RECM comfortable with large JD stake – look through the bad news says Hertzog

It's well known RECM was been piling into the shares in Steinhoff's beleaguered subsidiary, JD Group. So in today's CNBC Africa Power Lunch I quizzed the firm's Wilhelm Hertzog about his views after another disappointing trading update released late last night. Also in today's interview, Hertzog offers his perspectives on Steinhoff, Net1 and Blue Label. – AH

ALEC HOGG:  Well, let's get a more in-depth view of the market now.  Wilhelm Hertzog from RECM is with us in our Cape Town studio.  A little bit of a respite there for JD Group, Wilhelm, but my goodness I'm looking at the three-year share price graph here.  It's come down from R50.00 to R23.00.  I know you guys at RECM like to pick up these cigar butts and would have enjoyed the little up-tick today, about two-and-a-half percent firmer it is trading at the moment, but my goodness it looks like a problem child.

WILHELM HERTZOG:  Sure, look I think anyone exposed to the industry that JD Group operates in has had a tough time for the past number of years, I guess even after the recession of '07, '08, and '09 the industry never really got back to its former glory.  Undoubtedly, it's been a difficult period, obviously, at the moment, they'll unsecure lending sector being under such pressure, and these guys lending to very much the same client-based.  That also makes things difficult.  I guess the massive supply of credit.  It came into the market that the credit, the furnisher retailers used to serve, historically, made life difficult for them and we're seeing the fall out of that now.  Over the past year or two, I guess, we've already started to see the fall out, so yes, that's the way it is.  Businesses go through cycles and we are seeing a very severe down cycle but it is important to keep in mind this is a cycle and there will be casualties.

Ellerines has been probably been the first casualty of this down cycle, in the furniture retail sector and, at some point, things will up again and life will go on.  It is often difficult to see when that will happen, when you are stuck in the midst of a meltdown of sorts, as we are seeing in this sector at the moment but it is important to keep that longer-term perspective.  That these businesses are solid businesses, they will in the long term, be demand for furniture to be, bought and whether it's on cash or credit and these businesses will live to see another day.

ALEC HOGG:  So are you still accumulating JD's stock?

WILHELM HERTZOG:  We haven't been accumulating.  We have a large holding for all our clients and we are quite happy with the holding as it currently is.

ALEC HOGG:  It was interesting to see how the market reacted to, well both the JD announcement and the Steinhoff announcement, both of which came out late yesterday afternoon.  Steinhoff, lots of trade in the share today, three-percent decline, concerns there about its exposure to JD Group, are you exposed to it at all?

WILHELM HERTZOG:  No, our clients have no exposure to Steinhoff.  The only exposure to the Steinhoff Group is via the JD Group shareholding.

ALEC HOGG:  So how are you reading the Steinhoff announcement?

WILHELM HERTZOG:  Well, I guess the trading and up trade and the earning's numbers they put out may be a bit light, in terms of what's baked into the share price.  The share has had a spectacular run and there are some lofty expectations built into it.  The negativity around this exposure is an issue at the moment, which people tend to focus on in the short-term and that maybe drives the share price in the short-term.  However, I don't think it is something that's that material in sign-off life that it should impact the company in a dramatic way, going forward, really.

ALEC HOGG:  So if you've liked Steinhoff and you have been wanting to get in, seeing a three-percent pullback in the price today might be that opportunity.

WILHELM HERTZOG:  Sure, I think if you are hoping to buy Steinhoff shares, yes, I would view this as an opportunity but as I've said, our clients have no exposure to Steinhoff, so we certainly haven't been looking to buy Steinhoff shares.

ALEC HOGG:  You love deep value investments.  You are also well aware of the capital allocation qualities of Brian Joffe.  How are you reading Adcock Ingram, given that he went in there at R70.00, you can buy the shares today at a 25 percent discount, to what this great capital allocator has paid.  Is it enticing to you?

WILHELM HERTZOG:  I think it certainly is interesting.  Our clients have been substantial shareholders of Adcock Ingram in the past but of late, the exposure has been very small.  In recent months we have increased the exposure again, but given Bidvest's rhetoric, it's not a clear-cut case to us that they will necessarily come around with a dramatically higher offer than what the share price is currently trading at.  They may well just go bit-by-bit and try their best not to overpay for the asset or to get it cheaply even.  At the margin, yes, we do think that at the current price, in the R50.00 region, there is definitely some value on offer and, as I say, we have been buying and our clients do now have a small exposure to Adcock Ingram again and we certainly back Bidvest to do the right thing there.

ALEC HOGG:  I had a wonderful interview last week, with Serge Belamant from NET1; I know you guys have been looking at a similar type business in Blue Label, but has NET1 caught your attention?

WILHELM HERTZOG:  It has and, in fact, in the past our clients used to have a shareholding in NET1.  That is no longer the case.  I think with all the issues around the SASSA contracts, what will happen when it comes up for renewal and whether SASSA will take it in-house or not, in five years' time, couples with the SEC investigation into whether there was any corruption involved in the tender being awarded in this last round.  Those issues can be very material, if the outcomes that arise from them are against NET1's interests, so we are very concerned about those risks and our clients aren't shareholders of NET1 at the moment.  It is a company, which we have on our radar screen and certainly we have watched and, as I said, our clients were shareholders at times in the past.

ALEC HOGG:  You are worrying me, Wilhelm, because you guys go and do your homework and you certainly do lift up and have a look underneath every rock.  Clearly, if you are no longer a shareholder of NET1, there's perhaps, in your opinion, more smoke or more than just smoke behind those allegations.

WILHELM HERTZOG:  Potentially, but we don't know that much more than what's been said in the media about those issues.  I guess when we look at the share price we just see a share price, which discounts have a reasonably optimistic future and, which in our estimation doesn't properly factor in the risks of any of those outcomes being to NET1's detriment, so I'm not saying the company is going to blow up tomorrow or anything of those sorts.  On a balance of probabilities, at the current share price, we struggle to see the value.  At a much lower share price, as the stock is, traded at in recent years, we could make the case that even if the SASSA business is worth zero, the rest of the businesses in the Group still have value and you could buy the shares for a price below that value.  That is no longer the case, so we struggle to make the compelling value arguments for NET1 these days.

ALEC HOGG:  And you know the sector very well, are you interested or have you been accumulating more Blue Telecoms, is that your preferred route into that area?

WILHELM HERTZOG:  Sure, but we're not sector focused and our clients do have a holding in Blue Label but we look for value on a bottom up basis, on an asset-by-asset case, but these payment or these businesses involved in distribution of electronic vouchers or any mobile payments and that kind of thing.  These businesses lend themselves to very good economics.  It is a sector we are quite interested in, when assets in the sector are, priced attractively, we like to invest in those, and we find Blue Label to be one those assets, at the moment.  Our clients' holding in Blue Label as being reasonable stable over the last year to 18 months, I would say, but yes on the margin we do favour the Blue Label Telecoms as an investment in that sector.

ALEC HOGG:  Wilhelm Hertzog is with RECM.

 There may be small errors in this transcript