Bateleur Equity Prescient Fund 2017 Half year report back
1 Bateleur Equity Prescient Fund ( the fund ) 2017 1 st half report back to investors Current position Mar 17 Jun 16 Fund Swix Fund Swix Fund Swix Resources 12% 13% 13% 14% 9% 14% Industrials 63% 59% 66% 59% 65% 62% Financials 22% 28% 20% 27% 24% 24% Cash 3% 1% 2% Performance The fund declined -1.5% in the 2 nd quarter of 2017. The Shareholder weighted total return index (SWIX) was flat for the quarter under review. Year to date the fund has returned 2.1% against the SWIX gaining 3.3%. The equally weighted index (CAPI) declined 0.96% in the quarter and has returned 1.4% year to date. Contributors and detractors over the quarter The detractors for the quarter are similar to that of the previous quarter. Together EOH, Italtile and PPC detracted 1% from relative performance. These are overweight positions in the fund. In the previous quarterly commentary the fund detailed the reason for the EOH position, it s current dilemma and outlook. The fund is of the view that in the coming 12 months the short term working capital issues will have been rectified. The story in the press regarding a rent free lease to help win a tender is a further overhang to the company s share price. This the fund has previously commented on. There has been no new information regarding this matter and EOH has assured the market on several occasions that there is no truth to the allegation. The company, despite going through short term working capital difficulties, has a net debt to equity ratio of 23% and thus is not short of liquidity. With regards to valuation, at EOH s current share price of R110, the company is trading on a PE multiple of 12.8 times the financial year ending July 17 earnings. At this time we view the share price s underperformance as sentiment driven. Italtile makes up almost all of the fund s exposure to the SA consumer. While it is a detractor from a stock specific standpoint in the period under review, an underweight position to the overall SA consumer sector contributed roughly 0.6% in the quarter. This more than offsets the relative loss from the under performance of Italtile. The valuation of Italtile is currently attractive on 12 times 1 year forward price earnings ratio. PPC has continued to dissapoint. This position was acquired last year when the outlook for the South African economy and the company was better than it is now. The change in the outlook for the economy and the company scoring some own goals has decreased our valuation of the company. Unfortunately, the price of the share, has also declined sharply with this change in fortunes and now trades on a 15% free cash flow yield on a reported basis. The fund will not be adding to this position until the outlook is
2 more certain and will dispose of the stake should the environment deteriorate further. The fund has a 0.9% exposure to PPC. Large contributors during the quarter were Barclays Group Africa, Mondi and Dischem. Together these 3 companies contributed 0.6% to relative performance. The fund holds a 4.5% weight in Barclays Group Africa due to it s attractive valuation. (7.5% trailing dividend yield). The attractive valuation is due, in some part, to the placement by Barclays Plc of it s remaining stake. A pending placement of a large stake in a company often keeps investors on the sidelines either due to fear of this large seller in the market, or investors hoping to gain a portion of the pending placement. They therefore do not buy up to the desired exposure. Either way, the fund views the valuation as attractive and in most cases investors do not gain their desired allocation in the placement. This results in buying after the placement has occurred. Barclays Plc placed the shares on the 1 Jun 17. The placement was 3 times oversubscribed. Mondi has benefitted from strong kraftliner prices in Europe. This is expected to continue. Kraftliner is produced from virgin wood and used in higher quality packaging products most often associated with online purchases where more protective packaging is required. There is a shortage of virgin wood supply due to governments in Europe not allocating further forests for harvesting. Mondi is one of the few vertically integrated players in Europe, owning or leasing and managing the forests close to kraftliner plants. This provides Mondi with a structural tailwind which is likely to continue. Dischem was disposed of during the quarter and added 20bp to performance. This is a high quality business in an attractive sector. The rally in the share price however, far surpassed our valuation of the business and thus the position was exited. South African economy and the currency There have been no material changes to the outlook for the South African economy since the last quarterly report. The Rand is being supported by portfolio flows chasing South Africa s attractive real yield.
