Sanlam stock tips – Anglos cheap, industrials expensive, not Imperial

When the overall JSE is looking fairly valued, or perhaps slightly expensive, seeking out pockets of value become ever-more important, even as it becomes more difficult. In this interview, Sanlam’s Alwyn van der Merwe discusses some of his group’s top value picks. Like many, Van der Merwe sees value in the resources sector. However, he doesn’t favour single-mineral plays like Impala Platinum, but rather, the diversified mining house Anglo American. While he thinks that industrials are generally overvalued – particularly current favourite Naspers – he does see some value in stocks like Imperial. Overall, it seems that Van der Merwe believes that value can still be found on the JSE, although it may take a little more work to cut through the clutter than it did a year ago. – FD

ALEC HOGG: Well, I promised you some stock tips and here they come. Sanlam Private Investments released its ‘must have’ stocks for this year. Joining us to discuss these picks is Alwyn van der Merwe who is the Director of Investments at Sanlam Private Investments. Alwyn, I see you’re going along the same refrain from quite a few people that mining shares are very cheap (or resources stock generally, are very cheap). Which ones in that sector caught your eye?

ALWYN VAN DER MERWE: Good afternoon, Alec. Yes, we just used an example of Anglo American and we saw their production results yesterday. For us as investors, the best thing you can do is buy a quality share at a cheap price. Unfortunately, as we know, in the investment market you can’t have your cake and eat it, so you seldom find quality shares at a cheap price. Maybe I should just take a step back and say what quality is. Often, people associate quality with a smooth earnings stream, but I don’t think that is a fair definition of quality. You might even find, within the resources area, quality stocks. For us, the quality stock is a stock where the profitability is much higher or higher than the cost of capital through the cycle. I think what happened now in the market, is that there’s so much uncertainty about the earnings prospects of the mining companies and the resources companies, that people doubt the ability of those companies, that the profitability will be better than the cost of capital and therefore, those shares are cheap now. Probably the cheapest of the lot is Anglos, which currently trades at a price-to-book of one, compared to a price-to-book of three-and-a-half times, if you compare it back to 2008 where the story and the theme around resources was a very positive one.

ALEC HOGG: Alwyn, as you mentioned earlier, we did have the operational update. I was talking with Stephen Meintjes when it came out…just after the operational update came out yesterday, and he said that reaffirmed his view that Mark Cutifani is getting Anglos right. Do you agree?

ALWYN VAN DER MERWE: We certainly agree with that. I don’t think it is unique to Anglos. If you look at mining companies across the world, we’ve seen change in top managements across a whole range of companies. Maybe we can just compare it against the history. In the late 2000’s, there was the general view that we’re on a super cycle for commodities and the objective of many of these mining companies was to get the metals out of the ground as quickly as they possibly could. I don’t think they focused enough on profitability. With a change in management, you can clearly see – not only in Anglos, but in other mining companies as well – the focus has shifted to a proper allocation of capital to make sure that when you engage in a project, that the profitability of those projects will ultimately add to shareholder value. In the case of Anglos, that is a very acute focus and whatever Mark Cutifani has done up until now…he’ll always get the reconfirmation of exactly that.

ALEC HOGG: And also, that he’s prepared to take the tough decisions. We were having this conversation this morning. I’d love to get your insights. If Cynthia Carol, the predecessor – because we’re talking about people and we’re talking about management – if she were still running Anglo American, do you think that the platinum strike would have continued for the period that it has, or might Anglo have buckled by now?

ALWYN VAN DER MERWE: You asked for a personal opinion, so I’ll give you my answer. I think management is stronger now and my view is – and it’s simply an opinion – Cynthia Carol might have buckled. It’s perhaps an oversimplification. You can clearly see that it is not only (to my mind) Anglo’s decision, but you can clearly see that Impala, Lonmin, and Anglo American…the three companies stand together in this particular case.

ALEC HOGG: Indeed, they do, but you always need a leader. You need a leader, as you say, who is perhaps a little stronger this time around. Alwyn, what about the other end of the spectrum? Sure, we all love mining stocks right now and we might have to be patient, but what about a great performer like Naspers?

