July 2014

Twitter flying!

"OK, that is all nice, how does the company make money? Advertising on your timeline, I am sure as a user you have seen them. Promoted adverts. International revenue was 33 percent of total revenue in the last quarter, mobile advertising revenue was 81 percent of total revenue, 211 million of the 271 million monthly active users are mobile users. Average revenue per 1000 timeline views is a mere 1.60 Dollars."

To market, to market to buy a fat pig. Markets reached all time highs here in Jozi yesterday, fabulous news for all and sundry. I suspect that the tired old bears are feeling a little worse for wear, Marc Faber (you know, the gloom-boom-doom guy) suggested that equities were going to fall 20 to 30 percent. Thanks Marc for that. My word, it must be so tiresome to be so bearish all the time and then suggest when equity markets went down that you called it.

Byron will deal with whether the markets are over or undervalued and whether that really matters in the long run, I suspect long run means different things to different people. If you are in the equity markets trying to trade around non farm payrolls, or weekly jobless claims, good luck with that, rather you than me. I found this fabulous graph, via Barry Ritholtz, which led me to Catherine Mulbrandon and her website page titled: STOCK EXPONENTIAL GROWTH RATES.

You can see many wars and events trying to derail the trajectory of equity prices, to no avail, companies always find a way. That is why I will continue to advocate investing in businesses and not trying to worry about absolute market levels. The best investment is owning companies stock over the long term, as you can see from another graph on her website: RETURN ON GOLD, STOCKS, BONDS, AND BILLS SINCE 1928

That one line struck me though, below the graph if you follow the link: "if we look at the annualized return for 1928-2012: gold's return of 5.3% beats t-bills at 3.6% and bonds at 5.1% but still underperforms stock's return of 9.3%." The short answer is to stay long quality businesses, nobody ever knows what is going to happen and where it is going to happen next. Byron hopefully will flesh out the valuations side for you.

Twitter reported numbers for their second quarter last evening and they absolutely crushed it. Revenues against the comparable quarter grew an astonishing 124 percent, but yet is only 312 million Dollars. Only, why do I say only? This is relatively new to investors and users and as such the average spend per user is going to be lower until everyone adopts the handset as their primary news outlet. We have the internet to read flat pages, Youtube to watch all sorts of videos, TV is still huge, print media is struggling. I am still amused when radio stations look at newspapers in the morning, even some of the stories are ancient in this modern world we live in.

Trends are important. New technologies require time until they become mainstream. Twitter is on the cusp of being the number one news platform. It is customisable to each and every single user. Follow and unfollow becomes easy. If you do not like your friends on Facebook that is your problem, on Twitter it is so easy, it is business. Twitter is for the big issues and as such it will attract people who are interested in broader global issues as well as feeling they need to know what is going on. The fear of missing out, FOMO is real people!!

Now that we have tried our best to understand new technologies and how humans adapt (there must be thousands of entries on that) over time, let us do what we do, look at the business and their prospects. Rather than use the quarterly numbers, let us use the half year comparable numbers, it is something that we are more used to around these parts. OK, let us compromise and do both, here is a snapshot of the business:

The company is spending a bomb on sales and research and development. Twitter spent a whopping 58 percent of revenue on R&D in the first half. In addition to that 43.7 percent of revenues were spent on sales and marketing. That is of course why the company made an operating loss of 279 million Dollars for the first half. If you reinvest a large portion of your profits back into your business, this can be seen as a business expense and therefore tax deductible, that is the simplest way I think to explain it.

OK, that is all nice, how does the company make money? Advertising on your timeline, I am sure as a user you have seen them. Promoted adverts. International revenue was 33 percent of total revenue in the last quarter, mobile advertising revenue was 81 percent of total revenue, 211 million of the 271 million monthly active users are mobile users. Average revenue per 1000 timeline views is a mere 1.60 Dollars. Wow. Or 16 cents per 100. 0.16 cents (US) per timeline view. That is almost laughably low. In that I think lies the opportunity. Advertising revenues on traditional platforms are not nearly as pointed as they are on social media, there is so much data available, specific data.

So whilst these results with a marginal non-GAAP profit (14.5 million Dollars for the quarter), which translated to a marginal Non-GAAP EPS of 2 cents for the quarter, the excitement is that the business is there, it is enabled, the users now need to spend more, more advertisers need to move to the platform. That will happen. More exciting for shareholders that have felt left out of the rally is that the stock surged an incredible 28 plus percent after hours trade, now at 49.61 Dollars a share. Even opening at that level the stock would be down year to date.

Is this investable, this company? It clearly depends on whether you think all the advertising platforms will move quickly to the device that you use more than anything else, the device in your pocket. Twitter are starting to monetize their very pointed base. There are according to the company, millions of users who do not have an account and engage with the platform, that is why you might have noticed the subtle web changes.

If the company is not that committed to profitability whilst ramping up in the short run (as Amazon are in the errrr.... long run?), then you have to buy the company on the basis that revenues are going to continue to explode higher, as they did here. We like it, it is a buy, perhaps wait for a while to see where the price settles if you are thinking of adding after the heroic rally.

Byron's beats: Are markets expensive?

There is so much talk out there that the market is overvalued. Firstly what is meant by "The Market" and secondly is there merit in the statement?

Lets cover the first question and then deal with the relevance of the second question. When talking about "The Market" I am mostly referring to the JSE All share index. That is because this message is geared towards South Africans whose interest would be predominantly geared towards the JSE. But the JSE is directly linked to global markets so in essence we have to look at the NYSE which is accountable for more than 35% of listed assets. But even the S&P 500 gets nearly 50% of its earnings from outside the US.

This means essentially that markets are almost completely globalised. Especially a liquid one like ours where the biggest constituents listed on the JSE are not South African companies. Naspers, SAB, British American Tobacco, Richemont, Glencore and Billiton are all global businesses and they make up 45% of the ALSI. This means that the South African economy in fact has very little impact on the JSE. Global sentiment towards equities as an investment is what is most important.

So is the market overvalued? I came across a very interesting article by investment legend Byron Wien (great first name) titled Byron Wien Makes the Case for Another Huge Rally in Stocks. From the title I am sure you can see where this article is going but the fundamental arguments he makes make a lot of sense.

"One of the problems limiting investor enthusiasm may be valuation. If the S&P 500 earns $115 in 2014, it is selling at 17.1x earnings. Market peaks have occurred historically at 25x–30x times earnings. On that basis, the market is fairly valued but not exceedingly expensive. The average trailing 12-month price-earnings ratio when the inflation rate is 0%–4% is 17... If the economy grows at a rate of 3% real during the remainder of the year and inflation is 2%, then nominal growth should be 5%.

With productivity increases continuing and share buybacks, the S&P 500 should be able to show improvement of 7% over the $108 in operating earnings of 2013 and that would put us at $115. With considerable cash on corporate balance sheets, share buybacks should continue. Therefore, if earnings reach my target and the S&P 500 sells at 20x, we could reach 2300, which is 17% above the present level or more than 20% above the index price at the start of 2014."

