Coronation Industrial comment - Sep 05 - Fund Manager Comment25 Oct 2005
After a flat second quarter, the industrial market surged ahead once more in the third quarter, with the Coronation Industrial Fund returning 17.3%. For the 12 months to September the fund has returned 56.2% versus 56.3% for the FTSE/JSE Industrials Index. The compound annual return over three years to end September is 42.1% for the fund and 34.7% for the index. On this point, it is worth noting that these three-year figures as at 30 June (reported last quarter) were 32% and 20%: an indication of how recent returns have boosted even the multi-year numbers. Perhaps a bit of expectation management is in order.
During the quarter our relative winners were Famous Brands, Group Five, Woolworths, Bidvest, Naspers, Primedia and Tiger Brands. Our relative losers were Delta Electrical, Tiger Wheels, AECI and Trencor, all of them (incidentally?) rand hedges.
It appears that domestic economic growth is holding up very well and might continue to keep the earnings base of the average industrial company fairly high. Our valuation approach continues to focus on what a particular company is likely to earn in an average or 'normal' year, as opposed to next year. Given that times are currently good, we appreciate that many companies are experiencing boom times in profitability. To the extent that such profits are better than normal, one must be wary of placing much value on the unsustainable part of the earnings.
Our view is that earnings bases are fairly full, even though the market is not yet overvalued as far as its rating is concerned. Our response to these macro variables has been to position the fund defensively, concentrating on higher quality earnings bases which are unlikely to suffer depletion once the economic cycle turns down. Such defensive earnings bases are to be found in companies with strong brands, dominant market positions, legislated monopolies or other forms of 'franchise value'. We continue to believe that the quality differential between the 'best quality' companies and the 'average' companies is too low, favouring investments at the quality end of the spectrum.
Trading activity remained modest. During the quarter we exited from Altech, a stock we acquired the previous quarter. This uncharacteristic about-turn demands an explanation. Altech was a potentially attractive investment, being offered at around fair value at the time, but with a variety of 'blue sky' options in the telecoms space added for free. The souring of the Econet Wireless relationship impacted this optionality; without it the investment case no longer offered sufficient upside over and above the existing business value.
We also exited from Netcare. We acquired this position at a time when regulatory concerns in the health industry were high, depressing the rating. With the rating having staged a full recovery, this value has been realised.
On the buy side, we established a position in Richemont for the first time in a number of years. European equity markets generally have been derating, and Richemont has been 'growing into its rating' for some time. It is also our sense that the trading environment for luxury goods companies has improved. While the valuation still does not offer spectacular upside, we have enough conviction to invest and will be open to opportunities to build this position.
Our only other action on the buy side was to acquire a position in Famous Brands. Like most companies operating in the franchising environment, this company offers high returns and attractive cash flow characteristics. In this case these attractions are enhanced by strong volume growth and store roll-outs. Given that the group has a high fixed cost base, the volume growth benefits earnings significantly through the high operating leverage. Famous Brands also follows a strategy of integrating into its own supply chain, by investing in proprietary facilities for burger patties, rolls and the like. We believe that this business model will develop into a very high quality earnings stream in the years ahead.
In keeping with our theme of quality earnings streams, it is perhaps appropriate that we restate our investment case for SABMiller. Through a mixture of organic growth, acquisitions and turnaround capability, this group has emerged as the best portfolio in global brewing. It has a balanced exposure to beer's biggest profit pools on the one hand, and fast-growing emerging markets on the other. By historical accident, global investors have mispriced emerging market risks in the brewing sector in favour of the mature and shrinking incumbents in developed markets. Recent results from European peers have shown just how tough European markets have become. The valuation error is gradually being corrected, while SABMiller's exposure to growth markets continues to deliver strong earnings growth. The combination of growth and prospective further rerating, makes the stock a compelling proposition.
Dirk Kotzé & Karl Leinberger
Portfolio Managers
Coronation Industrial comment - Jun 05 - Fund Manager Comment12 Aug 2005
The industrial sector continued the fairly flat trend of the previous quarter, ending marginally up over the three months. With the market going nowhere slowly, we were well pleased with the performance of the Coronation Industrial Fund, which had a good quarter both in an absolute and relative sense. As usual, we like to keep the perspective firmly on longer-term returns. For the 12- months to end June the fund achieved a return of 52% versus 45% for the FTSE/JSE Industrials Index. For the three-year period to end June, the compound annual figures are 32% and 20% respectively.
