Sean Peche – Praising Mteto; comparing Discovery and Remgro; and stocks after rate cut

Ranmore founder Sean Peche specialises in finding cheap shares, often among the neglected small and medium-sized listed companies. He pays little attention to the ‘big news’ like the surprise 50 basis point rate cut from the US Fed, preferring to focus on areas where he can see opportunities to buy low and sell high. Freshly returned to his UK base from BNIC#1, Peche identifies the star of that show (Mteto Nyati) and uses the advantage of fresh eyes to compare annual results just released by Discovery and Remgro. He spoke to BizNews editor Alec Hogg.

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Edited transcript of the interview ___STEADY_PAYWALL___

00:08

Alec Hogg
Sean Peche is the founder and chief investment officer at Ranmore Funds. He was at the business conference last Thursday, gave us a wonderful presentation, which will be published in the course of next week. We’d love to get his impressions and also some insights on the interest rate cuts and some South African companies that have just released financial results.

00:38
Alec Hogg:

 Well, there we go, Sean, quite a mouthful. Let’s start with getting home, back to the UK, having a look at your homeland. It is your homeland, as I always say, there’s no such thing as an ex-South African. Unfortunately, wherever you are, you’ll be given away by your accent. What did you take from the conference last week?

01:06
Sean Peche:

Yeah, Alec, it was tough to come back, I’ve got to be honest. One week in beautiful South Africa is definitely not enough. And only a day or so in Hermanus. I thank you and thank you for the opportunity to be there. And, you know, September’s a beautiful time, Pro-Tier’s up and Bloom, it’s stunning. So, different beauty at different times.

Now, in terms of the BizNews Investment Conference, I mean, I thoroughly enjoyed it. And I must tell you a story which I didn’t get to. The night before I was staying at our place in T.V. on his cliff, and the night before I had drinks with friends. And one of the, and we were talking about Eskom and one of the ladies, Gail, good friend of ours, she, she said, “Oh, I must tell you, I worked with Mteto Nyati. The guy’s brilliant.” I said, “What makes him so special?” She said, “He’s a great leader and he’s so collaborative and he will bring people on site.” I’m like, “Wow, it’s amazing.” I hadn’t even looked at the agenda. I was so busy and so rushed to get there. I couldn’t believe it. I look at the agenda the next morning and there he is, speaker number two. So I had to go up to him and mention Gail’s name.

So it was really enlightening for me to see him speak and to hear about the wonderful stuff that he’s done. And I thought for me, he was the winner. Okay, he was up against some tough competition. But I thought Mteto Nyati was very, I thought it was a great speech. And I just think, you know, he has done remarkably well. And I think the other thing is, so often when everybody is on one side of the seesaw, everyone’s negative, “Oh, this load shedding is going to go on forever,” etc. Boom. You know, all of a sudden, like there’s no load shedding. So it just shows you one’s got to be careful about getting too fixated, too negative, too positive, etc. So congratulations to him and his team.

And the other thing which is interesting is that you’ll recall that one part in his speech, he talked about AI, joining the dots with individuals saying, “Well, hang on, this person does this job, but they’re driving a Maserati and live in a five million rand house in wherever,” you know, and those dots don’t line up, those points don’t line up and they use AI. Now, if a big corporation like Eskom is finding benefits from AI, it just shows you, and it’s a point I’ve made before, is don’t just think that the only beneficiaries of AI are Nvidia, it’s the other companies too. So, for me, that was just fabulous and I was ready to like to see, and you know.

That just makes such a difference to the small companies out there that can keep the lights on, the restaurants, the shops that are able to carry on charging people with their handheld terminals, etc. So it makes a big difference and it’s great and well done. So yeah, that was my key takeaway.

03:31
Alec Hogg:

You mentioned the small companies. Another takeaway from the conference was the appeal of small and medium-sized South African listed companies at levels that hadn’t existed for many years, if not decades. What was your take on that? Did you go back home and start looking at annual reports to see whether he was pointing you towards something interesting, given that you’ve got the whole world to choose from?

04:01
Sean Peche:

Yeah. I mean, look, we have a South African small-cap company, AACI, in the portfolio at the moment. And I mean that whole theme, if you think about it, like where has the money been going the last 10 years? It’s been largely in passives. That’s largely the large companies. And who have people been taking, you know, when people move their money from active managers to passive funds, well, the active managers have to pay for that redemption, so they have to raise funds somehow. And so quite often the small caps get discarded. So it’s a global phenomenon. And that was why, you know, and when you look at the number of the variables including the valuations, especially the valuations really, and the growth prospects. We are positioned in mid-caps and smaller companies rather than the large companies because they just offer better value.

