Money with a dash of Funny

Friday, 16 May 2014

Richemont. Timeless.

"One of the reasons that people acquire luxurious brands and products, either it is to show that you have arrived, or it is to know that you own that unique piece. Holy smokes, a Vacheron Constantin Tonneau Tourbillon costs 184 thousand Euros, or that was the quote that I saw. 32 stores globally. That is it, no more for now. There is not only the price of the pieces that are beyond reach of most, but they are difficult to reach. Exclusivity is however in the luxury goods business part of the allure. A rich and discerning customer wants to know that they are part of an exclusive and select group."

To market, to market to buy a fat pig. Rebecca Black says that it is Friday and seven am and you have to get up. I am not sure what is worse, Ms. Black's cheesy music or the fact that seven am is an acceptable time to wake up in the morning. What do I know, Rebecca Black has her other music videos on YouTube seen millions of times, really. And besides, many people in the industry might have spoofed the video, but Black possibly made good money and makes good money from her YouTube channel. And just in case you forgot, she is 16 now, 13 then. So, I should be championing someone who puts herself out there and gives her career a full go with the internet. Well done. But that does not mean I have to like the music.

Back to markets quickly, before I reveal my real music tastes and others suggest that I can't possibly like that! US markets were beaten up, concerns over global growth emerging again. Eddy Elfenbein (Byron is a big fan) in his weekly newsletter had some interesting points though. Worth revisiting actually. "Earnings aren't bad either. For the first-quarter earnings season, 76% of the companies in the S&P 500 beat earnings expectations, while 53% beat sales expectations." And the US jobless situation is improving. When the top line improves significantly for many businesses all the hard work done whilst the going was really tough will bear fruit. Of that I have no doubt. It is starting to happen already.

Wal-Mart had numbers yesterday that showed that the snow and poor weather at the beginning of the year dampening consumers enthusiastic shopping habits. Well, at least that is what the biggest retailer in the world is saying. Notwithstanding the bad weather, Wal-Mart managed sales of 115 billion Dollars for a ninety day period. Yes, if it is not a leap year then the first quarter has exactly 90 days. 1.277 billion Dollars of sales a day.

A bit of perspective here. In their last financial year, The Foschini Group had sales of 12.896 billion Rand. At the current exchange rate, 10.34 to the US Dollar, that equates to 1.247 billion Dollars. In the prior quarter, on a single day inside of all of the Wal-Mart stores the sales were more than The Foschini Group (brands like Foschini, Markham, exact!, sportscene, Totalsports, American Swiss, Matrix and Sterns). That is guaranteed to blow your mind. As Byron well points out, if I were to do the math for the entire annual turnover of the South African retail sector and compare it to Wal-Mart, we were probably be completely floored. Wal-Mart, is it a great investment?

I suspect that Wal-Mart falls into that category that when it gets dirt cheap (which it does from time to time), that is the moment to act. The yield is 2.5 percent, the multiple is 15.8. That seems expensive for a business that does not really have the ability to grow earnings quickly. A bit of irony here, the expectations for Facebook (unrelated to Wal-Mart of course, other than the pithy pictures of the people shopping there posted on the platform) earnings growth this year is somewhere in the region of 96.4 percent. And their multiple? 50 times. Price to earnings to growth means that Facebook has probably a lower PEG ratio than Wal-Mart. Sometimes the simple fundamentals tell you very little about the prospects, what matters at the end of the day is paying a reasonable price for a quality business.

OK, as promised: Richemont, the Swiss luxury goods group, announces its audited consolidated results for the year ended 31 March 2014 and proposed cash dividend. That is the download for you to read. At face value the results are not what you would expect, but there were definitely currency headwinds. The cash position is at an all time high.

OK, but the company talks about fewer stores opened but they were very pleased about sales in their domestic markets. In other words locals buying their goods. Asia Pacific is now the largest region (40 percent), that trend has been ongoing whilst the Chinese continue to indulge themselves with quality. I think that simple word quality is at the heart of this investment. Vacheron Constantin is 259 years old. Not the person, that is impossible, but rather the brand. Vacheron Constantin is a high end watchmaker. I guess if you are asking about what the price of their collections are, that may or may not be the right starting point.

That is however, one of the reasons that people acquire luxurious brands and products, either it is to show that you have arrived, or it is to know that you own that unique piece. Holy smokes, a Vacheron Constantin Tonneau Tourbillon costs 184 thousand Euros, or that was the quote that I saw. 32 stores globally. That is it, no more for now. There is not only the price of the pieces that are beyond reach of most, but they are difficult to reach. Exclusivity is however in the luxury goods business part of the allure. A rich and discerning customer wants to know that they are part of an exclusive and select group. And that is at the heart of it all, much like natural beauty (Table Mountain to the Kruger Park), you cannot replicate quality Maisons with hundreds of years of history. In fact, the bulk of the Richemont brands are over a century old. From the Richemont website, here are the years of founding of the respective businesses: Purdey (1814), Baume & Mercier (1830), Jaeger-LeCoultre (1833), Lange & Sohne (1845), Cartier (1847), Officine Panerai (1860), IWC (1868), Piaget (1874), Lancel (1876), Alfred Dunhill (1893), Van Cleef & Arpels (1906) and Montblanc (1906).

Not being able to replicate brands makes these businesses even more valuable than they were acquired for in the first place. The margins after the expensive store footprint and the heavy advertising (and possibly expensive watch and jewellery specialists, both back and front end) are 35 percent for jewellery and 26 percent for the watchmakers segment. Group operating margins for the year were lower at 22.7 percent. But still astonishingly high. Total sales for the group for the year clocked 10.649 billion Euros, profits were 2.067 billion, an increase of only thee percent. EPS was 3.676 Euros per share, remember that the shares here are one tenth GDR's (global depositary receipts). So our earnings here in Rand term in the exchange rate would be 5.25 ZAR per share. And the dividend, after the pesky 35 percent tax rate for Switzerland is 91 Swiss Franc cents. Which after the ten for one equals 1.06 ZAR per share. Remembering that if you get your paperwork in order you can claim back 20 more (2 for the GDR) Swiss Franc cents. That is then 1.30 ZAR per share. Not very generous on the dividend.

Even worse unfortunately is having to get the dividend difference (15 percent dividend tax here, 35 percent in Switzerland) back, which is not complicated, but a tedious process which requires leg work on the part of each and every individual. It is one of those unavoidable things in life.

Other than that, is Richemont a good investment? Yes. Very definitely yes. There are more rich people around the world than ever before in humanities existence. There are more people full stop. Aspirational consumerism is a huge trend that we like a lot. The currency headwinds are unavoidable, for now, the Euro levels will wax and wane relative to their prospects, but we should get a clearer picture during this current financial year around stability. This is one of the single best investments that JSE investors have access to. We continue to buy.

Byron beats the streets

Today we received a detailed update from Woolworths with regards to the David Jones acquisition. I'll break it up into 3 important parts namely rationale, funding and progress update.

Rationale

Sasha has covered this in detail before so I am just going to do a standard copy paste from the announcement to remind you.

"As an iconic Australian retail brand, David Jones provides the perfect platform for expansion in Australia, occupying a similar customer positioning to WHL in South Africa at the premium end of the apparel market, with both businesses enjoying strong aspirational brand identities and a strong alignment of values that put the customer first, offering excellent service and quality. The Proposed Acquisition supports WHL's strategy and is a rare opportunity to create a southern hemisphere retailer with meaningful scale, better able to compete with global retailers, leverage common fashion seasonality with enhanced sourcing capability and leverage the South African headquartered design, buying and procurement capability."

There certainly are some good synergies available. Pushing Woolies brands within David Jones stores makes a lot of sense. So does bringing the David Jones brand here to SA. We are huge suckers for foreign brands. The list goes on.

