Piet Viljoen’s “cockroach” fund, where he invests in bombproof opportunities, has enjoyed benefits from buying into Chinese equities ahead of the latest surge. He explains why the rebound is long overdue, and assesses the present value. Also, in this interview with BizNews editor Alec Hogg, Re:CM’s founder talks about the impact for investors of the latest GNU ructions and today’s news from PPC, York Timber and Renergen.
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Edited transcript:
Alec Hogg (00:13.698)
Pete Follion is joining us to bring us up to date with what’s happening around the world. I guess the big story today in the investment markets is the craziness happening in China again. The markets are really surging ahead. We have a lovely proxy here in South Africa through Prosus and Naspers, although they haven’t performed as well today as the Chinese markets. Why, Pete, why is China going so crazy?
Piet Viljoen (00:24.047)
Yeah.
Piet Viljoen (00:43.615)
Well, I saw a chart this morning showing that globally, fund managers have found China to be the least desirable asset. In fact, hedge funds have been net short on China for the first time in a very long time. Sentiment towards investing in China had become extremely negative. Now we see the government proposing various monetary and fiscal relief measures, which I believe has led to some covering of shorts and a knee-jerk reaction to get back into the market, pushing it up by quite a bit—about 20% or so over the past week.
Alec Hogg (01:33.592)
What does “covering of shorts” mean?
Piet Viljoen (01:36.665)
So, hedge funds, in particular, can sell an asset short if they think it will decline in value. They sell it with the intention of buying it back later at a lower price, thus profiting from the decline. This is different from most investors, who buy assets hoping they’ll appreciate in value. Hedge funds profit from short positions by making money when the asset goes down.
Alec Hogg (02:08.642)
So if the market moves against them, they have to rush in quickly to buy back the shares, otherwise they’re going to get hit hard.
Piet Viljoen (02:16.375)
That’s right. Most hedge funds operate on a leveraged basis. So every time the asset price goes up, they have to cover more than they initially borrowed. The further the market rises, the more they need to cover, creating a self-sustaining cycle.
Alec Hogg (02:39.384)
But that sounds like betting; it doesn’t sound like investing.
Piet Viljoen (02:43.545)
Yes, there are many short-term investors these days. With social media and various tools, the market has almost turned into a casino rather than an investment environment. This has led to a significant change in markets over time. If you look at turnover on different stock exchanges, the average holding period is now less than three months. This represents a big shift over the past few decades.
I think it was Munger or Buffett who said that in the short term, the market is a voting machine, buying what’s popular and selling what’s unpopular. But in the long term, it’s a weighing machine, assessing earnings and adjusting share prices accordingly. This still holds true today, even though the short-term market has become casino-like. In the long term, the market remains a weighing machine that judges share prices based on the underlying earnings power.
Alec Hogg (04:06.072)
So just be careful if you get sucked into the casino and are doing well for a period of time; you never know when the trend is going to change. Like in China, as you mentioned earlier, it’s been a one-way bet for a while.
Piet Viljoen (04:19.899)
Well, since 1992, China has delivered exactly 0% annual returns in US dollar terms. It’s been a disastrous place to invest over the long term for various reasons. It’s a communist country, and the governance is uncertain. The legal system is not well understood—if anyone truly understands it. In contrast, countries like the USA, Europe, and the UK have well-entrenched company laws. I don’t believe a solid body of company law exists in China.
Additionally, there are exchange controls, and there’s a strong capital outflow from local Chinese investors. The variable interest entity (VIE) structures used by Chinese companies to list offshore don’t provide ownership of the business; they merely offer a contract that gives ownership of certain cash flows. This introduces various risks. Finally, China’s population is not increasing; it’s declining. Over time, an economy typically grows through population growth combined with productivity growth, but China is experiencing a population decline. Therefore, we can expect GDP growth to decline in the future. It’s not surprising that it’s been one of the worst places to invest globally over the past 30 years—much worse than South Africa.
Alec Hogg (05:59.778)
But every dog has its day. Is this going to be a temporary surge or a long-lasting trend?
Piet Viljoen (06:06.337)
Personally, I’ve viewed China as a potential investment for a long time because the prices didn’t reflect the realities investors face. For years, everyone focused on high growth rates and expanding infrastructure, paying little attention to the risks involved. Now, the focus is shifting to these risks, and prices have declined to reflect them. As a result, China is a much more investable place today than it has been for a long time.
Alec Hogg (06:46.87)
Are you invested there?
Piet Viljoen (06:49.595)
In the fund where I manage a billion, the Cockroach Fund or the Merchant Waste Investments Worldwide Flexible Fund, I have invested in emerging market index ETFs. I don’t take stock-specific positions; I invest by indices or funds. In the equity portion of the fund, I am very overweight in emerging markets, and within that index, China comprises about 30 to 40%. So, yes, I am invested.
Alec Hogg (07:21.134)
Are you happy after the 20% gain we’ve seen in the last couple of weeks to remain invested?
Piet Viljoen (07:27.227)
Yes, I’m still happy. Just because a stock or asset is up 20% doesn’t mean it’s gone from cheap to expensive. We need to observe how things develop going forward and continuously adjust our price-to-value relationship as fundamentals and prices change. So, just because something is up 20%, it doesn’t mean you have to buy or sell. On a price-to-value basis, China still looks okay. The risks are there, but the price remains low enough to compensate for them.
Alec Hogg (08:04.62)
Let’s come home now. You’ve been bullish on South Africa for a while now, rightly so. However, the recent reactions, especially over the weekend with the government of national unity coming into focus after recent changes, including Salia Brink, the mayor, being voted out of office—does this worry you?