3 Chart 1. Real yield attracting net inflows into bond market. Equities have had net outflows for two years 40 30 Bonds (net purchases by foreigners) Equities (net purchases by foreigners) 20 10 0-10 -20-30 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Source: RMB Morgan Stanley Chart 2 shows South African GDP growth year on year versus SA business confidence and illustrates the close relationship overtime. The downturn in business confidence is likely a lead indicator for the further deterioration of SA GDP growth. Chart 2. SA Business confidence versus SA GDP growth. Continued low economic activity likely 100 90 80 SA Business Confidence (BER) SA GDP (y-o-y) (RHS) 8 6 70 60 4 50 2 40 30 0 20 10-2 0 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015-4 Source: Bloomberg Economic activity is likely to remain tepid due to political uncertainty and in many cases, share prices are not sufficiently pricing in the low level of growth. Chart 3 shows a basket of SA consumer facing companies. Since the beginning of Jun 2016 earnings estimates for these companies have declined 16% while share prices are down 1% on average. This illustrates that the difficult environment facing these companies is not yet fully priced in.
4 Chart 3. A basket of SA consumer companies. Earnings expectations falling, share prices resilient 110 105 100 95 Average Price Average EPS estimates 90 85 Ave EPS 16%, Ave share price 1% 2016 share prices reflect more stable political environment & green shoots in the economy 80 Jun 16 Aug 16 Oct 16 Dec 16 Feb 17 Apr 17 Jun 17 Source: Bloomberg. Basket contains: Truworths, The Foschini Group, Woolworths, Mr Price, Massmart, Spar, Shoprite, Pick n Pay, Clicks, Tiger Brands, AVI, Pioneer Foods, Nampak, Mpact, Barloworld, Imperial, Supergroup, Bidvest & KAP. New position: Equites Properties The fund has not been invested in South African property companies for quite some time. This is due to the sector being expensive relative to bond yields, there being better opportunities elsewhere in the SA market and aggressive space rollout relative to GDP growth which is beginning to result in increasing vacancy statistics in the retail and office segments. It has long been a concern of ours that the trends emerging in the UK and US property markets would ultimately emerge in SA. That being the growth of online retail sales taking market share from bricks and mortar retail space. Despite this trend developing slowly, it is important to take note of. Figure 1 illustrates the dynamics of online retail where it is estimated that online fulfillment requires 3 times as much big box logistics space than store-based fulfillment. Figure 1. Online retail continues to drive demand for logistics properties c.72 000 m2 of big box space is required for every 1 billion spent online 3 x as much big box space is required for online fulfillment compared with store-based fulfillment In the period to 2020 UK & Ireland will require 1.7mn m2 of additional big box space 790 000 m2 of UK big box space was taken up by online retailers in H1 2016 Source: Tritax Big Box REIT Annual report
5 UK online retail sales are forecast to grow to 94 billion in 2020 from 52bn in 2014. This equates to 10% CAGR over the period, compared to traditional retail which is expected to grow at low single digits. South Africa is likely to follow a similar trend, albeit a few years behind the UK. Chart 4 illustrates the strong historic and forecast growth in online retail sales in the UK and as is noted in figure 1, this growth will require large scale expansion and new builds of big box logistics formats. Chart 4. UK online sales forecast to grow strongly 100 Retail e-commerce sales ( bn) Retail e-commerce as % of total 40% 90 80 70 60 Expecting 10% CAGR: 2014 to 2020 35% 30% 25% 50 20% 40 30 20 10 15% 10% 5% 0 2014 2015 2016 2017e 2018e 2019e 2020e 0% Source: Tritax Big Box REIT Annual report The fundamentals of the big box logistics format are not only favorable from a growth perspective, but from a client one, lease times are usually longer with larger tenants. Equites Properties is the only specialised big box logistics property company in South Africa. Thus fitting the favorable long term structural theme highlighted above. Chart 5. Equites Property exposure by format. 79% logistics. Remainder held for sale or development Logistics 7% 3% 2% 3% Industrial Land for development 6% Under development 79% Commercial Commercial (held for sale) Source: Company data, Bateleur