Funding

The total purchase consideration is expected to be R22,351 million. R10bn of that funding will come from both cash on hand (R2bn from their latest results) and a R10bn term facility. The surplus of this cash will also be used to fund current operational cash needs. A A$400 (R3.98bn) bridge loan will be raised in Australia. I am sure the rates in Australia are very favourable. The difference (about R9.4bn) will be raised through equity bridge funding (which uses equity as collateral and will be repaid by a rights issue after the transaction is done). Woolies current market cap is R65bn so the rights issue will look to raise about 14.5% of the market cap from us the shareholders. That is not big at all which is good news. The details of the rights issue still need to be finalised but the recent resurgence in the share price I am sure makes this a lot easier.

Progress update

Both the Australian Foreign Investment Review Board and the Financial Surveillance Department of the South African Reserve Bank have given their approval. Shareholders now need to approve the deal which the board unanimously recommends. David Jones shareholders also need to approve. They assume this will all take place by 17 July when the acquisition will go through. Remember the rights issue will only take place after this.

The Vestact Take

At first we at Vestact were a bit sceptical of the deal. They were getting things very right going about their business and growing organically, why throw such a big spanner into the works? But the more we have looked into it the more we realise we have to trust management on this one. They have done it before and they certainly have the skills and expertise to buy a depressed asset and turn it around. If you are still not convinced watch this interview with CEO Ian Moir he goes into great detail about the acquisition. We continue to accumulate Woolies shares.

Michael's musings: Cisco down. But up

Wednesday evening we had Cisco release their 3Q results, which were a beat on the streets expectations. The beat resulted in an increase of 6% in their share price yesterday. So here are the numbers, revenue of $11.55 billion, down 5.5% but better than the expectations of $11.3 billion and even better than their own guidance of a drop between 6-8%. Margins were better than expected as well, with gross margins sitting at 62.7% compared to expectations of 61.3%. EPS is down to 42c a share from 46c the same time last year.

A big contributor to the drop in revenue is due to orders in emerging markets being down 7% yoy, with Russia and Brazil being the two weakest with drops of 28% and 27% respectively. Russia having a big drop is understandable due to their Ukraine foray, but I haven't seen a reason for Brazil. In any case they do say they don't expect emerging markets to pick up for a couple of quarters. Compare this to US orders being up 7%. The US is where the growth is due to its size, both in number of companies and spending power.

A big story for Cisco is their prediction that by 2020 the "Internet of everything" will have an economic impact of $14.4 Trillion. Not a small number by any means, with Microsoft saying that it will be worth $1.6 trillion within the next four years (a lot lower number but highlighting the potential for this new area of connectedness). The "Internet of Everything" is where you will have smart devices in your house and life. Where all these smart devices will speak to one another and to you were ever you are. This is great news for Cisco because as more devices start talking to each other the more switches and other networking devices they will sell.

The company has over $50 billion in cash, which is around 40% of their current market cap on a P/E of 16. So it is by no means expensive, but I think that the valuation given to it is based on the fact that we probably are not going to see it shooting the lights out in the growth department. Another problem is that a chunk of the cash is sitting outside of the US, so it isn't able to be put to work as efficiently as it could be, be it in the form of dividends or further capital expenditure. The internet and communication is the future and as more people come online the more products Cisco will sell, so the future looks good. We feel that the management team needs a shakeup though, John Chambers the CEO and Chairman has been there since 1995. In the world of tech it is important to stay one step ahead of everyone and in Cisco's case fresh blood could spur on growth.

Home again, home again, jiggety-jog. Markets are lower. There is a lot of anxiety. But that is natural and ongoing, all of the time of course!!

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Wednesday, 14 May 2014

Paralysed platinum pay problem

"The worst part in South Africa is that you have skills, race and class lines drawn as a function of the past, that stinky word that all of us wished did not exist, apartheid. The reality is that we are straddled with the inequalities of the past, white and black, still open for all to see. But if it did not exist, then the lines would not be drawn along race. More likely class, it would be a simple class struggle. The worst news however for labour is that mechanisation is a given."

To market, to market to buy a fat pig. OK, yesterday was not quite a record setting session here locally (in terms of where we closed) but it was certainly an intraday all time for the markets, the Jozi all share is now within a whisper of 50 thousand. Another market that set a first was the S&P 500, which crossed 1900 for the first time yesterday. 1800 was passed for the first time in November last year, 1700 in August last year, 1600 for the first time in May last year. All sounds quite close together, right? The S&P 500 however passed 1500 points for the first time in March of 2000, a full 7 years later it was more or less at the same level. Peaking at 1565 in October of 2007, when the US mortgage market was going nuts, the next time that level would be seen was 28 March 2013. A full 13 years from 1500 to 1567. With a whole lot of action in-between. So it you say that it took 14 and one quarter years for the S&P 500 to get from 1500 to 1900, that hardly sounds like the returns you would want as an equity investor, but again we always make the point that the index is not what you own.

You want to own individual companies. And in Jozi, your current choice is 354 listed businesses, bearing in mind that a handful of them are not currently tradable, as they are currently suspended. Most companies that fall into this category are most likely never to come back. If you slightly tweak your criteria to say, OK, I am only going to own businesses with a market cap of 500 million Rand, then the list here in Jozi shrinks to 247, with Keaton Energy being the last on that list. Change that to five billion Rand and suddenly your options start really getting small, only 134 companies. If your mandate as an investment manager was to only invest in businesses with a market cap of 1 billion Dollars or more, in other words 10.3 billion Rand, you would only be able to invest in the top 98 businesses listed on the JSE all share. And businesses larger than 10 billion Dollars, there are only 21 choices here in Johannesburg, Remgro being the last of those choices.

If I were to apply the same criteria in the US, businesses larger than 10 billion Dollars in market capitalisation (using Google Finance stock screener), that list is 1692 companies long. Which means that there could be an enormous variance between owning the S&P 500 as an index tracker saving option, or doing your homework and owning 10-15 of these companies with market capitalisations of larger than 10 billion Dollars. Sometimes having more choices is not necessarily easier or better for investors, but it does help.

We have this ghastly situation that continues to fall into the category of unsolvable for the time being along the platinum belt in South Africa. 100 odd days ago, newer mining union AMCU decided that they would draw a line in the sand and demand a minimum wage of 12500 Rand for the rank and file employee and they have stuck to that number, despite numerous rounds of negotiations.

I was most interested to see an opinion piece by none other than former spokesman of the National Union of Mineworkers, and now employed by an academic institution, the University of Kwazulu-Natal titled Amcu, the 'suicide bombers' of mining. I really do not agree with all of it, but he does make some good points. I see at the same time in Australia that overpaid associated mining industry workers at Port Headland (Iron Ore port in Aussie), the tugboat Maritime Union of Australia members want more. Understandably right? We all want more.

Deck hands (according to this article -> Australian iron ore trade faces labour unrest as boom fades) earn 135 thousand Aussie a year with the work cycle being four weeks on and four weeks off (every single day) want four weeks annual paid leave. Deck hands want their pay hiked to 70 percent of that of what tug boat masters earn, 220,000 Aussie a year is currently the salary. So, they want 154 thousand Aussie, 12.8 thousand Aussie a month. Which at the current exchange rate of 9.67 Rand per Aussie Dollar, that is 124 thousand Rand a month for Deck hands on tug boats, who would work 12 hours a day for four weeks straight. Of course societies are all different, eduction for starters in Australia is good. Not quite as good as South Korea (the best), but they rank 15th in the world (source -> Pearson always learnings), we do not even make it into the top 40.

