To market, to market to buy a fat pig. We were doing just fine around midday, and then drifted lower later on to the close. Perhaps that Massmart trading statement, which weighed on all retail stocks, was to blame. General retailers sank 2.2 percent, but listen in here a little. The first retailer appears in place number 15 on the market capitalisation ranking table, with only around one and one quarter of a percent of total market weighting. Many might be crowing that the retailers are overvalued, but that is relative to what? Are the historic measurements warranted? Well, perhaps not when you read the opening paragraph of this report: The Rise and Rise of the African Middle Class.
"The rise of the middle class, as a percentage of the population, has been steady - in 1980, 111 million or 26% of the continent's population fell in this category rising to 151.4 million or 27% of the population in 1990 with a further surge to 196 million in 2000 and a dramatic increase to 313 million in 2010 equating to 34.3% of the population (African Development Bank, 2011). In contrast, the rise in absolute numbers, compared to the percentage rise, has been more dramatic and this is best explained by the increase in population with Africa having hit the 1 billion population mark in 2010."
So, according to this report, the middle class across the continent has doubled in 20 years. So why shouldn't the retailers that operate here command a higher multiple? Why compare different eras that are completely different. If there are many more consumers inside of your operating territory, the chances of higher profitability in the future exist. And that was why WalMart were willing to pay up for Massmart, their expansion plans across not only here locally, but across the continent were too exciting to ignore. So whilst fund manager one would not pay more than 12 times earnings in 2002, 2012 is different. Don't compare different times to current times. And that introduces Byron's piece nicely:
Byron beats the streets Yesterday we saw a Massmart sales update which not only disappointed Massmart shareholders but the whole sector which fell over 2%. The sector is down 1.7% again today and has lost 13% this year. Let's look at the numbers and then the repercussions.
"For the 14 weeks to 31 March 2013, total sales increased by 10.3% and comparable sales increased by 6.0%, continuing the slower sales trends experienced towards the close of the financial year.
The South African consumer environment remains difficult and sales growth may be under some pressure for the remainder of the financial year. If the current sales trends continue, it will be difficult to meet our objective which is to achieve trading profit growth (excluding foreign exchange movements and Walmart transaction costs) equal to sales growth."
I guess what really spooked investors was the deceleration of sales. Massmarts year end is June so this is their third quarter sales figure. For the first 6 months sales had increased 14.7%. That is a fairly sizeable drop in growth. I can't say I am surprised, I have spoken about this extensively. How lower income groups have struggled from a stronger rand and a pull back in unsecured lending. Massmart have huge exposure to the lower LSM groups, especially with their Masscash brands.
If you have been following our posts over the years I am sure you know what I am going to say here. We are in this one for the long term and a speed bump such as the strikes of 2012 (I'm not playing this down, it has had terrible repercussions) is no reason to sell. And that brings me to another point. Clients may ask why we didn't reduce retail exposure when the strikes started happening and the rand started weakening?
The simple answer is that getting in and out of a stock creates extra costs and most of the time you get it wrong. The best way is to ride the wave and in fact add into weakness like we are currently seeing. Only 8% of Massmart sales come from the rest of Africa, the South African exposure is still huge. And when they start diversifying this geographic spread, which they are planning to do, then we should see earnings growth start accelerating again. Getting worried about a deceleration in sales is a short term "investors" worry. We think the long term story is intact, especially when you look at the report Sasha eluded to above, and are happy to carry on adding.
As for the rest of the sector, expect similar updates. Especially from the companies with more exposure to lower income groups. I don't think this trend will continue for one very important reason and it is political. This is the ANC's biggest voting bracket and the ruling government know that all too well. Unfortunately investing in this sector does have political risk so it will be volatile but the lower income bracket is in fact who everyone is fighting to uplift.
Whoa! Stand back here folks. Richemont have produced a sparkling trading update this morning, that indicate a likely increase in net profit of approximately 30 % compared to the prior year. Sales increased by 14 percent for the year, whilst in constant currencies only increased 9 percent. That was the benefit of a weaker Euro. As that crazy Jim Cramer says in the intro to his show, there is always a bull market somewhere. So, net profits are expected to increase by around 30 percent, so somewhere around 2 billion Euros for the full year.
That is almost double of what they did in 2011, so they certainly had a cracking year. Around 3.57 Euros worth of earnings per share (remember that the GDR here is one tenth of the Swiss listed entity) which translates to (at 12.08 ZAR to the Euro) 43.14 ZAR a share. Or at one tenth of that, 4.31 ZAR. The stock is understandably flying this morning, up nearly 6 percent in Jozi, at around 71.35 ZAR. 16.5 times historic multiple. For a company growing profits at around 30 percent, that is hardly demanding. A simple PEG ratio (Price to earnings ratio divided by annual EPS growth) puts that metric at 0.55. That is cheap, but their forward earnings growth at that rate is not clear. Either way, this is pleasing for shareholders.
