MAY 2017 PROSPERITY IN THIS CLIENT NEWSLETTER. Economic and market outlook Local and global equities

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1 MAY 2017 PROSPERITY IN THIS CLIENT NEWSLETTER Economic and market outlook Local and global equities

2 At the start of May, the Trump administration celebrated 100 days in office, yet many key questions remain regarding the efficacy of president Trump s growth plans. It seems that the President may remain mired in controversy for some time while the implementation of many of his policies is being hamstrung by his failure to achieve consensus in Congress. Meanwhile, Europe breathed a sigh of relief with the election of pro-euro Emmanuel Macron as French president. As with Trump, it remains to be seen whether his election will yield effective action to counteract Euro-pessimism. North Korea continued its sabre rattling and locally there were more revelations regarding state capture and increasing signs of politicians within the ruling party taking stance against the President. Notwithstanding such widespread socio-political uncertainty, global markets continued an upward march while volatility remained subdued. Earnings results, economic indicators and gauges of business sentiment are positive. This led several developed market indices to reach record highs in May. However, the news that China's sovereign credit rating was downgraded for the first time in nearly 30 years hurt most emerging markets. Despite good growth numbers from companies and economies and relatively high asset valuations, inflation remains low so low that the US may not see the two expected rate hikes previously forecast for Against this backdrop investors may need to adjust to an environment of lower future returns across all asset classes. So while our job of identifying growth investments with acceptable risk profiles has certainly become more challenging, for long-term investors, the principle of patiently allowing compounding to do its work still holds true, whatever the environment. Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things Charlie Munger, Berkshire Hathaway ECONOMIC AND MARKET OVERVIEW The SA Reserve Bank s Monetary Policy Committee (MPC) held the repo rate steady at its May meeting, as expected. The meeting occurred against the backdrop of a lower actual and expected inflation outlook, a steady rand, and economic growth prospects that have dimmed somewhat since the credit rating downgrades. The Bank cut its economic growth forecasts due to a deterioration in business and consumer confidence following the credit rating downgrades to 1% this year and 1.5% next year. This still represents an improvement from 0.3% in The Reserve Bank lowered its inflation forecast for 2017 to 5.7% (from 5.9%), while it expects inflation to average 5.3% in 2018 (down from 5.5%). It might have to lower these forecasts further, as April inflation data (which was released too late to be incorporated into the forecast) fell faster than expected. The Consumer Price Index (CPI) rose 5.3% year-on-year in April, down from 6.1% in March, and has therefore moved within the South African Reserve Bank s inflation target range (3% to 6%). A big move was in food and non-alcoholic beverage inflation which continued its fall since the start of the year to 6.7%. Food inflation touched 12% in December last year due to the effects of the drought. The MPC is still concerned over risks to the exchange rate (and therefore to inflation) should South Africa get downgraded further or should US interest rate hikes result in a stronger dollar. However, the US central bank (the Fed) has signalled its intention to raise rates in June, and yet the dollar and US long bond yields have declined. This suggests that the market has already priced in gradual rate increases and the MPC s concerns might be overblown. We could therefore see a rate cut or two towards the end of this year, which would take some pressure off embattled consumers. The JSE All Share Index delivered a negative return of 0.5% for May but is still up nearly 6% for the year. The big drag on the index performance has come from financials and resources, but industrials have again outperformed in May, with Naspers contributing significantly. Industrials are up nearly 15% for the year. The rand is also remaining strong against the backdrop of a weaker dollar while the price of key commodities such as oil and iron ore remain under pressure due to excess supply. Most developed markets posted gains in May and are positive for the year. The S&P 500 and Nasdaq reached new all-time highs during the month while Europe, Japan and Hong Kong also performed well. US corporate earnings and good economic data from GDP growth to consumer spending continue to buoy developed markets despite stretched valuations in some sectors, especially technology, and political uneasiness remaining across many parts of the developed world. However, US inflation remains low and the Federal Reserve might not be able to raise interest rates, as it had expected to do, twice more this year. A notable disappointment in the month was Moody s first downgrade of China s sovereign credit-rating in 30 years. Moody s indicated a concern over rising liabilities, but indicated that they hold a stable outlook for the Chinese economy. This dragged the Shanghai Composite Index lower during the month. 02