But does that simply mean that if you live in a society which is more equal and more educated and has a higher standard of living that your salary should just be adjusted to meet what the workforce would term reality? Should a tug boat hand in Aussie earn ten times more what AMCU are demanding here? Because AMCU are told that their demands are unreachable. The truth is, and this hurts, the tug boat workers did not create the demand for Iron Ore in Western Australia, neither did the Western Australian government. If there are only 14 tugs (source -> About Port Hedland - Shipping Information - Towage Fleet), how many people can there be working as deck hands? The point is that everyone is worth something, we are all commodities essentially. But the point about quality of the employee (skill set and productivity) relative to what they earn, is that ultimately down to the shareholders?

The whole idea that only shareholders should have the ultimate say is kept in check and balance by the regulators and broader society. As Amplats CEO Chris Griffith said yesterday, there is no way in a public forum that he is going to win a debate on corporate remuneration. If you look at the 2013 Annual report for Amplats, page 61, you will see that remuneration for executive directors and prescribed officers reached 100 million Rand. The base salary for Chris Griffith was 6,747,404 Rand (he paid a lot of tax on that, but most people would not mind that problem), with his medical and retirement benefits totalling 1,172,007 Rand. That is all laid out in the report, for all to see.

Also there for all to see is that the company pages salaries of 13.052 billion Rand in 2013, and retirement benefits of 1.074 billion Rand. As well as medical aid benefits of 524 million Rand. All in all employees of the company earned 15.152 billion, plus I guess the departing ones made 874 million in severance packages, you should add that in too. On the wages and benefits (page 39) the total is 15.6 billion, let us use that number then. Total number of employees and contractors? 46,139 employees and 14,528 contractors, 60,667 souls in total earned that money. The shareholders parted with that, in return for a workforce sweating their assets. Simple math means that before any deductions, the average salary at Amplats is 21428 Rand a month. Average. But surely there is a massive difference in skill sets between a senior engineer, a surveyor and a rock drill operator. And by extension earnings power, the market sets that.

The worst part in South Africa is that you have skills, race and class lines drawn as a function of the past, that stinky word that all of us wished did not exist, apartheid. The reality is that we are straddled with the inequalities of the past, white and black, still open for all to see. But if it did not exist, then the lines would not be drawn along race. More likely class, it would be a simple class struggle. The worst news however for labour is that mechanisation is a given. And the best part for those with remaining jobs is that they will be paid more as a result of their skill sets. Which means unfortunately that the least well paid, least skilled and therefore must vulnerable in society will be most affected. Sad, but quite probably true. Education changes everything, and that is probably why the department of lower and higher education is possibly more important than at any other time in our history.

Michael's musings: BHP becoming lean and mean

Yesterday BHP Billiton released a presentation that they gave at The Bank of America Merrill Lynch Metals, Mining & Steel Conference (quiet a mouthful to say). The highlights of the presentation were that during the current financial year there have been significant improvements in productivity with truck utilisation up 8% and their digging fleet utilisation up 10%. Increased productivity is great news for shareholders, invested capital is now producing greater returns, which brings down operating costs going forward.

Another focus was their drive towards core assets and to bring down their capital and exploration expenditure going forward. The rational for bringing down the expenditure is that less capital available increases the competition for it among different projects. The end result being that only the best projects are selected. The reason for moving towards their core assets is given in the slides, it is a bit disjointed due to it being bullet points but it gives you a good idea.

We have been progressively simplifying our portfolio for more than a decade... Our major iron ore, copper, coal, and petroleum assets demand our focus (because they) generate the highest margins and deliver a superior return on incremental investment.
Continued simplification will create an unrivalled portfolio of large, long-life, low-cost and expandable assets diversified by commodity, geography and market.

So in short quality assets give the best returns.

Part of their plan to focus on their core assets, BHP Billiton this morning announced that they were reviewing their Nickel West (Australia) operations, this is one of their two Nickel assets, the other being in Columbia. What this means is that they are looking at selling part or all of the assets associated with their Australian Nickel operation. The decision to review the assets fits with their plan going forward as their resource grouping of Aluminium, Manganese and Nickel only contributed 1.9% to EBIT in the previous quarter.

As an investor you want to see a company becoming more efficient and keeping a close eye on their capital investments. The best assets give the best returns and if an assets does not meant this criteria, then the company can return capital to the investors so that we can allocate it elsewhere.

Home again, home again, jiggety-jog. Stocks are higher here to start with, Naspers is on fire, up around 8 percent plus. Why? TenCent have had numbers that have completely blown the socks off the expectations. I see. Some more detailed analysis on those numbers tomorrow.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Tuesday, 13 May 2014

Broken clocks are right

"Do you remember how the taper from the US Federal Reserve was going to lead to a market contraction on a massive scale and the Fed were going to be forced to restart their bond buying program at double the pace? There were lots of people who talk openly with authority that this or that is going to happen, remember that almost always there is an agenda attached to that. If someone tells you that Naspers is wildly overvalued it may be that they never owned it, or sold it 600 Rand ago. Everyone has an agenda and puts theirs forward on powerful platforms (Twitter, the Internet and of course the Television), do not forget that."

To market, to market to buy a fat pig. Record setting everywhere. That is what it was like across the globe. Well, that is not entirely true, not true of many places. For instance, and this may surprise you, the Shanghai Composite Exchange (SSE) is down 63 percent from the October 2007 highs. Yes, down 63 percent since then. Astonishing. Year-to-date (YTD) that Chinese market is down 3 percent and has not enjoyed the same gains as across the globe. The Nikkei 225 is down 11.4 percent YTD, currently 14,443 points this morning as we speak/write. The intraday high there? Well, I suppose you do know about the Japanese asset price bubble from the late 1980s, so you would not be startled with the print being 38,957.44 all the way back on the 29th of December 1989. Only 25 thousand more points to go guys, looking good. Even the FTSE is not at an all time high, that index peaked at 6950.6 points on the 30th of December 1999. We are pretty close in London to reaching that all time high, the FTSE 100 closed up over half a percent yesterday to 6851.75 points. 100 points to go, to put the Great back in front of Great Britain!

The French were at an all time high on the CAC40 on Thursday by the close, the Australians find themselves (no coincidence I guess) in the same predicament as the Chinese (34.5 percent of all Australian exports in Q2 2013 went to China alone) with regards to commodity prices and the link to infrastructural development, the all time high on the ASX 200 was October of 2007. The Aussie index is down 18.6 percent from their all time highs. So, the all time highs that we saw for the Dow Jones, the S&P 500 and even the Jozi all share index were not really shared by many places around the world, but at the same time some geographies and their respective indices are close enough. The S&P 500 is closing in on that 1900 level, currently 1896.65, whilst the Dow Jones Industrial Average ended the session at 16695, a little lower than the 16704.84 print earlier in the day. Down here in Jozi we closed at a record high, as well as touching a record high during the day. For the record the number printed was 49239. Fifty thousand will have a nice ring to it when it comes.

Not all is however hunky-dory (the origin of the phrase is not quite clear, some time around the American Civil War) in the world, the Ukrainian crisis, informal referendums and clashes still mean that the situation is dire. Ditto in Thailand, admittedly with a lot less bloodshed. The "West" as we know it wants to impose more sanctions on Russia. The fellows from Boko Haram want to swap prisoners for the school girls that are missing, which means that they are all able to be located and swapped, so that is very good news, a smidgen of good news I guess. Also on the front of good news is that the elections in India are almost done and dusted, the BJP (Bharatiya Janata Party) are expected to win the Indian elections, the market there likes that. In fact the market over on that side of the world is up 6 percent over the last four and a half sessions. Good. Now if only "my" (and Michael's) team over in the IPL would do a little better, that would be good. Hear us Virat Kohli and AB de Villiers? Yes, we are RCB fans.

