Regular market commentator and value investor, Wilhelm Hertzog, from RECM joined Alec on the Power Lunch today to discuss the markets. Along with his views on the construction sector and Mondi’s latest trading statement, he shares some contrary views on South African companies benefitting from the wide-spread labour unrest. For some expert opinions that help us focus on the potential of a silver lining for SA inc. have a listen to this interview. – LF
ALEC HOGG: We’re such a nice, smooth flow, you know. It was like a scrumhalf pass into the fly-half pass, into the inside-centre, and you were supposed to break the line, but I think we dropped the ball there. Okay, Gugu’s question was, do you pay much attention to what happens to the Rand? My response to her was you look more at the underlying company.
WILHELM HERTZOG: Sure, we do but obviously, the Rand has a bearing on what the price of an asset is, if it is denominated in Rand. If a company is selling products that’s denominated in Dollars, you need to factor in the fair Rand/Dollar exchange rate. If you’re investing in companies globally, you’ll need to factor in what the fair Rand exchange rate is, relative to the currency of the asset that you’re investing in, so we do need to factor that into the equation. As we know the Rand and currencies in general, can at times become materially mispriced and you could go very far astray if you just ignore the fair value of the underlying currency, so we certainly factor that into the equation mainly, by looking at long-term purchasing power parity, and to try to derive a fundamental value for a currency, based on that basis.
ALEC HOGG: But on a day-to-day basis, I’m sure it isn’t going to change your decision to buy or sell a particular stock.
WILHELM HERTZOG: No, absolutely. On a day-to-day basis, the fluctuations are typically so small as to be negligible. It’s more on a five to seven-year basis that you’ll find big mispricing, so say in late 2008/early 2009, the Rand got too cheap. Now we’re six years down the road. We’re looking at a currency, which is again, potentially somewhat too cheap. In the meantime, it went somewhat too expensive, a bit too cheap, but it’s really on a longer term horizon that you find the great mispricing so it’s the big mispricing that we’d be looking to take a view on.
ALEC HOGG: You know, we had a really good chat yesterday with Arnold Goldstone from Invicta. I know it’s one of the favourite stocks, or was, amongst many value investors in years gone by. It is up fivefold in the last six years, so I guess it is no longer really a value stock, but he gave us a very interesting insight into what happens in the engineering sector, when you have a strike like the one that we’ve just gone through. He said that although many of his operations are not unionised, NUMSA arrived there with mobs of hundreds of people, with arms and stopped his own workers or the un-unionised workers from working, and damaged equipment as well. Now, this is ‘mob-rule’, which clearly the rule of law of a country is very important. Is it making you reassess SA manufacturers, or have you already worked all of this in?
WILHELM HERTZOG: I think much of that one has factored into the equation already, when assessing the longer-term future of South African manufacturing. I think the cost pressure etcetera, the impact of that on margins, and the sustainability of returns being earned in the sector, the labour situation in South Africa is nothing new. We’ve had a difficult labour environment for many years now, to the extent that it is a known factor. We have factored that into the equation. I think the more important thing to assess and to get your head around is whether that could change, because obviously, I think its common knowledge out there that South Africa has a very difficult labour market that makes it an unattractive environment for companies to invest in, etcetera. What does that do for individual businesses on the ground, for a company like Invicta? Well, it potentially prevents offshore competitors from setting up shop in South Africa and from competing with the likes of Invicta, so that is maybe not a bad outcome for a local business who can actually see through the difficult times and find a way to work through the labour situation. For South African aggregate and for the economy as a whole, having the labour situation that we do is a big negative, but for individual companies the impact could actually be very different depending on the dynamics of industry competition and how they manage to navigate the turbulent waters.
ALEC HOGG: It’s very rational.
WILHELM HERTZOG: So, yes, it is, factored into how we look at companies’ etcetera, but, clearly a very difficult environment to navigate, for most businesses.
ALEC HOGG: A very rational way of looking at it Wilhelm, and it would suggest that there’s actually an incentive for big organisations – we’ve got one of the representatives. We’re going to be talking to him in just a moment (Kaizer Nyatsumba) – the big organisations to continue with this turbulence, so that you keep international competition out. It’s not good for the country, but if you’re one of the incumbents, as if you’re an incumbent in the Trade Union environment – not so bad at all.
WILHELM HERTZOG: Definitely. I think if you can take the cyclical view of the situation, and you say this is like, this is almost like a mining business going through a bad commodity price cycle. We have manufacturing in South Africa, going through a cycle where labour costs are rising very rapidly. That typically takes out the weaker competitors in an industry. The stronger ones who can see it through, who have the balance sheet to carry them through the tough times. Typically at some point in time, the conditions change somewhat and if you’ve made it through the difficult times into the better times again, you stand to make good profits. The competition has basically, fallen by the wayside and you stand to gain market share, and grow your business. That is the alternative view of the situation, but yes, definitely in aggregate, it’s not a great situation for South Africa.
ALEC HOGG: Interesting inputs there because, on the other hand, on the other side of this coin, we have Gerhard Papenfus who looks after the small manufacturers – the weak guys, as you might say – and they are whining at the deals that have been done. As I say, we’ll talk to Kaizer in just a little while. Murray and Roberts, the share accumulation program of Coronation continues. They are now over ten-percent. Is this a value play?
WILHELM HERTZOG: I think if you look at the construction sector, broadly speaking, it definitely offers better value than the South African market, as a whole. From a relative value point of view, I would say yes, there is some value to be found there but obviously, we are comparing that to the SA market as a whole, which by our measuring is quite expensive. In absolute terms, we are not super excited about the value on offer in the construction sector. Our clients do have some exposure to the sector but it is not in a very big way so, on a relative basis, I can see the value. On an absolute basis, we are not that excited but I can see where Coronation is coming from, if you want to put it that way.
ALEC HOGG: But they do have huge portfolios and lots of cash that they have to find homes for as well, so I suppose you can’t always be that picky when you are in their situation. Mondi’s trading statement that came out today; did you have a chance to look at it?
WILHELM HERTZOG: I had a brief look at it without being able to delve too much into the circumstances around the trading statement. At first blush, it looks like a bit more muted growth than what we’ve become used to from Mondi. Mondi has really delivered the goods over the past five to ten years in terms of growing its business, growing the earnings, and becoming a market favourite. I think this type of growth number is maybe a bit slower than what many people are factoring in when you look at the type of multiples Mondi’s share price is trading at, specifically relative to its peers, in the packaging and paper sector. Mondi is a very highly rated share, which is and this maybe falls a bit short of that, with a caveat that I’m not quite sure if there have been once-off factors that weighed on this trading statement.
ALEC HOGG: Another major South African industrial group that is now much more invested abroad, than it is in South Africa. That was Wilhelm Hertzog from RECM.
