🔒 David Shapiro: Stocks on sale – Sasol at 2005 prices, Discovery at 2014. Mr Market over-reacting

South Africa’s favourite market commentator David Shapiro is licking his lips at the value which South African shares are offering today’s investors, especially Sasol and Discovery. He discusses the attraction of both companies in this interview, from the latest episode of Rational Radio. Not often you get to see a dripping roast like this – but as Shapiro explains, Mr Market seems to have completely “lost it” over the spread of the Coronavirus. – Alec Hogg

When I contacted David Shapiro this morning he was using stronger words than Oy vey. Red ink on his prices page, the JSE today having one of its worst days in a long time. It appears as though the Coronavirus is playing a big role as well as other issues affecting Mr. Market who’s suddenly gone negative on South Africa. Most of the indices are down by 3% or more, excepting the gold shares. In this conversation – our weekly wrap up with South Africa’s favourite market commentator – we talk about the market generally and focus on financial results that came out today from Sasol. These were for the half year to the end of December where the headline earnings collapsed by 72%, earnings before interest and tax were down 53% – caused by a reduction in the Rand price of oil – 9% down which has a direct impact on Sasol’s profits. But more so through the negative contribution from the Lake Charles chemicals project, where – if you add it all up – it came to something like a R5bn direct impact on the bottom line. Considering that headline earnings in this half year was less than R5bn, it shows what an impact Lake Charles – the Louisiana chemicals plant project – is having on the group. But here’s David.

What’s on the screen?

It’s been absolutely hammered, global markets as well. I think they were a little too complacent on the outcome of the coronavirus and I think the reality is just beginning to dawn. We know what’s going to happen – and these things tend to be short lived – but when it happens it’s scary. The markets today are driven by algorithms and high frequency trading, so the movements are exaggerated in both directions. But you live through it.

I would have thought that’s the opportunity. Mr. Market is in full cry, he’s panicking, running into gold, but yet earlier in the program I spoke with Gary and Andy Cronje – South African teachers in China – and they say that it’s actually turned. People are allowed out of their houses again, they’re going on the subways, It’s almost like the worst is over.

Well in China it is. But there was this lockdown in Italy which is causing the problems and also the escalation in South Korea. But we’re not talking massive escalation, there was in a certain area in Milan that seemed to be spreading so they locked down 50,000 people there which has caused a bit of a panic. So we say okay done this before, each year we get something like this, you just gotta take it in your stride. You don’t want to argue against the market but on the other hand you don’t want to be caught up in the panic.

You don’t want to go and join Mr. Market. That’s why Warren Buffett became a great investor by ignoring the market and looking at the fundamentals. Why would Richemont drop 4.5%? Surely if it was going to drop it would have dropped in the past because China was a problem.

Because they’ve closed luxury goods which rely heavily on Chinese consumption. It’s going to come under pressure in this quarter. There’re also issues with supply chains particularly in the luxury goods. There’s a fear that with Hong Kong under pressure and China under pressure, demand’s going to come down. So it’s hurt luxury in a big way because of the association of the Chinese with luxury buying.

But that’s all in the market, it should be in the market already . I see what wasn’t in the market was Sasol and it’s taken a hammering today on those results. What did you make of the interims that came out this morning?

They’re a lot worse than we thought. One’s got to go through them in a lot more detail. What’s bothered me is they say a lot has to do with the macro economic environment and they saw a 9% decrease in the Rand value per barrel of oil. So that’s quite distressing. But I also think the bigger worry is chemical prices which they see going down for the next 12 to 14 months. Remember Sasol is no longer classified as an oil company, they like to classify themselves now as a chemical company – because of their production of chemicals – and the Lake Charles project is solely reliant on chemical prices. So I think that’s where the damage is really being done. To be fair, we’re at levels that we haven’t seen since 2005, 2006 in the share price.

And below R200 per Sasol share, you got to go back 15 years for that.

And this is a big company. This is a company of which we’ve been incredibly proud as South Africans mainly because of the technology that they developed and also because of what they mean for South Africa. It started off admittedly in the back in the 50s when it was formed as a hedge against the sanctions in the apartheid government, but subsequent to that it’s developed into a world class business. Of late we’ve been seriously let down.

Have you had anything to do with the new CEO? He’s been keeping a low profile.

No, I don’t know him at all and I think the numbers that are coming out now are just pointing towards a lot of weaknesses in management or previous management. Suddenly I think the cracks are beginning to form and that’s a worry.

But let’s be honest about it. If you’re the new CEO you clear the decks. It’s an old story that they do, so if you thought you might have to provide against a potentially dodgy debt you just provide against it if you’re the new guy because you can blame it on the old people.