There is always going to be bad news around, leading you to be hesitant to invest in the equities market, because "things" are too risky and therefore it is too hard to call a cycle or an entry point into the market. Remember riots in Greece in the middle of 2011? Remember the wrangling around the debt ceiling, the US debt downgrade and the Fiscal cliff? Remember the sequestration? Cyprus? Syria? And now the Ukraine? These are all events, there are many more that were significantly worse, the financial crisis of 2008/2009 was not exactly fun. Those were dark days for the equities market, but it turns out that the best thing to have done would have been nothing at all. And that is how we positioned ourselves in the crisis. By encouraging clients to "hold the line", so to speak. It probably felt like getting ready to pick up those long poles with the English army rushing at you. Of course presuming that you are Scottish and that William Wallace is shouting at you, to hold. Yech, bad analogy, sorry.

Anyhow, here is an old chart that I asked Paul to dredge up, you can put this alongside a keep calm and carry on sign. This is an extension of the events that could force you to never invest in the equities market, because "things" are going to be so bad. Well, forgive me for being rude here, but listening to that sort of scare mongering over and over and taking it as advice can be more costly than doing nothing. Check, this graph is from Fidelity and includes all the major market moving events over a forty year period. Which should more or less be a good time to invest in equity markets. All of the time is a good time.

Rather, the best thing to do is to have a plan, stick to it. Remind yourself that you own businesses and not an index or a share price. Businesses will always find a way, notwithstanding the powers that be that make it hard to operate, somehow thinking that stakeholders are more important than the people who own the business and take the risks, the shareholders. Do you remember how the taper from the US Federal Reserve was going to lead to a market contraction on a massive scale and the Fed were going to be forced to restart their bond buying program at double the pace? There were lots of people who talk openly with authority that this or that is going to happen, remember that almost always there is an agenda attached to that. If someone tells you that Naspers is wildly overvalued it may be that they never owned it, or sold it 600 Rand ago. Everyone has an agenda and puts theirs forward on powerful platforms (Twitter, the Internet and of course the Television), do not forget that.

Home again, home again, jiggety-jog. Markets are lower, the Rand is stronger, that is somewhat of a drag on the markets. But you know what, this is excellent news for the inflation outlook and that is why the banks and the retailers have been moving higher in recent days.

Sasha Naryshkine, Byron Lotter and Michael Treherne

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Monday, 12 May 2014

Sappi. Value trappy?

"But if I wanted to be in the business of owning an extension of a clothing business and a demographics growth business, then it certainly would not be Sappi. Coupled with the unattractive outlook for what is their biggest business still (Tablets, reading devices and phones get more of our airtime nowadays), I would continue to avoid. The people that see deep value here (or did see deep value), they can keep it. The market seems to like it, Sappi is trading at a price last seen in the middle of 2011, 36.60 ZAR."

To market, to market to buy a fat pig. Friday was not a great day for the local markets, the strengthening Rand was putting a lid on some of the industrial stocks that have of course dominated over the last couple of years. You would have heard many value investor types point to this specific bunch of stocks, Richemont, Naspers, SABMiller and British America Tobacco as being completely overvalued and therefore they (the value crowd) were not buyers. I like to look at it a little differently. For instance, we may not own SABMiller across our client portfolios, but I can understand the rationale for people paying up for the business. There are very few (if any) public companies, listed in a jurisdiction like the UK, which have emerging market consumer exposure on that scale as SABMiller has. It is single handedly one of the few investments of its type, emerging market consumers across the globe, with well established consumer businesses in developed markets.

So whilst volume growth has been pedestrian (I mean how much can you grow beer volumes?), earnings have been pretty strong as the management of this business have worked hard to reduce costs. Still, on a forward multiple of close to 23 times earnings, it seems closer to a fair price than a steal. Expect growth to be a more muted lower double digit, from an earnings point of view, which translates to a PEG ratio forward (price to earnings divided by growth) of somewhere around 1.7, which is not considered cheap at all.

So whilst one would not mind paying that sort of PEG ratio for a company that could grow by 20 percent per annum for two years, paying that for a business only growing by between 10-12 percent seems excessive. But then you are presuming that the rest of the market is dumb, and that is both arrogant and smug. And often the two go hand in hand. As they say in our broader industry, past performance does reflect future results.

But the point is that SABMiller finds themselves in a fairly unique situation in being a global (and more to the point, developing) consumer business investable in a developed market, there are few comparisons. Nestle is perhaps another good example, the market affords the Swiss food giant roughly the same valuation. 22 times earnings. Richemont trades at 19 times earnings. Of course using simple PEG and PE ratios do not tell all of the story, they never do. Return on equity, working capital, quick ratio, debt-to-equity, price to book or just plain old bottom line, they all give you an indication of the financial health of the business.

And trying to predict future sales and current managements ability to work the assets harder and/or smarter, that is a tough business in itself. Trying to predict what future sales are going to be based on the specific consumer companies is very hard. I can imagine that some very complex models can have one input change and everything can go wrong. I am not dismissing the excellent work, do not get me wrong, those are amongst some of the very smartest people in our industry, but sometimes keeping it simpler can be better. Industrials as a collective, and these aforementioned heavyweight stocks (add Aspen for a fiver) have only managed to add 1.5 percent this year, and have lagged the overall index which is up 6.1 percent year to date. 132 days into the year chaps, it has been hard work.

Results from Sappi this morning, this is for their second quarter of their financial year. Now forgive me here for a second, this is definitely not a favourite of ours, at all. This is their best quarter since Q4 2012. I think that the reason for not liking this business (there is no unlike on Facebook, only on YouTube) are very evident on this breakdown of their sales by geography and product.

Quite simply, this is a company that sells 67 percent of their products in Europe and North America and of the total products sold, 62 percent of it is in coated paper. Which in case you needed a reminder, from the presentation: coated fine papers used by printers, publishers and corporate end-users in the production of books, brochures, magazines, catalogues, direct mail and many other print applications. What? The most exciting part of the Sappi business is the dissolving wood pulp part of their business, or cellulose, which is 16 percent of their business by sales.

In case you were wondering what the cellulose was used for, in part the clothing industry. You know, when you look at the tag and it says that this garment was made with synthetic fibres, rather than wool or cotton, this is where it comes from. Or one of the places. And Sappi are the biggest in the world (16 percent), but as far as I can understand it from a Sappi Investor Presentation September 2013, this is a very fragmented market with almost 50 percent more production being added over the next four years. The same presentation points out that cotton has many more preservatives than trees. Cotton however can grow from the same plant next year, and the year after. Not many years, it is a bit hard to find out, but it looks like 6 odd years. If you chop down trees, it takes a while to grow back. Not that costly as you may think.

But if I wanted to be in the business of owning an extension of a clothing business and a demographics growth business, then it certainly would not be Sappi. Coupled with the unattractive outlook for what is their biggest business still (Tablets, reading devices and phones get more of our airtime nowadays), I would continue to avoid. The people that see deep value here (or did see deep value), they can keep it. The market seems to like it, Sappi is trading at a price last seen in the middle of 2011, 36.60 ZAR. The ten year high was back in the middle of 2007, when the stock was above 138 ZAR, over 100 Rand more. Sappi unfortunately has a creaking debt problem, with 2.248 billion Dollars (23 billion plus Rand), that is bigger than their market cap of 19.2 billion Rand, at last close. Eish, that is heavy.

Byron beats the streets:

Continuing with our catch up of the US earnings season I am covering Caterpillars first quarter 2014 earnings release from a few weeks back. Sales came in at $13.24 bn which was flat on the comparable period. Per share earnings however came in at $1.44 compared to $1.31 from last year. Although sales are flat, within the company and amongst its divisions we have seen big changes. Take a look at the table below.

