Anglorand Investment Insights - June Compiled by Desmond Esakov and David Smyth, CFA INTRODUCTION Chart 2: JSE Resources Index In this issue we present our quarterly valuations of JSE sectors using our proprietary regression models. As a reminder, we aim for our models to be as objective as possible in applying statistically significant financial and economic input variables to determine the fundamental or intrinsic value of various JSE sector indices. Once we have selected appropriate input data and the regression model is run, the combined effect of the explanatory variables is defined as the simulated line. The simulated line is then compared to the actual values of the corresponding share index to determine whether the index is over- or undervalued relative to these factors. 10 8 6 - RESOURCES INDEX R² = 59.3% -27.8% DISCUSSION Chart 1: JSE All Share Index 10 8 6 - JSE ALL SHARE INDEX 1.7% In our March newsletter, we ran these models and at that stage concluded that the JSE, as a whole, was fairly valued on our selected explanatory variables. The explanatory variables that were selected to determine the valuation for the JSE included overall earnings, the USD/ZAR exchange rate and the international copper price, and at that stage those variables explained approximately of 9 of the markets movement. Before we get on to specific sectors we have rerun the model for the ALSI - as of 27 June - to determine if the situation has changed since March. Using the same variables as previously, our model now suggests the JSE is approximately 1.7% overvalued, largely the same as the situation in March. R² = 92.7% According to our model the JSE Resources Index is significantly undervalued after also being slightly undervalued in March. Given this valuation we feel investors can accumulate selected resource counters. We continue to favour selected platinum counters and certain large cap diversified miners. Chart 3: JSE General Mining 10 8 6 - MINING INDEX -29.1% The JSE General Mining Index - which includes the likes of Anglos and Billiton is significantly undervalued according to our model. We attribute this under valuation to a sharp decline in the index price in Q2 which was more pronounced than the fall in metal prices. Given this under valuation we would advise investors to begin accumulating higher quality mining companies with South 32 and BHP Billiton being our preferred picks. Following a significant operational turnaround and a substantial reduction in debt reported R² = 62. www.anglorand.com Page 1 of 5
by Anglo American, we also recommend investors buy stock at current levels. Chart 4: JSE Oil and Gas 10 8 6 - OIL PRODUCERS 6.8% The JSE Oil and Gas Index (Sasol) is slightly overvalued. This rich valuation reflects the decline in the oil price over the last few months coupled with a relatively sharp appreciation in the rand since the end of. We would however recommend that investors look to begin accumulating Sasol below R250. R² = 91.7% Chart 6: JSE Industrial Index 10 8 6 - Our model for the JSE Industrial index suggests industrial stocks remain overvalued. Although the index is richly priced, we are not suggesting that investors avoid industrial shares altogether; rather we stress the need to be highly stock selective. We have highlighted some industrial shares below that we believe still offer a decent risk reward payoff. Chart 7: JSE Retail Index INDUSTRIALS R² = 96. 15.8% Chart 5: JSE Platinum Index 10 8 6 PLATINUM PRODUCERS R² = 63.5% 10 8 6 GENERAL RETAIL R² = 89.3% -31.2% - -14.4% - According to our proprietary model the platinum index remains undervalued. Although earnings for platinum companies have remained depressed for years due to low prevailing PGM prices, we remain of the view that the current valuation of platinum shares is sufficiently attractive to compensate investors for the poor earnings performance. Other indicators such as price to book and price to sales ratios are also at levels not seen in the last thirty years, adding to the valuation appeal. As such we would advise investors to buy platinum shares, with Anglo American Platinum and Impala Platinum remaining our preferred picks. We do however stress that investors must exercise caution when buying platinum counters due to the volatile nature of the shares. With the price of the retail index declining by approximately 1 in Q2 our model indicates that sector is now significantly undervalued, this after being over valued for a few years. Given the relatively attractive valuation we believe that investors can begin to accumulate selective shares. Our preferred pick at this stage is Woolworths Holdings and we would advise long term investors to begin accumulating shares at R60 and lower. www.anglorand.com Page 2 of 5