In my opinion this is a good argument in favour of a fairly valued market and that we are far from bubble territory. Growing margins, a growing economy and manageable inflation rates should eventually result in growing sales which will be even more earnings enhancing. I'm talking about the S&P here.

But what about the JSE? A friend of mine sent me an interesting graph this morning which suggested that the JSE all share has recently reached a high in dollars previously reached in 2007 and then again in 2011 when the Rand was much stronger. Essentially this means that in dollar terms the JSE ALSI has done nothing for nearly seven years. My immediate reaction was that this is a buying opportunity. Another graph was then forwarded on to me which suggested that the growth was only due to PE expansion. The average PE of 19 was also back to the highs reached in 2007.

Referring back to Byron Wien's article along with my explanation of markets being globalised, it makes complete sense that the JSE has seen a PE expansion. Don't be fooled by negative economic data coming from South Africa, in fact the ALSI is a natural Rand and inflation hedge which is exactly what you want in this low interest rate environment. And according to the article above we could easily see more PE expansion which will filter across to the ALSI.

I don't like to get too absorbed in macro sentiment debates but for clients who are still looking to get into the market and are worried about timing, it is important to explain these types of factors. What is important from our perspective is that we pick companies that are growing regardless of short term macro factors. If we buy the quality, ride the sentiment wave and consistently add cash to these existing positions, these types of arguments are less relevant.

Home again, home again, jiggety-jog. Janet Yellen and the FOMC tapering further is apparently the biggest thing happening today, in equity markets that is. There is also ADP data. Another look at GDP for the second quarter in the US. Company results too continue to stream in. That is all that matters.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Tuesday 29 July 2014

Naspers, extra, extra, read all about it

"The stake in Tencent is worth more than the Naspers market cap. Again this reiterates that the South African investment community think that the Chinese in Hong Kong overpay for Tencent, clearly there is more than a whiff of arrogance in that."

To market, to market to buy a fat pig. Stocks closed higher on the day here locally, industrials were the real stars on the day. The reason was half attributed to Naspers, the stock moved higher as news came through that Chinese regulators have allowed Tencent to open a private bank, Webank is the name, Tencent will own 30 percent, the rest by private businesses and individuals.

Remembering that this is relevant to Naspers because they own 33.85 percent of Tencent, it is the biggest driver of their share price. 33.85 percent of Tencet's market cap of 1,204 trillion Hong Kong Dollars as per the Stock Information of the Tencent website (at 1.36 Rand to the Hong Kong Dollar) is 554 billion Rand. Market cap of Naspers? 545 billion Rand last evening. What? It does not make any sense to me, admittedly Naspers had not opened here, but you get a satellite TV business for free essentially.

A little more about Webank quickly, the other main founders are a crowd called Shenzhen Baiyeyuan Investment Company and Shenzhen Liye Group. The bank will be serving individual customers as well as small and micro-businesses. It will be located in Shenzhen. This is a push in the direction of the Chinese authorities to privatise the banking sector in the country, allowing for a more competitive landscape.

Alibaba and Tencent were able to capture around 65 billion Dollars of client funds into money markets at higher rates before the authorities even put those plans out to pasture, this is a sign that the authorities recognise that privatisation of the banking sector is needed. How does this make you feel as a shareholder indirectly of Chinese loans and banking assets? Much more on Naspers in just a moment.

A late surge in the markets on Wall Street after a poor start saw the S&P 500 and the Dow Jones gain back some of the losses Friday. Remember that this week is the non-farm payrolls week, which means major excitement into the weekend. On Wednesday there is the precursor to that with the ADP data, that is the private payroll estimate. US GDP data, the second look for the second quarter is due tomorrow too. On the local front we have unemployment data today, expectations for the unemployment rate are a shoulder-shrugging-we-must-try-harder 25.4 percent. Yowsers.

We saw Naspers release their annual report late last week, it is always a fabulous time to re-look at the company as an investment and see whether the reason you still hold them rings true. On an out and out earnings basis, the company is expensive, that much is true, on an NAV basis you are getting all the rest of the business for free. So it seems that the local market discounts the heavy weighting to Tencent and in doing that suggests that Tencent should be worth less.

Firstly, what do Naspers do now and what do they want to do in the future? A graphic capture from the annual report says it all:

Sounds rather ambitious and difficult to pin down at the same time, equally it is simplistic. The way I view it is simple, Naspers aim to be the champion of media platforms and ecommerce platforms mostly outside of the English speaking world. Their global platform spans all the continents, including the US and Canada, the focus will no doubt be in emerging markets.

The introduction spells that out:

"Naspers is a broad-based multinational media group with principal operations in internet services and ecommerce (especially online classifieds, etail and payments), pay television and print media. We operate predominantly in markets with growth potential. These include Africa, China, Latin America, Central and Eastern Europe, Russia, India, Southeast Asia and the Middle East. Most of our businesses are market leaders in their sectors."

The classifieds business are the likes of OLX, entail, think Kalahari.com, marketplace (swap), think Allergro, pricecheck.com is a comparison platform, Pay U is exactly that, a payments platform whilst the company has stakes in global growth businesses in India (Ibibo and Redbus.in). In amongst many other businesses that are key leaders in their geographies, that includes Souq.com and Flipkart, you might have heard of those businesses. So that is the ecommerce push, the next big growth area that Koos Bekker often refers to.

Next are the two businesses that you know possibly the best in the Naspers stable, the aforementioned Tencent (which trades on a very lofty 54 earnings multiple) and Mail.ru. Mail.ru is listed in the over the counter market in London and trades in Dollars, the current share price is close to 27.95 Dollars, the market cap is 3.32 billion Dollars at that level.

Naspers (through MIH) owns 29 percent of Mail.ru (see -> Mail.ru Shareholder Capital structure) which translates to 962 million Dollars, or at 10.6 to the Rand, 10.2 billion Rand. Interestingly Tencent owns 7 percent of this business, Mail.ru too. As a percentage of the Naspers market cap (545 billion Rand), Mail.ru represents only 1.8 percent. It was more, the share price of Mail.ru understandably has been under significant pressure.

As we pointed out above, the stake in Tencent is worth more than the Naspers market cap. Again this reiterates that the South African investment community think that the Chinese in Hong Kong overpay for Tencent, clearly there is more than a whiff of arrogance in that.

Just for comparison sake, Times Media (which after loads of selling of non core assets) owns Sunday Times, the Sowetan and the Business Day is valued by the market at 2.7 billion Rand or 0.5 percent of the value of Naspers. There was a time when these companies were considered peers, that time is best left to when Aurora touched the spinning wheel and fell into a deep sleep, through no fault of anyone, rather the sheer brilliance of Koos Bekker and some brilliantly timed acquisitions.

Interestingly the print assets, which consist of Media24, Paarl media, Abril (Brazil) and Jonathan Ball publishers still managed to generate EBIDTA of 1.073 billion Rand on 11.692 billion Rand worth of turnover. Pay TV, my favourite and most used Naspers product had revenues of 36.271 billion Rand and EBIDTA of 10.370 billion Rand. What would you pay for those businesses separately?

