There are a number of South African money managers who could claim to be world class. Particularly in financial services where veteran portfolio manager Kokkie Kooyman’s expertise has earned him a global following. Kooyman travels widely and often (always in Economy Class he once told me) to understand opportunities that others might miss – his latest trip to Japan motivated by a need to better understand how negative interest rates affect banking stocks. He covered his impressions in this week’s episode of Rational Radio – after sharing his perspectives on the debate around Discovery’s accounting policies which sent the highly rated group’s share price down to a five year low. – Alec Hogg
Kokkie Kooyman joins us now. Kokkie Do you own any Naspers shares?
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Yes I own myself and we at Denker own it in the funds.
Let me just mention that some people might be thinking that you are still with Sanlam. Denker, your new company has been going for three years.
Yes and Sanlam own 49% so we are part of the group and we get support from them and obviously outsource a lot of functions to them. you’re quite right in terms of when it comes to stock selection and research, we are totally independent.
It has been a very good listing on the Amsterdam Stock Exchange today for Naspers as we heard from Basil Sgourdos before. Kokkie, I know you’ve been travelling all over the world but I wanted to pick up with you on what’s going on with Discovery and the reason for this is that there was a report from Macquarie which pointed to some big hole in their liabilities. Discovery couldn’t respond because of the closed period that it was in. It then came out with the financial results and that should have given us more of an insight presumably into what exactly is going on. You got some insight for us?
I don’t cover it actively myself and our analyst that does Discovery, Barry de Kok is in the US visiting insurers and so I’m being thrown under the bus here. It is fairly complex but I’ll try and keep it simple. Firstly, bear in mind we don’t own any Discovery shares. We feel that the share is fairly expensive because, we think, of unjustified expectations about quite a few things. Specifically the offshore growth, Ping An, the Chinese business, which is still very small. A lot of investors are worried that they might lose out on Discovery, you know this could be another Naspers, Tencent story. But Ping An is going to take years to really become profitable and unlike Naspers I must say the rest of the operations were initially never that good. Discovery has really delivered on the health side. The problem where we are now is the argument about the current valuation of the South African business, which centres around accounting and actuarial assumptions they make when it comes to the business they write. Simply, if I write a new life policy, then there are all kinds of assumptions that go into how profitable that business will be. Life has changed over the last 10 to 15 years.
Increasingly regulators and accountants have forced banks and insurers to account for future profitability now so as to get a more even even flow but this has led to a lot of distortions. For example I write a life policy. I expect that policy to last for 20 years. Now I must calculate the profit I’m going to make as an insurer on that policy and discount it back to today’s value and show that profit now. But in that calculation a lot of assumptions about interest rates, about lapse rate, whether the policy will get cancelled or whether the person lives longer than the maturity or the life expectancy. So it seems, and this is what Macquarie are writing, is that Discovery have been aggressive on many of the assumptions they have made and they base this statement, comparing Discovery’s assumptions relative to the other insurers in South Africa. A second point they make is to look at the other insurers who generally have always reported what we call positive variances versus Discovery who had negative variances. The variances are what you report annually in terms of your assumptions that you have made in the past and whether those assumptions are still holding true.
When you’ve been too conservative like Sanlam have been. Every year there is a positive variance where the outcome was better than expected. Discovery have marginally had negative variances. So those two together made Macquarie worried that maybe the actuarial validation that Discovery reported is overstated. Thats about simple as I can keep it.
I think the essence is that if an analyst at a stockbroking firm like Macquarie is to go out on a limb against a very popular stock like this they better have done their homework. From what you’ve told us now it seems to be the case but the stock market after knocking the shares back to well below R100 a share has lifted them in the last few weeks to R125 a share right now. So did Discovery allay these fears in the financial results?
To an extent. Yes, I think there have been concerns and these concerns that Macquarie reported on have been around for a long time. The analyst Francois du Toit has been raising this for a long time. He’s now with Citi. So your more informed investors have been very aware of the potential mis-statements and obviously when we go the the management of Discovery, we challenge them as well. They have good answers, so it’s not a dark hole, but a difference of options. Because of recent results and the write ups, the market was expecting the negative variances could result in a big write off so the expectations about bad results were overblown and the results were better than expected in that sense. And hence a relief rally post the release.
