Wilhelm Hertzog was the market commentator on the Power Lunch with Alec and Gugu today. Wilhelm is an analyst and portfolio manager at RECM, where they focus on value investing – the practice of buying stocks that are substantially undervalued so that they can benefit from the correction of the price over time. This investing philosophy is one that is based on the analysis of the fundamentals of a business and the industry it operates in, and it is for this reason that Wilhelm’s insights offer a succinct amount of research-based wisdom. Today he discusses the retail sector while looking particularly at Ellies, the size of its market cap and how this affects its share price. He also unpacks the resource and construction industries in great detail, and offers us some sterling stock picks and trading adivce based on seeking intrinsic value. – LF
ALEC HOGG: Wilhelm Hertzog from RECM is with us in the studio here in Cape Town. It’s nice to be here with you Wilhelm, on a sparkling Cape day. The market’s not quite as sparkling. Let’s start with that Ellies story. A year ago, the CEO could hardly help himself. He needed to get out of the studio and go and buy shares at R8.00, and now it’s at R3.30. Was he just blindsided or is this a company that now starts coming onto your radar?
WILHELM HERTZOG: It’s not a company I personally know very well. It is something we have paid a bit of attention to in the past. One often finds with these small cap stocks that a certain hype builds, and you see some positive performance for a couple of years. People then start extrapolating that great performance of a year or two into the distant future. The share price gets ahead of itself. We find that management often get caught up in that positive sentiment and almost starts believing the hype that’s been created by short-term results. The CEO’s response – rushing out to buy shares – I don’t know whether he actually did buy shares.
ALEC HOGG: It was on the SENS report.
WILHELM HERTZOG: So he did. It seems as though he honestly believed that there was a lot of positive growth ahead and his expectations missed, if you want to put it that way. That’s just one of those things. That’s the way small cap shares often go. They are very volatile and it is something to keep in mind when you invest in the smaller cap sector side of the market, because sentiment and individual investor sentiment often drives prices to extremes either way. You can find terrific bargains, but you can often find very expensive stock in that sector as well.
GUGULETHU MFUPHI: Wilhelm, doesn’t this just highlight the concerns with South African Inc. companies in that sometimes, economic conditions do have an impact on the overall companies’ performance?
WILHELM HERTZOG: Absolutely. No company is immune to overall economic conditions and they are sluggish in South Africa, as we all very well know. Ellies have come off a good run and it’s probably finding life a bit more difficult now as companies do, but it’s also important to remember that is the way of business. Businesses go through cycles. You go through up cycles and down cycles and the key thing to keep in mind is at the top of the cycle, things won’t stay as good as they have been and at the bottom of the cycle, they won’t stay as bad as they have been in the recent past. That’s often a great source of opportunity because investors tend to focus on the recent past.
They tend to, as I say, extrapolate recent positive performance into the distant future, and extrapolate recent poor performance into the long-term future. If you can find a more solid middle ground and a more realistic middle ground, and base your expectations on that, you can often find great investment opportunities.
ALEC HOGG: The unfortunate thing is that too many of the politicians – when things are good, – see it as continuing indefinitely as well.
WILHELM HERTZOG: Sure.
ALEC HOGG: Tsogo Sun is an S.A. Inc. company, mainly based in South Africa. It seems to be doing okay. There was a SENS announcement today where the management are now going to get even greater portions of that pie.
WILHELM HERTZOG: Yes. I must say it’s quite a bold move by management. I think Tsogo Sun is a great business, owns fantastic casino assets in South Africa, is a share, which our clients own in decent size, and we have great respect and admiration for both Tsogo Sun’s management team – headed by Marcel von Aulock – and HCI’s management team, which is the holding company of Tsogo Sun. They own just more than 50 percent of Tsogo Sun, if I remember correctly. Be that as it may, at the current price we do think it’s an attractive investment. Hence, our clients owning substantial amounts of Tsogo Sun shares, but still, Marcel von Aulock (the CEO) is putting down R86m to buy shares – financed by the company (it has to be added) – so it isn’t cash coming out of his back pocket. There is a financing scheme in place by the company, but it is a bold move and it expresses a great deal of confidence in the company’s future.
Hopefully, a better place than Wayne Samson’s was a year ago. As I say, I think Tsogo Sun is probably a company of greater substance than a small cap, in South Africa. It’s understandable that they’re willing to put down money, but it is quite a bit of money.
GUGULETHU MFUPHI: Wilhelm, just to look at the resources space for a moment or two – the likes of Anglo American and BHP – the usual positive performers when it comes to the resources space. Just a moment ago, if I do recall correctly, Piet Viljoen – one of your colleagues at RECM – is quite bullish on platinum stocks. Is this also an opportune time to be picking those up? Do you share his sentiments?
