The Ingham Analytics Weekly Letter on Sunday - 27 September 2020

Sunday, 27 September 2020

Welcome to another Ingham Analytics Weekly Letter on Sunday in which we aim, inter alia, to take a step back to see wood for trees, in South Africa and around the world.

Heritage Day was a temporary respite from the COVID-19 gloom and there were several colourful, cheerful and socially distanced celebrations around South Africa. It is terrific to see an IsiZulu song Jerusalema spreading joy and a spirit of inclusion far and wide in the world. Music knows no language barrier and can be a unifier. When it comes to full voice and dance South Africans take some beating, with a sense of rhythm, lyricism and movement rarely found in other cultures.

World financial markets were rather less soulful, with heightened jitters and volatility this past week. In foreign exchange, commodity currencies like the Australian dollar, Norwegian krone, Brazilian real and the rand were sold off sharply. 

US equity indices closed Friday 18 September weaker and this rolled through to Monday with weakness persisting through Thursday before this week ended firmer. European markets were persistently weak and ended this week down, with banking stocks at their lowest in years. The STOXX Europe 600 index is 15% below its level in January. Asian markets are mixed, the Nikkei 25 Index is back to where it started the year but the Hang Seng index in Hong Kong is still almost 20% below. Whilst the JSE All Share index is 7% below the start of the year in ZAR, in USD it is 23% lower and that is thanks only to a handful of mega-cap stocks that have little or nothing to do with the real local economy.

In the US, the unedifying fight over the next Supreme Court judge, reduced prospects of further fiscal stimulus, ongoing racial flareups, the possibility of a contested Presidential election after 3 November and persistence of the COVID-19 pandemic are all bearing down on sentiment.

Gold has come into its own, again. The precious metal had been firm for some time and then started to appreciate from the $1,200/oz region in early 2019 and climbed to over $1,500/oz by August last year. Over a 52-week range the high and low differential exceeds 40%. At the high in early August this year gold was 35% higher than at the start of the year. Unlike fiat currency, gold remains a store of value and has other unique attributes.

In our note on the gold market this Friday, entitled "All that glitters?", we write that the fall back from over $2,000/oz to around $1,850/oz is a welcome breather as gold has moved quite quickly and price sensitive central banks had eased off on purchases. However, we see gold as having the potential to be significantly higher in future. In real inflation adjusted terms gold remains favourably priced. Our note unpacks what is driving interest and how to play this from an investment point of view when other asset classes are so volatile and susceptible to fragile investor sentiment in a highly uncertain world.

This all ties in with our other note this Wednesday entitled "Uh-ho!", addressing the resurgence of turmoil in US equity markets. We expect further volatility and a weakening bias, particularly as the upside has been a one-trick "tech" pony for which valuation multiples defy common sense. We write that a mixture of loose policy and febrile psychology is a potent elixir. Signals we continuously monitor in currency, bond and credit markets aren't encouraging.

We read the reviewed annual results this week from Advanced Health for which the auditor has provided an emphasis of matter in their review opinion. We have long admired this plucky company for its farsighted approach toward affordable healthcare through day clinics, a concept they have successfully run in Australia, but which has struggled to gain traction in South Africa. Prohibition of elective surgery due to COVID-19 had a materially adverse effect on revenue and profits. The company does have some optionality with respect to the future and we wish them best of luck in a difficult situation.

Another company we've been close to for years is Hulamin. This is just the sort of technically demanding manufacturing that South Africa needs more of if the country has any aspiration to be an industrial developing country rather than a deindustrialising one in premature economic decline. Hulamin is among the leaders in its field of aluminium rolled products but has faced challenges, locally and in the important overseas markets that are vital for its survival. Packaging and automotive demand account for 60% of sales.

Hulamin is in the right areas to exploit environmental concerns and the projected sharp growth in electric vehicles. The interim results reflected the impact of COVID-19, with a reversal of fortunes, but management has a good track record of holding the line in difficult circumstances. This is another unloved company on the JSE all but ignored and trading at a significant discount to net asset value. In fact, you couldn't start this business from scratch at what the equity is valued at, let alone the market capitalisation.

