Duncan Artus, one of the key portfolio managers and director at Allan Gray, is celebrating a decision to make hay while the foreign dumping of MultiChoice was happening – delivering a quick 30% return for his investors. So strong has been Allan Gray’s purchasing that the firm is now MultiChoice’s second largest shareholder. On Rational Radio this week Duncan spoke about why we South African radio stations should be quoting Naspers rather than the gold price; admitted to holding about 6% of Tongaat when the company crashed; and shared what he thinks will be the JSE’s winners during the next year. – Alec Hogg
A warm welcome to Duncan Artus who is a director of Allan Gray. Duncan, have you guys been exposed at all to Tongaat? It’s been a pretty big part of our show this evening.
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Yes we have unfortunately. But a lot less than we had at one stage. Obviously Tongaat has been listed for a substantial period of time, it also had Hulamin within it so it must be one of the stocks that’s been listed on the JSE for the longest time. But a while back we started selling fairly aggressively. But even with that our clients still own around six percent of the company. So it’s a very small portion of the portfolio but it’s never nice to own a stock that has been suspended at the moment.
And what’s your take on the survivability of it now that all of this stuff is coming out?
Well the one thing I’ve learned is that lenders have the upper hand. I remember in Supergroup – although that turned out to be a good story for me – Supergroup had two rights issues at the bottom. But when you owe money to lenders, the money can become due at any time. I mean the equity holders take a back seat to the lenders and I guess they rightfully sit last in the capital structure. I think Tongaat’s market cap when it was suspended was around R1.8bn. The gross debt closer to R10bn and net at R8bn. Whenever your equity is so small relative to your net debt on the balance sheet, it becomes difficult. And I guess you could be at the whim of lenders. We’re not going to know until the results are eventually published. Whether it was recognising revenue too early on property sales or valuing the sugar cane incorrectly, those are non-cash transactions. So when it comes out it’s going to be important to see what the cash was and that’s what we became concerned about over the last year. So if you looked at the accounting profits they were fairly different from the free cash flow. But we’ll have to see. I guess if you are a contrarian investor you know you’re going to have a few of these in your career. It’s very hard to manage public money if you’re too scared ever to make a mistake when something appears cheap on the face of it.
Duncan, somebody who is really enjoying life right is anybody who owns a gold share – again today they had a fantastic run. Allan Gray, for a while you were very contrarian, you had a lot of gold shares. Do you have any exposure to them now?
We don’t. We’ve had a lot of big stakes in gold over the past 18 years but only at various points in the cycle. And sometimes it worked out, and sometimes it hasn’t. At the moment we have a small exposure, we have some Goldfields. We also have actually the physical gold. So in the Allan Gray balanced and stable funds we actually hold the listed gold ETF that lets you benefit from the rising rand gold price. Generally we’ve found with the gold mining companies and platinum companies it’s been better from a risk adjusted point of view to own a little bit of a physical product. I certainly remember when I started in the market people always said it was better to own the mines because they were geared on the upside. That worked for the first five or six years but after that, during the last decade or so it’s been obviously much better to own the metals than the mines.
Ironically we spoke to former gold miner and Bernard Swanepoel a bit earlier about the bubble in the exotic game market. Is this what we’re seeing in gold now? These shares have really run like scalded cats in the last three weeks. Is there a bit of a bubble developing there to?
When gold hits a bubble the shares will go up a lot more than this. You have to look at the charts in history. As you would know, gold mines have a lot of their costs reasonably fixed so anyone with a spreadsheet knows if you change a gold price from $1,200 to $2,200 all of a sudden the profits go through the roof. And then at the same stage people start to value your resources (and reserves). What I mean by that a gold company has reserves in the ground obviously that they mine every year and by definition they also have other gold in the ground that can become profitable at higher gold prices and people start to put a value on that as well. So I think when you get into a gold bull market what I would look for to tell us we’re close to the top would be when gold exploration companies and other companies that haven’t even started production yet start to get valued at high valuations in places like Canada and the AIM market in the UK.
So I wouldn’t say it’s a bubble. It’s very hard to pick the top right because the liquidity tends to disappear on the way down. So you have to be a disciplined seller if you’re a long term investor. If you’re a trader in gold shares, good luck. You can make money which can often lose quite a bit because they’re not the highest quality companies in the world. The one thing I would say that’s changed in the larger cap miners is obviously we’ve seen a lot of consolidation in the mining sector.