As you can see, Construction has leaped 20% while resource industries have fallen 37%. Energy and transport has been stable and was actually the biggest profit driver for the period with 43.5%. Construction contributed 36% while resources was only 7,8% for this quarter. In 2013 for Q1 Construction contributed 15.4% to profits while resources contributed 31%. It really is all over the place.

Expectations for the full year is for the company to make $6.51. The share trades at $105 or 16 times this years earnings. The company is expected to grow earnings by 8% to $7,03 in 2016 thanks mostly to cost cutting and less Research and Development spend. Most of the commentary is stating stronger construction demand as Europe and the US recover. The miners however are consolidating and holding back on their capital expenditure. This is of course not good for Caterpillar.

It is certainly useful to read their outlook for the overall economy. These guys operate on the ground floor and will know better than most what it is like out there. Here is what they had to say about 2014 which certainly seems cautiously positive.

"Overall, our expectation for world economic growth in 2014 has changed little from the outlook we provided with our 2013 year-end financial release in January of 2014. We anticipate global economic growth in 2014 of about 3 percent, up from about 2 percent in 2013. Economic indicators that signalled improvement in global economic conditions during the last half of 2013 continued to indicate improvement during the first quarter of 2014. Interest rates are at record lows in many countries, and low inflation coupled with elevated unemployment should cause most central banks to keep interest rates low throughout 2014.

Despite recent softness in some commodity prices, improvement in the world economy should increase demand for mined commodities and energy, keeping commodity prices at levels that are profitable for production. As a result, we expect mine production will continue to increase in 2014. While most commodity prices should be high enough to make investments attractive, we expect mining companies will remain cautious with equipment investments, and we expect continued decreases in mining capital expenditures for equipment in 2014."

My biggest concern with this business is the cyclicality of it all. Have a look at those profit swings within their divisions which I mentioned earlier. Fortunately their diversification stabilised the overall results but it doesn’t always happen that way. The lag in decision making by big business when times are either good or bad is extremely reliant on confidence. This may not be investment grade for most. You certainly need a strong stomach. We approach this one with caution.

Home again, home again, jiggety-jog. Markets are higher, US futures are higher, even the Dow Jones Industrial average touched a record high on Thursday and on Friday it registered a closing high. Cool beans, we continue to stay long here.

Sasha Naryshkine, Byron Lotter and Michael TreherneEmail us Follow Sasha, Byron and Michael on Twitter 011 022 5440

Friday, 9 May 2014

Alibaba. More than 1001 nights!

"There are around 600 million internet users in China, which means internet density is not yet at the 50 percent mark. I don't think that the human mind can compute those numbers and by extension the spending power of hundreds of millions of online users. In 2012 total online spend for China was $210 billion compared to the USA $226, this would make sense due to the US having a higher GDP per capita. A thing to remember though is that China is growing at 7.5% a year meaning that two things are happening. The first is that the people who are already online have more money to spend, the second is that more people now have the means of accessing the internet; so the customer base is growing as well as getting richer."

To market, to market to buy a fat pig. A marginal gain here for the markets, the Jozi all share marched back through the 49 thousand point mark with a modest 0.17 percent gain on the day! Banks caught a bid, by my reckoning that is a record high as a collective. Over the last year the banks as a collective have returned 22.1 percent. Standard Bank has done better than that, up 25 percent plus over the last year, Barclays Africa the laggard (by a long way) up only 1.6 percent over the last 12 months. Nedbank is up 30.1 percent, astonishing! FirstRand has just outperformed the index, the share price is up 23.4 percent for the last 12 months. Wow, what is up at Barclays Africa, formally known as ABSA, before the integration of all the separate businesses across the continent. The business is now 62.3 percent owned by Barclays Bank Plc, the only other major shareholder is the PIC, which owns 7.3 percent of Barclays Africa.

The outlook for all the banks is decent enough, there no doubt will be growth, but it is possibly muted with earnings expected to be in the high single digits/low double digits for the next three years. That means I guess that you won't force these valuations too much over low double digits. Barclays Africa again are the lowest rated bank, from a valuations point of view, relative to the rest of their peer grouping. The high dividend payout ratio sees the yield of Barclays Africa MUCH higher than Standard Bank, FirstRand and Nedbank. Their expected yield for this year is (before tax) 5.6 percent, relative to the other three, which are forecast to be 4.4 percent for Standard, 4.3 percent for Nedbank and 4.1 percent for FirstRand. Why is Barclays Africa discounted relative to their peer grouping? Well, for starters the other banks are expected to grow earnings at a faster rate, in the mid teens and as such catch up quicker, grow into their multiple that the market currently affords them. Perhaps the management team is not as well regarded, I have heard that argument before too.

Meanwhile parent company of the Barclays Africa Group, Barclays Bank plc announced yesterday that they were to cut 7000 jobs in their investment bank division by 2016. That is around one in four current jobs at the division, I can't imagine that this is the best news for those folks employed there. No, let me rephrase that, any job lost is always disheartening to hear about. 19 thousand jobs across the whole bank, obviously including these 7000 jobs. What is happening here is that the new CEO, Antony Jenkins, has decided that the new path must steer away from the riskier trading businesses, commodities, currencies and fixed income, which are volatile in nature and steer more towards his background, retail banking.

So what does that mean? Because Barclays are not the only bank to move in this direction of more stable and less risky earnings mix. Jenkins suggested that this was a generational change, a move away from risk towards reliability. Again that has repercussions for investors across the sector, if there is going to be less risk taking, that is a good thing for the financial system as a whole, but that also means that earnings are likely to be muted. And if Jenkins is right, and this is a generational change, that means that there must be a rerating of banks to a lower level that is more predictable but less profitable. We have been drumming on about this for a while, suggesting that as a result of heightened regulation coupled with lower risk taking, that could possibly mean that bank earnings would be more utility like, less blow out.

The question then is a simple one, in the investment banking and securities industry, which company would you want to own? Goldman Sachs looks cheap on a 10 odd multiple historical and forward it is around 9.23 times. Yet the stock trades closer to the 52 week low than their 52 week high. I am not too sure that either the shareholders, the management, the regulators and the political powers that be want a return to the higher risk activities of the last decade. Interestingly I plotted the S&P 500 against the Bank of America Merrill Lynch, JP Morgan Chase, Citigroup, Goldman Sachs and Wells Fargo over the last ten years and only Wells Fargo was a better investment than an index tracker. But all the others were not, Goldman Sachs was about the same as the broader market. Citi and Bank of America were disastrous investments over the last decade, the blow up in 2009 was not kind to either institution.

So that then begs the question, for the amount of risk that you assume as a shareholder of financial institutions, do you get just rewards? Possibly not. And with increased capital requirements, more compliance, more probing eyes from regulators and politicians alike, it is unlikely to get easier for these institutions. As such I suspect that they will all (and it is a poor show to generalise) be less profitable than before. As a rule we generally avoid the big banks, because it is very difficult to make heads or tails of what is going on under the hood, what is really oiling the profits machinery. Their best assets go up and down the lifts each and every morning and evening, perhaps more true of investment banks than normal good old fashioned banking. It does however attract some of the finest and smartest people I know, the broader financial services industry.

Most people I know fancy themselves as music aficionados and more specifically their music choices are superior to other folks. They just don't get it, right? And you can mock them and suggest that they are listening to X or Y (Justin Bieber or Taylor Swift) but the truth is that X or Y have sold many albums, so they might be seen as commercial/mainstream/bubblegum, but that is what the people want. People love music, the rhythm is in our core, perhaps to those days that we all danced around the fire each and every evening.

