Podcast: A review of our SA equity fund and ideas, and the platinum sector

Nigel Barnes:

Welcome to the Denker Capital podcast. Today is the 29th of November 2021 and I’m joined by portfolio manager, Claude van Cuyck, and equity analyst, Ricardo Micheals, from the South African equity team at Denker Capital.

Claude, I’m going to come to you first. Could you give us a recap on how the Denker Sanlam Collective Investments (SCI) Equity Fund has performed this year?

Claude van Cuyck:

Yeah, thanks Nigel. You know, the best long-term investment opportunities generally present themselves post a crisis and the Covid-19 pandemic has been no different – we wrote extensively about that in April 2020. Over the past 12 months the Denker SCI Equity Fund has performed* well – with a total return of 41.4% as at the end of October, net of all fees. That’s well ahead of the market and the average of its peer group in the Asisa category. The alpha generation was fairly broad based at stock level – it was fairly consistent across all sectors (industrials, financials, resources) and also across large, mid and small caps. I think this is testament to the idea generation within the team.

Nigel Barnes:

Okay, great. Do you want to dig into that and give us more detail in terms of small and mid caps, the counters and some of the ideas?

Claude van Cuyck:

The small cap area is one area that differentiates us from our peers. Within the small cap sector, one of the standouts to highlight is Combined Motor Holdings (CMH). It’s an extremely well run motor retail business, with an exceptionally high return on invested capital. The management team reacted swiftly to the crisis – they cut costs aggressively and, although new car volumes came under pressure during the crisis, because of the lack of supply in the industry they actually had quite a bit of pricing power through this period. If we look at the used car market as well, it was fairly buoyant and this resulted in strong performance over the past 12 months. CMH’s share price was up ~68% over the period.

Within the mid-cap sector, Mr Price, Pepkor and Italtile are three great opportunities that we held during the crisis. They’ve got superior management teams, strong competitive positions within their markets and extremely high returns on invested capital. These are three key criteria that we look for in any company.

One of the large caps that performed particularly well for us, which we had quite a large shareholding in, is MTN. MTN sold off aggressively through the crisis and fell below R30. We saw that as a key opportunity to buy. The price was essentially implying that shareholders would be paying mostly for the business’ South African operation. It meant that shareholders would be getting Nigeria, Ghana and the rest of the assets almost for free. The share price has gone up five times since – so overall, stock picking has been quite solid.

Nigel Barnes:

Fantastic. Ricardo, let’s come to you now. This is the first time we’ve had you on podcast, so welcome. You joined the business back in the September last year and are a senior analyst on the team.  You cover some of the resources as part of your day-to-day activities and the platinum sector is topical at the moment. Please give us a bit of background?

Ricardo Micheals:

On the plats side, it’s been an interesting year. The year started out fairly well as most of the miners rebounded from the Covid-19 related issues that we saw in 2020, but since April it’s been pretty choppy for the platinum group metals (PGM) miners. As the world opened up, demand started to increase and we’ve seen supply related issues disrupt many industries. One of those industries was the semiconductor space. So we saw that most of the auto manufacturers didn’t order enough semiconductor chips this year because they put a lot of the orders off last year. So they were put to the back of the queue, and because most of the PGM metals go into autos – 80% to 90% of rhodium and palladium go into autos – we saw the demand for those metals plummet as well. So that resulted in the PGM basket price pulling back quite aggressively since April, and that very much affects the companies that we are invested in. However, we monitor this situation fairly closely and believe that the lower demand is a fairly medium-term issue and it should steadily pick up again as the chip shortages are sorted out.

We think the valuations of the businesses that we are invested in and the fundamentals remain attractive. We are exposed to the space through our overweights in Northam Platinum and Royal Bafokeng Platinum (RB Plats). We like the growth profiles of these companies. Their positions on the cost curve and the prill splits that they have make them very attractive. But over the last month or so, we’ve seen a lot of corporate action in the platinum space as RB Plats became a target for both Northam and Impala Platinum. Both of these companies made offers for RB Plats, so it’s becoming a very topical space. We think it’s still a very attractive industry and we took the opportunity to increase our RB Plats positioning. At the moment we are invested in both Northam and RB Plats and we still see these as very attractive opportunities going forward.

Nigel Barnes:

Great, thanks Ricardo.

Claude, looking forward to 2022, how are you feeling about the positioning the portfolio and some of the metrics as they stand today?

Claude van Cuyck:

I think the SA market is still offering attractive upside. If we look at SA valuations relative to emerging markets (EM), SA underperformed a large part of the EM market. So, certainly from a pricing metric and valuation perspective, SA is fairly attractive – in particular, relative to developed markets. There are still a lot of potential opportunities in SA. Having said that, I think the easy money has been made. We’ve seen a strong recovery in the SA market and the rest of the world. So it will be a little bit more difficult from here. It does make sense for us to look at possibly concentrating the portfolio. The breadth of opportunities has narrowed over the past 12 to 18 months. So with that, we’ll probably start reducing the number of stocks in the portfolio to have slightly greater concentration. Having said that, on our assessment of underlying intrinsic value the portfolio is still trading in its entirety at about a 10% discount to intrinsic value (this is after assuming our required annualised return of at least 14%). This implies that it’s probably not unreasonable to expect double digit returns in the upper teens from the portfolio. This obviously does come with traditional health warnings, as we know that’s assuming no big macro events or crises that are certainly out of our control – but that is why we manage diversified portfolios.