We suggested in the review of the results, titled Priming ecommerce that the TV assets could be worth between 80 to 100 billion Rand. On the same rating as Times Media group (EBIT of 13.5 times), the print assets are worth 14 billion Rand. Add the TV and the print together and you get a business that is roughly 100 billion Rand. You get that for free.

So what is the conclusion, we could talk about this business all day long. At the one end of the market you have the chattering classes suggesting that Tencent is woefully overvalued. To a large extent the prospects of Naspers in the medium term depend on the success of Tencent. I have seen an analyst report on Tencent that suggests a PE unwind to 2016 of 21 times at the current price, suggesting earnings grow rates of 40 percent plus this year, 30 percent plus next year and nearly 30 percent the year thereafter.

I would say for that reason alone one should continue to accumulate Naspers, Tencent will seem cheap at these levels in the coming years. If we (the collective we being South African) are so "clever" to discount them at current prices, then we should be so lucky that the real discount is inside Naspers. Great to re-look and confirm again.

Byron's beats

On the 24th of July Cerner reported second quarter results for 2014. Just as a refresher here is what this exciting healthcare business actually does according to the presentation.

"Cerner's health information technologies connect people, information, and systems, at approximately 14,000 facilities worldwide. Recognized for innovation, Cerner solutions assist clinicians in making care decisions and enable organizations to manage the health of populations. The company provides clients with a wide range of in-house services, as well as an integrated clinical and financial system to help organizations manage revenue. Cerner's mission is to contribute to the systemic improvement of health care delivery and the health of communities."

If you take a look at the image below which I screen grabbed from their website you will get a better idea of the services they offer. This includes linking pharmacies with hospitals and doctors, allowing data from medical devices to be recorded and stored by practitioners and member engagement which sounds very similar to what Discovery's Vitality do. I urge you to explore their website for a better feel of the company.

Lets take a look at the numbers.

Revenues increased 20% to $851mn while earnings per share grew 18% to 40 cents. Earnings for the full year are expected to come in at $1.66. That is expected to grow to $2 in 2015 and $2.36 in 2016. The stock currently trades at $57 or 34 times this years earnings. But with earnings expected to grow 20% next year and 18% the following year you can understand why. Another phenomenal figure which Cerner boast is a gross profit margin of 80.9%. Software businesses have low capital costs. This figure was actually down 1.3% on the previous quarter because some third party outsourcing had to be done to fulfil ever growing orders.

Having absorbed all of the above it is quite clear why this company falls within the Vestact recommended list. They are creating technologies which make healthcare more efficient. And lets be honest, everyone wants healthcare to be more efficient from government, to the poor, to the rich. The more affordable and accessible healthcare is the better a place the world becomes.

Cerner are still very much a US company and growing their footprint around the globe has huge potential. Their CEO, Chairman and Co-Founder Neal Patterson is held under very high regard. The company already has a market cap of $20bn and is one of the leaders in the industry. We continue to add to Cerner as one of our leading exposures to the healthcare industry.

Home again, home again, jiggety-jog. Markets are trading near a record high locally if I am not mistaken, the Russians are on the back foot I guess. I suspect that sort of behaviour might be welcomed back home, the rest of the world however frowns upon that.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Monday 28 July 2014

Still beating!

"Top line growth will return and as we have said over and over again, companies would have done all they can in terms of cost cutting, innovating and streamlining. An economic downturn is ironically not the worst thing in the world, the excesses are flushed and the fittest survive to drive economic activity even further. It always feels awful at the time."

To market, to market to buy a fat pig. After spending much of the day in the green we slipped at the end, perhaps some results in the US that were not up to scratch, I suspect however that the Ukrainian slash Russian slash NATO and the rest of the West "situation" is going to weigh heavy at some stage. The Americans and Europeans are gearing up for more sanctions, the situation in Gaza is hardly improving and lastly if you thought that capital markets were going to have an easy time of it, Argentina is about to default.

This would potentially be the third time in three decades, heck, they win the World Cup more often. I actually took a dig at a CNBC Africa producer who was wearing an Argentina football shirt, which had two stars above the logo. I said to him, is that how many times Argentina has defaulted since Messi was born? Not too far off.

An interest payment of 539 million Dollars is due on Wednesday. All I can say that if you have wonk economic policies this is the outcome. The FT points out here (Argentina braces for sovereign debt default) that the quantum of a likely default is not the same as 2001, it is smaller. Would you lend money to Argentina in your personal capacity? No from my side.

The issues of global tensions and wonk economic socialist policies aside, Eddy Elfenbein had this to say in his newsletter on Friday, which once again underscores why the markets are not really that impacted by these events in the long run:

"According to the latest numbers from Bloomberg, 77% of the S&P 500 companies that have reported so far have topped Wall Street's expectations. Also, 64% have beaten their sales expectations. The S&P 500 is currently on track to deliver Q2 earnings growth of 6.2% and sales growth of 3.3%."

What is quite different is that top line growth, although muted, is starting to top expectations. As we saw last week too is that margin expansion has had much to do with earnings growth. Correction, almost everything to do with earnings growth, widening margins. Top line growth will return and as we have said over and over again, companies would have done all they can in terms of cost cutting, innovating and streamlining. An economic downturn is ironically not the worst thing in the world, the excesses are flushed and the fittest survive to drive economic activity even further. It always feels awful at the time.

We skipped it last Thursday, there was too much going on at the time, rather late than never, here are the Vodacom Group Limited quarterly update for the period ended 30 June 2014. The table snapshot from the press release sums it up:

Clearly you can see that local revenue, South Africa at 80.88 percent, is still the lions share and unfortunately only growing at 1.7 percent. Why? In part interconnect rates having fallen and in part a fall off in prices of 25.3 percent (average price per minute is 68 ZA cents), the pickup in caller traffic (up 26.1 percent in outgoing traffic) however has offset that. Mostly however there was a surge in devices and accessories revenue which represents 21.4 percent of total revenue.

The company has invested a lot in infrastructure, adding a further 473 LTE sites and thereby increasing the fastest mobile internet infrastructure by 50 percent. Good work. Whilst data prices fell 30.3 percent per megabyte, traffic increased a whopping 70.1 percent. I can deduce that there are better and more expensive devices accessing more data as we converge towards the internet of everything, as Cisco term it. Data revenue continues to grow quickly and more and more South Africans are getting connected to the internet. There are now 8 million smartphones and tablets connected to the networks, with 17 million data users.

Data will continue to be the main focus. Whilst Vodacom still waits for ICASA and the competitions authority on the finalisation of the Neotel transaction (7 billion Rand for all of it, announced 19 May 2014), the offering to businesses is clear when Vodacom have their paws on the "other" fixed line operator: "The combination of Neotel and our existing fibre network and enterprise business will accelerate our unified communications strategy in addition to yielding substantial cost and capex synergies." I want faster and more reliable internet, we all do.