I am one of those, I love my music, but not quite enough to wear headphones whilst I walk around. Headphones, earphones and speakers, that is what Apple inc. are being rumoured to be buying, a business called Beats electronics. For as much as 3.2 billion Dollars. None other than Dr. Dre is involved, in fact if you visit the website, you are met by the BeatsbyDre branding. Dr Dre is Andre Romelle Young, a 49 year old entrepreneur, producer and of course himself a recording artist, he has six Grammy's, three for producing (he is known as a perfectionist) and three for his talents in the singing department. The initial stake was a lot, I am not entirely sure what Dr. Dre could stand to net if the deal happens.

So why would Apple want to own a 6 year old business that makes fine (expensive, 300 odd Dollars apiece) headphones and speakers? Well, there is also a streaming music service, that could be worth a lot more in the coming years. Perhaps the fine speakers in both their handsets, notebooks and even motor vehicles (a Chrysler deal) means that the options could be many. But if this deal was to go ahead and as I understand it from this FT article -> Apple in talks for $3.2bn Beats deal, this would be the biggest deal that Apple would ever have done to date. Amazing. Astonishing. The next biggest transaction from that table in the FT article is a 400 million Dollar transaction in 1997 (roughly 580 million Dollars on an inflation adjusted basis), when Apple bought NeXT computer systems. Steve Jobs and Ross Perot were corporate directors at NeXT.

Music streaming seems to be the reason why Apple are interested in this business, but all the other hardware must be interesting too. Selling high end Apple branded headphones might be very attractive for many. We wait, and most likely will have news on this next Tuesday. Or so we read. Who are these people who are always familiar with the negotiations? I will tell you, non secret keepers and people that could be in trouble soon!

Michael's musings: Alibaba, the all in one company files for IPO

So on Tuesday, Alibaba filed for their IPO, the most anticipated IPO for this year. Alibaba are an internet e-commerce China based company. The IPO is relevant to us because they thrown into the same group as Tencent (Naspers biggest asset). Also being an internet based company, it affects other internet stocks like Facebook and Twitter, with talk going around that we are in another internet bubble like in 2000.

The IPO is expected to raise between $15 - $20 billion dollars and will put the market cap in the range of $150 - $200 billion, with some market commentators predicting a quick rise to the $250 billion mark. For comparative purposes Facebook has a market cap of $147 billion.

To give you an idea of what they do, see the below table comparing Alibaba entities to Western Companies from this Quartz article -> All the Western companies you'd have to combine to get something like Alibaba. The article gives a better breakdown of each entity, but the table is self explanatory.

The shareholders of Alibaba are Softbank with 34.4%, Yahoo with 22.6% and Jack Ma (the founder and Chairman) with 8.9%. Softbank are a Japanese internet company founded by a man called Masayoshi Son who has the distinction as "the person who has lost the most amount of money in history!", when he lost $70 billion dollars in the dot.com crash. Ouch! He is now worth around $9 billion, so not all bad for him.

Now onto the numbers, their revenue for the last nine months was $5.6 billion with their last quarter being $3.01 billion up 62%, huge growth! On the earnings side they were $2.85 billion with the last quarter earnings of $1.33 billion up 104% compared to the previous corresponding quarter. All these earnings have translated into them having $7.8 billion in cash. This is where the big difference comes between now and the dot.com bubble. This company and others in the category have real customers and real profits, most importantly they have CASH!

There are around 600 million internet users in China, which means internet density is not yet at the 50 percent mark. I don't think that the human mind can compute those numbers and by extension the spending power of hundreds of millions of online users. In 2012 total online spend for China was $210 billion compared to the USA $226, this would make sense due to the US having a higher GDP per capita. A thing to remember though is that China is growing at 7.5% a year meaning that two things are happening. The first is that the people who are already online have more money to spend, the second is that more people now have the means of accessing the internet; so the customer base is growing as well as getting richer. The great thing with internet companies in China is that you are exposed to the rapid GDP growth of the country and you are also exposed to the internet (computer) revolution that is sweeping the world.

The impact of Alibaba and the internet on China can be highlighted in an article that I read about a farmer in rural China who made just enough to survive. Alibaba then came along and connected the farmer's products to other parts of China and the world. He now drives a Jag and his wife shops in Paris. This isn't the case for everyone, but it highlights what can be done. There are now 14 areas called "Taobao Village" which Alibaba defines as a village in which over 10 percent of households run online stores and village e-commerce revenues exceed 10 million yuan per year.

A big advantage to Alibaba and Tencent is that the Chinese online space is closed to their Western equivalents, meaning that these two companies can to take advantage of all the growth happening in this space. As much as this is a big advantage, it is also a big risk. If the government decides to deregulate, these companies are going to have to share their "backyard" which will mean a drop in profits. Most political analysts do not see this happening anytime soon though.

Alibaba is a very exciting company in a space that is changing the world. I don't think that investors quite know how to value this type of company, so expect a wild ride in the share price when it lists.

Home again, home again, jiggety-jog. Stocks are lower to begin with, the Russians celebrated Victory Day today (Europe yesterday) in which they were flexing their muscles. Not good for anyone. The ECB yesterday signalled their intent to stimulate the European economy, that saw a Rand go firmer. Hey, to the USD we are near the best levels of the year. So much for the finished emerging markets!!

Sasha Naryshkine, Byron Lotter and Michael TreherneEmail us Follow Sasha, Byron and Michael on Twitter 011 022 5440

Tuesday, 6 May 2014

Health and caring, JNJ, GE and Stryker

To market, to market to buy a fat pig. Oh dear, we went slip sliding away from the start, tensions in the Ukraine continue to weigh heavily on all and sundry. From the outside and my reading of admittedly what would be called Western media (who I hope would be unbiased) there is little by way of law and order in some key cities, with citizens taking matters into their own hands. And that is always dangerous, on the eve of our own elections we can be grateful that there is certainly tolerance of sorts here in South Africa. Not as much as we would want, we definitely need more, but to paraphrase Spanish Prime Minister Rajoy, South Africa is not the Ukraine.

Our overall market fell yesterday, stocks slid from their record highs, down just over four-tenths of a percent with financials and in particular banks leading us lower. African Bank released another awful trading update and I have seen folks suggest that there may have to be another round of raising money from their shareholders, who have certainly changed in their makeup. Heavily made up by some institutional types who have been loading up as either the shorts or smaller shareholders bail on what looks like the perfect storm. The irony is that interest rates have been relatively unchanged through this time, the shocks would have been worse in an environment where the consumer would be seriously compromised. Local PMI bucked the global trend and sank to the lowest levels since July of 2011, the Kagiso PMI coming in at 47.4 points. To read the whole report, download it -> Kagiso PURCHASING MANAGERS' INDEX^TM (PMI^TM).

We continue to hear that the consumer is under pressure (I should have put that in inverted commas), but both casual dining companies Famous Brands and Taste Holdings released trading updates that seemed really good. Famous Brands said that they expect "to report headline earnings per share (HEPS) and earnings per share (EPS) (calculated on an IFRS basis) of between 402 cents per share and 410 cents per share. This is an improvement on the prior year comparable HEPS and EPS of between 19% and 21%. The group also expects to report diluted HEPS and diluted EPS of between 401 cents per share and 409 cents per share, an improvement of between 20% and 22%." The share price added over a percent to close at 108 Rand a share. Results are in two weeks time, EPS are expected to then be somewhere in the region of 482 cents, at 108 ZAR the stock trades on a 22.3 multiple, but growing at that rate means that the PEG ratio is around 1.1 times. You would prefer that to be under or closer to one, but still, the company continues to grow in this fast growing part of the economy.