6 Equites operates in proven logistics nodes (50% Gauteng, 34% Western Cape, 16% UK) and has high quality tenants. Vacancy rates are 0.1% across the Gross Leasable Area (GLA), with 70% of leases expiring in greater than 5 years. The balance sheet is conservative with a loan-to-value ratio (LTV) of 22.5% with all debt hedged. The properties are internally managed and key executives are closely aligned to the performance of the group through equity ownership. The management team s focus is on sustainable distribution growth, meaning, paying dividends out of operating cash flow (recurring income) without financial engineering (capital profits). Furthermore the company is committed to remaining a specialist, high end logistics warehousing provider and has strong demand to develop their remaining land for this format. Equites trades on a 12 month forward distribution yield of 7.5%. While there are listed property companies on higher dividend yields, Equites offers a more certain and superior growth in distribution of 11% over the next 3 years, development opportunities and a strong balance sheet, warranting the premium rating. Fund positioning and conclusion The fund is positioned for a sustained tough domestic macro backdrop and rand neutral versus the benchmark. Note the benchmark has a large rand hedge exposure. Foreigners have been net sellers of SA equities, partly explaining the de-rating. However, while the market as a whole is not yet attractive enough, pockets of value are beginning to emerge. As and if conditions deteriorate further, high quality companies will become increasingly attractively priced. The fund welcomes this scenario and is in a position to take advantage of these opportunities. Galen Hossack Fund Manager James Easterbrook Head: Distribution
Bateleur Capital (Pty) Ltd Authorised financial services provider FSP no 18123 SG109 Ground Floor, South Wing Great Westerford Building 240 Main Road, Rondebosch 7735 T +27 (0)21 681 5060 F +27 (0)21 681 5066 E funds@bateleurcapital.com W bateleurcapital.com Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CIS s are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. There is no guarantee in respect of capital or returns in a portfolio. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. CIS prices are calculated on a net asset basis, which is the total value of all the assets in the portfolio including any income accruals and less any permissible deductions (brokerage, STT, VAT, auditor s fees, bank charges, trustee and custodian fees and the annual management fee) from the portfolio divided by the number of participatory interests (units) in issue. All documents, notifications of deposit, investment, redemption and switch applications must be received by the Manager by or before 13:00 (SA), to be transacted at the net asset value price for that day. Where all required documentation is not received before the stated cut off time the Manager shall not be obliged to transact at the net asset value price as agreed to. Fluctuations and movements in exchange rates may also cause the value of underlying international investments to go up or down. Forward pricing is used. The Fund s Total Expense Ratio (TER) reflects the percentage of the average Net Asset Value (NAV) of the portfolio that was incurred as charges, levies and fees related to the management of the portfolio. A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The current TER cannot be regarded as an indication of future TER s. During the phase in period TER s do not include information gathered over a full year. A Money Market portfolio is not a bank deposit account and the price is targeted at a constant value. The total return is made up of interest received and any gain or loss made on any particular instrument; and in most cases the return will have the effect of increasing or decreasing the daily yield, but in the case of abnormal losses it can have the effect of reducing the capital value of the portfolio. The yield is calculated as a weighted average yield of each underlying instrument in the portfolio. Excessive withdrawals from the portfolio may place the portfolio under liquidity pressures and a process of ring-fencing of withdrawal instructions and managed pay-outs over time may be followed A Fund of Funds is a portfolio that invests in portfolios of collective investment schemes, which levy their own charges, which could result in a higher fee structure for these portfolios. A Feeder Fund is a portfolio that invests in a single portfolio of a collective investment scheme which levies its own charges and which could result in a higher fee structure for the feeder fund. The Manager retains full legal responsibility for any third-party-named portfolio. Where foreign securities are included in a portfolio there may be potential constraints on liquidity and the repatriation of funds, macroeconomic risks, political risks, foreign exchange risks, tax risks, settlement risks; and potential limitations on the availability of market information. The investor acknowledges the inherent risk associated with the selected investments and that there are no guarantees. Prescient is a member of the Association for Savings and Investments SA. Bateleur Capital Pty Ltd, an AFSP; is the investment manager of the Funds. Prescient Management Company (RF) Limited, Prescient House, Westlake Business Park, Otto Close, Westlake, Cape Town, 7966 Copyright disclaimer: This commentary and its contents are the intellectual property of Bateleur Capital (Pty) Ltd and permits you to make use of this solely for information purposes. bateleur capital 2016