The Ingham Analytics Weekly Letter on Sunday - 30 August 2020

Sunday, 30 August 2020

Welcome to another Ingham Analytics weekly research summary, highlighting pertinent local and international financial newsflow, recent notes that we have published, and what has been among some of the most read notes in the past few weeks or months.

Interesting and often depressing South African corporate newsflow continues. Some of the more noteworthy financial results this week on the JSE were Bidcorp, Nedbank, ABSA, Distell, Lewis, Adcock Ingram, Murray & Roberts, Massmart, Sibanye Stillwater, Grindrod, and Italtile.

Famous Brands announced it was selling its 51% shareholding in Tashas back to the founding Sideris family, perhaps providing a ray of light for the future of the struggling restaurant trade. Old Mutual put out a downbeat trading statement, expecting a decline in half-year earnings.

Dis-Chem reported 8.8% growth in sales for the 24 weeks from 1 March 2020 to 15 August 2020, benefitting from being an essential service, but we'll have to wait until 5 November to see what the interim earnings will be. Adcock Ingram, which reported full-year results to June that were essentially flat, also benefitted from being an essential service provider.

Similarly, Aspen Pharmacare will report an increase in revenue and earnings for the full year to June on 9 September.

Steinhoff provided a quarterly update for the nine months to June 2020 during which revenue declined 6% in euro terms.

Nine months it isn't a fair reflection of the March to June COVID-19 world and management admit that performance for the full year is uncertain. There are various complications associated with Steinhoff that mean we continue (as we did before the collapse in late 2017) to recommend avoidance but credit to the team for the progress made given what seemed like an untenable position at one point.

In studying various results, it is clear that, with the few exceptions, most domestic facing companies that were already struggling with years of economic decline in South Africa have been dealt a hammer blow by the COVID-19 induced lockdowns.

Forecasting, as the saying goes, is difficult, especially about the future, but it is impossible now to hazard a guess as to what the future holds for revenue let alone profits - which in turn makes valuing assets particularly tricky. Companies are largely holding their cards close to the chest on the outlook with the focus on liquidity and trying to keep the wolf from the door.

Analyst and fund manager questions at results webcasts which in the past dwelt on revenue expectations and the inevitable "margins" now tend to be around can you keep on as a going concern and what cash can you fall back on. The days of "lazy balance sheets" with companies urged to gear up and spend are history.

Indeed, those companies we keep an eye on abroad that have high levels of gearing are in a serious sweat. Interest rates may be at multi-year lows but if you need to borrow and your metrics are already dodgy, you pay up - Ford Motor Company in the US had to pay close to 10% on new US dollar debt securities in April.

Mining is one of the rare exceptions and we note Sibanye Stillwater this week, which reported an impressive six-month result, stated that "the operating and financial outlook for H2 2020 is positive."

What we find impressive too is that Sibanye Stillwater didn't start its results presentation with the financials but with environmental, social, and governance considerations. ESG is a factor that fund managers are increasingly taking cognizance of and is a feature of CFA and other professional body talks and papers.

Company tax revenues to the fiscus, already under pressure, will be turning in many instances into assessed tax losses seemingly from here to kingdom come. Income tax revenue due to job losses and voluntary or involuntary pay reductions are being felt whilst cautious consumers with less to spend will mean less VAT and excise duty, and tax leakage due to the bootleg economy.

Distell for example, a quality drinks business we rate as an investment in more normalised times, records in reported turnover excise duty. Excise duty is not directly related to sales, unlike VAT, and thus not recognised as a separate item on invoices. So, for Distell and SAB, excise duty is a cost to the Group and reflects in cost of goods sold. Last year,Distell paid excise duty of R7.1bn which is 27% of total revenue. Because of higher excise duty the amount paid by Distell increased 11% whereas sales increased by only 7%.

What was interesting about the Distell full-year result to June 2020 was that revenue was 15% lower on 23% lower volumes whilst revenue excluding excise duty was down by 16%. But in the first half revenue grew by 3% on 7% lower volumes but excise duty grew by over 6% to R4.1bn. Second-half sales fell by 35%, mostly due to the four-month lockdown through June, which means excise is down by at least as much.

KAP is another quality group of companies, which includes the well-known PG Bison name, that has sadly also borne the brunt of the government lockdowns. The first half was difficult enough in a poor economy but the 6% decline in six-month headline earnings looks positively rosy in the context of a 68% decline for the year, meaning a loss-making second half.

Gearing increased, cash generated halved and shareholder equity declined by 25% to R9.5bn. You couldn't start this group from scratch for R9.5bn. At a share price of 275 cents the market capitalisation is R7bn, itself a 25% discount to an already discounted NAV. Would we ordinarily be buyers of KAP? You bet. KAP is just another example of a terrific yet neglected JSE listed stock.

Italtile has had a very good run of increasing revenue and profits but its full-year results to June 2020 put an end to that. Whilst the 19% decline in underlying earnings isn't that bad at face value given the carnage we're seeing elsewhere, the final dividend of 10 cents per share told the real story - down by 47% on an unchanged dividend cover.

We've now had three of the big four banks report interim results whilst FirstRand reports full-year results on 10 September. We put out a banking themed note this week entitled "Skin on the bones" in which we said that the latest numbers from ABSA, Nedbank, and Standard have will have shareholders reaching for a tot or two of Three Ships (which is a Distell product by the way). We are on record as long recommending avoiding banks', but we would put Standard Bank back on the radar and suggest levels for new money at or around R95 per share.

In "An Apple a day...?" we featured that well-known brand that designs, manufactures and markets smartphones, personal computers, tablets, wearables, and accessories, and sells a variety of related services.

Apple costs $500 a share, an amount of money barely gets you on the bottom rung of their product offerings in the US and if you fancy a MacBook Pro you'll be forking out $3,000 plus taxes.

We make the point that Apple is a good example of the Tech mania that has replaced the COVID-19 hysteria of March. We also unpack this phenomenon of share buybacks that inflate EPS. If Apple meets our target EPS for the twelve months ended September 2020 then EPS will be 12% higher than in 2018 and that's with 13% fewer shares in issue. In January, the share could be bought for $300 whereas it is now $500 (after recovering from an intraday low of $203 in March) but the trouble is you are paying 70% more for the same earnings stream.

Share price inflation has boosted PE multiples in most US Tech stocks and this is compounded by share buybacks - because of a lower denominator, you think they are doing better than you are.

With bonds, we're keeping watch on the US Treasury's. Yields on longer dated bonds are rising (prices falling) as investor capacity to mop up a deluge of government debt issuance seems to be getting indigestion.

The US ten-year yield hit 0.78% this past week whereas less than a month ago it was 0.5%. That is a more than 50% movement in yield. If you'd bought lower down, you'd be nursing a big loss on capital. The longer end of the yield curve has steepened in the US whilst the shorter end has been flat.

For us, US bonds (indeed any of the major international bonds) are not the place to be right now as any capital gains are in the past and the yield simply too unattractive. And South African government bonds are the second highest yielding in the emerging (or should that be submerging) universe - for good reason, the risk, so we aren't taken by them either.

Thank you all for visiting us.

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