3 GLOBAL EQUITIES WALT DISNEY In Walt Disney s latest quarterly report (2Q17), the group reported total revenues of US$13.3bn (+3%). Operating income for the period rose 5%, with operating margins rising slightly to 30%. Earnings per share increased 10% to US$1.50, which was above consensus estimates of US$1.40. Parks & Resorts was the best performing division for the quarter, with revenue and operating income rising by 9% and 20% respectively. This growth was driven by US parks and the new Shanghai theme park, which continues to surpass management s expectations. Within the Media Networks division, revenue grew by 3% but operating income declined by 3%. This was largely due to ESPN s higher programming costs in college football and the NBA. Management commented that ESPN advertising sales were also weaker than expected although they remain optimistic ahead of the upcoming NBA playoff season. Regarding ESPN, Disney is expected to launch their own branded direct-to-consumer offering using the technology of their recent acquisition, Bamtech. The initial take up of this offering will be worth watching closely. Added to that, Disney is currently partnering with some over-the-top (OTT) providers (Sling TV, Hulu YouTube TV), which reduces the subscriber declines from traditional distributors. MICROSOFT Microsoft reported an increase in profit for the third-quarter that beat analysts' estimates, driven largely by strong growth in cloud business, as the software giant continues its transition from key software business to cloud business. The company reported third-quarter profit of US$4.80 billion or US$0.61 per share, up from last year's profit of US$3.76 billion or US$0.47 per share. Excluding once-off items, adjusted earnings for the quarter were US$0.73 per share, up from US$0.63 per share last year. Revenues in the Intelligent Cloud segment, which includes its Azure on-demand computing services, increased 11% to US$6.76 billion, with Azure revenues surging 93%. Under Satya Nadella, Microsoft has been transforming itself and focusing more on cloud-based services as PC shipments continue to drop. Revenues in productivity and business processes climbed 22% to US$7.96 billion. Revenues in the More Personal Computing segment, which includes Windows operating system, declined 7% to US$8.83 billion. Worldwide shipments of traditional PCs--desktop, notebook, workstation- totalled 60.3 million units in the first quarter, up 0.6% from last year, recording its first growth in five years, according to the International Data Corporation. AB INBEV Anheuser-Busch InBev (AB InBev), the world s largest brewer, reported first quarter revenue growth that beat estimates, as demand for mainstream brands such as Stella Artois and Tuborg rose, helped by an improving European beer market. Despite struggling against headwinds in Brazil, AB InBev s first-quarter revenue rose 3.7% to US$12.9bn. Adjusted earnings before interest, tax, depreciation and amortisation rose 5.8% to US$4.81bn in the first quarter. Analysts expected 3.8% growth. Earnings growth excluding Brazil was 12%. The maker of Budweiser is cutting more than jobs as it aims to get US$2bn in cost savings from its acquisition of SABMiller in the next three to four years. The company reiterated its forecast that total revenue growth would accelerate in Sales rose 2.4% last year, held back by a slowdown in Brazil, which suffered its worst recession in decades. 05

4 LOCAL EQUITIES VODACOM PROSPERITY Mobile phone network Vodacom managed to grow revenue and profit slightly in the year to end-march despite cutting rates. The company also announced that it was acquiring 35% of Kenya s Safaricom from its UK parent Vodafone in a deal valued at R35bn. Revenue in the year to end-march grew 1.5% to R81bn and after-tax profit rose by 1.7% to R13bn. The group declared a final dividend of R4.35, taking its total for the year to R8.30, a 4.4% raise on the previous year s R7.95. In South Africa, Vodacom grew its subscriber numbers by 8.6% to 37.1-million, of which 32-million were prepaid customers. It attributed its growth in prepaid customers to its "Just 4 You" bundle offer and its "NXT LVL" youth marketing campaign. The company added contract customers during the year with improved loyalty leading to reduced contract churn of 4.2%. Outside of SA, Vodacom grew subscribers 9.3% to 29.7-million, recovering from the drop caused by African countries enforcing subscriber identification rules. Service revenue outside of SA declined 5.6% to R16.8bn, mainly due to registration requirements in the Democratic Republic of Congo, Mozambique and Tanzania. Vodacom said it was buying all but 5% of Vodafone s 40% of Safaricom in exchange for million new shares and R51m cash. Safaricom s remaining shareholders are the Kenyan government, with 35%; public investors, with 25%; and Safaricom employees, with 0.07%. Kenya has a mobile penetration of 88%, which is well below SA s mobile penetration of 146%. Safaricom s leading mobile money platform, M-Pesa, is an important driver of Kenyan economic growth, providing essential financial services to over 19-million 30-day active customers. MONDI Mondi s underlying operating profit for the first quarter of 2017 was down 6% due to lower selling prices and inflationary cost pressures. Underlying operating profit fell to 252 million in the three months through March from 269 million a year ago. The figure was up 12% on the fourth quarter last year due to higher sales volumes and prices. The packaging paper division was impacted by lower selling prices for containerboard, while significantly lower gains on the value of its forestry assets, lower average export selling prices for hardwood pulp and white top kraftliner products, and a stronger rand impacted the South Africa division. Management have indicated planned price increases for the first quarter of Although implemented, these price increases had only a limited impact on the first quarter numbers. Major input costs escalated over the year (along with a broad rise across most commodities) in addition to higher energy prices in Europe. Strong demand has been in Mondi s favour, however, cost control will become increasingly important should pricing pressures continue. Looking forward, the Group expects planned maintenance shuts to impact profit by around 80m with around 50% to be incurred in the first half of Positively, good cash flow generation continued with net debt reduced and the 500m Eurobond redeemed in line with guidance which should reduce annual interest charges by 28m per annum. MEDICLINIC Mediclinic International s expansion into the Middle East and UK resulted in both its revenue and profit rising in the year to end-march. According to the company s full year results, Mediclinic s Swiss subsidiary Hirslanden contributed 48% of the Group s 2.7bn revenue and 58% of its 243m net profit. Its Southern African division contributed 28% of revenue and 34% of profit, and its Middle East division 24% of revenue and 9% of profit. Revenue from its 29.9%-owned UK hospital group Spire Healthcare has not added to Mediclinic s top line, but its British associate s net profit contribution doubled to 12m from 6m, accounting for 5% of the group s total. Mediclinic s merger with Abu Dhabi s Al Noor helped its Middle East division nearly double revenue to 648m from 328m. However, its woes with the government requiring state medical aid users to pay 20% of private hospital bills resulted in net profit from the Middle East plunging 62.5% to 21m from 56m. Subsequent to its financial year end, on April 28, Abu Dhabi s crown prince reversed the 20% co-payment rule with immediate effect, which should improve Mediclinic s coming interim results. In SA and Namibia, Mediclinic operated 52 hospitals and two day clinics at the end of its financial year. With a total of beds and employees, Mediclinic said it was the third-largest private hospital provider in Southern Africa. Mediclinic said its Southern African division grew revenue 7% to R14.4bn. Mediclinic declared a final dividend of 4.7 pence, maintaining its total for the year at 7.9p. 03