Piet Viljoen (08:32.355)
No, I mentioned from the outset when the GNU was established that there would be a lot of noise. It is a compromise between different parties, and as with any compromise, there will be points of disagreement that need negotiation. These negotiations may manifest as public actions or take place in private. What happened in China is a public negotiation process, and I expect to see more of that going forward. So, I anticipate volatility. The GNU won’t be a smooth process; it’ll be influenced by the varying negotiating positions of its participants. This reaction doesn’t change my investment stance at this point.
Alec Hogg (09:40.514)
That said, there is increasing pressure on politicians to collaborate for the public good, but historically, they haven’t had a good track record in our country.
Piet Viljoen (09:53.967)
No, well, in any country, as it happens. If you look at UK politics over the past five years, it has been a greater clown show than anything the GNU has experienced. The situation in the US is another prime example; what’s happening there is absurd. Politicians often do not work in the best interest of the country; they work in their own best interest, primarily trying to get elected again. If the GNU can create an environment where most South Africans’ lives improve, it increases the electability of the politicians involved, which incentivizes them to continue their efforts in the GNU.
As long as they act in the public interest, I believe it can work in our favor as citizens.
Alec Hogg (11:01.262)
Pete, when can we expect these political changes to impact the markets or the bottom line of companies? We received an update today from PPC, which indicated that cement sales volumes in South Africa have declined by 5% over the past four months. Is it too early to expect improvements in that area given the political stability?
Piet Viljoen (11:31.247)
Yes, it’s far too early to expect any significant changes in fundamentals or earnings power of companies or the economy. Political stability is the first step, which then fosters confidence, leading to increased spending by companies and the government on infrastructure. The fundamentals follow later. When valuing an asset or business, there are two components: the cash flows it generates and the interest rate at which you discount those cash flows to present value.
The cash flows reflect its earnings power, which won’t change just because we had an election two months ago. The earnings power will materialize over the next six to 24 months as confidence builds in the economy. Since the election, long bond yields have decreased by 250 basis points, from 13% to 10.5%. If cash flows have remained constant, which I assume they have, the earnings power hasn’t changed, but the lower discount rate means today’s cash flow is more valuable than yesterday’s. So, valuations have improved due to lower interest rates, but we still need to see increased earnings power in the future.
Alec Hogg (13:22.04)
Have share prices overreacted? The JSE has reached a new record.
Piet Viljoen (13:28.986)
A significant portion of the JSE’s rise is due to stocks like Naspers and Prosus, which have reacted to developments in China and do not necessarily reflect local South African conditions. Yes, companies that I categorize as “SA Inc.” have seen their shares rise by 20%, 30%, or even 40% over the past couple of months since the election. However, I don’t believe they have run ahead of themselves. Their valuations are adjusting to the lower discount rate being used in the market. I think there’s still room for further gains due to improved fundamentals and earnings power. While there may be a correction in the future, the second shoe to drop is the increase in earnings power, which could lead to even more upside for these shares.
Alec Hogg (14:30.51)
Thanks for clarifying that for us, Pete. I’m curious about a company called York Timbers. I know you’re interested in smaller and medium-sized companies trading at significant discounts. The share price today is 225 cents, while the company’s net asset value exceeds six rand. However, I’m concerned about their earnings report for the year ending June, which indicated that the value of their net assets increased by 11% over the past year. We all remember what happened with a similar company, Tongaat Hulett, where the asset values seemed inflated. Should we approach York Timbers with some skepticism?
Piet Viljoen (14:53.359)
It’s important to analyze the assumptions behind the calculated standing value of the timber. I haven’t looked at it closely, so I can’t comment specifically on those assumptions. However, I suggest examining the management and the incentives driving them. At Tongaat, there were significant incentives related to share price and options that led management to inflate asset values, which ultimately spiraled into what looked like fraud.
York Timbers was previously owned by a private equity firm that needed to justify its valuation, especially as their fund reached the end of its lifespan and they had to sell. This situation may have incentivized them to inflate values, though not necessarily through dishonest means—just using aggressive accounting methods that the market eventually saw through. For years, the share price stagnated.
However, new management took over about two years ago, and I believe they are good capital allocators. They’ve taken significant shareholdings, and I think they will make the right decisions for the business long-term. Based on who’s in control and their incentives, it’s worth considering for long-term investors.
Alec Hogg (17:30.149)
It’s good to see them improving; they moved from a loss of about 70 cents a share to a profit of 30 cents a share over the past financial year. That’s a positive direction. To wrap up, how about Renagen? Has that company ever caught your interest?
Piet Viljoen (17:52.091)
Yes, I looked at Renagen a while back and owned it briefly when it first started in 2019. However, at one point, it became very promotional. When management becomes overly promotional, it often indicates they are more focused on selling the story rather than creating real value. I decided to sell my shares at that point.
I know they’ve made promises to the market, but those have not yet been fulfilled. The market is now in “show me” mode; Renagen needs to prove it can produce gas and helium at the promised quantities. They are about two to three years behind schedule, which gives them a credibility problem. The only way to solve that is through actual performance rather than just promises.
Alec Hogg (19:08.418)
Today, they released quarterly results indicating they have started producing helium, moving beyond the testing phase. However, they’ve encountered some production issues. At least now we can keep an eye on their progress.
Piet Viljoen (19:21.849)
Exactly. This is common with engineering and mining projects—they often take longer, cost more, and encounter more problems than initially anticipated. This isn’t unique to Renagen; it applies to any mining or engineering venture. Just think about home renovations; they often come with a long list of unexpected issues!
Alec Hogg (19:44.12)
Indeed! It seems like our snag list just keeps growing. But that’s the nature of things. Thank you, Pete. This has been a valuable discussion. I’m Alec Hogg from BizNews.com.
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