After a strong year for South African equities, portfolio manager of the Denker SCI Equity Fund, Claude van Cuyck, covers some of the sectors and stock ideas that have generated solid returns for investors in the fund. He also touches on the positioning of the fund and the outlook for the new year. In the same episode, equity analyst Ricardo Micheals provides some insight into the platinum sector and what we expect from the sector going forward. Listen to the podcast or read the transcript below.
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.
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.
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?
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.
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.
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.
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