We allocate our capital to businesses that can handle it and allocate it very well and treat it really well because if they do that the market will reward them and our portfolio will be a reflection of the underlying. Up until Maria Ramos stepped in and I’m not certain what happened because this was not going to make it to the market but Maria and her team, perhaps together with a change of management at Barclays found out that a lot of what was happening inside the book was not of the right pedigree in terms of credit quality of the book, credit granting standards, the mix between…well, the bank wasn’t diversified enough, I think 80% of their earnings came out of retail and property.
I think up to 2000 if you had to compare Barclays Group Africa, it was called Absa at that point, to the darling which is FirstRand today, there really was no comparison. So I think the CEO had said [by] 2015 Nigeria would have come right and so he’s bet his entire reputation and credibility on that so the market I think will hold him to it.
But I think they’ve reached for more risk too. Tiger Brands has chosen the opposite and this is the risk when you choose the opposite, to go and buy a big acquisition that is transformative at one go. But when you start going for companies that have fundamentally higher risk because they’ll begin to participate in the economic growth process then you’re doing the wrong thing, you are making the statement that high risk equals high return when you really should be inverting the statement and saying lower risk equals high return and why would you not want to do that? But it’s a very rational thing, some people are built that way and these are people that count their money in inches, I can make the next 10%, just the next 10% and then I can get out, then they get stuck in there for 30%, 40% and then before you know it, something is a hump on the road which disturbs the global economy and the stock market falls and those people have to try to get out the door quickly.
HILTON TARRANT: What makes Tiger Brands so compelling? Is this the African consumer story? HLELO GIYOSE: No, it’s not even that, when we invest we don’t think thematically, we don’t think about demographics as destiny. HLELO GIYOSE: Yeah, well, up to three days ago it was completely out of favour.
You won’t believe that Sanlam’s offshore earnings are not 50% as you’d imagine, they’re probably in the region of 10%, 12% with this latest result but they’ve been nibbling at it, making sure that they can handle what they bite, they can digest it, they can build off of it. You tell me what’s driving that? It’s not as if Harmony earns above a cost of capital, it’s not as if it deserves to be rewarded for how it behaves or how it treats capital but then why is it going up so much? I think it’s the weak rand effect, which is going to act as an extra layer of profitability for these businesses, something they wouldn’t have worked for but they’ll just get anyway.
For instance what they’re saying is that the consumption of cement per capita in some of these markets is so low, 3%, when it ought to be 400%, 500%, 600% higher, maybe 2000% higher in Angola certainly, in Nigeria certainly, so on and so forth.
HILTON TARRANT: You make an interesting point in that fourth quarter portfolio management report, you draw a comparison between Sappi and Tiger Brands, Tiger Brands one of your core holdings in the portfolio, we’ve seen outperformance by Sappi and you liken this to football.
HILTON TARRANT: Is PPC starting to look interesting, given the big and deliberate push outside of South Africa? HLELO GIYOSE: Well, PPC is also doing what I’ve just described, they’re thinking thematically, they’re thinking demographically. So it’s a thematic business, not a branded business, it’s going to be run on cost efficiency and I think they’ll be successful for a certain period of time, personally I think so.
Today a completely different story, this is completely out of favour. HILTON TARRANT: You make the point in your fourth quarter portfolio management report that there has been a step change in volatility, this links to what you’ve just said. Absa was trouncing FirstRand left, right and centre, they really had it at their disposal.
Our guest this week is Hlelo Giyose, chief investment officer at First Avenue Investment Management. I think what Tiger Brands is looking at in South Africa is that the market is saturated for them, not only that but very competitive with Unilever stepping up, Nestlé stepping up.
The amount of protective gear or competitive gear, well, the repertoires they have borne over years and years of institutional memory allows them to navigate a strong rand, weak rand, high interest rates, low interest rates, high inflation, low inflation, great consumer environment, lower consumer environment and so on and so forth.
