The Ingham Analytics Weekly Letter on Sunday - 25 October 2020

Sunday, 25 October 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 - not too seriously, there is enough of that about.


First off, three cheers to Brian Joffe and his team at Long4Life for ploughing through an unenviable six months bearing the brunt of various levels of lockdown. With names like Sportsmans Warehouse, Outdoor Warehouse, Chill and Inhle beverages, and Sorbet the Group has been at the sharp end of COVID-19.


But true to form, Brian has prevailed in circumstances without precedent in his outstanding business career. He is an inspirational leader and inspires confidence, a precious intangible asset for any business. Long4Life has emerged stronger and in the lifestyle, category will be a survivor and a thriver too. The name of the Group says it all and is apt at a time when spirits are low.


The stock market cheered the message from the interim result on Wednesday, which Brian delivered in his common-sensical way devoid of corporate-speak.


At R3 per share, Long4Life deserves a far chunkier rating but that should come once sentiment turns for the better - this is one stock you want to be exposed to. Tim Martin of J D Wetherspoon in England, whom we referenced last week, and Brian Joffe have much in common in their business philosophies.


Our note last week "Nickel for Elon?" also acknowledges another rare leader and entrepreneur Elon Musk, who seemingly singlehandedly is pushing the proverbial envelope in automotive propulsion and related energies. If his electric vehicle aspirations are to be realised Tesla will be needing a lot more nickel, a metal which BHP refers to as a "future-facing" commodity and in which it sees big promise. Our Sunday letter last weekend delved deeper into this topic.


Tesla reported Q3 results on Wednesday too and there are signs that sustainable profitability could be in sight, making the company potentially eligible for S&P 500 inclusion. With a market cap of around $400bn not being in the S&P 500 may seem like an anomaly but the deciding committee have various criteria for inclusion that Tesla hasn't hurdled yet. Zero-emission credits seem to be one of those hurdles, the company has earned $1.2bn in credits over three quarters and will likely generate $1.6bn for the fiscal.


Netflix reported good Q3 results on Tuesday. With cinema's shut around the world the traditional Hollywood model, which was being slowly being disrupted anyway, is up the creek without a paddle. Meantime, Netflix keeps churning out appealing and more cost-effective streaming entertainment - no million-dollar salaries for big-name actors here. AT&T, which reported pleasing Q3 numbers this week, is also doing quite well with its WarnerMedia entertainment offering and HBO continues to gain subscribers. The HBO Max premium service, which only launched in late May, doubled its activations in the quarter.


Our note "Road to nowhere?" this week made the point that the current polarisation in politics is obvious to see all over the world. Attitudes are hardening and realities are not that encouraging. South African domiciled investors have seen local options narrow considerably and this means casting the net far wider than used to be the case, but with caution.


We've discussed the rising appeal of gold in various letters and notes and we see that gold-backed ETFs recorded their tenth consecutive month of net inflows during September. Global net inflows of 1,003t (worth $55.7bn) in 2020 have led overall gold investment demand and taken the gold ETF holdings to a fresh new all-time high of 3,880t and $235bn in assets under management.


With interest rates low, and even the ECB along with the Fed saying it'll tolerate higher inflation, the opportunity cost of gold continues to improve and boost investment demand, outweighing lower jewellery and central bank demand of late.


China alone accounts for over 20% of annual gold demand. The gold price ended the week firm at just over $1,900/oz.


This week we introduced a Banks Monitor to add to the Energy Monitor and Mining Monitor. The note is entitled "Irish eyes aren't smiling." Banks around the world have been reporting large impairments but we caution that whilst banks may think they have been conservative in fact they may not have been conservative enough. Moody's the ratings agency is of the view that internationally, the loan default rate is expected to exceed the bond default rate.


If you want to see how bad things can get for banks in a COVID-19 world look at Ireland. Banking shares generally in the EU zone, especially the Club Med countries, have been hammered but the Irish banks probably rank the worst.


Long-suffering Sasol shareholders were presented with a 146-page circular on Thursday relating to the sale of a 50% interest in what's termed the Louisiana Integrated Polyethylene JV LLC in Lake Charles to LyondellBasell.


As we previously pointed out in our Sunday Letter dated 11 October, LyondellBasell is paying what we estimate is a discount of at least 30% to what it has cost. LyondellBasell has admitted they are buying in at the bottom of the cycle whilst on the other hand, Sasol is a forced seller of assets at the bottom.


Sasol has sunk so far that this constitutes a Category 1 transaction in the JSE Listings Requirements, requiring more than 50% approval by shareholders and a bulging circular. Sasol shareholders vote on 20 November.


A transaction is categorised by assessing its size relative to that of the issuer. A Category 1 transaction is 30% or more of market capitalisation. With LyondellBasell buying for $2bn or over R32bn that is half of the R63bn market capitalisation of Sasol. Not that long ago the deal would have been a Category 2 transaction, around 10% of market cap, requiring an announcement not a circular.


The cost of this exercise? An estimated R557m or about $34m before VAT goes to bankers, accountants, lawyers, and sundry other service providers. These costs are about 2% of the proceeds to be paid, after which Sasol will still be lumbered with $8bn in borrowings.


To add insult to injury, which includes R140bn in write-offs over three years that are more than double the market value of the equity, this does nothing to remove an overhang concern around a possible $2bn rights issue and potentially huge dilution to shareholders. A rights issue would also constitute a Category 1 transaction and require pro forma estimates of the impact on the balance sheet and earnings per share.


By our calculations, a $2bn rights issue even at R100 per share, which is generous, would require the issue of around 350m new Sasol shares to add to the 620m currently outstanding. This takes pro forma shares in issue to 970m, an increase of 56%. Let's further assume Sasol gets back to profitability and makes R15bn in 2022. That would be R24 per share on current shares in issue. If we assume a rights issue EPS falls to R16, dilution of 33%. And that is not where it ends. Sasol still has $6bn in borrowings or R100bn, more than its market cap today.


Sasol shareholders are stuck between the devil and the deep blue sea; to mix metaphors, damned if they do support this deal and damned if they don't.


If you're a Sasol shareholder and want to get your own back, then you may want to consider LyondellBasell shares.


The company has been a consistent dividend payer and currently paying $1.05 per quarter or $4.20 per annum. The company paid dividends of $350m alone during Q2 this year on 340m common shares. The most recent dividend declared was also $1.05 per share, paid on 8 September. At $77 per share on the NYSE (code LYB) you're earning a gross yield of over 5% in USD, not bad - not least if you're making nothing on Sasol because it can no longer afford to pay a dividend and which runs a high risk of further capital depreciation.


On a cheerful Irish note to end with, we were pleased to see that UK drinks giant Diageo (share code DGE in London) launched an alcohol-free Guinness stout on Thursday. Initially, this is for the British and Irish market but given the popularity of the stout worldwide it'll probably be a matter of time before it's exported internationally.


Guinness 0.0 took four years of laboratory experimentation to get right. A 440ml can contains 70 calories compared with 177 for regular Guinness which has 4.2% alcohol by volume. Apparently, you cannot tell any taste and flavour difference between the two. Guinness stout, a hero zero. We'll raise a glass to that. Slinte is tinte!


Cheers to Guinness 0.0, the new alcohol-free stout launched on Thursday.



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