Sanlam’s second Malaysian deal and Net1’s share bounce
First Avenue's Matthew Warren is a Sanlam fan. Even more so after today's R1,25bn acquisition of a controlling stake in a Malaysian life assurer, the group's second investment in the South East Asian country in the past year. In our interview today on CNBC Africa's Power Lunch, Warren explained why he is holding tight onto his Sanlam shares – but won't be buying any Net1 stock even though the price has recovered since last week's Constitutional Court setback. – AH
ALEC HOGG: Toyota plans to introduce a new low cost, locally produced car into the South African market next month. Based on the last Corolla sedan it is expected that the Corolla Quest will be priced at R170 000, and in the South African market that's low cost. Hey Matthew, 170 grand and it's a low cost vehicle in our market. They should perhaps take a trip to India where they have vehicles for one thousand Dollars I think it is, one thousand US Dollars – ten thousand Rand. We're a long way from it.
MATTHEW WARREN: Yes, I'm actually used to lower price plans on cars from my home country as well, but I think people are shifting down to lower price points and more fuel efficient vehicles in response to a tough economy and higher gas prices etcetera. You tend to see that in the auto market right now.
ALEC HOGG: Matthew, it's interesting to pick up on the other bits of news there…the big piece coming from Malaysia where Sanlam made an investment. I was reading through the SENS report, struggling to understand exactly how the Malaysian laws work. Did you make any more sense at all?
MATTHEW WARREN: I must admit I'm not an expert on Malaysian insurance in particular, but what you see Sanlam doing… They went in there last year with a large interest and a short-term insurer (Pacific Orients) and now they're going into the life space. They really want to be a diversified insurer across different types of products and have the whole gamut wherever possible. You've seen them do this in quite a few African countries. You've seen them go into NDA. You've seen them make a bigger presence here now in Malaysia. I think what they're looking for is commonalities to South African markets, so a relatively nascent market, and not quite as competitive as some of the global well-established markets. They're not looking to push in and be the 15th player in the markets, necessarily, but to use their expertise in terms of how to work that business model from the low end up and gain customers that way at a good margin.
ALEC HOGG: So, applying the learning they had from South Africa, elsewhere.
MATTHEW WARREN: That's right, and they've done it very well in Africa, as you see. They continue to push along with their partner Santam, certain banking partners, and some geographies as well, to try to get that holistic offering and build up to a scale-type offering on the larger players in each one of those markets.
ALEC HOGG: Are you a shareholder there, Matthew?
MATTHEW WARREN: Yes, we do own shares in Sanlam.
ALEC HOGG: And you wouldn't be offloading on the strength of this deal.
MATTHEW WARREN: No, not at all. The valuation looks very reasonable for such a high quality insurer. They have some of the highest margins, they have the best balance in their business, very efficiently run, and very conservatively stated financials. We like everything we look at when we look at Sanlam.
ALEC HOGG: Johan van Zyl ran it well, didn't he?
MATTHEW WARREN: Yes, because his company wasn't there a decade/15 years ago. In insurance and in banking, management matters a lot. There are risks you need to avoid. There's discipline, which you need to instil into the institution. You need efficiency. It's foremost in banking and in insurance, and the current management team at Sanlam has done a phenomenal job.
ALEC HOGG: We've been looking at the whole Net1 court action here on CNBC for a few days now. The mass media is picking up on it today as well – raising concerns. The investors in Net1 don't seem to be worrying too much about the fact that the court case went against it.
MATTHEW WARREN: Yes, if you look at it, they won this tender and took the business from an Absa subsidiary, and then I think there's been a question mark around that tender process. What the courts are saying now is that there are irregularities in that process and that it needs to go to tender again, but they don't need to put in a new provider right away. It looks likely that the current five-year contract might actually go through and then from there, a new decision taken up. I think that by the fact the court's going to make them publish their financials, it provides an avenue for the wounded party to perhaps pursue, financially, what maybe should have been theirs.
ALEC HOGG: But it is interesting that the courts did not find any corruption or any malfeasance. What they did find were a couple of technical reasons more than anything else, with which they hadn't complied. I guess, perhaps the Net1 shareholders are also thinking they might well get the contract again.