When you talk about large in the South African context it means Naspers. and Naspers makes up about 20% of the weight adjusted index. A lot of South Africans, every South African who’s got a retirement policy has got some Naspers exposure.
I would say it’s probably South African people’s biggest asset after their house. That is a guess of mine because I mean it would be their pension fund and by the way South Africa’s biggest net asset management is Tencent. We can’t think of any asset that the country owns offshore that’s bigger than Tencent. So yes, that’s very important to South Africa. Talking about gold, the radio stations always quote the price of gold but that’s crazy, we don’t produce much gold anymore; they should start off with the price of Naspers.
But going back to Naspers, we’ve got the results coming out tomorrow and because they so important in a South African context, what’s your sense of what we should be looking out for?
I think what people look for in the results in Naspers – obviously Tencent reports separately and quarterly on the Hong Kong stock market. So people have a fair idea what the Tencent numbers are. So what people are really looking for in the rest of Naspers – now that they’ve unbundled the pay television business MultiChoice which is separately listed that used to provide the cash flow which Naspers would use to invest growing their, for want of a better word, e-commerce social empire across the world. I think what people want to see is progress in their online classified business. And I think in the last set of results it just turned profitable if you excluded the US operation.
And the MultiChoice spinoff which came out with results earlier this week. Have you guys held on to your MultiChoice shares?
Yes we bought bucket loads more. It has been announced on SENS. Our clients are close to the second biggest shareholding in MultiChoice now and we actually wrote something about it in our latest quarterly commentary. If people want to look on the website we wrote about it in our equity fund fact sheet. It was a great opportunity because obviously MultiChoice, let’s say it was valued somewhere between R100 and R200 a Naspers share, and Naspers was trading over R3,000. So most of the big American and Emerging Market investors bought Naspers for Tencent. So when they got MultiChoice shares unbundled, they just dumped them on the market, they didn’t care because MultiChoice was such a small part of the portfolio. So we were buying aggressively at the time between R90 and R100 per MultiChoice share. So it’s turned out to be a reasonably good decision given where the share price is today. I think the reason why people were hesitant was, I mean the risks are fairly well-known but this is still a business that generates a lot of cash flow. The big call is whether in their African operations they can get back to breakeven which is fairly ironic given that most people used to own Naspers many years ago for the Africa exposure.
That’s been a fantastic investment Duncan. If you bought around R90 to R100 a share and it’s now above R130. For those who who weren’t as smart as you, would MultiChoice be a stock to be accumulating at these levels.
Yes. we think it is value, otherwise we wouldn’t hold it. My own personal views as we go forward is if the share goes up a little bit there’s going to be quite a split view in the market. There are going to be people who say streaming is going to take the top end out. Whether it’s Netflix, HBO or Disney or sports being streamed. At the lower end where the growth is coming from, you have to find a few subscribers but we feel for lower end subscribers Africa is quite a big call. So I can see quite a split opinion. I can see a good bear case and I can also see the reasonably good bull case. They were a very good set of results that came out earlier in the week
So good set of results and a big portfolio holding that you’ve got in MultiChoice, you’ll be watching it like a hawk. Just to close off with Duncan, We’ve spoken a lot about local versus offshore. How are you positioned.
In our unit trusts where I guess most of your listeners who are invested with us have their money, we are only allowed to be 30% offshore and we’ve always been close to that. We’ve always said when the rand was slightly weak or fair value versus a basket of global currencies we’d almost always be close to 30 percent. Why is that because you want diversity. On the JSE, the top 10 stocks probably make up 60 percent of the market. And we don’t have whole sectors like healthcare utilities. I mean how do you get exposure to technology other than Naspers. So we think it makes a lot of sense to be diversified. I think what is interesting is that South African bonds, obviously you have got a really high yield in real terms at the moment. I think we must be close to number one or number two in the world for investment grade real yield. So if you said to me the rand strengthened, I wouldn’t be too surprised. So we wouldn’t bet just owning Naspers, Richemont, British American Tobacco, Mondi and go completely offshore. And we also wouldn’t go completely local. In fact we think there might be an opportunity over the next year in local consumer shares given how tough the economy is as we see in all the businesses reporting, as an example AVI reported its first ever down earnings recently.
So it’s really tough out there in the economy and there is a chance people buy low earnings on a low PE multiple, which means share prices could fall quite a bit from here, if that happened. But no, we wouldn’t have a massively strong view.
Duncan Artus is a director with Allan Gray.
