The Ingham Analytics Weekly Letter on Sunday

Welcome to our Ingham Analytics Weekly Letter on Sunday where we take a step back to see wood for trees, taking stock of things that grabbed our attention during the week that was, not too seriously, and with tongue in cheek.

Eskom employs too many staff for too much money– $100,000 apiece at purchasing power parity   

Last week we analysed interesting titbits pertaining to Berkshire Hathaway and noted that Berkshire Hathaway Energy (BHE) could teach an electricity utility in South Africa a thing or two. This Thursday in parliament the ANC deputy president declared that Eskom had too many workers and that “we must scale down…the amount of energy we are producing is less.” You don’t say, this is as close we get to vague financial literacy from the political powers that be.

BHE, with about the same 40,000MW generating capacity as the local outfit, although with a different and arguably more complex composition, gets by with 22,000 employees. Eskom battles along with 46,000 staff. We checked, the 2008 annual report states that Eskom employed 35,000 in that year, so a 30% increase.

Those 46,000 were paid an average of R700,000 last year. That’s roughly $50,000 – which is coincidentally the average annual salary in America.

We checked the latest IMF data base. Given the cost-of-living differences, the implied purchasing power conversion rate for the rand this year is R6.91/USD compared with the prevailing R15/$. $50,000 in South Africa is the purchasing power equivalent of $100,000 in the US, therefore. If we need another indicator of why the country is staring bankruptcy in the face, this is one.     

Another South African firm laid low is Sasol. Like another firm beginning with an S we can think of they didn’t need government help, they did it all by themselves. This week we issued an update note on Sasol entitled “A fifteen-year gulf” which contained some not-such-fun facts. Our thoughts on Sasol are always the most popular reads for reasons we can’t quite fathom, other than maybe Sasol has been such an iconic name for decades. The other reason may just be morbid fascination.   

Years ago, Brent crude oil nudging $70 a barrel and a rand at R15/$ would have had the share price shooting to the troposphere. Instead, the share seems to have the service ceiling of The Wright Flyer of 1903. Leave aside 2021, our forecast adjusted earnings in 2022 are well below where they were in 2006 whilst the market cap today in USD is 66% lower.  

For those who believe the old Brent oil/rand exchange rate relationship will still hold and get Sasol’s share price cracking again we have disappointing news. There is now a clear disconnect between the Sasol share price and the trend in Brent crude oil.

Asset sales at the bottom of the market, loss of a full share of Lake Charles earnings at a time when its operating conditions will perk up considerably, a compromised balance sheet and the unaffordability of dividend payments for the future don’t make for promising Sasol share price catalysts.    

Not-such-fun fact: if Sasol had simply grown earnings at a nominal 5% per annum in USD over the past fifteen years and the stock market rating had stayed the same, the USD market capitalisation today would be approximately six-times higher.

And now for something Orwellian. The eurozone is a bit like Animal Farm, some euros are more equal than other euros.

Following on from our recent note on central banking entitled “Now what do they want?” this week we issued “Is there a TARGET(2) on my back?” If you’re in for a horror story, then we’ve got one up on Netflix.

We examine the uncomfortable truth of what is at the heart of a fundamentally unstable euro. Could the euro crack? What are the implications? Target2 imbalances at the heart of the European payment and settlement system reveal why one euro is not the equal of another euro, dependent on the country within the eurozone.

A German domiciled euro is perceived to be safer and more valuable than one in Italy, Spain or Greece. If you want to know why a German bank and a Swiss bank charge you for keeping your cash on deposit rather than offering a small positive rate of interest, this note will give you a startling picture as to why.

A fact that deserves a separate analysis all on its own is that the German central bank and the German taxpayer as backdoor supporters of the so-called “Club Med” are shouldering a large liability if the system collapses.

However, the larger risk to us is not a Grexit or Itexit or Frexit it is a Dexit with Germany throwing in the towel and reverting to a new German mark. Political goodwill only goes so far.

What history does teach us is that the improbable can suddenly become a painful reality, to be dissected years after by historians who didn’t see the event coming a mile off. The assassination of Archduke Franz Ferdinand at just before 11am on 28 June 2014 set off a domino effect that lasted until the unconditional surrender of Japan in August 1945, marking the end of World War Two.   

On the topic of history, twenty-one years ago this week the Nasdaq Composite Index got to an intraday high of 5,132. By October 2002, the index reached a low of 1,108. That 2000 high was only seen again in November 2014 and in inflation adjusted terms the Nasdaq Composite only got back to the 2000 high by August 2017.

On Friday, the Nasdaq Composite closed at 13,319, 6% off its all-time high of 14,175. But here is the thing. If you’d bought the index at around 5,000 in March 2000 and done a Rip van Winkle, you’d have woken up this week with a return after inflation of 1% per annum. Only the mattress would have done worse. Time in the markets is a cliché, knowing your timing is smart even if you aren’t always spot on.   

Anyone surfing a narrowly based asset price bubble this past few months fuelled by absurdly low interest rates and the stay-at-home COVID-19 behavioural effect would need to take pause for thought. We’ve analysed this phenomenon in various notes and the one thing we are pretty sure of is that there is nothing so fundamentally different that this time it’ll really be different.   

In our Letter a couple of weeks ago we mentioned that interest rates had taken a turn up after being unduly depressed since COVID-19 unfolded last year. The yield on the ten-year Treasury on Friday exceeded 1.62%. That is a big jump from 0.9% at the beginning of January. US mortgage rates are also higher.

Our recent note “Booming along” joined the dots and “Elevator to the stratosphere?”, “Stop the Game – I want to get off” and “Now what do they want?” will also give helpful perspectives.

As yields climb so perfection-priced Nasdaq stocks should decline. A bond is typically safer so if they offer higher yields, they are again an investment alternative to shares. That doesn’t take away from the fact that bonds have had capital depreciation since the low yields of last year and are likely to have further capital losses as rates harden.

We only need to see the US 10-year Treasury get to 2% and the Nasdaq Composite Index could be closer to 11,000 rather than 14,000, its recent peak. Corporate bonds too would react with higher yields and the price of equities would also need to be 20% cheaper for relative positions to be the same.

And that’s at 2%. Get back to 3% on the US ten-year, as it was in October 2018, and you’re looking at a correction of 35%. The higher the price earnings ratios the steeper the correction. The Nasdaq is on 31x earnings.

We’ve analysed the price earnings ratio inflation phenomenon previously, with share prices raising well above the increase in company profits, spurred on by cheaper money. Over time, share prices follow earnings. And unless the cost of capital has been perpetually reduced then when interest rates do rise so too should this inflation in equity be reversed.   

And finally, a fortnight ago we referenced the boom in special purpose acquisition company’s or SPAC’s. This week we learned that Virgin Orbit is looking to go public via a SPAC. The satellite launching startup is mooted to be eyeing a valuation of $3 billion. In January, there was a successful test launch of one of its rockets. The rocket is launched from a Virgin branded Boeing 747.  

In 2019, the space-tourism company Virgin Galactic went public through a SPAC. The stock (SPCE:NYSE) has done quite well and although off the boil with the recent deflation in the tech market commands a market value of $8.5 billion.

Richard Branson, the irrepressible English entrepreneur, owns 80% of Orbit and a Middle Eastern wealth fund the balance. With the Virgin empire struggling under the weight of COVID-19 flight constraints this is a bit of good news. Best of luck Sir Richard!     

Thank you all for reading our Sunday Letter.