Taste Holdings had a similar range: "A review of the financial results for the year ended 28 February 2014 by management has indicated that the earnings per share and the headline earnings per share are expected to be between 17% and 23% higher, compared to the earnings per share of 12.8 cents and the headline earnings per share of 13.3 cents for the year ended 28 February 2013." The stock trades at 380 cents, down 10 cents yesterday. With EPS expected at 15.4 cents in the middle for the range, Taste trades on a historical 24.7 multiple and a PEG of 1.23 times. Those are often used to see if these companies are just expensive, but what matters most are their prospects from here if you are considering buying them (Famous Brands too). Let us be clear, we think that the sector, casual dining is a fabulous investment in emerging markets. It is part of the broader aspirational consumerism theme that we like.

Taste of course have recently announced that they have have signed an exclusive 30 year Master Franchise agreement with Domino's Pizza. The existing Scooters and St. Elmo's stores will be converted. As at 31 May 2013 (a year ago), there were 132 Scooters and 26 St. Elmo's stores, I presume that there are more now. But that already gives the brand here locally a major presence. I have no doubt that Taste are going to grow aggressively off admittedly a much lower base than Famous Brands.

Both these businesses have energetic management teams who are invested in their respective businesses, and as such have as much to gain as you. Darren Hele is a new appointment as CEO (Kevin Hedderwick is now Group CEO) and is a young fellow, by running listed business standards. He is 41 years old according to Bloomberg. Carlo Gonzaga, the Taste CEO is only 39 according to Bloomberg and has been at the business since the beginning in 2000. He is energetic and entrepreneurial in nature, everything you want when investing in a smaller business, relative of course. Both these businesses have experienced rapid growth over the last decade and will continue to do better as the middle income segment across the continent grows, outpacing global middle income growth. Soft luxury, very good.

OK, sorry, we have been backed up here with too many off days and too many results to cover properly at the same time. We had Q1 2014 numbers from JNJ on the 24th of April, which in trading terms is so far back that you cannot remember. Q1 sales when measured against the comparable quarter were 3.5 percent better at 18.1 billion Dollars, net earnings at 4.7 billion Dollars and EPS clocked 1.64 Dollars. The dividend had a few days prior been hiked by 6.1 percent to 70 cents a quarter. That is 2.80 Dollars a year, which means that at 100 odd Dollars the yield is easy enough to work out, not so? Earnings guidance for the rest of the year is in the range of 5.80 to 5.90, which means in the middle of the range the stock trades on a forward multiple of 17.1 times, with a yield of 2.8 percent. The earnings growth for the year is expected to be somewhere in the region of 11.8 percent. Relative to their peers, the company is afforded about the same rating.

The difference between JNJ and their "peers" as it were is that they are probably not an out and out pharma company, neither are they a consumer business. Nor are they a devices and diagnostics business. They are all of those things. In fact, in the last annual report the sales breakdown is 39 percent pharma, 40 percent devices and diagnostics and the balance, 21 percent is their consumer division. The acquisition of the business Synthes, an orthopaedics business has boosted the sales of the devices division specifically.

As Byron says, sometimes you need to have a pharma background to get to know these businesses intimately and understand specifically their pharma products, as well as an orthopaedics background to get a fair understanding of their devices and diagnostics business. The consumer businesses are a little easier, everyone can understand baby products (no more tears!), their skin and hair care products (Clean & Clear, Neutrogena to Piz Buin) as well as Listerine through to Band Aids, more commonly known as plasters around here. Throw in Acuvue and Visine, the shorter sighted folks would definitely know those ones! Easy enough to understand, right?

Without getting to know the blockbuster drugs (personally or reading reams of information) and in order to appreciate why 25 percent of sales are from new product releases inside of the last five years, you need to look at the Research and Development annual spend. Last year it was 8.147 billion Dollars on an annual revenue number of 71.312 billion Dollars. The year prior to that, in 2012, the company spent 7.665 billion Dollars on R&D on a revenue number of 67.224 billion. On both occasions R&D spend is approximately 11.4 percent of annual revenue. This will continue, and has to continue in order for the business to produce the NEXT blockbuster ahead of what is a very tough and competitive space.

But the margins are good, both in their core business and their newer businesses and having diversified more (Synthes), shareholders can expect more stable returns. Is this an exciting business however? Apart from a potential value unlock, with one or two parts of the business being floated (with the Merck announcement of them selling their consumer business to Bayer, it becomes increasingly likely that JNJ will consider doing the same) separately it remains a core part of a theme which we really like, healthcare. We continue to accumulate a great quality business.

Byron beats the streets: GE results

A couple of weeks back we had results from GE which I've only had time to cover now. Fortunately we are long term investors so short term swings to things like results releases are not important to us. The actual numbers however are so lets take at look at GE's first quarter of 2014.

Operating earnings came in at $3.3bn which was down 18% from Q1 2013. This is because there were a few once off sales last year as well as some effects from the bad weather in the the first period of the year. Revenues came in at $34bn which was down 2%. This equated to EPS of $0.33 which beat expectations by 1 cent. Expectations for the full year are for $1.70 and $1.80 for 2015. The stock trades at $26.58 or 15.6 times 2014 earnings. Growing earnings at 6% I'd say that is a fair price. Earnings growth is expected to accelerate to 8.3% in 2016.

As you can imagine the business is complicated, this table says a thousand words and breaks down the divisional Revenues and profits.

Aviation had a really good quarter and is a very profitable business. Earnings are quite choppy though because it is driven by big once off orders. Capital is the most profitable division but also carries the most risk. Talks are that this is going to separately list but ideally would be sold to another Bank. It would probably attract a price tag of $100bn with those sort of profits so that will narrow down potential buyers to the fingers on my one hand.

So why invest in GE? All the sectors they operate in have bright futures. Power and Water is crucial as both become scarce in a growing global economy. Oil, Gas and energy management fall in the same category. Aviation will grow as more people enter the middle class and are able to travel. This is happening as we speak. Air France has ordered $1.7bn worth of GE engines for the the 37 Boeing 787 Dreamliners they have bought.

Transportation falls in the same category as developing nations require these services as they develop. In fact Transnet get a direct mention in the results report for the 233 Advanced Evolution Series locomotives they have ordered worth $0.7bn. A direct example of a developing nation using GE to help grow their infrastructure. Healthcare as you know is a great theme to be invested in with still so much room for improvement.

If you are still not convinced explore the GE YouTube account and see what they are up to. Here is an example from their Healthcare division to prevent queues in hospitals, a YouTube clip titled Eureka Place - Imagining A Hospital With No Waiting Rooms - GE. They are exploring better alternatives and products in all the essential services and finished goods they sell. We continue to buy the story and it remains a core holding in our portfolio.

Michael's musings: Cash and recalls

One of our favourite sectors is the healthcare industry. As global wealth rises so should the amount spent on healthcare, the one thing that can make us live longer and more comfortable. Added to this trend are the ageing baby boomers, who are getting to the age where they require more healthcare.

J&J is one of our favourite stocks in this sector as is Stryker. Stryker are a relatively small company with a market cap of $29.5 billion compared to J&Js $283 billion, they (Stryker) operate in over 100 countries, South Africa included. Their three main divisions are Reconstruction, Medical Surgery and lastly Neurotech & Spine (one of their products is a spinal implant, I didn't know that we could do this yet!).

On to the results, their EPS were down 77% to 18c per share, due to earnings dropping to $70 million from $304 million in the previous comparable period. The reason for the huge drop in earnings is due to the recall of some of their products. The one product being recalled is their replacement hips which started to corrode, not ideal having a corroding hip inside of you! As you can imagine it is very costly having a recall on hips because the cost of the recall includes having a surgery to change hips. Another of their products is a waste management system, from what I understand it is like the suction devise used by dentists except this one is larger and used during surgeries. Both these recalls started in 2012, so they are not unexpected, they are costly though in terms of impact on earnings and reputation damage.