Elon Musk in his battery day claimed that 20m Tesla vehicles were the target - that is twice as much as VW and 30% of all cars and light truck sold globally in 2019. Going from 368,000 Tesla cars in 2019 to 20m is a stretch. Furthermore, a lower price of $25k is targeted helped along by plans to begin building its own battery cells in 2022 at a volume roughly triple the amount of cells it got last year from its factory in Nevada. Panasonic is the current battery technology provider. The interesting thing is that the share price of Panasonic on the Tokyo Stock Exchange in no way mirrors that of Tesla with the stock no higher now than five years ago and 45% lower than a high in 2017/2018. That contrast is perhaps another cautionary sign to dampen Tesla stock enthusiasm.

On the topic of electric vehicles, California has now decided to ban sales of new internal combustion engine vehicles starting in 2035. The EU's cap of 95 grams per kilometre on carbon-dioxide emissions, which has already been reduced, takes effect next year and drops to 47.5 g/km in 2030 with the EU requiring fully electric vehicles to account for 60% of new-car sales in Europe--up from 4% now.

Whilst we are all in favour of pushing the boundaries of propulsion technologies, regulators should be more mindful of the law of unintended consequences. We cite the example of the average age of cars in the US being 12 years and with one in four cars or light trucks 16 years old. With California sometimes emulated in other states and with fourteen years to go, you'll have a situation where that new petrol engine car you've just bought will have little to no residual value. Finance deals of 6 to 7 years are commonly available in the US, together with balloon payments. If residual value tank this brings a new layer of risk for financial institutions. World-wide sales of new electric cars accounted for just 2.8% of total sales last year and even in California it is currently less than 4% of new cars. This green enthusiasm also faces the issue of raw materials availability such as copper, lithium, cobalt and nickel. Is it likely that dirty old miners like Glencore and BHP will have the last laugh and longer lives than anticipated?

We wrote in "BA(D) 900 news?" that South African banks are hoarding liquidity in preference to writing new loans and advances to virtually all sectors of the economy. What caught our attention this week was what's going on in Australia where banks have been criticised for also being restrictive.

Australian Treasurer Josh Frydenberg announced that lending rules were set to be relaxed, under a proposed revision to the country's consumer credit laws. The Australian government is seeking to streamline and simplify the loan process that would see the focus go from 'lender beware' to 'borrower beware'. The credit laws would target home loans, credit cards, payday lending and personal loans which could result in the Australian Securities and Investments Commission's ability to enforce responsible lending rules across the banks abolished. The idea is to simplify the loan application process and reduce barriers to switching. The Australian government is keen to see credit flowing freely in a COVID situation. The Hayne Royal Commission findings and fines may have also put banks off. The Australian Banking Association has responded positively to the suggested changes.

Meantime, a spike in coronavirus cases in Europe and money-laundering allegations against major global banks have further pressured bank share prices. The share price of HSBC is back to where it was twenty years ago. Yet more severe lockdowns would be disastrous for the real economy and financial markets. Unless real economic activity rebounds strongly even tech stocks trading at what appears to be COVID inflated multiples won't escape the effects.

On a lighter note on which to end, we see that Costco in the US, the second largest retailer after Walmart, has been boosted by COVID-19, reporting Q4 earnings up 12.5%. This was higher than street expectations. Same-store sales for Costco grew 11.4% in Q4, double that of Q3. Full year same-store sales grew 9.2% with net income up 9.3%. There seems to be an element of front-ending here, the test will come when things settle down post COVID disruption and the binge buying of lavatory paper. Even the CFO admits that shoppers are spending less on travel and dining but redirecting some of that spending. An interesting tidbit, because food is selling so fast its helping profit margin due to lack of loss on spoilage or sell-by-date discounting.

Thank you all for visiting us.