You can, the Lake Charles project is also just battling to come right and I think – they reckon that they’ll be profitable in the second half – what’s troubling which no one foresaw are the chemical prices. In other words the end product is a lot lower than they forecast and therefore the returns on the amount that they’ve invested are pretty low. And you have to write it down to those levels. But Sasol is now – and this is a company that was easily within the top 10, 15 – it’s down at R124bn which is about half the value that we generally associated with it. So it’s really fallen down the ladder.

On the upside we said a moment ago that the new CEO – Fleetwood Grobler – would have cleared the decks as much as he could, he’s not going to make a forecast that Lake Charles will break even in the second half of the year if he isn’t absolutely certain.

I know. That we have to look forward to. I’ve got to go through the detail. You’ve actually got to go through page by page and get a feel. It’s a big company, with a lot of areas of business and you’ve got to get a feel for each one of those. But I must admit it’s thrown me off course and also the analysts. No one foresaw this. Nobody has come out and been highly negative on Sasol. Most analysts – and this is a broad generalisation – had targets of R330, R400 a share even higher than that. So this has really caught everybody off guard.

As has the substantial jump in the gold price. Dave, would you be climbing on their bandwagon?

Maybe. I’m not going to ignore it and I’m far from a gold bull. From a trading point of view, you can’t ignore where this is going, but it’s not my style. You buy a chunk of gold for protection and you hold it. I like to look 3,4,5 years down the line. There’s a fascinating piece in The Economist this weekend about the digital economy – which I think everybody should read to get an idea of where global economies are moving – and that’s where I focus. This is a big disrupter and it’s going to change the way we live and the way that economies work. So that’s where I’d be focusing. Would I buy gold against that? Probably not.

The problem about buying an inanimate object is that you’re going completely against the whole idea of companies which are supposed to be scaled by the human ingenuity.

That’s what’s so fascinating. Economists are trying to put a value to data. What value can we put on this object that they’re gathering? And how is it best put to use because with computerisation today, with sophisticated tools that one has, it enables you to run businesses so differently from the past in a much more efficient way. Also to understand the consumer. What’s interesting is people just give their data away. They’re quite happy. If you say to them just fill out this form and we’ll give you a half an hour extra data or we give you one week’s data. Yeah okay I’ll fill out the form. I’ll tell you about my life and all of that information is used to understand how people are thinking and operating and buying and so on.

But just to close off with David. The market as a whole had a horrible start, will you be picking up some of your favourites on a day like today?

Absolutely no doubt. You’ve just got to wait, you don’t have to be too hasty, but I think there’s no doubt that it’s going to throw up opportunities. I think this will pass. For the first time, you’ve got to look at South Africa from a value point of view and I think that private equity is going to come in. Alternatively companies will say I’ve had enough, I want to go private. Alec, you’ve been around a long time like me. Companies like Afrox, like Nampak, like ArcelorMittal, businesses that are real bricks and mortar, businesses that have a long history whose prices are trading on the market at literally fire sale levels, so I think that from this point of view one’s got to just do a lot more homework on the SA market.

And my favourite stock of the moment is Discovery. After going through the results carefully and having a lovely interview with Adrian Gore, I’m really enthused about the potential of this business and where its positioned. I know we’ve had conflicting views on it in recent times but at around R100 a share?

Yeah. This is the level that you can buy them. He’s got an incredibly bright management team. I think perhaps the brightest in the country and amazing energy levels as well. Where we’re all concerned, is that the South African economy is not in their favour and that’s hurting their traditional businesses. That’s Adrian’s worry. There’s nothing he can do to turn it around but you can’t take away innovation from them and where they’re heading.

And if you look at the detail of those financial results David, it’s absolutely amazing what they’ve managed to achieve outside of South Africa. They had the life operations in the UK that affected the overall picture at the interim stage, but if you look at the progress they’ve made in America with John Hancock, in China with Ping An – which is the biggest by far – they’re reaching 32m people on the app. Just put that the South African context, it’s everybody over the age of 10 maybe? And they’re only starting. Their management is looking at a 10 times target from where they are at the moment. If you start absorbing this from a global perspective, this is a stock that just jumps out at me and says please buy.

I see the innovation. My daughter Karen works there, she’s been with them for 15 years in New York. They operate out of Chicago. She’s on a lot of different projects and from that point of view, you can’t take the enthusiasm and their focus away from them. The trouble is they’ve got to start monetising that and then hopefully down the line that’s going to happen. But at the moment it’s a bit tough in South Africa which is where their traditional businesses is and the businesses that gave them the base, but you’ve got to watch them for innovation and you’ve got to commend them for their exceptionally bright people.

As I’ve been on my own globalisation journey for a period of time, I know how tough it is to crack into these international markets and what they’re doing in China simply defies belief. When you have a look at the share price of Discovery today knowing the decision that they’ve taken, to not generate profits, to only look at a 1% profit margin in the partnership with Ping An, because they’re going from RMB10bn turnover to RMB100bn. This gives you an understanding of where Discovery is aiming for – not where it’s going to get to – where it’s aiming for, what an amazing story.

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