The Denker SCI Equity Fund is well diversified across sectors, both locally and internationally. If we look locally, its diversified across industrials, financials and resources. From a size perspective, its diversified across small, mid and large caps. We’ve got 80% of the fund invested in South Africa and 20% globally. Half of the global allocation is invested in Kokkie Kooyman’s Denker Global Financial Fund, three and a half percent in the Denker Global Equity Fund and the balance (around about six and a half percent) across three high conviction global stocks that we cover. So, effectively, you’re getting the best of Denker’s equity capabilities by investing in the fund.

Looking at the portfolio metrics, we reference normalised ratios here. So the normalised price to earnings multiple for the fund is around about 11x, 50% of the stocks in the portfolio are actually trading on normalised price to earnings multiples below 10x, and the normalised dividend yield is around 4%. So just to clarify, when we refer to the normalised metrics, we’re referring to the sustainable earnings power of the underlying companies and the sustainable dividend paying capability of the underlying companies that we are invested in.

Nigel Barnes:

Thank you. It’s been a really strong year. A lot of alpha generation in the portfolio, with some challenges around the platinum sector but I think you’re well set for the new year – so thanks for all your efforts.

*Fund returns quoted are annualised and net of the R class of the Denker SCI Equity Fund, which has an annual management fee of 1.55% (incl. VAT). The annualised returns are the weighted average compound growth rates over the periods measured. The fund returned 41.4% over the last 12 months and 8.2% over 10 years. The benchmark (a composite of 87.5% Capped Swix and 12.5% MSCI World Index) returned 38.9% over the last 12 months and 10.5% over 10 years. The highest calendar year return in the last 10 years was 22.21% and the lowest was -6.41%. Source of returns: Morningstar, 31 October 2021.

Disclaimer

The opinions expressed in this podcast are those of the participants and do not necessarily represent those of Denker Capital. This podcast does not take the circumstances of a particular person or entity into account and is not advice in relation to an investment. Please do not rely on any information without appropriate advice from an independent financial adviser. The value of investments may go down as well as up, and past performance is not a guide to future performance. Denker Capital is an authorised financial services provider in South Africa (FSP number 47075).

The information included does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act. Use or rely on this information at your own risk. Independent professional financial advice should always be sought before making an investment decision. The manager retains full legal responsibility for the third party named portfolio. The Sanlam Group is a full member of the Association for Savings and Investment SA. If the fund holds assets in foreign countries and could be exposed to the following risks regarding potential constraints on liquidity and the repatriation of funds, macroeconomic, political, foreign exchange, tax risks, settlement risks and potential limitations on the availability of market information. A schedule of fees and charges and maximum commissions is available from the Manager, Sanlam Collective Investments, a registered and approved Manager in Collective Investment Schemes in Securities. Sanlam Collective Investments (RF) (Pty) Ltd (SCI) is a registered and approved Manager in terms of the Collective Investment Schemes Control Act.

The Manager of the range of Denker Capital South African funds and feeder funds is Sanlam Collective Investments (RF) (Pty) Ltd (SCI). The Manager retains full legal responsibility for third party named portfolio. The Sanlam Group is a full member of the Association for Savings and Investment SA. A schedule of fees and charges and maximum commissions is available from the Manager. Standard Bank of South Africa Ltd is the appointed trustee of the Sanlam Collective Investments schemes.

Collective investment schemes are generally medium- to long-term investments. Please note that past performances are not necessarily an accurate determination of future performances, and that the value of investments / units / unit trusts may go down as well as up. Changes in exchange rates may have an adverse effect on the value, price or income of a product. Collective investments are traded at ruling prices and can engage in borrowing and scrip lending. Collective investments are calculated on a net asset value basis, which is the total market value of all assets in the portfolio including any income accruals and less any deductible expenses such as audit fees, brokerage and service fees. Actual investment performance of the portfolio and the investor will differ depending on the initial fees applicable, the actual investment date, and the date of reinvestment of income as well as dividend withholding tax. Forward pricing is used. Additional information of the proposed investment, including brochures, application forms and annual or quarterly reports, can be obtained from the Manager, free of charge. The Manager does not provide any guarantee either with respect to the capital or the return of a portfolio. The performance of the portfolio depends on the underlying assets and variable market factors. Performance is based on NAV to NAV calculations with income reinvestments done on the ex-div date. The Manager has the right to close any portfolios to new investors to manage them more efficiently in accordance with their mandates. Lump sum investment performances are quoted. All the portfolio options presented are approved collective investment schemes in terms of Collective Investment Schemes Control Act, No 45 of 2002 (CISCA). The portfolio management of all the portfolios is outsourced to financial services providers authorized in terms of the Financial Advisory and Intermediary Services Act, 2002.