And I mean the other thing is if growth is hard to come by, well one of the ways in which the big companies can grow is to gobble up the little companies, you know, and to make bids for them at huge premiums. And so you have that optionality in the smaller companies that you’re not going to have. No one’s going to take over Amazon or Microsoft or Nvidia, but you know, somebody, somebody could take over some of the companies Pete mentioned. And I’m not going to, you know, people are going to watch his presentation to hear the name. So I totally agree. And I totally, and I think it’s a global phenomenon as well. And of course, you know, South Africa is not the only cheap market in the world. Hong Kong is pretty cheap. And that’s why we’ve got, in fact, we have about as much, if not slightly more, in Hong Kong than we have in America. Some people might go, “You’ve got to be kidding me.” I’m going, “Well, that’s where the value is.” That’s the market that’s been ignored. They go, “But I’m in China. What about the growth?” You go, “Well, it’s hardly like the US economic data is all roses.” That’s why the Federal Reserve is lowering rates a little bit. They’re worried about the unemployment. I think they’re on the money pit side.

06:18
Alec Hogg:

The Federal Reserve lowering rates, we heard last night that Jay Powell, the Fed Chairman, is cutting interest rates there by 50 basis points or half a percent rather than what many thought would be only a 25 basis point cut. Were you surprised?

06:48
Sean Peche:

To be honest, I didn’t pay any attention to that. I didn’t have a forecast. You know, no one in our team, we didn’t poll our team and say, “How much do we think the Fed’s going to lower rates?” because we just don’t worry about that kind of stuff.

What is interesting is I read an article this morning that of the 113 economists who were surveyed by Bloomberg, only nine of them expected a cut of this magnitude. Now you never really know because it’s also not just about the numbers, what did they say and what they said is that they’ve got a dual mandate, they’ve got to achieve maximum employment and inflation around 2%. So they’re obviously a little bit happier with inflation coming, falling largely because of the base effect. But unemployment has been ticking up and so they’ve got to manage it. And I guess to go 50 basis points, if it’s, you know, they don’t want to be too late. They were too late last time. So let’s err on the side, maybe err on the side of caution and do that.

The one point I haven’t really seen a lot of people comment on this morning is that what they did say is the committee will continue reducing its holdings of treasury securities. Now that’s quantitative tightening that I touched on in my presentation. And I hope my presentation wasn’t too complicated for, you know, so maybe, well, maybe that means I have to watch it a couple of times, which is not a bad thing. But you know, one has to recognise that the era of quantitative easing and low interest rates is really over because I mean, you’re down to 4.75 to 5%. That’s not the nought.

That was the environment which many of these companies flourished in. So, yeah, I mean, I know the other thing, Alec, and I think we’ve just got to be mindful of this and I guess it never appears at the time, but if you look back, we don’t have a lot of data points on this. Okay. But the Fed’s rate cuts happened before the last two recessions. And actually, if you go back and that was in 2000 and 2019, obviously COVID, you know, exacerbated that thing. So let’s take that.

So the problem is we don’t have a lot of data points, but if you go back to, you know, 1974, typically when the Fed starts lowering rates, it means lower economic growth. Okay, that’s what they’re seeing and that’s why they’re lowering rates. Okay, so we just got to be quite on the ball. If that flows through to companies’ earnings, that’s going to be a factor. But that’s what history tells us. History also tells us that the best time to be buying shares is when interest rates start falling.

09:15
Alec Hogg:

There is a direct correlation between the two. Now that’s markets generally. Clearly it’s not really your game because you’re looking for the jewels in any kind of market condition. But if you are a person who owns a lot of exchange traded funds and in other words just buying the market generally, is this a good time to be upping the ante?

09:44
Sean Peche:

Well, you know, I think, you know, the problem with looking back, and we never really one of those people who say, “Presidential years markets do well” or that kind of thing is because every time there’s different situations. So yes, it’s, you know, maybe it has been a good time, but it depends on what the valuation is. So in 2000, when they started lowering interest rates in 2000, you know, valuations were pretty much where they are now. And over the next year, markets fell in a heap. In 2019, prices were lower, but also fell in a heap, but that’s because of COVID. So each time it’s different. And that’s why we don’t really pay too much.

We’ll be aware of it. We know that the Fed’s lowered rates and all that, and we’ll say, “Okay, well, what does that do?” That’s not good for companies that have got a lot of cash, because what does that mean? It means that they’re going to earn less interest income on those businesses. And so, and it is good if those rates, that lower rate gets passed on to the underlying companies. It is good for those companies who are indebted, but you’ve got to be careful about making sweeping statements because it depends if a company’s got a lot of debt.