WILHELM HERTZOG: Absolutely. As a firm, we all sing from the same page and we share the same investment philosophy, so yes, absolutely. We view the opportunity in resources to be fantastic – not throughout the resources sector. There are sectors, which we are still very cautious of – iron ore being one, but broadly speaking, platinum in South Africa, some of the diversified miners – Anglo American, specifically – we think those stocks offer fantastic value. They are really priced as attractively as they have been in the last 20 years, even going back to the early 2000’s, if you look at price-to-book ratios and normal earnings ratios, they are fantastically attractive. We very much share those sentiments.
ALEC HOGG: You’re also looking at ArcelorMittal. I know that was one of your favourites that Piet was talking about. Today, we saw Evraz’s results (the old Highveld Steel) – Russian owned – and Evraz has had troubles internationally. Do you look at that to get support perhaps, for your bullishness on ArcelorMittal?
WILHELM HERTZOG: They’re very different in terms of scale as well as in terms of the type of product they produce. Steel isn’t steel. Evraz produces a specific type of steel. ArcelorMittal produces a different type of steel and Evraz has had numerous operational problems. The company’s really in a bit of a different boat to ArcelorMittal, which we think is a much safer and solid company.
ALEC HOGG: So you won’t be buying Evraz.
WILHELM HERTZOG: No. We’ve had a close look at the company, given our interest in the steel sector, but the company has many issues: some of them are well known – others less well known. Our research has dug up some issues, which we’re just not comfortable that we can our heads around and put numbers on, so we’ve steered clear of Evraz.
ALEC HOGG: That’s interesting. So there’s also a management aspect to all of this with Paul O’Flaherty going in as the new CEO at ArcelorMittal.
WILHELM HERTZOG: Sure. Look, management at ArcelorMittal South Africa is pretty much driven by ArcelorMittal globally, so taking a view on how ArcelorMittal will be managed is also taking a view on how the Mittal’s will implement management in South Africa. We think they know what they’re doing and they wouldn’t allow ArcelorMittal South Africa, which is a sizeable asset in their portfolio, to be run by just anyone.
ALEC HOGG: Well, Paul comes from the construction industry. We’ve seen an interesting movement this morning in the Aveng share price, dropping by four percent. Is anything to be read in there?
WILHELM HERTZOG: Nothing that I can really say. Aveng specifically, has had numerous troubles as well as have many of the construction counters over the past year or even number of years. It has to be said that Aveng has probably scored a couple of goals in terms of operational execution, but why the share price dropped by four percent in one day, I wouldn’t really know.
ALEC HOGG: The construction sector as a whole: is that becoming attractive to you?
WILHELM HERTZOG: Sure, it is. It isn’t at the bargain basement levels that we saw in the early 2000’s, but definitely, our clients do own Aveng shares. For one, we’d have some exposure to other construction counters – Stefanutti Stocks being another and Raubex being another – but it’s not in substantial size. The opportunity, in our minds, is not as compelling as it is for instance, in platinum and resources, as we mentioned earlier. We have to say we definitely do think it is much more attractively priced than the market overall.
ALEC HOGG: When we were talking a little earlier, you made the point that business is not that easy, and sometimes when times are tough, we think they’re going to get even tougher. Of course, when times are good, it’s vice versa. However, there are companies who go bust. We have Alert Steel as an example. It went into Business Rescue and now it looks like it might not make it out of it. Do you ever go and look at those types of companies: those sinking companies… and look at that last puff before it goes bust?
WILHELM HERTZOG: Sure, we do and we have. In the past, we’ve invested quite successfully in some of those, but they are typically very small and for an institutional asset manager it almost isn’t worth the effort to deploy R10m or R20m in a business that’s on the verge of going bust. The size of the opportunity just isn’t enough to justify the effort. That’s a fertile ground of research for individual investors, but you have to know what you’re dealing with. It is a high-risk area, but if you get it right, you can make phenomenal returns. In South Africa, it is bit more difficult with companies going through bankruptcy. In the U.S. you have Chapter 11 – much more organised, much more developed, and a much more formal process of taking companies through bankruptcy, and keeping them listed.
I think that in South Africa, we’ve yet to see a listed company going through Business Rescue or liquidation, coming out intact on the other side in, and with investors not having lost a great deal of money. In South Africa, it’s perhaps an area that needs to be approached with even more caution than one would in the U.S., for instance.
ALEC HOGG: Wilhelm Hertzog is with RECM. It’s an appropriate reminder, given everything that’s going on at the moment, that businesses are not all home runs. In fact, many of them do go bankrupt and the difference between survival and thriving can sometimes be a very thin line.