We’ve got a sharply weaker rand at the moment, the risk of imported inflation, likely to have a further interest rate increase or two this year, how does one position one’s portfolio, given what I’ve just said? HLELO GIYOSE: I think the wonderful thing about being focused on high quality businesses, businesses with great intrinsic value is that they handle that for you.
HLELO GIYOSE: Yeah, the payoff could be good and I don’t think companies should look at it that way and I don’t think companies should say…because I don’t think investors should do it, I’m going to go into a high risk country or high risk environment because the returns could be good.
Now clearly those moments don’t come too often where you can get out and get into cash because, by the way, the stock market is a hell of a train, it will go up because it’s reflective of human ingenuity over time, as civilisation pushes forward so does the stock market. That’s going to benefit businesses that were on the margins of customer wallet and so those businesses are also going to grow sales and grow earnings and you can see the market is running ahead of that buying those companies up and basically reaching for risk, fundamentally riskier businesses that are going to benefit from a rising tide, both GDP growth as well as the wealth effect.
That saves us, by the way, a great deal because then we’d have to figure out what’s going to happen at the next MPC meeting and I don’t want to be in a position where I have to be best friends with Gill Marcus so that she whispers to me in the middle of the night over a glass of whiskey what she’s going to do tomorrow.
That’s not a diversified company, is it, for a large bank. As long as that thing that hasn’t run is a high quality, great. Of course, when you do that you lose your money but you just don’t know it yet. You don’t want to be landing when an economy is growing, you actually want to be pulling back and being rational when an economy is growing and you want to be seeking the best clients when the economy is slowing down because only those people can afford your high credit granting standards.
We’ll be interviewing them or the institutions they represent once every two months or once a quarter. A good example here is Woolworths maybe, it wasn’t cheap, it was fair value, slightly above fair value but the idea with it is just to hold it and it put out results today [Thursday] the market isn’t going to react that spectacularly to those results, in the next set of results it will have grown into its valuation, so the earnings coming up next will have made this valuation today look very reasonable.
So that’s what you do if you can get out. That’s really what’s going to push volatility upwards to give you capital gains but people that do that clearly are people who value their risk or their gains more than their losses. If that thing that hasn’t run is low quality, don’t do that, just step out and get in the cash.
Hlelo, we last spoke in September, it’s been about four or five months since then, what’s on your mind at the moment? HLELO GIYOSE: Well, what we’re seeing at this point, actually which started about halfway through last year, so the second half of last year and it’s certainly continued this year is how the fog that has hovered over the global economy has lifted with the IMF and all other such bodies forecasting peak GDP this year for the first time in five years.
It tells you a lot about risk when you can look at a longer period over a year, two years and actually notice how much more volatile our local market has become. So it behooves them to actually get it right because along the way they’ve taken on more debt, along the way their intrinsic capital has fallen and you could argue along the way the focus on South Africa is not as intense as it used to be just by virtue of how deep they’re starting to swim, as simple as that.
Simultaneously central banks have done a great job of inflating assets, so the stock market in South Africa and the United States has doubled from what it was in 2008, the housing market has rebounded, the developed markets’ stock markets have also come back up, the yields in Greece, Italy and Portugal have fallen, so assets have really rebounded. But I think therein lies the rub that if it’s a commodity what you’re saying is how long will it take me before somebody else can do exactly what I do, there’s no shortage of people who can put money in, Lafarge, Dangote and so on and so forth, they can put plants just as quick as PPC.
So continue to buy companies that can not only give you a return on capital but return of your capital, so these are companies with fundamentally lower risk but a fundamental margin of safety. HILTON TARRANT: Hlelo, Barclays Group Africa, which is pretty much the old Absa Group, your second largest overweight position in the portfolio, five years ago this was the bank in South Africa, you absolutely had to own this stock.
They set about not only resetting the credit quality and underwriting standards but also rebalancing the entire business. Whereas the real job is to think about it from a brand standpoint and I think that’s where they’re having challenges, their brands don’t have traction in Nigeria.