Removing the cost of the call backs, adjusted earnings come in at $1.06 down from $1.09. The lower earnings are due to non-operational expenses and increased shares through options granted. Even though earnings went sideways revenue was up 5.3% to $2.31 billion.

So onto the reasons why we like the stock. The company has a new CEO who has shuffled the management team a bit, which I hope eradicates another product recall. In the health industry when you lose the confidence of your customer it is very hard to get it back, people don't want to take chances with their health. Stryker have been on an acquisition spree to add to their product range and offering. According to one market analyst healthcare providers are starting to reduce the number of supply vendors to get better prices on their bulk purchases, so for Stryker being able to offer a number of products is advantageous.

Stryker have also increased their R&D spend by 16%, which according to my calculations puts the total spend at over half a billion dollars. Being relevant and innovating is key to future growth.

The company generates a large amount of cash, with the current figure sitting at $4 billion (13.5% of current market cap) and they are expected to generate an additional $1.4 billion over the 2014 financial year. All the cash allows them to fund their R&D, further acquisitions and from an earnings perspective further share buy backs. There are still $700 million dollars' worth of share buy backs pending.

Stryker are a global company in an industry that will see significant growth in the coming years. So it is where you want to be, the only worry for me is that there might be another run in with the regulators resulting in more recalls. This is a small risk and not enough to rule out the stock, they are in the correct sector and generate strong cash, so are a strong contender to be one of your health care stocks.

Home again, home again, jiggety-jog. Markets are mixed, almost flat in fact. A bit of news here and there, European services PMI data at nearly a three year high. Sorry? Where are those people who said that the Euro are/region was going to the dogs? I miss those people.

Sasha Naryshkine, Byron Lotter and Michael TreherneEmail us Follow Sasha, Byron and Michael on Twitter 011 022 5440

Friday, 2 May 2014

Monopoly tendencies

To market, to market to buy a fat pig. Wednesday seemed a while back, and in truth a missed day might be missed economic activity in some sectors, but in entertainment and services it seems like pay dirt. I went for a really late lunch and could not get a table at a couple of places, plus we were led to believe that there were a lot of people out of town. Suburbia must have had some lonely pets yesterday in Jozi. The first part of my morning was spent engaging in Monopoly, the timeless classic. My youngest won, she had hotels on the light blue (and houses on the dark blue) part of the board. And even though being assessed for street repairs dented her bank balance, in the end my eldest and I could not avoid the allure of staying on the North Coast of Durban.

My only other observation from the old (30 years plus) South African Monopoly board to the new one, is that Cape Town quite rightly has replaced Jozi as the prime property on the board. The other observation is that airports have supplanted railways as the means of transport. It is great for kids, it teaches them to transact and be patient, to own and that life is not always easy. In much the same way of course the equities market can be rewarding in the long run and equally frustrating in the short run. Your patience is always going to be tested. But what I would do to get my hands on an original board of Monopoly!!!

We were chatting about British American Tobacco on Wednesday, their size and scale, their shareholders and the South African portion, but we did not really touch on whether or not it is an investable company. Quite clearly on a four percent yield in Pound terms and little chance of interest rate hikes (aggressively at least) any time soon, the boxes that the company ticks from an investment point of view makes them quite compelling. Strong cash flows, aggressive share buy backs to boost earnings have all held their shareholders in good stead. Plus, if you own them here, in the face of a weakening Rand it has been a solid investment. In the last 12 months the stock is up 21.85 percent in Rand terms, but actually down 4.1 percent in Pound Sterling terms. The Pound to the Dollar touched a four year high earlier in the week, reflecting the strength of the UK economy. Some, including myself, might be very surprised by that.

There are however many reasons not to own any company in this industry. Rising litigation and associated costs from the companies are a real concern, although the consumers of the products are well advised of the health risks of using the product. OK, so that part is obvious. Companies selling the product (cigarettes) still have pricing power, but recent surveys in rich countries have produced a sharp negative corresponding price increase versus stick consumption. Stick consumption plummeted when consumers (and this was done in France) were faced with real price increases, their tendencies to smoke less appeared over a decade. However, and this could be a risk to the company, as people become richer their health patterns improve and the less they tend to smoke. Smoking is obviously bad for your health. In many emerging markets smoking is seen as a luxury.

And too much of it can kill you, not too dissimilar to eating too much bad food, that is equally bad for you. There is increasing awareness around food consumption and what is worse for you, fizzy drinks and the like. Governments rate viewing cigarettes and the industry as a soft target. But the regulators realise that there is a tipping point. But do you (if you were a regulator) try and kill the industry at the risk of losing the revenue and see a rise in the illicit cigarette trade? Or, do you try and save on the future obligations in healthcare spend by encouraging people to be more healthy? I suppose you can't nanny people, but the flip side of that argument is if you pay for their healthcare then you have a right to tell them what they can and can't consume. Is that fair? I think so.

These are all assumptions, the other assumption we often make as investors is that the past is somehow going to be somewhat similar to the future. You see that all the time, people comparing a period in history to now. For instance that 1929 chart to now. Back then there was no transatlantic flights, let alone seamless face to face communication anywhere in the world via a smartphone. No two times are the same, but pattern recognition and chart viewing has meant that we somehow draw a parallel in different times. Cash flows for BAT have been flat for four years. Volumes are in decline. It is a business that we will continue to avoid, too many headwinds in the coming years. I would go so far as to say that if you own it, this is about as good as it gets, but I have been saying that for a while. Avoid.

Michael's musings: The CERNERverse

As Sasha mentioned in early February we added Cerner to the stocks that we cover. They provide technology to the healthcare industry, the core of their business is moving as much information from paper to digital, with what they call Electronic Medical Records (EMR). Cerner's aim is "support evidence-based clinical decisions, prevent medical errors and empower patients in their care." Moving patient information to digital means that one set of records are kept for a patient that can then be accessed by the doctor treating them or the patient themselves.

Moving to digital is a win for everyone involved. For the doctors they have quick access to all the patients' data, meaning that they can make a more informed decision about what is wrong. For the patient, you want to know that the doctor has quick and easy access to all your medical records. The human body is very complex and the more data that is at the hand of the doctor the better. Then for hospitals this system gives them the ability to offer better products and be more efficient which will lead to cost saving.

On the Cerner webpage they say that 98 000 people die a year due to medical error. Some of these errors could be as trivial as bad doctor handwriting or giving medication that the patient is allergic to. That is a scary figure!

They only have a market cap of $17 billion on a PE of 43, so they are small and pricey but you are paying for the huge growth potential. Revenue for the quarter past was up 15%, their gross margins grew from 81.3% to 83.5%, with EPS growing 9.7%. For the next quarter revenue is expected to grow 11.7% - 17.3%, and more importantly EPS is expected to be up 14.9% - 17.9%.

As a patient (and most likely doctors) in a couple of years I will avoid hospitals that do not have an EMR system, and going forward healthcare treatment will be customised to your DNA which means having EMR is even more important. Given the huge growth potential in this sector, margin growth and the strong earnings growth this definitely a stock to have in your portfolio.

Home again, home again, jiggety-jog. Today is jobs day, it is that time of the month when everyone gets excited about the health of the US economy, because jobs of course is a proxy for that. Whilst exciting at the time and even you can predict what it is, the ISM numbers across Europe looked decent in the struggling economies. So that is good news. Jobs are very important and it is always much better to have one, than to not have one, right? Of course.

Sasha Naryshkine, Byron Lotter and Michael TreherneEmail us Follow Sasha, Byron and Michael on Twitter 011 022 5440