INTRODUCTION: GOOD ALPHA GENERATION & GREAT RESULTS

Transcription

1 ALPHAWEALTH PRIME SMALL & MID CAP FUND COMMENTARY MAY June 2018

2 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY INTRODUCTION: GOOD ALPHA GENERATION & GREAT RESULTS The AlphaWealth Prime Small & Mid Cap (AWSM) Fund had one of its largest alpha generation months during May Unfortunately, AWSM Fund ended May slightly down by 1.8%, but our benchmark (FTSE/JSE Mid Cap Total Return Index) collapsed a massive 8.4% during this month. This means that the AWSM Fund generated a positive alpha of +6.6% during May. Interestingly, Top 40 Index also fell 3.1% during May, thus AWSM Fund even outperformed the large, safe stocks in our market. Adding to this positive alpha, almost every stocks of ours that reported during May reported great results: Wescoal Holdings (WSL) release a trading statement indicating that HEPS are to rise at least by +303%, CSG Holdings (CSG) reported HEPS growth of +13% (with a Cash Conversion Ratio of greater than 100%!), and Santova Logistics (SNV) reported superb results with HEPS growth of +12% (despite the strong currency shaving +5% to +10% off this growth). Also, despite the market, Coronation Fund Managers (CML) noted marginally higher HEPS while Calgro M3 (CGR) reported exciting results with key Core HEPS growing +7%. More importantly, Calgro M3 s Memorial Parks (now c.5% of the Group s profits) and Residential REIT businesses are growing quickly and should soon (3 to 5 years time) be material, profitable part of the Group. The only disappointment during this period was the results from Tongaat Hulett (TON) with profits falling by about a third. Here we acted quickly to lower our position size and minimize the impact which has worked well and we are considering our options. In summary, our underlying businesses are highly profitability, very cash generation and (at least) sustaining their growth rates (I expect many of these growth rates to pick up over the next year or two). Hence, ignoring market volatility in the shortterm, the AWSM Fund should do very well. It, though, is just a matter of time and patience. The big picture question is: How does our domestic small cap market look globally? South African smaller capitalization equities have been deeply soldoff and are the amongst the cheapest equity sector in all the markets around the world. Given that we expect the latter half of this year going into 2019 as the start of our domestic economic recovery and JSElisted small caps stand to benefit from this, we could not be more excited for the next year or three in the AWSM Fund. Allow me to illustrate what I mean when I say that our domestic small cap market is amongst the cheapest equity markets in the world. THE CHEAPEST EQUITY SECTOR IN THE WORLD: LOCAL SMALL CAPS The below three graphs (Figure 1, 2 & 3) clearly illustrate that the South African and JSElisted small and mid caps are amongst the cheapest sectors globally. While the sample of global markets below includes all the major exchanges across the world, we also specifically include all major regional small cap indices so that we can demonstrate that it is not just small caps in general that are cheap, but specifically South African small caps that are this way.

3 MXRUSC Index JPNKMS Index SMX Index FTSEMIB Index JSMLC Index MIDCAP Index MXBRSC Index DAX Index MXCNSC Index MXEUSC Index NKY Index SML Index CAC Index SX5E Index W1SML Index TRAN Index ASX Index UKX Index IBEX Index MEXBOL Index IBOV Index RTY Index MID Index SHSZ300 Index NYA Index SPTSX Index COMP Index OMX Index HSI Index SMI Index DWCF Index SPR Index UTIL Index INDU Index AS51 Index SPX Index TOP40 Index NYP Index OEX Index CCMP Index CFIN Index FTSEMIB Index JSMLC Index MIDCAP Index MXCNSC Index HSI Index IBEX Index MXBRSC Index MXRUSC Index SX5E Index CAC Index W1SML Index SMX Index DAX Index JPNKMS Index IBOV Index NKY Index SHSZ300 Index SPTSX Index UTIL Index UKX Index ASX Index MXEUSC Index AS51 Index NYA Index OMX Index TOP40 Index SML Index SMI Index MEXBOL Index MID Index RTY Index CFIN Index DWCF Index SPR Index COMP Index SPX Index OEX Index TRAN Index NYP Index INDU Index CCMP Index ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY Figure 1: Global Market Indice's Various PricetoBook (x) South African small and mid caps Figure 2: Global Market Indice's Various PricetoSales (x) South African small and mid caps

4 MXRUSC Index FTSEMIB Index IBOV Index DAX Index MIDCAP Index JSMLC Index UKX Index MEXBOL Index SX5E Index IBEX Index ASX Index CAC Index NKY Index HSI Index MXCNSC Index JPNKMS Index TRAN Index MXBRSC Index TOP40 Index UTIL Index NYA Index SPTSX Index COMP Index AS51 Index MID Index SML Index MXEUSC Index OMX Index OEX Index SPR Index SPX Index SHSZ300 Index DWCF Index W1SML Index INDU Index NYP Index RTY Index SMI Index CCMP Index CFIN Index SMX Index ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY Figure 3: Global Market Indice's Various EV/EBITDA (x) South African small and mid caps Note: By utilizing book value, sales, enterprise value and EBITDA, we have hoped to control for financial, geographic and market eccentricities (e.g. tax, yields, gearing, accounting rules and policies) that could distort the results. Also, using more than one measure allows us to view relative valuations from multiple (no pun intended) perspectives ensuring that we are not distorting the results by use of selective metrics to suit our argument. While the JSElisted small and mid caps are not the cheapest on any of these measures, they are consistently within the bottom few. Other than the Italian market s equivalent of our Top 40 Index, no other indices feature regularly at the bottom of the pile on every measure, other than our small and mid cap indices. Interestingly, the JSE Top 40 Index does not share this same relative value that our small and mid cap stocks do. The Top 40 looks pretty fairly valued on many of these measures. But, remember, the Top 40 Index is predominantly nonsouth African in its exposure while the small and mid cap stocks are uniquely South African. In other words, the socalled SA Inc stocks are very cheap at this point. It is interesting to note the above graphs are only one point in time (i.e. right now). Is it possible that the South African small and midcaps are actually fairly priced according to their risk. Maybe South African small caps are always cheap relative to the other indices, thus meaning that they are unlikely to rerate upwards ever. How can we find out if this is true or not? If we take the JSE Small Cap Index and track its PricetoBook (chosen due to its stability and comparability across markets) against itself (i.e. historical average and standard deviations) and then compare this against a global equity index and a global small cap index (once again, ensuring that we are ignoring the size discount), we arrive at the same conclusion: South African small caps are cheap. This is illustrated in Figure 4 on the next page.

