Investment Manager Commentary
Abax Investments

The JSE All Share Index rose 1.8% in May. Of the major equity sectors, industrials delivered the best performance, posting a total return of +5.1%. Financials recorded a loss of 2.0% and Resources (-3.8%) posted its first negative return since January as the strong US dollar put pressure on commodity prices. Our holdings in Naspers (+18.3%), Mondi (+12.7%) and British American Tobacco (+11.3%) enhanced the fund’s performance, while positions in Netcare (-9.9%), Woolworths (-9.2%) and FirstRand (-7.1%) detracted from performance.

The South African economy continues to struggle as evidenced by the first quarter labour force survey which shows an increase in the unemployment rate to 26.7%, an eight-year high. We struggle to identify catalysts for growth within the South African economy and believe that political reform would be required to avoid a recession. In spite of this, S&P kept South Africa’s sovereign credit ratings unchanged at their recent review (3 June 2016). However, guidance from the rating agencies have highlighted deteriorating growth conditions and volatility in the political sphere as the primary contributing factors to their negative outlooks on South Africa’s sovereign debt. A marked improvement on both fronts (which is unlikely) would be needed to avoid a downgrade by the end of this year.

Such a downgrade will likely prompt further credit tightening and worsen confidence, both of which will weigh on investment and demand. Given this, we maintain our bias for industrial rand hedges and only own select domestic focused businesses of which Mr Price is one example. It is a business that can continue to drive margins higher (through operational efficiency) and the tough trading environment should benefit their value orientation as consumers seek out less expensive clothing and homeware. Having less credit (17% of group sales) in the business will also help as the new affordability legislation is negatively affecting credit sales growth. The company recently reported a very respectable financial result, growing headline earnings by 15% despite the extremely challenging consumer environment.

This year has been characterised by high levels of volatility and it is expected to continue given a variety of concerns - Brexit risks, US elections, local municipal elections and South Africa potentially losing investment grade status in December. These events create both challenges and opportunities. We will use the opportunities presented to invest in economically robust businesses, at reasonable prices, which we believe will produce consistent compounding growth in profits and dividends.

The Nedgroup Investments Rainmaker Fund currently trades on a forward rolling Price/Earnings (P/E) ratio of 15.5x and a dividend yield of 3.0%.

It was another very volatile month for local equities and the 3.0% decline recorded by the JSE All Share Index for the month masks the impact of the 9% decline that the market recorded up until 21 January before staging a partial recovery. At the sector level, there was marginal outperformance by Resources (-2.7% for the month) relative to Industrials (-2.9%) and Financials (-3.3%). Our holdings in FirstRand (+5.5%), Reinet (+3.5%) and AVI (+2.9%) enhanced the fund's performance while our holdings in Mondi (-16.0%), Aspen (-13.1%) and BHP Billiton (-12.4%) detracted from performance.

The volatility has continued into February and we expect it to last as investors and the market vacillate over the outlook for many fundamental drivers. Our reality is being shaped by several major forces, namely; China's problematic economic situation and the collapse of most commodity prices, Fed liftoff, the Nene fallout and a drought in South Africa. Later this month, the South African government is faced with a difficult task of balancing the budget while maintaining its credibility. The need to constrain consumption is crucial, which leaves us cautious on the earnings outlook for domestic consumer stocks.

In our view, South Africa's near-term outlook is likely to be characterised by depressed commodity prices, fiscal and monetary austerity and weak domestic demand. It all makes for troubling prospects in 2016. At times like this, we apply our minds to try and look through the noise and headlines and evaluate where we find long term fundamental value. We retain our under-weight position in commodities as we see little or no likelihood of a recovery in demand while so far little has been done to curtail supply. We view the short-term relative weakness in Mondi, one of our larger holdings, as an opportunity to add to our position as we expect this very well run, low cost, integrated paper and packaging producer to once again grow its earnings and report strong results which we expect in late February.

The Nedgroup Investments Rainmaker Fund currently trades on a forward rolling Price/Earnings (P/E) ratio of 14.3x and a dividend yield of 3.3%.