Chart 8: JSE Food Producers Index 10 8 6 - FOOD PRODUCERS The JSE Food Producer Index remains overvalued although this is largely due to low earnings following the severe drought that hit South Africa in /16. Good rains in the second half of, however, have meant that maize prices and other key input costs have come down sharply. These lower costs have yet to be reflected in results, but will begin to feed through in the remainder of and 2018. As such we expect earnings to normalise towards historical averages, which will make the valuation of the sector more appealing. Our preferred stock picks in the sector are Zeder, Tongaat Hulett and Quantum Foods. We also feel that investors can look to purchase recently listed Premier Food & Fishing at current levels. Chart 9: JSE Telecoms Index 10 8 6-11.8% Our telecoms model suggests that the index is still significantly overvalued after being undervalued by around in December. The current valuation is somewhat misleading as it factors in MTN s latest earning, with the company reporting a loss largely due to the heavy fined imposed by Nigerian authorities for not adhering to correct regulatory procedures. Over time we expect MTN to once again generate profits which will almost certainly see the valuation of the overall sector improve. Even assuming normalised earnings for MTN, TELECOMS R² = 92.5% R² = 51.3% 49. we continue to avoid the stock due to a rising debt burden and continuing pressure on the Nigerian Naira, with almost of MTN s revenues stemming from the West African country. Although Vodacom is a high quality business, we believe at current levels the valuation is still excessive. For investors seeking exposure to the sector we recommend Blue Label Telecoms. Chart 10: JSE construction Index 10 8 6 - Our model for the JSE construction index continues to suggest that the sector is undervalued. Despite construction spend in the country remaining under pressure and a downbeat outlook, we believe that at current valuations investors are compensated for this subdued environment. We must however stress that as a result of the ongoing recession in the sector, a number of companies have seen a sharp deterioration in their balance sheets and we therefore emphasise that it is imperative that investors remain highly stock specific. Our preferred picks in the sector are Group Five and Wilson Bayly. Chart 11: JSE Information Technology Index 10 8 6 - CONSTRUCTION INDEX -17.7% According to our model for IT stocks, the sector at present is overvalued. Despite this we feel that investors looking for exposure to the sector can look to purchase TECHS R² = 38.5% R² = 77.6% 39.5% www.anglorand.com Page 3 of 5
Alviva Holdings (formerly Pinnacle Holdings) and EOH at current levels. Chart 12: JSE Financials Index 10 8 6 - Our model for JSE Financials suggests that the index continues to remain overvalued. Given this elevated valuation we do not believe a sufficient margin of safety exists to invest in the sector as a whole via an instrument such as the Satrix Fini. Nonetheless we do believe that certain banking stocks now look to be offering compelling value. Chart 13: JSE Banks 10 8 6 - FINANCIALS INDEX 19.2% Following an 8% decrease in the price of the banking index in H1 our model suggests that the banking sector is marginally undervalued. Given the current valuation we recommend investors begin accumulating banking stocks with Standard Bank, Nedbank and Barclays Africa our preferred picks. BANKS INDEX R² = 83.4% R² = 91.2% -6.1% Chart 15: JSE Listed Property 10 8 6 - JSE listed property stocks continue to look fairly valued after being overvalued for some time. Listed property stocks are however highly negatively correlated with South African long-term government bond yields and as such this variable is a key determinant of the valuation of listed property stocks. Although long bond yields are now around 8.8% this is well below the 50-year average of 11%. We continue to remain of the view that a further credit downgrade, a deteriorating fiscal position and potential currency weakness pose a risk to bond yields. We believe that any movement towards the long-term average would result in a selloff in of the JSE listed property index as a whole. Although we are negative on the outlook for domestic property funds we are more positive on properties in select international markets, with our preferred international counters remaining Stenprop and Sirius Real Estate, a property company which owns industrial and commercial properties in Germany. Greenbay Properties is suitable for inclusion in portfolios of investors with a higher risk tolerance. SUMMARY With the exception of a few sectors, our models indicate that most sectors appear to be fairly valued. As such, we continue to stress that investors need to be highly stock selective when investing in SA equities. We continue to believe that a number of companies offer value and remain firmly of the view that solid stock selection in the mid to long-term will provide superior after-tax returns when compared to other investment classes such as bonds, property and the money market. Disclaimer LISTED PROPERTY R² = 78.9% -2.6% This report and its content are confidential, privileged and only for the information of the intended recipient. Please destroy this document if you have received it in error. The Author of this report (AR) make no representations or warranties in respect of this report or its content and will not be liable for any loss or damage of any nature arising from this report, the content thereof, your reliance thereon its unauthorised use or any electronic viruses associated therewith. This report is proprietary to the AR and you may not copy or distribute the report without the prior written consent of the AR. The author of this report www.anglorand.com Page 4 of 5
currently holds some of these shares on behalf of client or in a private capacity. www.anglorand.com Page 5 of 5