Our long-time core holding Delta Electrical performed excellently upon the sale of its engineering business. We still see much value here. Other performers were Aspen, Tiger Brands and our big core positions in Naspers and Telkom. On the negative side, New Clicks suffered yet more disappointment. We continue to bite the bullet. AVI, another core holding and a great investment, also performed below the market.
Given the magnitude of the overall returns, we appreciate that the industrial market is no longer as cheap as it was this time last year; and especially this time two years ago. We still do see many examples of excellent value, however. This is evidenced by our inability to find good 'sells' from the existing portfolio, and an ever growing list of 'possibles' knocking on the door to get in. Resisting the temptation to take profits too quickly on existing holdings, we stick to a rigorous evaluation of new candidate investments. As a result, the portfolio saw but little trading in the period under review, and the concentration in our high-conviction ideas has been maintained.
During the quarter, we finally exited our investment in Johnnic Holdings. We do remain highly exposed to the attractive media sector via Naspers, Primedia and Johnnic Communications. Another position exited was Aspen. We have doubled our money and although we still feel that this share has upside, the risk/reward profile is no longer compelling enough to defend its place against other opportunities. On the buy side, positions were established in Super Group, Altech and Tiger Wheels.
We continue to concentrate on situations where long-term value is offered. In this commentary we feature Group Five and Tiger Wheels, two stocks that demonstrate different elements of our thinking.
- It is clear that the macro environment for fixed investment looks promising. Evaluating investment opportunities in the sector is however unrewarding: the construction industry is known for its volatility of earnings, low visibility and poor returns on capital. Pulling the top-down view through to our more comforting bottom-up, we find that Group Five nevertheless offers an attractive risk/reward trade-off. Like other companies in the sector, past disappointments have made for internal change and a new risk-averse approach to contract business. The group is out of past loss-making contracts and the order-book is sound. New work secured in the Middle East appears profitable and not overly risky. The manufacturing operations have, in our view, staged a sustainable turnaround. The group is over capitalised, with the impending sale of investment properties and operational cash flows aiding de-gearing and cash returns to shareholders. On a 6x PE, it is attractive.
- Tiger Wheels was a darling stock of the late 1990s, when its strong earnings growth and rand hedge qualities took it to three times the market rating. These same attributes sank it after 2000, when the rand firmed and the global automotive markets suffered. In a fairly weak macro environment, an amount equal to half the market capitalisation was spent on expanding production. This has not yet shown up in earnings, which have been depressed by various once-off effects, including currency losses. From the present base, the company will show good earnings growth. Tiger Wheels' local retail businesses will also benefit greatly from the increased vehicle population in SA. We believe this group has improved its underlying quality. With the rand-hedge element thrown in for free, one is now getting the same excellent firm for a below-market rating; a clear value situation.
Coronation Indus-For fans of media and cash retail - Media Comment02 Jun 2005
There has been little trade in this fund recently, as fund managers Karl Leinberger and Dirk Kotze say they are not paying a premium for quality companies. They have avoided furniture retailers, preferring cash businesses such as Pick 'n Pay, New Clicks and Mr Price. The fund has avoided diversified groups such as Barloworld and Imperial, preferring telecom and media counters such as Naspers and Primedia, as well as food shares Tiger and AVI.
Financial Mail - 3 June 2005
Coronation Industrial comment - Mar 05 - Fund Manager Comment20 May 2005
After a very strong fourth quarter 2004, the first quarter saw momentum finally run out of steam with the industrial market (after a few wild gyrations intra-quarter) ending the quarter at around its year-end level.
The Coronation Industrial Fund achieved a return of 44% for the 12 months to end-March versus 38% from the FTSE/JSE Industrials Index. For the three year period to end March, the compound annual figures are 33% for the fund and 18% for the index.
We consider recent market developments to be healthy, given the concern we raised in the previous commentary that investor expectations were too high. As stockpickers, the focus for us remains on finding investments at good prices and then waiting for the value to be realised.
For stockpickers, the quarter was fairly unrewarding, given that the market tended to trend strongly up and then down, without much discrimination between what we see as the good, the bad and the ugly. Thus some of our core positions went out with the tide, despite our faith in them remaining as strong as ever. Examples include Bidvest, Naspers and Mr Price, the latter retreating after having being pushed on disposal rumours early in the quarter.
On the positive side, the Johncom/Johnnic unbundling finally came through. We also did well out of Trencor, Aspen, VenFin and AECI.
