March 2017 PROSPERITY IN THIS CLIENT NEWSLETTER Economic and market outlook Local and global equities
The unfortunate local events leading to the replacement of both the finance and deputy-finance minister has undermined market confidence and has weakened the outlook for the South African economy. At the time of writing, S&P has already downgraded South Africa to subinvestment grade which will have negative longer-term consequences for our financial markets and the broader economy. The rand and interest rate-sensitive assets like bonds, financial shares and listed property are likely to remain under pressure. The consequences of these political machinations remain uncertain, but our investment view remains focused on the most sustainable growth opportunities. While South Africa s macroeconomic conditions had been gradually improving in recent months, this progress is now at risk. Our local portfolios have been overweight rand hedge stocks and these have benefitted from the recent uncertainty and should continue to do so. In our multi-asset class portfolios that hold international assets we have been at our maximum allowed offshore exposure. These holdings have been negatively impacted as the rand strengthened in 2016 but are now performing in line with our expectations. On the international front, we continue to see slowly normalising interest rates in the USA. Donald Trump s executive orders are being kept in check by the US constitutional framework. This has dampened market expectations of fiscal stimulus, but it has arguably also reigned-in political risk. What remains to be seen is whether Trump can combine corporate tax relief with infrastructure investment in a way that carries the support of the Senate. In the UK, Theresa May now confronts the reality of Brexit and in Europe there is a lingering risk that the populist vote can bring power to those who advocate nationalism. In this environment of increased political risk it is critical that investment portfolios remain appropriately diversified, but more importantly, that investors stick with their strategy. In investing, what is comfortable is rarely profitable. Robert Arnott ECONOMIC AND MARKET OVERVIEW Headlines were dominated by the axing of Finance Minister Pravin Gordhan and his deputy on the last day of the month. This turned what would have been a strong March for the rand against the US dollar into a negative month. It also cast a dark cloud over the recovery story for the local economy. Earlier in the month, data showed a narrower current account deficit, lower inflation, and a better growth outlook. The global context is fortunately very different to when then Finance Minister Nhlanhla Nene was fired in December 2015. With hindsight, the timing of that event could not have been worse, as global investors were already extremely pessimistic about emerging markets and commodity prices were close to multi-decade lows (certainly in real terms). The US dollar was at its strongest level in 13 years as the Federal Reserve was about to embark on an interest rate hiking cycle for the first time in a decade. All these factors have improved from the rand s point of view: emerging markets are back in favour as economic growth picks up, commodity prices have rebounded somewhat from bombed-out levels, and the US dollar appears to have peaked as only gradual interest rate hikes are expected. The Reserve Bank was forced to hike interest rates soon after Nene was removed, compounding the economy s growth decline. However, the Reserve Bank s Monetary Policy Committee left rates unchanged at its March meeting, and noted that it may have reached the end of the hiking cycle. Despite its recent volatility, the rand ended March stronger against the dollar on a year-to-date basis, supporting a better inflation outlook. Nonetheless, S&P Global responded to the Cabinet reshuffle by cutting South Africa s foreign currency credit rating to BB+, into so-called junk territory. The local currency rating remains investment grade at BBB-. Both ratings have a negative outlook. Global markets have long priced South Africa as a junk status, with our credit default swaps (CDS) trading in the same region as Brazil, Turkey and Russia (and well above other BBB- countries). 02
LOCAL EQUITIES FIRSTRAND FirstRand reported interim results that were largely in line with expectations. Normalised diluted earnings per share and net asset value rose by 7% and 8% respectively to 207.6c and R18.43. Group net interest income rose 12% on 4% growth in advances and 6% growth in deposits. Fee and commission income (83% of non-interest revenue) grew 8%. Insurance revenues grew 23% due to volume growth in funeral and credit products in FNB. The group increased its dividend by 10% to 119cps. Total operating expenses increased 8% and continued to trend above inflation as FirstRand remains committed to investing in its insurance and asset management franchises. FNB, the group s retail and commercial bank, contributed 58% of group earnings. Normalised earnings rose 3%, underpinned by growth in noninterest revenue growth (increased customers and volumes) and quality net interest income. Rest of Africa earnings were down 29%, negatively impacted by subsidiaries in Zambia and Mozambique. RMB, the group s corporate and investment bank, contributed 25% of group earnings and Wesbank, the group s instalment finance business, contributed 17%. Overall, management were pleased with the growth given external conditions. Earnings were in line with expectations and similar to peers who have reported earnings growth between 5%-10% for their reporting periods. Management are expecting a slight increase in economic activity through 2017. FirstRand trades at a price to book of 2.6x versus the local peer average of 2.3x. AVI In its interim results release, AVI (which is home to brands such as I&J and Spitz) reported an 8.1% and 11.6% increase in operating profit and revenue respectively. While gross profit rose 8% to R3.12 billion, its consolidated gross profit margin dropped from 45.3% to 43.8% as some categories have yet to fully recover the input cost pressures resulting from the weaker rand exchange rate. Headline earnings per share (302.9c) and the interim dividend rose 7.6% and 8% respectively. Food and Beverage brands increased revenue and operating profit by 13.7% and 10.2% respectively. Entyce and Snackworks performed soundly with good growth in operating profit. I&J achieved profit growth from favourable exchange rates and improved fishing in the second quarter, although the result was tempered by an operating profit shortfall of about R25 million