Maybe they fixed the rate. You know, maybe they’ve got so, so that that rate is locked in. You know, it’s only helpful if it’s variable. You know, it might help the housing market. And I see the home stock, home building stocks, you know, hit a new high. So one’s got to be careful about making sweeping statements. That’s the second-level thinking I like, you’ve got to look a bit deeper, you know, and I mean, what was interesting yesterday is that the market.

11:11
Alec Hogg:

The market initially took the news positively but then closed on the lows. Many people were saying that wasn’t a good sign. However, you wake up the next morning, and Asia is up, Europe is up nearly 2%. That’s good. Also, it has an impact on currencies. The Euro is strong, the pound is strong; they’re all close to yearly highs. The rand is strong, and the Brazilian real is too. For those with money in the US, it’s worth noting that the US dollar is not the best currency right now because other currencies are appreciating.

11:41
Sean Peche:

Yes, indeed. There are lots of moving parts, which is why we focus on bottom-up individual companies rather than trying to predict numerous variables. Some say “sell in May and go away,” but that strategy can lead to losses if applied indiscriminately. It’s similar to horse racing advice, such as not betting on a horse making its second run after a rest, though many horses have won under such conditions. With so many variables in play, it’s crucial to look at individual companies rather than relying on broad strategies.

Speaking of moving parts, South Africa had two well-known companies report their financial results today. While it’s not my primary focus, let’s briefly consider Remgro, often touted as a cornerstone of a South African portfolio, and Discovery, known for its success internationally, including in the UK.

I haven’t reviewed these companies in 20 years, so bear with me. I had only an hour this morning to quickly assess them. Being from South Africa and Canada, I approach this without bias, as if I’ve just discovered these businesses.

13:05

Remgro is deeply tied to the South African economy, with significant holdings in MediClinic, OutSurance, Air Products, and others. However, EPS hasn’t grown; in fact, it fell to R10.18, down from R11 in 2013. Over the last 10 years, total return, including price and reinvested dividends, has been around 12%, but for investors, it’s been a poor performer, with returns of just 44% in 10 years.

The stock was previously at a premium to book value but is now at a discount. The market has wised up. Remgro was once seen as a business with inherent value, but it hasn’t delivered as expected. They claim an intrinsic value per share of R251, yet earnings remain at R10, translating to a 4% return, which is quite poor.

A large portion of the intrinsic value is tied to their telecoms business, which is currently losing money. Why would one pay a high price for a loss-making business, unless it’s seen as a one-off issue? Conglomerates often face fluctuating performance across their subsidiaries, leading to discounted valuations. Management needs to unlock value, which has been disappointing.

Looking at the management team, who have been in place for 14 years, and the CFO for nine, the stock has a 1.6% dividend yield and trades at 11 times earnings with low ROE. Based on this, I wouldn’t be buying it.

16:22
Alec Hogg:

That’s a very insightful analysis. Often in South Africa, Remgro is bought simply for its reputation. Now, what about Discovery?

16:45
Sean Peche:

Discovery, under Adrian Gore, shows a different picture. Operating income is up 17%, headline earnings up 15%, NAV up 16%, and embedded value is up 12%. Their Ping An Health Insurance JV is contributing significantly, up 85%, which is impressive. Discovery’s growth prospects with Ping An and new business up 18% make it a strong performer.

Discovery’s total return has been 61% over the last 10 years, compared to Remgro’s negligible return. Even in dollar terms, Discovery is up 3%. It’s trading at 12 times forward earnings, a similar valuation to Remgro, but Discovery clearly offers more growth potential.

18:12
Alec Hogg:

Given their similar ratings, if you were to choose, you’d go long on Discovery and short on Remgro, expecting the market to adjust the valuations accordingly?

18:42
Sean Peche:

Shorting involves risks, such as potential positive news from Remgro that could impact the stock unexpectedly. If forced to choose, I would definitely prefer Discovery.

19:12
Alec Hogg:

Discovery’s insurance business is already separately listed, so they don’t have that option, but they have other unlisted stocks in their portfolio.

19:40
Sean Peche:

As for the US interest rates, what happens next is worth watching. Over the last 20 days, the equal-weighted S&P 500 has outperformed the market-cap-weighted S&P 500 by 2%. This suggests that smaller companies outside the major tech stocks are gaining traction. If lower rates help earnings grow and reduce funding costs, valuations should rise.

It’s not just about the US; central bank actions globally could also influence economic growth. While many investors have focused on the US, it’s worth considering opportunities elsewhere. It’s similar to rugby; while everyone watches the backline, sometimes the eighth man on the blindside scores.

21:01
Alec Hogg:

Sean Peche from Ranmore Funds, thank you for your insights. I’m Alec Hogg from BizNews.com.

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