What next? Expect ARPU's to stabilise, I think we are close to the tipping point in terms of ARPU's starting to move higher. Calls are cheap, people are speaking more, data is cheaper, people are using more of it. Whilst Vodacom are going to continue to see their rest of Africa business move quicker and quicker ahead, it has a long way to go before picking up any slack offering here in South Africa.

Parent company Vodafone (65 percent holder) will continue to extract top Dollar, as a minority shareholder (alongside the South African government who own 13.9 percent), you can benefit from the superior dividend stream. The analyst community have the company on a forward dividend yield of 6.9 percent, the after tax yield is closer to 5.86 percent forward. For those who want to extract more by way of income, this is a good business to own in a low interest rate environment, MTN remain our top pick in the sector.

Home again, home again, jiggety-jog. Markets are higher here, the Rand has weakened a little after a fabulous run. Keep calm and carry on there!

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Friday 25 July 2014

Bucks

”Coffee is a great product. It is a socially acceptable stimulant that doesn't seem to have any long term negative affects. And it is delicious. The Starbucks coffee brand is by far the leader in the sector."

To market, to market to buy a fat pig. The firmer local currency to the US Dollar, which I think is a response to the weakening Euro. As such some of the heavyweight stocks in our markets have been under pressure over the last few days. Whilst that is not good for market levels overall, it is very good for you and I and the inflationary outlook. Much hotly debated amongst economists, our living costs and what the Central Bank can do. I am afraid very little in the face of economic policies that even insiders (of government) do not agree with, no clear pull together on the NDP can be seen. Well, at least from where I sit.

Over the seas and far away the S&P 500 eeked out a gain, the Dow Jones did not. The nerds of NASDAQ lost a few points, all in all it was an uneventful day. However there was one number, weekly jobless claims which had a 2 in front of it, 284 thousand, which was a 8 year low. Now an 8 year low is never great unless you are talking about fewer people applying for unemployment benefits. That means that the labour market in the US is looking better and better. A better US economy is good for the rest of the world.

Today there is the small matter of UK GDP, which will no doubt have a bearing intraday on the markets that operate inside of these times zones (we can count ourselves lucky in that regard) and a little later today in the US there is another small matter of US durable goods orders. More durable goods bought by the broader population almost always is an indication of a positive outlook. You would not buy a dishwasher or washing machine if your cash flow was limited over the coming months, as a result of you perhaps losing your job. No. You do not buy a big ticket item unless you are comfortable with the outlook.

Here is what I mean, Scott Grannis from his blogpost last year titled Amazing changes in relative prices had this magnificent graphic, in which you can see as time goes on, on a relative basis durable goods get cheaper and cheaper.

A couple of interesting company announcements this morning, firstly from Woolworths in which the Australian Foreign Investment Review Board have okayed their takeover offer for the rest of Country Road that they did not own. Woolies owned (as per the release) on the 23 of July after market, 87.92 percent of Country Road. Who are these shareholders who are going to get bumped out? Long suffering it seems. I have to share this, from the annual report:

Brilliant. I love the fact that the small shareholders, who own small parts of the company get to be part of the shareholders list inside of the annual report. People like Mrs Kerri Louise Summers, who owns 25,479 shares. And Mr Juan Carlos Fuentes with his 9,487 shares. They are the fourth and fifth biggest shareholders collectively, owning 0.03 percent of the company. More importantly for you as a Woolworths shareholder is that Australian Retail Investments Pty Limited (Solomon Lew), which owns 11.88 percent of the company, has accepted the offer from the South African company triggering the offer to minorities as you can see. Folks like Kerri and Juan Carlos. Another obstacle removed, Woolworths in the end got what they wanted.

Anglo American have released their interim numbers to end June this morning, to view the interim presentation follow the link. Even if Anglo manage to make around the same as last year, 2.10 Dollars in earnings and pay the same dividend of 85 US cents (in a lower commodity price environment), surely there are better investment options.

Quick math, Anglo trades at 286.5 Rand a share, translate that into Dollars you get to a 13 multiple. However, the expectations are for the company to earn less than that, somewhere in the region of 1.8 Dollars per share, meaning that forward the company is trading on an earnings multiple of 15 times. I can buy BHP Billiton on less than that, their assets are better, energy is more attractive (to us) than diamonds and platinum. Plus the yield is hardly a kings ransom, 3.1 percent before tax compared to BHP Billiton yield of 3.5 percent. And as far as the turnaround, I suspect that is over 24 months ago. We continue to favour BHP Billiton over Anglo American and at these prices is in my view a sell.

Visa takes you places, or so the strap line goes. Visa has also taken their shareholders places, mostly always good ones. Why do we like this company? It is pretty simple, the investors relations landing page (do we still call them that) obviously describes the company better than I ever could:

"Visa is a global payments technology company that connects consumers, businesses, banks and governments in more than 200 countries and territories, enabling them to use digital currency instead of cash and checks."

Why would digital payments be better for everyone? Firstly it is safer for the user, there is no need to carry cash. Eliminating cash eliminates the need for expensive security associated with the handling cost. In South Africa we have seen the familiar sights of armed men in bullet proof vests standing thirty odd metres from heavily armoured trucks carrying money. No physical currency = lower security = cheaper banking costs. Consumer wins.

Checks are obviously a distant memory here, but are widely used in Europe and North America. Notwithstanding that there is relatively high check payment usage, the payment method is jurassic (hunting in packs and feathered apparently - another story) and dated. Doomed to extinction in my lifetime no doubt.

Lastly, the folks under most pressure for revenue collection, governments globally would love to see only electronic payments methods, there would be a trail. Not a paper one but a more easily traceable electronic one. Crime and cash go together, eliminating the use of cash would also be better for broader society too.

Ironically by owning Visa you are encouraging the usage of safer transfer methods and promoting compliance, doing good.

Doing good is one thing, investing your hard earned money and getting an acceptable return is more important to our readers as blunt as it may sound. We invest our money to make money. If we happen to do good alongside, that is an added bonus. Is Visa a good company to invest in then? Let us first have a look at their third quarter results to end June 2014.

Net income increased 11 percent to 1.4 billion Dollars off of operating revenues of 3.2 billion Dollars. You do not need to be especially good at math to realise that is a fabulous margin business. On an EPS basis the company earned 2.17 Dollars. The quarterly dividend for the current financial year is 40 cents, US of course. Operating expenses fell 3 percent, margins expanded 300 basis points to 64 percent, that is fabulous.

The company during the period bought back 5.6 million shares at an average price of 207.13 Dollars, using 1.2 billion Dollars of shareholder money. That is over a percent of the shares bought back during the quarter, no mean feat. 3 billion in total this financial year, the company noted that they will buy more shares as they see fit. There is 1.9 billion Dollars available in the current share repurchase program, about 1.5 percent of the current market capitalisation.

There were some "issues". As per the conference call (courtesy of SeekingAlpha - Q3 2014 Results Earnings Conference Call), from the prepared remarks of the CFO Byron Pollitt:

"For the June ending quarter, the sequentially downtick of 1 percentage point in cross-border was broad-based and spread across China, Russia, Ukraine, Venezuela, Argentina and the Middle East as you might expect, given political tensions and the early on-set of Ramadan."

