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Stock Pick - 9 January 2013

It was a tale of two markets last year.  Will 2013 be more of the same? Local markets are no longer a bargain and though analysts are not banking on a boom in commodities, they expect more progress on the issues that have hampered global growth.

Rarely has the market diverged so much as in 2012. It is often said that the most important decision in fund management is to get the right balance between resources and financials & industrials. It was certainly true in 2012. The total return for the year was a healthy 20% but as usual the average doesn't tell you much.

There was a relief rally in the fourth quarter for resources but Lonmin lost two-thirds of its market value, Gold Fields lost 27% and Anglo American 12%. Nobody had predicted how something specific to SA - the dysfunctional industrial relations which were the backdrop to Marikana - would influence the sector.

Herman van Velze, head of core equities at Stanlib, says that even among this rather dismal cast, it has been possible to find strength. Stanlib did not hold either Anglo or Sasol - a bold move in an institutional portfolio - but took a big position in BHP Billiton, which was up 26,4%. "In the long run it is a better business, better managed, more diversified than Anglo and with less exposure to SA."

He argues that resource shares are in trouble even though commodity prices have remained high - prices need to move well ahead of their record highs before many of these shares can show profitability comparable to that of quality industrials.

"With China slowing and interest rates on hold all over the world until at least 2014, a commodity boom seems a long way off."

Jean-Pierre Verster, an analyst at boutique manager 36One, says resources are lower-quality businesses than industrials or financials. "They have no pricing power as they are hostages to global commodity prices; and the cost issues are becoming more of a problem, especially in gold shares."

But he says Anglo American will be an interesting share to watch, with the new CEO and the possibility of a bid from the merged Glencore/Xstrata.

Many fund managers now prefer to get their precious metals exposure through exchange traded funds such as Newgold onshore and platinum ETFs overseas.

David Shapiro, probably SA's best-known stockpicker, says he is not ready to commit to a recovery in platinum stocks but oil prices will be strong enough to justify holding on to Sasol.

He expects the sweetener to market performance to come from selected resource shares such as BHP Billiton, Exxaro and Kumba.

The issues that hampered a full global recovery in 2012 are still around, he says, but are slowly being resolved. In the US the housing market is improving and the unemployment rate is falling.

"With a lot of liquidity and low rates, the uptrend in equity markets should hold course."

Shapiro says he is optimistic that the Chinese recovery will continue. As for Europe, he says: "As long as the region's leaders keep meeting week after week, the market will learn to adapt."

But as SA markets are no longer a bargain he would be satisfied with a 10% return from the JSE in 2013.

No-one can dispute that many shares on the JSE are already expensive, notably the retailers. Local fund managers ditched these shares only for foreigners to climb in. In a developed world with ultra-low yields, a 3,1% tax-free yield on Foschini, a world-class retailer, looks good.

The market was not a tide that lifted all retailers - the big winners were Woolworths, up 80%, and Mr Price, up 70%. Massmart, the darling of previous years, was up just 10%.

Stanlib was among the last to reduce its retail exposure, though it still has positions in Woolies, Mr Price and Spar.

Shapiro says it is not yet time to sell last year's winners, particularly Woolies, Mr Price and Life Healthcare.

Adrian Saville, manager of the Cannon Equity fund, says it is hard to reconcile the performance of consumer shares and the rest. "We seem to have forgotten that retailers are cyclical as well. It is not just the resources shares that are unloved but a whole lot of quality industrial shares, such as Trencor, Invicta, Hudaco and Reunert. Their earnings track record is every bit as good as that of more glamorous counters, such as Naspers, BAT and Richemont."

He points out that Mr Price's market cap is almost the same as that of the entire construction sector - yet five years ago its market cap of R5,4bn was dwarfed by the R33,8bn for Murray & Roberts and R24,1bn for Aveng.

These have fallen sharply and Saville argues the current ratings sharply underestimate the potential of the construction sector to start pumping again.

Saville isn't quite ready to back Murray & Roberts, which has fallen further and faster than other construction stocks. Neil Brown, co-manager of the Old Mutual Top Companies fund, argues that any risk is more than reflected in the price - Brown was a strong backer of the M&R rights issue earlier this year.

Saville says a few retailers are still undervalued: the credit furniture chains Lewis and JD Group.

Jason Hsu, a portfolio manager at Research Affiliates in California, says investors tend to over-extrapolate recent growth rates into the future, leading to rich valuation levels. These then produce low future returns.

And he says there is a danger of a secular slowdown in EPS growth. With an oversupply of able-bodied workers from the baby boom generation, companies have captured a disproportionate share of earnings relative to the labour force. But in the long term a scarcity of labour in the West and Japan will eventually put more power in the hands of labour and reduce earnings growth.

Hsu says companies in emerging markets must be better placed in the long term because of their younger populations and abundance of labour.

Back in SA, Van Velze believes health care is now a more exciting sector than retail. "It is a nondiscretionary item, as people don't have much choice when they need to go to hospital or take antibiotics. The main determinant is the pool of insured lives [medical aid members] and if that is growing, the prospect for health-care stocks is good."

He likes Life Healthcare and Netcare among the hospital groups and Aspen among the drug manufacturers.

He also believes that among the megacaps mobile phone operators have scope to grow, though it is hard to tell which will have a stronger 2013.

"Vodacom is a fantastic yield play, giving close to 7% tax-free, and it has maintained its fat margins. MTN is the great frontier market investment, with better growth prospects, but less cash to throw around."

When it comes to broad industrial shares, Stanlib has Bidvest and Imperial as core all-weather holdings in preference to Barloworld.

When it comes to life assurers, Saville remains a strong holder of Old Mutual, which looks underrated when the value of its holdings in Nedbank and US asset management are taken into account. Van Velze prefers the more homespun charms of MMI, which will benefit from the cost savings and scale given by the merger of Momentum and Metropolitan.

Financials do not generate as much excited debate as resources or industrials. Perhaps the most controversial area is the second-tier banks, Abil and Capitec, which had a difficult time in the second half of 2012 amid mounting concern about levels of unsecured lending. Verster says the two most promising banks are Absa and FirstRand. The market view that Absa is thin on management skills is greatly exaggerated, he says. At the other end of the scale, FirstRand is the strongest banking group - up to 1m accounts switched to FNB last year - yet its 13,5 p:e is in line with the rest of the banking sector.

 

What it means:

Resource shares in trouble even though commodity prices high

SA markets no longer a bargain

 

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