OK. That’s what we call it, a relief rally because there’s still so many moving parts.
That’s my terminology and if I’m wrong then it’s a real rally.
Yeah but there are many moving parts in Discovery and we’ll get to see it. If you are invested, you’ve got to trust management. And I suppose believe that although they might be more aggressive with their accounting and please help me if I’m misinterpreting this, is that even though they might be a little more aggressive than the others they’ve got good growth prospects elsewhere and that’s really what you’re betting on.
Absolutely, you’re totally right. A lot of investors have seen this with a Capitec and a Naspers. Discovery has been an amazing company in terms of what they’ve achieved and what they’ve delivered and their ability to think outside the box, again now with the banking operations. What they are trying to deliver takes longer and more expensive than initially thought, but the product is good. They’ve always delivered good product and the market is paying up for that. Companies like these, like Capitec, Discovery or Naspers are extremely rare. So the market tends to pay up for it in the short term. What made us sell out a few years ago is when the economy went into a recession or slow growth. That is when your risk of aggressive assumptions is the highest. As long as the economy grows and the offshore operations grow according to plan, then if your assumptions were aggressive the risk is low. But as soon as your economy deteriorates then the risk of those aggressive assumptions leading to negative variances is big and that’s why also when that report came through there was a sell off.
Interesting to see that if you had believed the Discovery story you could have got the share at a five year low a couple of weeks ago. We now know that South African investors are getting a better feel for international investing and particularly banks which seem to be everyone’s top list of the cheapest value shares around, although we do know that value investors have had a rough time of it lately. Kokkie you travel all over the place. Last time I tried to get hold of you, you were in Japan. Are you spotting some green shoots of re-rating prospects for banks globally?
I went to Japan to try and find some green shoots there and also to try and learn what happened in Japan as to how they call off a Japanification of Europe, and how European banks will handle negative interest rates. It’s very difficult to really get the cost to income ratio. As an example, the largest bank in Japan has a cost to income ratio of 68% and here in South Africa Alan Pullinger of FirstRand is trying to bring his cost to income ratio down under very difficult circumstances to 49%. To answer the question. The banking sector and insurance globally has been derated significantly, even in the US. Although Citigroup and Wells Fargo were D rated on specific issues. Wells as you know on the mis-selling. But they are cheap in comparison to other sectors. So momentum growth strategies have really worked for a lot of investors. If we look at Europe, its incredibly cheap. The average dividend yield now of the banks and insurers we hold in our global financial fund is about 6%. We’ve just been buying Swedbank. It’s the largest bank in Sweden with SEB, on a dividend yield of 6.7%.
A dividend yield. So that means that if you buy it today you’ll get it back as a cash dividend next year. How does it compare just briefly with South Africa?
Well South Africa dividend yields are around four and a half, five and a half. We always take tax off the dividend so your net yield here is about four and a half, five and they are six point seven. Now remember the cost of the comparative savings rate that you can get here, you get government bonds at eight point something per cent so dividend yields of 5 are not that attractive but in Europe and in Sweden you’re getting government bonds at negative and you’re getting dividend yields of six to six and a half percent, and I don’t know if you’ve noticed in the last two days there’s been a sudden rally in all these cheap banking and insurance stocks because we couldn’t understand why the market is missing this as you get the certainty of six and a half percent yields versus long bond yields of negative or half a percent. And it looks like suddenly the market is waking up to that. The more interesting ones are your challenger banks like Capitec.
Metro Bank in London. Do you know much about that?
That was a bit of a disaster.
The problem is always when guys have been too aggressive in their accounting and assumptions. We’ve got one little savings bank which we invested in with Aldermore and unfortunately they got taken out. Fortunately we’ve got quite a good price from First Rand. Everything in the UK, Legal & General, Pru, all those good insurance shares, if you look at the valuations, they are down to 10, 20 year lows and on the ground it’s not great but they’re doing well, they’re generating a good return on capital. So know in that space in Europe and the UK they’re actually very good opportunities.
Kokkie Kooyman is with Denker Capital, as you heard earlier and he’s given us some very good steers on the European markets.