Russia remains a problem not only for the company and the people that live there, but for all of us. The cross border transaction volumes were a 15 year low, some countries cracking down on externalisation of their currencies after precipitous falls. Byron has some juicy stories about the wonky economic policies in Argentina and how it leads to black market rates and official rates for the local currency. Sigh.

Digital payments, what about that? Who is going to be the winner in all of this? I suspect that Visa and their competitors will evolve to continue to process the transactions from the traditional physical to the digital world. On the conference call, CEO Charles Scharf, thanks again to SeekingAlpha and the above link. We have to thank them, that is part of the deal!

"First of all, there is a lot of clutter in the market about who is doing what in the digital payment space. It can be confusing for sure. We have a very specific point of view and a set of strategies here. Simply put we are keenly focused on achieving the same success in the digital world that we have had in the physical world. .... As in the side our card not present volumes today are growing three times as fast as card present which we feel is still just a fraction of the opportunity in this space."

The company is enabling many more partners. Visa is opening a innovation center in San Francisco to enable new and old partners to sit side by side to promote and create payment methods. They are investing in smaller companies to help them keep up with innovation. Visa Checkout is more easily usable on both mobile and web through newer published APIs and SDKs. Huh? An API is an application programming interface. A SDK is a software development kit. Electronic payments through ecommerce, Visa being one of the preferred payment technologies.

The guidance given was a little lighter than the market anticipated, hence in the after hours the shares pulled back 3 percent. This is an opportunity to buy more of what is one of the best investments out there with huge growth potential even in developed markets. Buy.

I want to add something here. Statistically speaking, flying is still safer than any other method of transport. There is however a fascination with aeroplane crashes, I guess because they are not supposed to happen. I read a Bloomberg story this morning that suggested that over 100 thousand commercial flights take place each and every day. Our expectations are for each and every one to arrive. Read the press release from Iater yesterday: Statement from Tony Tyler on Tragic Week in Aviation in which he said: "In 2013 more than three billion people flew and there were 210 fatalities."

I then downloaded this report from the World Health Organisation: Global status report on road safety 2013 In which they say: "eighty-eight countries have reduced the number of deaths on their roads - but the total number of road traffic deaths remains unacceptably high at 1.24 million per year."

And then even more worrying:

"only 28 countries, representing 449 million people (7% of the world's population), have adequate laws that address all five risk factors (speed, drink-driving, helmets, seat-belts and child restraints)."

After having read that you should be afraid to get into your car. Unfortunately the opposite perception is created by almost everyone. Nuts if you think about it.

Byron's beats

Last night we received Q3 results from one of my favourite companies listed in New York, Starbucks. Before we delve into the numbers here is an extract from an article I read titled 3 reasons it's hard to hate Starbucks.

"Five years ago, Seattle-based coffee chain Starbucks wasn't in a good place. In its fiscal 2008 annual report, the company showed a 3% contraction in comparable store sales, a bitter piece of punctuation following three consecutive years of sales growth deceleration. This is no exaggeration. By the end of 2008, Starbucks stock was trading below $10, less than half of where it was at the end of 2007 and well below its 2006 peak of just above $35. Investors apparently wanted nothing to do with a company whose business is predicated on premium coffee and free Wi-Fi."

If you read the article it goes on to explain how Howard Schultz, the well known CEO, turned the business around by investing in the employees and the people of Starbucks. He really is one of the best CEO's out there, in the league of Jeff Bezos, Steve Jobs and Warren Buffett in my humble opinion. Read the article, it is very insightful.

Fast forward to 2014 to a record third quarter with sales growth of 11%, comparable stores sales growth of 6%, operating income growth of 25%, operating margin expansion growth of 2% to 18.5% and earnings per share growth of 22% to 0.67c. The company opened 344 stores in the quarter with a total of 20863 stores. Compared to McDonalds with 350000 there is still a lot of room to grow. This is the 18th consecutive quarter of same store sales of more than 5%.

So what are these guys doing right? Firstly coffee is a great product. It is a socially acceptable stimulant that doesn't seem to have any long term negative affects. And it is delicious. The Starbucks coffee brand is by far the leader in the sector. The Nike or the Apple of the coffee world.

But for Starbucks the innovation in other sectors is really exciting. Teavana which is a fine tea and tea bar concept endorsed by Oprah already has over 360 stores. Breakfast sandwiches grew by 40%, baked goods are flying and they have big plans for the lunch market. The business is also experimenting and succeeding with online retail. The Starbucks app allows you to order online before you pick it up as well as do the payment through the app. Here is what Howard Schultz had to say about the quarter.

"Starbucks Q3 represents another quarter of outstanding operating performance in which each of our segments contributed to record results. The increasing power of the Starbucks brand, the success of our best-in-class mobile, social and digital technologies and our greatest asset - over 300,000 partners who deliver the Starbucks Experience to over 70 million customers around the world each week - position us to continue growing our business around the world and into the future."

As you can imagine, the stock is not cheap, earnings for the full year are expected to come in at $2.70. Trading at $78 or 29 times earnings a lot is expected from this company. But with earnings growing around 20% and sales expected to grow 10% for the next few years you can see why. The company expects to add 1600 new stores just this year.

Another huge potential growth factor is the geographic spread. At this stage the US and Canada is still responsible for 75% of sales. Even Europe is less than 10% of sales. The opportunity to expand what is already a global brand to areas where they do not have exposure is there for the taking. South Africa is a prime example. We love the theme and we back management to continue to grow from what is actually still a low base. We continue to add to this stock.

Home again, home again, jiggety-jog. Markets are marginally higher here, a moderately weaker Rand coupled with firming commodity prices see the resources complex move higher.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Thursday 24 July 2014

Shorts! Where are you? Time to Face the Book!

"I am going to end off saying that Mark Zuckerberg is one of those unique people that come around every now and again. His mission is not to make money. His mission is to connect the world. He lives in a modest home by his wealthy standards and lives a fairly ordinary life, I guess. In the last quarter one of the things the company has done that makes him most excited is the fact that internet.org (in conduction with the mobile networks) has helped 3 million people in the Philippines, Paraguay and Tanzania connect to the internet for the first time."

To market, to market to buy a fat pig. We closed flat here on the day, no, let me rephrase, we lost a few points on the day to end marginally in the red. And that was after a more than decent start, again Ukraine in the news, two military jets from the Ukrainian Air Force shot down by Russian Ukrainian separatists. I tried to explain my simple understanding of the situation in the Ukraine to two people and the conclusion was that I have no idea of the solution and what will happen next.

All I know is that the Europeans are preparing new sanctions, which prevents capital in financial services sectors from flowing both ways, in and out of Russia. 40 percent of the gas needs of Germany come from Russia, 80 odd billion Dollars of trade takes place between those two countries. It is as important to one another, remembering that Germany took an executive decision about nuclear power post the Fukushima Nuclear Power plant disaster. Of course the likelihood of a meltdown as a result of an earthquake and subsequent tsunami in Germany is obviously less than Japan, because of the tectonic plates relative to the respective geographies. You know what I mean.

