RECM’s Jan van Niekerk on valuations: Sasol, SABM, Ellies and Telkom

Both emerging and developed market share prices are now solidly into highly volatile territory again. The S&P 500 had three losing days in a row on the back of recurring concerns over global economic growth prospects. The JSE All Share has not been left unscathed. In this CNBC Africa Power Lunch interview RECM's Jan van Niekerk helps us find out whether the market pull back has revealed obvious bargains yet, specifically the current valuations of Sasol, SAB, Telkom and Ellies. Jan also had some interesting comments on share price appreciation option schemes offered to Calgro and Phumelela's executive teams. – CP

ALEC HOGG:  Jan van Niekerk from RECM is in our studio in Cape Town. The S&P futures, Jan, after three straight losing days and some big losses there…one-and-two-third percent again last night. Things seem to be finally stabilising on Wall Street today, but I guess you guys might be looking at it as a buying opportunity. Or, not yet…?

JAN VAN NIEKERK: Alec, I think the three days of losses is probably not enough to get assets cheap enough, but if you look at the makeup of the companies or the stocks that have lost a lot of value it seems like globally, many of those stocks that have been priced almost for perfection in the last while. Consumer staples, that investors would call 'equity bonds': there've been some heavy losses in those as people lose confidence about the future there. It seems as though there's been heaving selling in the energy spectrum as well, on the back of the oil price and other energy prices coming off, so those seem to be driving the current aggregate indices.

ALEC HOGG: Talking about energy…we are going to be talking more in this program to the IEA – the Chief Economist – at the end of this show. Sasol: so far, so good despite a decline in the oil price. If the Rand holds, I suppose we must watch out if the price goes lower.

JAN VAN NIEKERK: The oil price definitely has a major impact on Sasol. They have other benefits and they have a big project planned in the natural space in U.S. as well, which I think underpins some of the valuation there. For the South African investor: certainly, the currency does play a role, but if you consider Sasol in the context of global energy companies [inaudible 01:59], Sasol is probably one of the more expensive energy players for a global investor.

ALEC HOGG: Up by 11 percent in the past year. R360bn market cap on Sasol at the moment. Getting specific about the news out this morning, SABMiller produced its trading update. It refers liberally to something called NPR, which I had to do quite a detailed search to find. It means net producer revenue. What is that, Jan?

JAN VAN NIEKERK: Alec, I was stymied by some of the terminology, too. There was also reference to premiumisation of their lagers in Africa, which I assume means that people are happy to pay more for the beers that are branded better. I think the overall picture emerging from this update from the breweries is that they managed to grow organically, although at a very slow pace. They've given a breakdown and it seems as though some parts, especially the Asia-Pacific area has been under pressure, in not only volume but pricing as well. It's such a large company with so many moving parts. They didn't give details about specific currency impacts, but the references made in the announcement suggests that the emerging market currencies might have moved against those investors that buy their brewery shares on the London stock exchange or the New York stock exchange.

ALEC HOGG: Fortunately, for breweries' shareholders, there's still that potential takeover in the wings.

JAN VAN NIEKERK: Look, the market's been speculating about Anheuser-Busch and whether they're going to take over. Once we saw the announcement that the breweries were rebuffed from the Heineken takeover, the share price shot up but I think we've lost all of those gains in the meantime. Normally, we would be cautious, investing in any company on the prospect of someone else taking them out. Perhaps it's a possibility when it's really cheap. We think that breweries is a fantastic company, but the share price and the current valuation reflects fantastic expectations for the future. Then, to expect a possible acquirer to take out such a large company…the only assumption you can make is that either their paper trade is more expensive or they think they can [inaudible 04:16] enormous amounts of cost. We think breweries is a well-run business.

ALEC HOGG: Jan, Telkom…I'm not going to ask you whether you think it's a well-run business. However, what I would like to know from you is it was clearly, a value opportunity some while back. In the last little while – in the last few weeks – the share price has been bouncing from R62 all the way down to R50, back up to R62 and today, back to R52.

JAN VAN NIEKERK: Yes Alec, we certainly don't think it's currently a value opportunity. We have calculated fair value for the business, which is somewhat lower than the current share price. However, we do understand that as sentiment in the company changed, where management packed in terms of their mobile operations change and the ability for the business to generate cash flow to investors is still significant. I think there's uncertainty coming in. Telkom has been a stellar performer in terms of percentage. It's probably one of the better performing stocks on the JSE for the year, but it has become volatile and I think there's still uncertainty looming about how their cellphone operations play out in South Africa where a coup could be profitable as well as how their regulation further influences their profitability.

ALEC HOGG: Down by six percent today – Telkom. Another share under pressure today is Ellies, down three-and-a-half percent. Your colleague, Wilhelm Hertzog, told us last week that you guys had been following this company. I suppose the rights issue must be pretty imminent.

JAN VAN NIEKERK: As an investment opportunity, Ellies is probably a binary one where either the company gets the capital that they need (and it carries), or it doesn't get the capital in time and there's a problem. As an investor… What you need to figure out is at what price that additional capital is going to come. The longer you wait, the more desperate the company probably will become, so it is a business that we have been following and we're keeping a close eye on. What the market is currently telling me is that management is leaving it quite late.

ALEC HOGG: A binary opportunity there – my goodness. It doesn't sound too good if it goes the wrong way. Jan, on a broader scale, yesterday we had the Chief Executive of Calgro in the studio. I've also been watching Phumelele's Chief Executive buying a lot of shares. Why I mention these two in the same breath is that they both have share price appreciation option schemes. If the share price goes up by a particular amount then the Executive team gets lots of share options. It seems like a rather strange way to incentivise management who should be focusing on profits.

JAN VAN NIEKERK: Yes, Alec. In our engagement with company management, boards, and the remuneration committees, we try to stress that the thing that's under the control of management is operations and the profitability of the business, particularly the 'per share' profitability numbers (not the aggregate numbers so much) because as shareholders, we're aligned with management. We think that's quite a sensible way of looking at things.

ALEC HOGG: But the share price itself…

JAN VAN NIEKERK: By implication, we think share prices shouldn't be the objective of the management of the company, especially if you think about a business as something that you want to own over many years. In that event, we think the best way is for management to focus on the operations and not on the share price. We like businesses where management shares with us as shareholders when the share price increased. Not just because their actions have been focused on the share price, but also rather because their actions have been focused on the operations of the business.