MATTHEW WARREN: Well, the cash flows are certainly coming in… It looks like good odds that the cash flows are coming in for the duration of the contract and then there'll be a new tender process. There's even some word in the press that they might bring this process inside. I guess, at the end of this contract there'll be another chance. The business already switched over. Absa wound down what they were doing and these guys are scaled up. That's where the business sits now. To me, it looks very unclear, going forward, what might happen next.
ALEC HOGG: Yes, when it's uncertain then it's probably best to stay away.
MATTHEW WARREN: Yes, we have no interest in shares in Net1.
ALEC HOGG: Uncertainty also in the pharmaceutical industry worldwide with the big moves happening yesterday, particularly with GlaxoSmithKline. Have you had a chance to unpack? Do you have any views on those?
MATTHEW WARREN: Yes, I definitely heard about the news and saw some of it. I don't cover pharmaceuticals in particular, but it looks as though Novartis wants to scale up in oncology. Really, the way I looked at it, they're getting rid of a couple of pieces of their businesses. It sounds as though they want to pursue better growth and better margins in the bulk of their business so they can shape the portfolio that way. You tend to get better reward by investors if your portfolio looks like that – big deals all around, but a lot of activity in the drug space.
ALEC HOGG: Huge bets that are being laid for the future. From a South African perspective, obviously you have Aspen (the dominant player here), but also, Brian Joffe moving more aggressively now with Adcock Ingram. Are you expecting that there'll be knock-on effects?
MATTHEW WARREN: Aspen is a world-class generics drug company right here in South Africa. They've expanded around the world and they've done it extremely successfully under Stephen Saad, so we really like Aspen. We're shareholders there. We're also shareholders in Bidvest, so if Adcock can be improved under new leadership with new direction, we benefit indirectly that way. You see a couple of high quality companies, especially Aspen, and there are some portions of Adcock that look pretty attractive as well, if it's better managed, perhaps.
ALEC HOGG: Matthew, there's been quite a lot of talk lately on this program with deep value investors, about the appeal of resources stocks. What's your take at First Avenue?
MATTHEW WARREN: In resources, it's extremely difficult to find quality or sustainable competitive advantage. Everybody is a price-taker essentially, in each of the various metals that they mine. What can you do? You can carve out a sustainable cost advantage by being a world-class producer and being in the low part of the cost curve. That's really the only way to do it. Billiton did that by having long life, large-scale projects, where they essentially get the unit cost down per ton of metal. They've done that very well over a number of years. Some other players have, but only in parts of their business, so we struggle to find quality. We own Billiton, but low quality miners, especially in South Africa have steady high operating costs every year, and not really the productivity to match, so you're in a bit of a vice. When the Rand therefore blows out, as it has in the recent past, it breathes a breath of fresh air into companies that frankly, were struggling. Now, for that to continue, you need the metal prices to continue to go higher, or the Rand to continue to blow out, or for the operating costs to come in line. To bet on any combination of those on a sustainable basis, looks like gambling to us.
ALEC HOGG: And platinum shares, now that it looks like maybe peace will break out…
MATTHEW WARREN: Yes, it's possible. They're talking about some mass meetings perhaps, over the next week. I find it encouraging for the country and for hard currency earnings, for example if they can bring this to an agreement. However, we don't invest in gold miners and we don't invest in platinum miners at this stage either. Much of what you see doesn't really resemble capitalism, in my opinion. You have pressure from all the various parties trying to grab at a piece of the pie. Even in an oversupplied situation with a low metal price, you don't see a lot of supply coming out of the market with various pressures involved. How can you get to an equilibrium price? How can you forecast that situation and normalise earnings? I think it's very difficult, actually.
ALEC HOGG: Do you like going into areas where it's simpler/easier to forecast?
MATTHEW WARREN: That's right. If you're going to pin a valuation on a company and you have a discounted cash flow model, you want to have some certainty around the parameters that key metrics into that model and results. That's what we're looking for.
ALEC HOGG: Matthew Warren is with First Avenue. Thanks Matthew, for coming in to this studio today.