Across the Atlantic on Wall Street, the S&P 500 closed on an all time high (a closing high) after having reached new intraday highs during the day. I made a note on my Vestact cap that said S&P 500 2000, the idea being that is the next stop. Just a number! It could be fun to see. The futures market this morning is pointing to a lower open, there are of course companies reporting through the next few weeks, so far so good. A pleasing first look at PMI data this morning might also do much to quell fears around a China slowdown. Earnings chaps, earnings, that is the most exciting part.

SABMiller released a trading update this morning. You can download them here: F15 Q1 Trading Update The best performing segment is local, you will be pleased to know. Many public holidays and Easter apparently leads to more people drinking beer and soft drinks. Why are they, "soft drinks"? Soft is not hard, and hard drinks are drinks that have alcohol in them. Here is a screen grab of the organic constant currency growth rates.

NPR stands for net producer revenue, I had to search for that. This company trades on a very lofty valuation. Very lofty. 27.5 times historic earnings. Now you might say to me, well that never scared you before, more especially if the growth rates in earnings keep pace. The only question I have when looking at SABMiller is simple, in a more health aware world, how much more beer do you think your customers can drink? Surely there is a limit. Unlike say for instance how much you can use your handset, or growth rates of users on the internet. Which dovetails nicely into the next piece. Forget the potential regulatory hurdles that companies like SABMiller face in the coming years.

Facebook reported numbers post the market close last evening. Once your base grows bigger and bigger it becomes a mathematical impossibility to grow at the same rate. Firstly, most of the users have adopted Facebook already that were keen to do so and secondly your potential user group gets smaller. I guess one could argue that if every human with a reliable internet connection had a Facebook account, the company could have a whole lot more than 1.32 billion users. Roughly 63 percent of that base use Facebook daily. Monthly active user growth is around 3.5 percent, which I think is astonishing, others are not wowed. 40 million users were added in the last quarter and now one in five people around the world log into their Facebook accounts on a monthly basis. Differently put 4 in 5 do not have a Facebook account.

Cast your mind back to when the business listed, their IPO price was 38 Dollars a share on 43 cents worth of earnings, the growth rates were that hotly anticipated that Mr. Market was hungry for the stock, the listing did not go as planned and the rest is history. The stock traded as low as 18 odd Dollars and everyone called the Facebook IPO a disaster and started to question whether or not the company would be able to monetise mobile. That was the real anxiety. Those concerns were quickly put to bed as the company showed their ability to keep up and modify what is a successful model.

We all like to know what our mates are up to. We would like to think that they would like to know what we are up to too, pictures of your dogs and kids and your wonderful time is actually of interest to me. For most people who have left school and tertiary institutions the platform is perfect. I could not care that teens are not too taken with Facebook, they see their ~~frenemies~~ friends each and every day. Once you have a life that involves working, a partner to share that with and little people (and pets), the natural way is to share that with others, that is the way we are designed. Communication is at our core. Fear of missing out is real.

The company sums it up perfectly in the about us segment on their investor relations page:

"Founded in 2004, Facebook's mission is to give people the power to share and make the world more open and connected. People use Facebook to stay connected with friends and family, to discover what's going on in the world, and to share and express what matters to them."

Anyhows, I am sure that there are many people preparing their respective theses on user patterns and how it impacts their lives, we are more concerned here on the business of their business. So let us start with the numbers. Revenue for the quarter was 2.91 billion Dollars, well up from the corresponding quarter this time last year, which was "only" 1.813 billion. That is a 61 percent increase. For the half year the company had revenues of 5.412 billion, on a per user basis that equates to 68.3 US cents of revenue per user per month. When you put it like that suddenly you can hop out of your chair and say, yowsers, that sounds like nothing and the potential to leverage off that base is huge.

Net income for the quarter was 800 million Dollars, for the half year 1.976 billion Dollars. Earnings per share, Non-GAAP, 42 cents for the quarter and 76 cents for the half. Whilst Facebook is still a value investors dragon to slay, they are ironically half the valuation of when they listed and double the price. In roughly two and a half years. Astonishing.

The anxiety of the company being able to monetise mobile? Ha-ha! Mobile advertising revenue represented 62 percent of total advertising revenue in the last quarter. Mobile ad revenue grew at a mind blowing 151 percent year over year. 1.07 billion people check out Facebook on their mobile phones and more amazing is that 399 million people ONLY use their mobile phones to check Facebook. That number is climbing all the time.

The most incredible set of numbers out of all of this is just how scalable this company is, notwithstanding the fact that they continue to add staff and expenses. I have taken this slide specifically from the Quarterly Earnings Slides:

Expanding margins on growing revenues leads to outsized growth on a per share basis. Obviously this cannot continue forever, there are a few key points to make about their current business. Firstly revenues are still very much cemented in the developed world, USA & Canada and Europe account for 43.9 and 28.2 percent of advertising revenue respectively, that is 72 percent in total. Asia accounts for 15.2 percent and the balance for the rest of the world. That means people like us are not really that active.

I am going to end off saying that Mark Zuckerberg is one of those unique people that come around every now and again. His mission is not to make money. His mission is to connect the world. He lives in a modest home by his wealthy standards and lives a fairly ordinary life, I guess. In the last quarter one of the things the company has done that makes him most excited is the fact that internet.org (in conduction with the mobile networks) has helped 3 million people in the Philippines, Paraguay and Tanzania connect to the internet for the first time. The internet is a library. You can teach yourself anything on the worlds open library, provided that you have the aptitude and correct attitude. The starting point is to connect the world, not too dissimilar to Bill Gates intentions all those years ago.

As you can see from the earnings, the company is wildly expensive on a fundamental basis. The options are open for explosive growth still, continuing to have what is the most pointed advertising platform currently. It is not a business that is for everyone to own even if the prospects look amazing. I definitely have a buy rating on the company and continue to believe that their adaptations to the world around us will continue to drive user engagements and subsequently higher revenues. Facebook will pursue a multitude of new business angles, from payments to software/hardware like Oculus. This company is mostly an advertising business with different interesting other segments to it. Sound familiar? Oh yes, sounds pretty much like Google. The market likes the numbers, the stock is up 5.5 percent in post market trade.

Home again, home again, jiggety-jog. Markets are lower here today, the currency remains strong. Chinese PMI and European PMI numbers were a beat, that is encouraging. In fact the HSBC flash Chinese PMI number was at a 18 month high.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Wednesday 23 July 2014

Apple pips estimates

"Obviously the iPhone releases will be key to ramping up revenues. The business tie up with IBM is interesting, the company plans to roll more of their products across business and noted that the likes of Medtronic, which has developed over 175 internal apps for around 16.5 thousand iPhones used by its employees and Nestle who's employees use over 25 thousand iPhones are committed users already. The products are beautiful, the markets are still big."