I don’t think they should do that. A perfect way in which a company has gone about this is Sanlam, Sanlam has made bite-sized acquisitions and has been at it since 2000. HLELO GIYOSE: Yeah, I think that the idea behind investing is to actually buy value and not risk.
I don’t want that. HILTON TARRANT: Welcome to this Market Commentator weekly podcast, our series of interviews with chief investment officers, fund and portfolio managers.
So don’t make a habit of getting out every five minutes, you really need a Six Sigma event as the nifty fifty to get out but short of the nifty fifty what you will do, as is going on today with interest rate related stocks perhaps they were ahead of their valuations, 10%, 15% premiums, not 30% premiums, not 40% premiums. HILTON TARRANT: If you buy a good quality company, so perhaps not these more risky companies, buy a good quality company, asset prices inflating, valuations get ahead of themselves, is there a temptation to take profits at some point or do you let the earnings catch up? HLELO GIYOSE: That’s a fundamentally phenomenal question because in the 1950s and 60s, in other words a rally of high quality companies, it’s known in history as the nifty fifty and that is when valuations of high quality companies like Motorola really screeched way ahead of even the compounding capabilities of those companies and in that instance I think it behooves every investor to actually get out of the market, stand on the sidelines, don’t get out of the market and get into low quality companies.
I want to be sleeping, get my eight hours so that I can be fresh to serve my clients the next day. HILTON TARRANT: You make the point in your fourth quarter report that you’re not economists and you don’t do economic forecasting. These are long run products with short production cycles, every week they need replenishment and if you have a brand with great customer awareness you’ll get custom every week and that’s what it is about it and especially in times of tough economic environments where you have pricing power, which Tiger Brands has not exercised, at least to the extent that it should have.
HILTON TARRANT: Are we starting to see a junk rally on the JSE? HLELO GIYOSE: Oh yeah, it started in June last year and my God, if you just take a company like Harmony, which has not put out spectacular results, which has recently killed eight people, obviously not intentionally, sadly it’s a very dangerous business, it’s going up 5%, 6% on any one given day.
So that’s created a wealth effect, people feeling good about where they are, vis-à-vis their ability to see out life and so they’re going to start spending money on non-essential goods and products and services.
If you were to compare this to the sport of soccer and you were to say 38 games over a season, Tiger Brands would win 36 out of those 38 against Sappi but there will come a time in that season where Sappi plays that one game like it’s a cup game and that happens when a junk rally comes up as it happened in December I think, in the last two weeks of December Sappi must have gone up 15%, 16%.
HILTON TARRANT: This shift by Tiger Brands into Nigeria it introduces an element of risk to that business that perhaps has not been there before but the payoff could be good.
It’s the fact that my grandmother, my great-grandmother, my mother and yours did the same thing every week, they went to the store and 20% to 30% of their baskets were Tiger Brands products.
A year and a half ago until today, my goodness, it has just been an enormous amount of pain because the market didn’t quite appreciate the amount of fixing that had to be done and Absa also didn’t communicate how much and how hard it’s going to be but I’m delighted that they did it and the results that came out two years ago proved that what essentially has happened is Absa has become for the first time a counter-cyclical bank, it’s run not at the same pace and breath as the economic cycle but it’s run against the economic cycle, which is a fantastic thing for commoditised business because banking is commoditised.
So they’ve thought, well, how do we expand, we certainly can’t go into the developed markets, you don’t go into the eye of the tiger, we go to Nigeria, which is a big market but for them I think they’ve thought about it demographically and thematically.
HILTON TARRANT: Hlelo Giyose is chief investment officer at First Avenue Investment Management. HLELO GIYOSE: Yeah, certainly Tiger Brands has its challenges by the way because they’re going through an inflection point in the strategic direction going into Nigeria, which they have to get right but having said that I think this was a company born in 1921, what, 93 years old and it just has phenomenal brands, institutional memory of how to create value out of them.
In a junk rally even a lower division team if it’s really, really up for it can beat Real Madrid or Barcelona, one of those teams.
People have a habit of saying, well, this has run too hard, let me find something else that hasn’t run.
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