ALWYN VAN DER MERWE: If you just look at the other side of the spectrum and if we may, focus on the sector, I think industrial shares in general, are expensive. As I’ve explained in the introduction, there’s very good reason. The industrial shares – many of the Blue Chips – produced, I think, very good earnings records over the last three or four years, which was a very tough economic environment. Most investors…the brands are hotwired, so they just extrapolate the historic pattern going forward. That provides them with comfort and therefore, they’re prepared to pay up. In the case of Naspers of course, it is exactly the same. Naspers, with their holding in Tencent has of course, produced wonderful earnings. Tencent itself, over the last few years has certainly, (to my mind) beaten expectations. The question is what do you pay for their outperformance in profits. I think Tencent is currently trading at an historic price earnings multiple of about 55 times. For me, that is quite a steep multiple. Based on consensus earnings, I think you’re talking about a forward multiple of about 43 times. Again, for me, that is on the expensive side. If you get any disappointments relative to expectations, the risk is that the share price will underperform and therefore, to our minds – and putting the value hat on – I think it is time to be quite cautious about Naspers. Some analysts would say, if you look at it on a net asset value basis, that the discount is still wide, but you must remember that the biggest building block within that net asset value is Tencent, and that share is priced only for good news.

ALEC HOGG: Indeed, it is. Anyway, it’s very hard for us to understand exponentials or the Chinese view of thinking in hundreds of years. That’s not something you have to worry about though, when you look at Imperial. You have 62-year old Chief Executive in Mark Lamberti whose been appointed there. It’s one of your tips. Are you thinking that Mark’s going to make a big difference there, or is it just a value play?

ALWYN VAN DER MERWE: We think it’s a value play. I think Hubert Brody did a great job. When Hubert took over, he restructured the business. I think the business now, is in a very healthy condition and I think it is a very easy business to understand because it was broken up into very clear segments. I think Hubert did a great job. As I mentioned about the mining companies, I think he also focused on proper return on capital. Hubert clearly explained why he wanted to leave the hot seat and we know we have experience coming in, but I personally don’t think that is really going to make a big change. The share price came under pressure because you have to understand that through vehicle sales and related industries, about 75 percent of the earnings come from that particular sector. As we know, vehicle sales have come off. Sales are currently probably flat, on a year-on-year basis. It certainly had a major impact on the company’s rating. The share currently created a multiple of just over ten times, which is a significant discount to the rest of the market. I think if you can look through the cycle – given the fact that the business is in a healthy condition – I think there are certainly growth prospects in Africa and even in other areas of the world if you’re patient. I think in this case, valuation will again be underpinned in terms of price movement. It will protect you against the permanent loss of capital, and when the news flow improves, hopefully the share price will respond positively.

ALEC HOGG: No doubt, you’ve also been talking to Mr Brody himself, whose now living close to where you are. Alwyn, just to close off with, two of your other picks that I just really want to get a sense of is Sun International and Invicta. Are they both value players, similar to Imperial, that they’ve been ignored?

ALWYN VAN DER MERWE: If you look at the Invicta share price, it had quite a strong fourth quarter last year, so if you look at Invicta over the longer term, it’s been one of the outperformers. Again, if you look at the share, the share has growth via acquisitions. You certainly need to put that share in the quality basket. For the last three to four months, the share price has moved sideways, but as I said, after a period of decent performance we think the company will do some of our work for us, where we say to clients ‘you must invest your money offshore because there’s better value in certain areas offshore;. What many of these companies do – and Invicta is one of them – they’ve made offshore acquisitions, and again, based on the historic track record where most of their acquisitions were very successful and they’ve added shareholders’ value. We think that over time, Invicta will continue to do that. That is the Invicta one, so it’s certainly a long-term one.

ALEC HOGG: Alwyn van der Merwe is the Direct of Investments at Sanlam Private Investments.

Well, that’s all from us here in South Africa. I hope you took down those names on the screen. We didn’t get a chance to talk about Sun International or indeed, about Kumba, but you can hear the way Alwyn thinks and it’s very similar to Kokkie Kooyman, his colleague there at Sanlam. They look beyond the cycles. They look past the cycles. They look for value and I think if you do your own homework, you are probably going to find similar value as well.

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