due to a three-week illegal strike at the trawling operations in August. Headline earnings rose 8.5% to R979.8 million with the growth in operating profit and an improved result from I&J s Australian joint venture partially offset by higher finance costs in line with higher interest rates. The overall performance by AVI s Fashion Brands was satisfactory in the context of the difficult consumer environment. Footwear and apparel saw revenue and operating profit growth of 4.3% and 1.3% respectively. Both Spitz and Green Cross grew operating profit in the period despite pressure on footwear sales volumes at the materially higher price points necessary to protect gross profit margin. Looking ahead, management expect a continued difficult trading environment and competitive pressure. AVI trades at a forward earnings multiple of 19.5x versus the peer average of 16.4x. OLD MUTUAL Old Mutual posted a slightly above-forecast 2016 adjusted operating profit of 1.67 billion pounds. This represents a 1% year-on-year increase, which was aided by a focus on costs in a volatile political and economic environment. A final dividend of 3.39p and total dividend of 6.06p, down 32% year-on-year, was declared. The group is making headway with the managed separation as OM Wealth disposed of its Italy business and reduced its holding in OMAM to 51%. This is in addition to reducing head-office costs and reducing head office debt by 17%. Old Mutual Emerging Markets and its reliance on South Africa remains a key consideration as the group approaches managed separation finality. The group announced the appointment of Trevor Manuel as Chairman and Peter Moyo as Chief Executive of its Emerging Markets business. OM Wealth is growing its presence in the UK and presented resilient results in light of the market environment. However, progress on the platform transformation project remains disappointing, with management indicating potential timescale and cost creep. A material completion of managed separation is expected by end 2018. Newsflow is likely to dominate share price movement over the upcoming year as no key transactions or events were announced. 03
GLOBAL EQUITIES CONTINENTAL Despite the muted growth in the global vehicle market, Continental released a decent set of full year 2016 results. The company once again grew faster than the underlying markets in which it operates in and margins expanded. Sales for the year were up 3% to 40.5 billion, slightly ahead of consensus expectations of 40.2bn. Adjusted earnings were flat at 4.3 billion, with margins ticking up to 10.8% from 10.5%. The automotive division, which generates 60% of sales and 45% of earnings, grew organic sales by 5%, ahead of global vehicle market growth and its EBIT margin was 6.7%. The Rubber group, which includes the highly profitable Continental Tires, grew organic sales by 3.9% and EBIT margin to 17.8%. Looking ahead, management guided to revenue growth above 6% for the 2017 fiscal year, ahead of the forecast 1% increase in global vehicle production and 2% increase in the tire market. EBIT margins are expected to remain above 10.5%, despite the increases in key raw material prices (rubber) during the past year. Continental is currently trading at a forward earnings multiple of 12x, below the peer average of 16.9x. ACCENTURE Accenture s second quarter results were largely in line with expectations. Revenue for the period rose 5% to US$8.3 billion. On a constant currency basis, revenue was up 6%. Adjusted earnings per share declined by US$0.01 due to a higher effective tax rate following profits from the sale of Navitaire. Despite this decline, at US$1.33, EPS was slightly ahead of the US$1.30 consensus average. Group operating margins rose 20bps to 14.7% and the semi-annual dividend was increased by 10% to US$1.21. Free cash flow for the year-to-date was US$1.05 billion versus $765 in the previous period. Geographically, growth markets (18% of revenue) reported the highest revenue growth of 12% in USD. North America (48% of revenue) increased revenue by 4%, while revenue in Europe (34% of revenue) grew by 2% in USD. Management expects third quarter revenue to increase by between 5%- 8%, reflecting a 2.5% negative currency impact. For the 2017 full year, management slightly increased the lower end of their revenue guidance from 5% - 8% to 6% - 8% growth. Normalised EPS for 2017 are still expected to be between US$5.70 - $5.87, with management further guiding to a once-off US$0.39 per share pension termination charge that will impact the full year numbers. ABINBEV ABInBev reported disappointing full year 2016 results after a difficult year, particularly in Latin America. Revenue for the period grew by 2.4%. Total volumes declined by 2.0%, with own beer volumes declining 1.4% and non-beer volumes down 6.2%. EBITDA margins contracted by 92 bps to 36.8%, mainly as a result of weakness in Brazil. Excluding Brazil, EBITDA margins grew 6.3%. Net interest cost rose to US$5.2 billion from US$1.2 billion due to the bonds issued for the SAB deal. Profit attributable to shareholders was US$4.8 billion versus US$8.5 billion in the previous year, due to the high finance costs and unfavourable currency translation. Earnings per share fell to US$2.8 from US$5.2 for the above mentioned reasons. Management reported synergies of US$282 million from the SAB combination for the period April December 2016. Management also updated the aggregate cost saving expectations from US$2.45 billion to US$2.8 billion. The majority of the cost savings are expected to be captured in the next three to four years. Despite the disappointing growth in 2016, management had a constructive view of the year ahead particularly on the new combined entity s prospects, some key markets that performed better than expected (Mexico, US and Europe) and better performance from the group s own brands versus third party brands. Management guided to accelerated growth in FY17, driven higher by solid growth in the group s global brands (Budweiser, Stella Artois & Corona) coupled with stringent cost control, which will lead to margin improvement. ABInBev is trading at an earnings multiple of 21.2x out to December 2017 compared to the peer average of 20.9x. 05 The Estuaries, 2 Oxbow Crescent, Century City 7441. PO Box 207, Cape Town 8000, South Africa. Tel +27 (0)21 524 4400 Fax +27 (0)21 441 1060 www.omwealth.co.za Private Client Securities: Cape Town: +27 (0)21 524 4400 Sandton: +27 (0)11 245 3805 Pretoria: +27 (0)12 369 7236 Durban +27 (31) 581 0600 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. 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