To market, to market to buy a fat pig. We have been talking here in the office for a while about the format of these messages, I am pretty sure that for most of our clients the market segment is *nice*, are the company updates more useful though? We often trumpet from the roof tops that whilst short term geopolitical events, domestic political economic policy, sentiment around what central bankers are going to do next and so on, that determines sentiment, but not the collective value of the companies.

The index is just a number. For whatever reason it is quoted widely along with the gold price. What does it mean to you when the price of gold is quoted and you hear it on the wireless? The oil price and the currency are more relevant to South Africans as that indicates what you are likely to pay for petrol in the coming months. Of course that has a lead/lag impact on what consumer pay, more especially the prices of what food is likely to be in the coming months too.

Whilst inflation is above the place where the MPC are comfortable with, food and alcoholic beverages are 20.8 percent of the basket. Housing and utilities account for 24.5 percent of the basket. Transport, 16.43 percent of the basket. Add those all up and you can see why energy prices are expensive and a big constituent, whether it is your electricity at home or the petrol you fill up with. Or the goods you buy.

To end this segment off, do you the readers enjoy where the markets closed yesterday, is that important to you? If not then we can deviate a little off the S&P was up X or the local all share is down Y and so on. Whilst the market movements are important to many on a day to day basis, if you ask ordinary people about market levels (do it) see what the answer is. For the record, the all share index added nearly a percent to close near the all time highs, just below the 52 thousand mark. The S&P 500 closed within a whisker of their all time high, 1983 and a half points.

Apple results for their third quarter hit the screens last evening, post the market close. The Investor relations page has been spruced up since I last visited it, certainly looks better. In the traditional clean and crisp Apple way. How do they do it? The beautiful look, they are so very good at it.

Remember that the company did a share split, 7 for 1, so the earnings on a per share basis, as well as the dividend are adjusted accordingly. Revenues clocked 37.4 billion Dollars for the quarter, profits a whopping 7.7 billion. Yowsers. At the same period last year the numbers were 35.3 billion Dollars worth of sales and 6.9 billion Dollars worth of profits, the 2.1 billion Dollars represents only a six percent increase.

On a per share basis, the company earned 1.28 Dollars (1.07 at the comparable stage) and the highest growth rate in seven quarters. The dividend has been guided higher to 47 cents a quarter, which amounts to just shy of a two percent yield at this share price. Not a king's ransom by any stretch of the imagination, but consider that the company only paid their first dividend on the 9th of August 2012. Not their first ever, but their first in the current cycle. The dividend cycle was broken from November 21 1995 all the way through to that one paid in 2012.

The company has pots of cash, they generated 10.3 billion Dollars of cash during the June quarter and returned in the aforementioned dividends and share buy backs around 8 billion Dollars. Yowsers, that is serious. Cash on hand? 164.5 billion in cash and marketable securities, with 26.8 billion Dollars of that in the US. That means that Apple has cash of 137.7 billion Dollars worth of cash around the world. Oh I would love to know how the Apple hedge fund operates.

Historically the company trades on a price to earnings multiple of 15.8 times, if you strip out the cash (cash represents 28.8 percent of the market cap), then it is closer to 11.2 times. Wow. In my humble opinion this company is still cheap.

Apple sold 35.2 million iPhones, which is a third quarter record and an improvement of 4 million on the comparable quarter last year. That is a healthy 13 percent increase. Remembering that the rumour mill is suggesting a newer iPhone, in fact the rumour mill suggests two newer models with larger screens. As long as it still fits in your pocket. The iPhone still represents 70 percent of the business, it is their most important product. As such the next one is always going to be highly anticipated. Always.

They also had a record quarter as far as Mac sales are concerned, 18 percent higher year over year, selling 4.4 million devices. What makes those Mac sales even more mind boggling is the fact that (on the conference call - read the transcript - Q3 2014 Earnings Conference Call) according to a crowd by the name of the IDC, they estimate the PC market shrank by 2 percent. Apple Mac has gained global market share for 32 of the last 33 quarters.

We had speculated about this in earlier messages on Apple, wondering if when people upgraded they would get a Mac. Once you are in the ecosystem it is a whole lot easier. They are certainly beautiful devices, my MacBook is simply awesome. It is always on, no waiting for updates, no waiting for booting up. Simple, clean and easy to use. That is another thing about Apple users, they suddenly turn into sales people with the devices that they have. The success of the beautiful devices can be attributed to the company as well as the wonderful friendly user platform. I cannot wait for Yosemite.

Their fastest growing business? iTunes, where billings grew 25 percent year over year, and the last quarter was a record high. Once you are locked in and Apple have your billing details (genius) with a simple click of a button you can purchase an app, a song, a book and the list goes on. Movie? I have bought one of those before too. iTunes billings grew to 5.4 billion Dollars for the quarter, annualise that and you are closer to 22 billion Dollars for the year. From iTunes. Cumulative app downloads have passed 75 billion. And most importantly is that developers have earned 20 billion Dollars in sales through this platform. The larger the number gets, the more developers it will attract. The app gold rush.

The only blight on what are very good numbers are that tablet sales globally have tapered and are in fact decline, even though Apple have been shown to be the number one goto company as far as customer satisfaction is concerned. As per the conference call, where CEO Tim cook said "iPad sales met our expectations but we realized they didn't meet many of yours.". The company still managed to sell 15.3 million units which was better than the 14.6 million in the comparable quarter last year. Strong sales from the Middle East (sales up 64 percent), China (up 51 percent) and India (up 45 percent). Since the product was unveiled, the iPad that is, the company have sold 225 million. I remember many people were quite perplexed about the usefulness of the product.

The next powerful operating system and apps that can go with it are key for driving tablet sales globally, at least that is my sense. Having said that, people are so happy with their iPads. A crowd called ChangeWave surveyed iPad users and found a 100 percent customer satisfaction rate for users of the iPad mini with retina display (the crystal clear one) and 98 percent customer satisfaction for the iPad Air. Wow. Apple interestingly had internal data that suggested more than half of the iPad sales are to first time users.

Guidance for the current quarter was around 37 to 40 billion Dollars in sales (I think if I am not mistaken Mr. Market was expecting above 40 billion Dollars), gross margins of between 37 and 38 percent (inline with expectations). After all was said and done with the results and analysis and the conference call and the Q&A session (quite limited, but that is usual), the share price traded lower in the after hours session. Currently mooted to open at 94.15 Dollars, down 0.6 percent after having traded higher by 0.83 percent to 94.72 in the normal trading session. That tells you that these results were made of Goldilocks, the market got it right, not too hot and not too cold.

So where to next for Apple? Obviously the iPhone releases will be key to ramping up revenues. The business tie up with IBM is interesting, the company plans to roll more of their products across business and noted that the likes of Medtronic, which has developed over 175 internal apps for around 16.5 thousand iPhones used by its employees and Nestle who's employees use over 25 thousand iPhones are committed users already. The products are beautiful, the markets are still big. Margins should be maintained as the company does not discount the quality, it seems that will remain that way.

