Counterpoint value fund manager Piet Viljoen shares his strategy on how to protect and build wealth during inflationary periods. Many money managers have not dealt with such macroeconomic headwinds, given that the last time inflation was this entrenched and sticky was over 40 years ago. Piet is sticking to his knitting, buying undervalued businesses and investing in commodity companies where the supply-demand imbalances are causing prices to skyrocket. The Counterpoint value fund is built on a ‘bundle of twigs’. Each twig is fragile and subject to volatility in its own right; however, when bunched together in a portfolio, is strong. Coal counters Exxaro and Thungela are discussed as investment propositions, which wraps up the conversation. – Justin Rowe-Roberts
Piet Viljoen on inflation being entrenched
The most important part of managing money in this environment is to try and protect your portfolio against inflation. That is probably your main driver right now, as you point out, inflation is entrenched. We have the highest inflation level with us over 40 years and it’s eroding the purchasing power of your wealth.
On oil being the primary driver of inflation
Inflation is the annual price increase, so if the price of oil goes up to $100 and stays there for a period – say for more than a year – then inflation will go zero. It’s not only the price increase itself that matters, but the rate at which it increases over time. But yes, oil has been going up for the past 12 months since the pandemic-related lows of negative $40 a barrel in March 2020 and has been going up consistently. It has affected the inflation numbers. But it is not only oil, it’s also labour. People have to pay more to employ people, especially in developed markets and the supply chains are constrained.
On which sectors to be overweight in an inflationary environment
The historical data on that is quite mixed. It is clear energy is a definite hedge against inflation; in almost all inflationary periods in the past, it’s been the best performing sector. I think your strategy should be to invest in assets where the supply is constrained or limited because those companies that supply those assets will have the pricing power to some extent. So, one has to look at the supply situation for different products and commodities and where the supply is limited. I believe you’ve got a good chance of finding inflation-beating prospects.
On where to be positioned in the market
In the last 10 to 15 years, this generation of fund managers has become used to buying quality companies that can control the price. Companies can pass on pricing to their customers because of the brand they have, because of the distribution power they have and because of the disinflationary period we’ve been living in. These companies’ margins are widening and widening. The market has been buying these companies up, causing their share prices to increase. Those are exactly the sort of businesses that will not protect against inflation going forward because of the impact on margins inflation will have. In other words, inflation will start eroding their margins and these companies might be able to pass on some of their pricing to consumers, but a large portion will be eaten up by increased input costs. Those are the sort of companies one should avoid. One should gravitate towards companies where for environmental, social and governance reasons – or other reasons – they are not allowed to expand their supply of the products they produce and where there is definitely a lot of demand. Think of steel and copper used in electricity generation in the drive to net-zero emissions. Steel and copper are very important. Iron ore and building infrastructure, this whole ‘build back better’ theme that seems to be topical post-Covid-19. There will be a strong push towards infrastructure spending, and all of those types of companies are constrained from expanding and have been for quite a while. So, to the extent that the world will need more of the product, it just won’t be available and to get that product, you are going to have to pay up.
On what to do when a stock nears its fair value
Well, there is only one action and that’s to reduce your position size. Position size is always dependent on two factors. Number one is your expected return from the investment. The second factor is the risk attached to the investment. As something like Steinhoff approaches fair value – and it is still being a highly leveraged risky proposition – you would reduce your position, which is exactly what we did in the Counterpoint value fund.
On Thungela’s earnings guidance
The market didn’t have a clear view on its earnings and they’ve now made it clear they are going to be earning R60 a share and there is quite a large dividend coming as well. The market can now see what the earnings profile is. Of course, the market is saying, “Well, you know, we want to phase out coal and it’s two to three years.” Unfortunately, that’s not going to happen. I think coal is still going to be around for 10, 15, 20 years. It is an important input into baseload energy generation in emerging markets like South Africa, India and Indonesia. The demand is growing. It’s not declining. It’s going to be around. Despite the best well-intentioned efforts of the zero-emissions crowd, the use of coal will still be widespread for a long time.
Exxaro vs Thungela from a valuation perspective
Well, they are both equally cheap. They’re on prospective price-to-earnings ratios of two to three. Exxaro’s capital allocation, there is a question mark around that. So, one will have to look at the capital allocation very clearly.
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