5 LOCAL EQUITIES CONTINUED PIONEER Poor hedges on maize and a stronger rand are among factors that impacted the interim results of SA food and beverage producer, Pioneer Foods. Adjusted earnings per share and headline earnings per share were down 48% and 47% to and cents per share respectively, to the end of March Revenue was up 2% at R million, while net asset value per share was up 4% at cents. Group turnover was up 2%, with the local business increasing turnover by 4% and international declining 11%. Essential Foods, the group s largest contributor to revenue, rose 7% due to price inflation (mostly in maize). However, operating profit declined 49% due to unfavourable maize hedging contracts. Operating margin for the unit dropped to 5.1% from 10.6%. Revenue and operating profit in Groceries declined 3% and 12% respectively as this division was impacted by tightening margins and lower beverage volumes. Pioneer s international business comprises 21% of operating profit and experienced the most severe profit contraction, due to lower export beverage volumes, a smaller raisin crop and a stronger rand. Positively, in March, Pioneer acquired a 49.89% stake in Weetabix East Africa for R190 million. This means a partnership with Weetabix UK and a chance to build a strong breakfast position in East Africa and a platform to introduce more Pioneer products. Looking ahead, Pioneer believes its performance will improve in the second half, notwithstanding a constrained trading environment in South Africa. An increased raisin supply, lower maize input costs from June, lower beverage input costs and Aeroton bakery and Weet-Bix capacity should help to improve profitability. CONTACT US CAPE TOWN TEL: ADDRESS: Old Mutual Wealth, The Estuaries, 2 Oxbow Crescent, Century City JOHANNESBURG TEL: ADDRESS: 93 Grayston Drive, Ubomi Building, 3rd Floor, Sandton, 2146 PRETORIA TEL: ADDRESS: 43 Ingersol Road, 3rd Floor, Podium at Menlyn, Lynnwood Glen, 0081 DURBAN TEL: ADDRESS: 61 Richefond Circle, 2nd Floor Ridgeview Building, Ridgeside Office Park, Umhlanga Ridge, Kwazula Natal 05 The Estuaries, 2 Oxbow Crescent, Century City PO Box 207, Cape Town 8000, South Africa. Tel +27 (0) Fax +27 (0) Private Client Securities: Cape Town: +27 (0) Sandton: +27 (0) Pretoria: +27 (0) Durban +27 (0) PCS@omwealth.co.za Old Mutual Wealth is an elite service offering brought to you by several licenced Financial Services Providers in the Old Mutual Group. Old Mutual Wealth Private Client Securities ( PCS ) is a business unit of Old Mutual Life Assurance Company (South Africa) Limited ( OMLACSA ), a licenced Financial Services Provider, Reg. No: 1999/004643/06. PCS is authorised to provide financial services on the OMLACSA license. This document is for information purposes only and does not constitute financial advice in any way or form. It is important to consult a financial planner to receive financial advice before acting on any information contained herein. Old Mutual Wealth and its directors, officers and employees shall not be responsible and disclaims all liability for any loss, damage (whether direct, indirect, special or consequential) and/or expense of any nature whatsoever, which may be suffered as a result of or which may be attributable, directly or indirectly, to the use of, or reliance upon any information contained in this document. To report unethical behaviour, call the Anonymous Reporting line or visit