The company continues to be well placed, 29 other transactions have been done over the last 7 quarters, not including the one that was splashed out, the Beat's one of course. The company plugs away, always looking for awesome businesses to add onto their ever growing eco system. And whilst it is hard to tell, on the conference call Time Cook said that the Gartner research suggested that by 2018 tablet sales globally would be around 350 million annually with PC sales at 315 million, Apple aims to continue to add devices one at a time. We continue to buy this company.

BHP Billiton have released their production report for their full financial year to end June 2014. Iron Ore production at a record of 203.564 million tons, the quarterly run rate suggests annual production of around 225 million tons. i.e. If the company were to maintain the last quarters performance, from an Iron Ore point of view.

For the next financial year the company is expected to ramp up to 245 million tons. I have seen suggestions that BHP Billiton breaks even at 53 Dollars per ton, according to a FT article that cites research done by UBS -> BHP mines record level of iron ore. The iron ore price currently 92.74 (all grades) as per the end of June. That follows from 114 Dollars a ton this time last year, but the price has been as high as 137 Dollars per ton during the year.

The average price of Iron Ore over the last 12 months has been around 122 Dollars per ton, but remembering that production was ramped up in the second half of the year where prices averaged 112 Dollars per ton. So obviously the volume increases do offset the prices and the margins remain elevated, if not as much as before. The average selling price that the company received for the full year was 103 Dollars. So what to expect from here is for the iron ore price to find a level. Chinese steel demand remains key to the equation and this is (whether one likes it or not) the most profitable business that BHP Billiton have. Guidance, as mentioned before is for a 11 percent increase in volumes for the 2015 financial year, which is almost a month old now.

Total petroleum production, per barrel equivalent was a record 246 million barrels. In fact, rather than trying to spell it all out, let me take both the production table, which appears here:

And then I will take the average prices for all of their products:

As you can see across the commodities complex prices fell. A company like BHP Billiton has little control over the majority of these prices, what they have control over is the cost of their various businesses and more importantly recognising which projects to pursue and which ones not to pursue. The obvious examples are the ramp up of the Pilbara iron ore project and onshore gas in the US. The obvious examples of assets that they own which they have not pursued as hard as we would have thought have been the potash project in Canada. No doubt that will come, with the Russians keeping a lid on prices, do not expect anything any time soon. Slow steps.

It is our core holding in the commodities complex, there is good diversity across the business, both geographically and products. Most importantly their capital allocation has been better than their peers and management is cautious, not really in the miners role. They are the biggest in size and scale and we should be so lucky that we can buy them here, as a result of historical reasons.

We are not active buyers of the company at present levels, nor are we sellers, we believe that if you held them historically they are bound to reward you handsomely with a greater dividend stream, last year the company paid 116 US cents, expect more this year, with the interim dividend having been 59 US cents already. I guess that means that the stock is currently trading at levels that you would call a hold, even though I dislike that term.

Byron's beats

It's been a tough week for McDonald's following the meat scandal in China which Sasha covered on Monday and then they released a disappointing set of second quarter results yesterday. Global comparable sales were flat, revenues were up 1%, operating income was flat and diluted earnings per share increased 1% on the back of share buybacks. This equated to $1.39bn or $1.40 a share. This is still a big and profitable business even though there is not much growth.

The biggest question to ask of course is why are sales flat? Is it an issue from the company or are consumers in general staying away from fast foods? From the surveys I have read and judging from the commentary from management the company has lost a certain amount of relevance with consumers. In fact I found this US burger survey the other day titled Best and worst fast-food restaurants in America. As you can see from the image below McDonald's burgers got the worst rating out of the whole bunch.

The survey which covered 96208 meals at 65 different chains went on to say the following. "Americans are spending more than ever to dine out-topping $680 billion per year (South African GDP is around 385 billion Dollars). And they are demanding more for their money, higher-quality fast food, and greater variety than can be found at titans such as Burger King, KFC, and McDonald's."

It makes sense. The first movers in fast food have been caught up and now quality is more important. Fast quality is what is required. Although McDonald's can tinker with their menu, their unique taste is what defines them. Innovation of the menu is extremely important and it seems like management have fallen off the ball somewhat.

Don't get me wrong, McDonald's is an amazing business with a very special history and I have no doubt they will come up with solutions to change consumer perceptions of them versus their competitors. My biggest concern about this business however is something a lot more serious and which is mostly outside of McDonald's hands.

Peoples awareness of a healthy lifestyle has never been higher. Heart disease is by far the biggest killer in the US and there are big campaigns to eradicate this. A healthy and fit lifestyle means you live longer, feel better and sometimes more importantly to some, you look better. Unfortunately McDonald's find themselves at the forefront of this issue with lots of negative press.

The reason we liked McDonald's in the first place was because we love the theme of fast convenient dining, especially in developing markets. That theme is not going away and I still strongly believe in the thesis. But the world is changing in the way it views food. Calories, protein content, Tim Noakes, carbohydrates and many other dietary related terms are being thrown around more and more. It's certainly rife in this office. Maybe this issue is not as prominent in developing markets but the bulk of McDonald's sales still come from the US and Europe.

So to answer the question above, the issues McDonald's are facing are coming from both internal and external factors. The stock trades at 17 times this years expected earnings and sales are expected to be slow to flat for the next couple of years. Not cheap with no growth.

In light of all that has been mentioned above we advise you to sell this stock. As mentioned above, we still really like the theme but we see Starbucks as a much better entry. Their food and juice offerings are healthier and coffee is receiving more and more positive reports from health surveys. They are also coming off a much lower base. If you already have Starbucks, a healthcare stock or even Nike would be a good swap. Both these stocks will benefit from the negatives facing McDonald's.

Michael's musings: Vertigo

Two articles that I found very interesting, were relating to company valuations and the stock price vertigo that most people are currently experiencing. Personally I think that if people could only see the stock price today and not the movement of the last 5 years they would be less worried. Is human nature to say what goes up must come down at some point?

Here are the articles. Apple's 6,000% Rally Began With 'Stretched' P/E of 165 and Is the JSE really too high?

"...the stocks with the top 10 highest P/Es in the Nasdaq 100 a decade ago are up an average of 185 percent since"

"...the market was effectively flat between January 2008 and July 2012. In other words, three and a half years of the five and a half year bull run were actually just spent getting the market back to where it started"

If you have cash at the moment, equities are really your only investment option if you want returns. Property might give some return but it requires a large capital outlay and has large amounts of admin involved, so not an option for many people. These limited options mean that equities are worth more and part of the reason why multiples are higher than average.

Buying the quality means that even if multiples drop at some point in the future, you do not need to sell, earnings and dividends will continue to grow and the capital "loss" made during the pullback becomes inconsequential.

Home again, home again, jiggety-jog. The Rand has strengthened up significantly here. Perhaps that has nothing to do with the local reserve bank rate hike and everything to do with the fact that the Euro is trading at a 8 month low to the Dollar. That translates to Rand strength. A flat day for the equities market nevertheless.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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