We were particularly pleased with the very strong performance from Trencor. We had purchased these shares a year ago at around R12 when neither the valuation, nor the 'catalyst' that would unlock the value, was obvious to the market.
As a matter of policy, we firmly de-emphasise the timing decision if we believe the value is there. Once convinced of the value, one does tend to need a little faith when buying into a longer-term story. It is thus doubly gratifying when an investment case comes through over a shorter time period than expected. The resolution of Trencor's tax disputes now opens the door to simplifying the pyramid share structure and some kind of unlock of value. Trading performance remains robust, albeit at above mid-cycle levels. We believe that the share remains undervalued and continue to hold our position.
VenFin is another share worth featuring. It is a share that is in some ways neglected by the market and trades at around 80% of its quoted net asset value. Vodacom comprises over half of the valuation and appears to be consistently undervalued by the market, perhaps due to its unlisted status. In shares like this, one can never forecast the catalyst that will unlock value. For us that is not really relevant. The company consistently grows its net asset value, it is returning excess cash to shareholders through buybacks and it remains a core holding in the fund.
Coronation Industrial - Focus on cash flows - Media Comment04 Feb 2005
Fund managers Dirk Kotze and Karl Leinberger still have a high 23% retail exposure but they prefer the predominantly cash retailers such as Mr Price, Woolies and Pick 'n Pay to high-flying credit retailers. Coronation house view favourites Naspers and Telkom, both with extremely strong cash flows, are prominent in the portfolio. Rand hedges such as Trencor, Delta and Oceana detracted.
Financial Mail - 4 February 2005
Coronation Industrial comment - Dec 04 - Fund Manager Comment27 Jan 2005
The fund had another strong quarter in a rising market. The total return of 53% for the 2004 calendar year compares favourably with 47% from the FTSE/JSE Industrials Index. For the rolling three-year period the fund achieved a 27% p.a. return, which also compares favourably with 18%pa from the index.
The industrial sector continues to forge ahead, propelled by the most buoyant domestic economy we've seen in many years. The economic momentum is translating into strong earnings growth, keeping valuation levels reasonable despite strong share price gains. In many of our previous commentaries we argued that industrials offered good value after posting negative returns in six of the seven calendar years that preceded the April 2003 low. Whilst we continue to believe that the prospects for above-average long-term returns remain good, we are for the first time in many years raising a flag of caution:
- While valuations are in general not yet demanding, they are now within 10% of our assessment of fair value and are therefore no longer compelling. In fact, valuations for some companies are becoming quite stretched as the market becomes more comfortable with putting premium ratings on companies where the level of earnings is high.
- As so often happens in bull markets, expectations are too high and are in fact increasing. Just as investors should be revising their expectations for future returns downwards, they do the opposite. The hard-learned lessons of the excesses of the late 90s are being fast forgotten.
Whilst we have flagged the need to be more cautious, our view remains that there are still more than enough opportunities for stock-pickers such as ourselves to deliver above-average long term returns. Companies are showing very strong growth in underlying business value and managers are allocating capital in a much more shareholder-friendly way than at similar points in previous cycles.
The strong rand is also giving us the opportunity to buy many shares where the level of earnings is quite low. We remain of the view that the rand is in overshoot territory and that it will return to more normal levels over the medium term. Although our holdings in rand hedge shares have detracted from performance in the short term, we remain of the view that these shares are attractive at current rand levels and offer material upside should our view on a gradually weakening exchange rate prove to be correct.
This quarter we feature Woolworths, a share that has contributed greatly to performance but that still offers upside at these levels.
Woolworths is a business with strong franchise value, above-average returns and an excellent management team. Yet it trades at only an average rating. The food business has cornered its end of the market and has the potential to grow strongly as it rolls out stores to meet market demand. This roll-out should prove highly profitable, given the excess capacity that Woolworths has in its supply chain.
The clothing business also offers good growth. One, as it benefits from operating in a buoyant consumer environment and two, as Simon Sussman's team tackles the last under-performing divisions in the company (childrenswear and menswear). Whilst the clothing retail industry is close to the top of its cycle, Woolworths, with its high staples mix and the money it makes in its lending activities, is more defensive than most.
Finally, this is a management team that works for its shareholders. They have recently committed to return more cash-flow to shareholders and intend to gear their loan book up to the levels needed to make an attractive return for shareholders. This shareholder value focus, coupled with Woolworths' impressive franchise, argues for a premium rating, not merely an average one.