George Herman: Great job by SARB, S&P, in holding their post-Abil nerve

Citadel's George Herman is a big picture guy. He refrains from passing comment on individual stocks, preferring to analyse broad themes and how they will impact on the value of his clients' portfolios. So debate around the SA Reserve Bank's reaction to the Abil disaster and how the ratings agencies responded is right up his alley.  As you'll hear (or read) from today's interview on CNBC Power Lunch. – AH

ALEC HOGG:  George, the big news on the corporate action front yesterday, was BHP Billiton and the splitting off, of SpinCo.  I see today that somebody thinks Brian Gilbertson might make some kind of a comeback there.  Pallinghurst has been doing terribly well (Gilbertson's little company), but I guess where Pallinghurst has about R3m market cap; this new company (this new SpinCo) would be at least 20 times that size.  It's a bit of wishful thinking.

GEORGE HERMAN:  Alec, there's some concern in the foreign client base that maybe they're making a mistake with the structure in terms of what they're expecting, especially from SpinCo, so there's still a lot of speculation around it and it wouldn't surprise me if Mr Gilbertson made a comeback now that it's all separate.

ALEC HOGG:  Just take us through your reading of SpinCo.  It is a vote of no confidence in South Africa.  You can't dress it up any other way – the huge BHP Billiton selling off all its South African assets and putting a few others in there – but primarily, the South African operations.  Is it something we as country, should be listening to more carefully?

GEORGE HERMAN:  Alec, this is probably one example of where a company makes strides toward listing in a different place, selling off some of its assets, and getting itself abroad.  Unfortunately, South Africa is currently in a tough place with our macroeconomic factors somewhat deteriorating.  It is affecting many industries.  We've seen that in the banking industry and the retail industry.  The consumer is in a tough place and quite a few companies are expanding more towards abroad, and I think we could see more of this in the future, yes.

GUGULETHU MFUPHI:  So what does this mean for your view George, on the resources sector?

GEORGE HERMAN:  Well, the US Dollar is currently making a good comeback as quantitative easing comes to an end, and with the United States now talking about normalizing interest rates.  The Dollar is getting stronger on the back of that, and as that is happening, commodity prices are under some pressure.  However, in the medium term, the resources sector is still where there's a lot of value.  Those companies are quite cheap.  There are quite a few opportunities in there, so amongst all the sectors you would find that many investors look for opportunities in the resources sector – still positive about that.

ALEC HOGG:  We have a couple of interesting stories coming up later.  Very shortly, we're going to be talking to Matthew Pirnie from S&P.  It's interesting that Moody's downgraded Capitec, and then went and downgraded the four South African banks.  S&P doesn't do the Capitec rating, but it hasn't moved on the South African banks.  George, what are we to make of all of this?

GEORGE HERMAN:  Alec, this is a very unique situation.  The SA Reserve Bank's action when they moved in last weekend on the curatorship of Abil, created a new precedent as to how they're going to handle these types of systemic, risky situations. 

As you've often seen in real life, when firefighters move in, it ends up where the water does more damage than the original fire. 

In this example, it's very similar so we can have many debates about whether what the Reserve Bank did and how they structured the new balance sheet of Abil – post this restructuring – whether that was the optimal way to set the precedent, how it handled with debt and other creditors, and how it handled equity holders.  However, that's not the issue.  They moved in firmly, quickly, and established systemic calmness in the market.  Hence, the downgrade we saw of the banks afterwards. 

I personally think it was a very quick move to actually save themselves (the rating agencies), more so than a true reflection of the creditworthiness of South African banks.  In fact, S&P's comments today, that they consider the South African banking sector more creditworthy than their sovereign does: that just tells you the exact picture and I fully agree with them.

ALEC HOGG:  Yes, indeed.  It does.  You did mention earlier that more South African banks are coming under a bit of pressure, but we've seen that in the retail sector, too.  Not Shoprite, which released results, and we've had Truworths not looking too clever either.  Just from your perspective, are you expecting or anticipating that we'll see a little bit more sogginess in that sector, going ahead?

GEORGE HERMAN:  Alec, indeed, for the last year we've been writing about the deteriorating situation of the South African consumer and unfortunately, specifically for the low-income consumer.  They've had many tailwinds over the last four or five years, with government increases, increases in spending, growth in employment, low-interest rates, and a very accommodative credit environment.  Suddenly, all of that is turning into a headwind with rising interest rates and credit not as available anymore.  We've had a touch higher inflation over the last year or so.  Unfortunately, the low-income consumer is under severe pressure and undoubtedly, there will be knock-on effects not only in that micro-banking sector that services them, but also in the consumer sectors.

GUGULETHU MFUPHI:  Does this mean that you're realigning your view on the retail sector space?  If so, are there any particular stocks, which you'll be keeping in your portfolio, George?

GEORGE HERMAN:  I'm not the stock specialist, so I'll leave that to our stock-pickers but undoubtedly, yes, we have been very cautious about the South African equity market per se.  Our argument was that the deterioration of the consumer position in South Africa actually put it at a situation where global equities offer us better opportunities than South African equities do.  In addition, you reduce the specific risks that we face as South African investors in the South African market, with a deteriorating South African economy, low growth rate, and increasing inflation.  We've been negative on South Africa in relation to global stock markets for quite a while so undoubtedly, we have adjusted portfolios to reflect that.  Are we negative on this and thinking that the market's going to fall over?  Not at all.  Equities is still the place to be, but some worries about the South African economy, South African currency, and South African debt markets are undoubtedly, fair.

ALEC HOGG:  Another story we're picking up on is with Alan Olivier from Grindrod.  His results are out today.  I don't know if you had a chance to look at that, but it is a transforming business and certainly, a play on the infrastructural capacity/growth in this part of the world.

GEORGE HERMAN:  That's not my part of the business Alec, but undoubtedly, they've done a great job in diversifying their business, so get it from the horse's mouth.

ALEC HOGG:  Okay, getting back to those downgrades and the knock-on effect.  I know that at Citadel, you have many relationships around the world.  If you talk to people outside of the country, what are they making of this?  Are they of the view that Moody's are maybe the guys who're doing it right?  We in South Africa, all seem to think that they have it wrong.

GEORGE HERMAN:  There are two sides to that, Alec.  On the one hand, global investors look at South Africa and they say the writing's been on the wall for a long time – not referring to Abil now, but on the slowdown of our economy and of the position of our consumer.  We have had many structural problems that have been in existence for a long time.  Hence, it doesn't surprise them that we struggle to grow and that our economy is not keeping up with other emerging market economies.  On the other hand though, they compliment us on one of the best banking sectors in the world – magnificently regulated and very well capitalised – and because of that, they enjoy investing in South Africa.  They get the carry trade because of our high interest rates, so you get hot and cold, depending on which angle they look at.  Foreigners still give South Africa the thumbs-up vote.