5 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY Figure 4: South African Small Cap PricetoBook versus World Equity & World Small Caps 140 Most global equity markets are one standard deviation expensive, except for South African small caps South African small caps are almost the same valuations they were in the Credit Crisis JSE Small Cap Index MSCI World Index FTSE Global Small Cap Index JSE Small Cap (Std Dev.) JSE Small Cap (Std Dev.) JSE Small Cap (Ave.) South African small caps are trading one standard deviation below their average PricetoBook valuation. In fact, they are almost at the same lows they experienced during the Credit Crisis (2008)! Not only this, but they have gotten cheaper on this measure since late 2012 while the rest of the global equity markets and global small cap sectors have, in fact, gotten more expensive. I believe the above lends weight to our view that the South African small and mid cap market is (pretty much) the cheapest equity market sector on Earth right now. It does not hurt that we are starting to see the socalled green shoots of growth returning across our domestic economy. Along with growing consumer confidence, these green shoots are starting to become a recurring narrative from many meetings with lots of management teams across a range of listed South African companies. These meetings have all taken place in the last month or two and, in all likelihood, point towards strong results being reported across the board in the latter half of this year. Hence, while South African small caps may amongst the cheapest equity market sectors in the world right now, it is also one where fundamentals are starting to improve. CONCLUSION: LOW VALUATIONS + POSITIVE PROSPECTS = GOOD RETURNS We believe that our qualityfocus in small cap investing continues to demonstrate its superior merit. The proof of this lies in our alpha generation in May (+6.6%), the many positive results from the companies we are invested in and AWSM Fund s highquality fundamental metrics below (Figure 5).

6 Ratio (%) ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY Figure 5: AWSM Fund's Fundamentals Against Benchmark & South African Market 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 10.0% Debt:Equity Gross Profit Margin Return on Equity Growth in Earnings AWSM Fund 28.2% 37.5% 17.9% 30.1% Benchmark 42.0% 26.2% 7.7% 3.7% Top % 42.0% 15.0% 10.7% I remain invested in AWSM Fund with the majority of my liquid wealth and very confident in our forward, longterm returns. Finally, as illustrated above, I hope you agree with me that we are currently investing in a set of rather rare conditions: 1. Very low, pessimistic (small cap) valuations, & 2. Improving prospects for growth in our domestic economy that will benefit our small cap stocks. AWSM Fund is invested in highquality, fastgrowing South African small caps that we believe are trading at large discounts to their intrinsic value. As always, the rest is just patience and compounding. Kind regards Keith McLachlan (CA) SA Fund Manager AlphaWealth Prime Small & Mid Cap Fund

7 ALPHAWEALTH PRIME SMALL & MID CAP FUND INVESTOR LETTER MAY Disclaimer: Collective Investment Schemes in Securities are generally medium to longterm investments. Different classes of units apply to these portfolios and are subject to different fees and charges. A schedule of fees and charges and maximum commissions is available on request from the Company. Commission and incentives may be paid and if so, would be included in the overall costs. The price of a participatory interest is a markedtomarket value. Forward pricing is used. The purpose of the money market yield is to indicate to investors a compounded annual return for all money market portfolios on a comparable basis. The yield calculation is not used for income distribution purposes. A forwardlooking yield is used. This means that the last seven days yield (less the service charges, including VAT) is taken and is annualised for the next 12 month period, assuming the income returns are reinvested. Yields for money market funds are published daily. The value of participatory interests may go down as well as up. Past performance is not necessarily an indication of future performance. Performance numbers and graphs are sourced from Global Independent Administrators (Pty) Ltd are calculated on a NAV to NAV basis and do not take initial fees into account. The Company does not provide any guarantee either with respect to the capital or the return of the portfolios. Income is reinvested on the reinvestment date. Actual investment performance will differ based on the initial fees applicable, the actual investment date and the date of reinvestment of income. Dealing prices are calculated on a net asset value and auditor s fees, bank charges and trustee fees are levied against the portfolios. The total return to the investor is made up of interest received and any gain or loss made on any particular instrument. This will have the effect of increasing or decreasing the daily yield but in case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures where a process of ringfencing of withdrawal instructions and managed payouts over time may be followed. CIS are traded at ruling prices and can engage in borrowing and scrip lending. The manager may borrow up to 10% of the market value of the portfolio to bridge insufficient liquidity. Prime Collective Investment Schemes Management Company (RF) (Pty) Ltd is a registered Collective Investment Scheme Manager in terms of Section 5 of the Collective Investment Schemes Control Act and is a wholly owned subsidiary of Prime Financial Services (Pty) Ltd, a member of ASISA