To market, to market to buy a fat pig. Right. The same old bad friends came back to haunt us, European problems and US budget issues. Welcome back, we err..... didn't miss you. Last evening it became clear that Italian politics is just as entertaining as ever. Why do I say that? Well, in the period from 1948 to 1994, according to Wikipedia's piece titled Politics of Italy, there were 61 different governments in that time. Less than 50 years saw 61 governments? And we are surprised by this current outcome?
It is a good thing that a strong civil service holds the whole thing together, the bureaucrats rather than the leaders. In fact, talking leaders, Italy is sometimes called a gerontocracy, which quite simply means a society in which the leaders and their sidekicks are a whole lot older than the average age. But much older. Sounds familiar? I guess the other problem in Italy is that although it is one country, it was not too long ago that this came about. The monarchy was abolished after the Second World War. All I am try to say is that we are pleasantly surprised by Italian politics when we should not really be, history is sometimes not kind.
So what now? You have Beppe Grillo, the comedian and actor with his five star movement with 109 of the 630 seats in the chamber of deputies (the house), you have Pier Luigi Bersani's centre left with 344 seats. That old crazy Silvio Berlusconi, who sees the worlds most beautiful person in the mirror each and every morning with his centre right coalition with 126 seats. Lastly Mario Monti with 48 seats. The communist party got a whole three seats so that is a definite no-no. Yes, at least the Italians have some sense to be weary of those communists. As far as I can tell, the civil revolution party got zero votes too. Yeah, that sounds bad as well, a civil revolution is not likely to solve anything.
But..... it is in the senate that the same said parties need a majority too. As Wiki says about the Senate: "Results in the Senate are more unpredictable as there are 20 regional elections in which the winning coalition is secured of more than half of the seats even if they had a much lower proportion of votes. Moreover, the electoral thresholds are set much higher. A list should belong to a coalition that reached 20% in order to have a threshold set at 3%, otherwise, it should reach 8%. Unitary lists should also reach 8%." Sounds complicated. But the long and the short of it all is that the senate is not decided and in order to govern, a party needs to have a majority. The reason for the angst is simple, the comedian wants a referendum on whether to stay in the Euro or not and the philanderer promised to reverse some of the austerity measures imposed by technocrat Mario Monti. This is probably the worst outcome for stability in Italian politics (seemingly a rare thing at the best of times) and that is why markets in New York and indeed Europe sold off heavily.
Berlusconi is saying this morning that the people have spoken. The Spanish are watching Italy. Italian bonds have sold off sharply. Some Italian banking stocks have been halted limit down, meaning they have been stopped out. The Italian market is off nearly five percent today, after almost entirely reversing a 4 percent intraday gain yesterday. Ten percent here we come in a matter of days. Berlusconi is implying that markets are irrational, but of course he would say that, in his mind bunga-bunga parties are rational. Italian stock brokers must be sweating in Milan today, even though temperatures are expected to peak at 4 degrees Celsius today. The upshot of this bad outcome in Italian elections is that the uncertainty overhang is placed firmly back. I await the responses from the French and Germans as to what they think of these results. A relative calm that had descended on Italy is now broken I guess.
That wasn't the only reason however that markets sold off heavily. The Dow registered the worst session of the year, down over one and a half percent, whilst the broader market S&P 500 sold off even more sharply than that, down 1.83 percent on the session. We lost two thirds of a percent from our highs. The other reason that markets fell, which we alluded to earlier, was that bad old friend in the form of the US Budget. With spending cuts looming, the sequestration is close enough to get everyone frothing at the mouth again. If you are confused, then there is a really good description of the automatic spending cuts: The Sequester: Absolutely everything you could possibly need to know, in one FAQ. Most of the cuts this year come in defense spending. The single biggest cut to a specific program is a 13.5 billion Dollar cut to military operations. Out of the 85.4 billion Dollars. It is not really huge in the bigger picture, but it all adds up and the impact could be as much as 1.5 percent to the US economy this year.
So, let me get this right. Everyone wants desperately to reduce the governments involvement in the US economy, but the cuts are too deep to bear, even if it actually in the long run is the right thing to do. The democrats want to raise taxes, the republicans want to reduce domestic spend and keep defense spending as is. But I get the sense that everyone can't have what they are looking for, and perhaps the moment for cuts and higher taxes is not now, the recovery is still seen as too fragile. But either way it seems like the cuts in government spend should probably be delayed to get a sense of how tax receipts are improving.
Most important question is do I do anything at all? The answer is no. Will companies change their current plans as a result of Italian elections and the sequester? Most probably not. Our advice is always, don't panic. If anything, turn the argument around and say, I am buying a piece of a company that I wish to hold for as long as possible. In the Berkshire 1988 chairman's letter, written by Warren Buffett, when he spoke about recent investments, he said: "our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds." Own the quality, be patient, buy when nobody else wants to.
- Byron beats the streets. Yesterday we received 6 month results for the year ending December 2012 from WBHO. On the face of it they looked good. Financial highlights included 43% growth in revenue, operating profit up 22%, headline earnings up 18% and the dividend increasing 23%. 2 things need to be noted here, firstly this is compared to a tough period in 2011 where the company had to make some impairments. Secondly, WBHO since the beginning of 2009, have comfortably out preformed the construction index. This means that as the star in the market, you cannot use them as a proxy for the sector. It is interesting to see what they say none the less.
It is quite clear in these numbers that the reason for the growth, especially on the revenue side was due to a 61% increase in their Australian division which is now comfortably their biggest revenue driver. In fact it is now responsible for 51% of revenues. 26% comes from building and civil engineering while 23% comes from roads and earthworks. But and this is a big but, the roads and earthworks division is where the best margins are at. That division brings in 51% of profits, building and engineering brings in 24% and the Australian division contributes 23%. The rest comes from 'other operations'.
This has been a great example of how geographic diversification in the right area can be the difference between your average company and your market leader. According to the report the Australian market, which has benefited extensively from selling commodities to China, has seen a big uptick in the residential market and WBHO Australia has benefited from this.
Locally we are seeing the same old pattern, growth in demand but margin squeeze due to intense competition and higher input costs.
From their building division:
"The last six months have shown an increase in activity in the industry, particularly in the building sector, however, the pressure on margins remains. Revenue increased by 21% to R3,2 billion with an operating profit of R139 million."
From their Roadworks division:
"Trading conditions for the division have remained very competitive and the environment in the local market resulted in lower margins. The division has maintained its momentum through focusing on the resources sector in Africa. Revenue increased by 40% to R2,7 billion and operating profit increased by 25% to R288 million."
For us, even with the best operator in the market, there are too many risks. Yes government have earmarked hundreds of billions of Rands to infrastructure but where is that money going to come from? The industry is also too competitive and that is why we are seeing big collusion inquiries. And how, if they have to resort to collusion, are they going to cope with increases in Labour and electricity costs? As for WBHO in Australia, this has clearly been a great move but Australia's complete dependence on the Chinese economy is still a risk.
The prospects seem encouraging as a whole for the South African economy but as investors I would prefer to put my money elsewhere.
Crow's nest. That Italian outcome has spooked them all. Good for them. I can't remember the Italian election results in 2001, but according to the World Bank data that I have, the Italian economy is nearly twice the size now versus back then. So to worry, or not to worry? Julius Caesar supposedly said: Veni, vidi, vici, which translates loosely to I came, I saw, I conquered. In this case it is more apt to say, Veni, vidi, nec victoris, or I came, I saw, none were victorious.
Sasha Naryshkine and Byron Lotter
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