Caterpillar reported results pre the market yesterday. The company has a rich 100 year plus history. You have watched War Horse, right? Those horses that pulled the giant guns through the mud, remember those poor things? Actually Caterpillar's predecessor, Holt, supplied tractors to the Allied armies in Europe. To do the "donkey work" in the mud on the Western Front. Lately for shareholders however, it has felt like the rest of the portfolio has been dragging the stock along with it. Over the last 12 months, the S&P 500 is up 11 percent, Caterpillar is down 22.3 percent. Why? Well, in part worries about the slowing Chinese economy, which has impacted both the building sectors and mining companies. Lower demand equals lower production, which means fewer equipment purchases. In part a softer Europe is also to blame for underperformance, but then again, anyone who has visited Europe looks at buildings that last got a proper lick of paint around 1797. Not fair, but you know what I mean.
The results were lighter than what the market was looking for, 1.31 of earnings was a miss of 7 cents versus consensus. Sales and profits were markedly lower, but there were some reasons around that. The company had guided earlier: "In our year-end 2012 financial release, we said the first quarter of 2013 would be challenging, and it certainly was. As expected, inventory changes were a major factor. Caterpillar and our dealers usually add inventory in the first quarter to prepare for higher end-user demand in the spring and summer. In the first quarter of 2012, we added about $2 billion to inventory, but this year, we cut inventory by about a half billion dollars. In the first quarter of 2012, Cat dealers added machine inventory of about $875 million, and this year, they reduced machine inventory by about $700 million. Those are significant year-to-year swings, and coupled with moderating end-user demand, resulted in sales and revenues being down 17 percent"
And the forecasts were toned down, the range is now 57 to 61 billion Dollars worth of sales, with profits of 7 odd Dollars a share in the middle of the range. What has happened already is that the stock re-rated to these levels. And in fact after these results rose 82.71 Dollars a share, up 2.8 percent. And around one quarter of a percent after hours, so the company stock price had a great day yesterday. The company is still going to repurchase stock to the tune of 1 billion Dollars, not insignificant against a market capitalisation of 54 billion Dollars. They are using the lower share price to "reward" shareholders. Dividends I guess are always more welcome, but this represents that the company is of course aligning their interests with yours. In the eyes of the board the stock represents the best possible allocation of shareholder capital, this is not always the case. Reducing the number of shares in issue spruces up earnings. And reduces cash on the balance sheet, increasing return on equity (fewer shares in issue) and a higher return on assets (fewer assets as a results of using cash to buy shares). So some key financial metrics are met as a result of share buybacks. That cash however belongs to the shareholders, and requires their approval ultimately.
At 7 odd Dollars of earnings, and a quarterly dividend 52 cents (208 cents for the year), the stock trades on fundamentals of 12 times forward earnings and a dividend yield of 2.5 percent. At face value that is not too bad, but bearing in mind that revenues are actually set to be lower than the prior year, I think that the stock is well priced at these levels. However, if you are bullish on continued global infrastructure plans in emerging and developed markets, and believe that this will continue to see resource demand increase in the coming years, then Caterpillar is a great vehicle to be invested in. The problem is that there are swings and roundabouts in demand, not too dissimilar to those of retail consumers and automobiles, this is possibly even more than that. We will continue to recommend the stock and stay long if you have them. The global economy is not in free fall, and is currently just chugging along at a fairly anaemic pace. But that will change. And when that does, you want to be holding the stock, because whilst the economic recovery takes place, the price would have moved long before it becomes clear that this is the case.
Shorts. Digest these.
Why have we underperformed the rest, along with other emerging markets? We tried to explain it yesterday, and indeed I stumbled across another piece that had a go: Emerging problems.
This is amazing. Read this piece first: Why the US economy doesn't weigh as much as we thought it did. Two things here, one is that the change by the BEA in the measurement of GDP will give it a boost, but to me the one line in there was most interesting: "America just gained an Argentina". 100 odd years ago there was a debate on which one of those countries will be bigger economies in the coming decades. Well, we know who won that and who has the wonky economic policies. All this is relevant because of the pending GDP release Friday. As these fellows point out: Guess What? Growth is Back!
Crow's nest. There is nothing more important today than the Apple results. Really. If those go better than expected, I suspect that there could really be another leg to this rally. If the company disappoints, phew, I suspect that it might look poor for the stock for a while. What I don't want the company to do is to react to the falling share price by implementing measures that will make short term shareholders happy. Focus on the core business and the client, the rest will fall into place. I want to hear about cool new products and strong demand for existing ones. After market today. We wait.
Sasha Naryshkine and Byron Lotter
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