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QUARTER 03 2020
Consistency is the only currency that matters.
CONSIDER THIS
GETTING BALANCED
POST-PANDEMIC
pages 8 and 27
BETTING ON THE LEISURE SECTOR pg 13
THE UN-KNOWABLE FUTURE pg 20
PRIME PROPERTY ON SALE pg 29
Contents Consider this Q3 2020
8 29
TABLE TALK: Why Balanced Funds Treading carefully in a cheap SA
are a sound bet for long-term listed property market
investors With a plethora of SA listed property
companies trading at exceptionally
13 attractive values in the past quarter,
which companies has Prudential
In the eye of the storm: SA hotels,
casinos and restaurants chosen to increase our portfolio
Hotels, casinos and restaurants have exposure to and why? Equity Portfolio
seen their share prices taking a serious Manager Yusuf Mowlana sheds some
hit given that South Africa’s leisure light on this for our clients.
sector has been possibly the worst
affected by Coronavirus pandemic. 37
Equity Portfolio Manager Kaitlin Byrne Fairly valuing corporate bonds for
discusses how these businesses have our clients
navigated the shutdown and gradual In the wake of the March market
reopening, and investment prospects sell-off and subsequent credit rating
for the sector. downgrades, the local corporate bond
market has been very slow to react to
20 the higher risk investors now face in
buying these assets. Gareth Bern, Head
Things we can know and the
futures we cannot of Fixed Income, explains what’s been
Aadil Omar, Head of Equity Research, driving this and how Prudential has
offers a framework for thinking about managed the pricing disparities in the
how we can best approach decision- market.
making in a world where the future is
uncertain. 44
Prudential CSI: Showing we care in
27 times of adversity
Israel Mqingwana, Head of Human
VIDEO: The Prudential Balanced
Fund: Positioned to deliver in a Capital, reports how, like so many
post-Coronavirus world other South Africans, Prudential and
Watch a recording of our 22 July our staff have been devoting time and
Pruview webinar in which Michael resources to helping out those in need
Moyle, Head of Multi-Asset, and amid the health and economic crisis
Letter from the CEO
Chris Wood, Senior Equity Portfolio our country is facing.
Bernard Fick provides Manager, take a closer look at
a perspective on 48
03
important developments across
markets and fund
financial markets in the past three Book Review: The Third Pillar: How
returns during the last
months in the wake of the Coronavirus Markets and the State Leave the
few weeks and what
we could expect going pandemic, and answer client questions Community Behind
forward. around how we have been actively
managing the Prudential Balanced
Fun.
Consistency is the only currency that matters.
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LETTER FROM THE CEO
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Letter from the CEO
Benard Fick
CHIEF EXECUTIVE
A s we move into the third
quarter of 2020, we remain
concerned about the high
the world. That said, investment
markets are forward looking, and
will begin to reflect improved
numbers of people, businesses economic activity well before we
and communities still being turn the corner. To some extent
impacted by the Coronavirus this already happened during
pandemic and the resultant the second quarter, on the back
lockdown regulations. Many of the reopening of many of the
lives have been lost due to the world’s largest economies and
virus, and livelihoods severely some promising news concerning
affected by the repercussions the development of COVID-19
of the continuing regulations. vaccines.
Investors should know that
Prudential Investment Managers ©
we expect prolonged volatility At Prudential our business
ahead given the weaker economic continues to operate smoothly.
growth outlook and general Our teams are working successfully
uncertainty prevailing around and efficiently between and
Consider this QUARTER 03 2020 Page 1
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LETTER FROM THE CEO
among each other from many webinars on our website at
disparate places, and we have www.prudential.co.za/insights.
been able to keep ourselves
as closely focused on actively Prudential’s approach to
managing our clients’ assets as portfolio management
ever. For Prudential it has been a time
to be cautious, but not timid, in
Communicating with our managing our client portfolios.
clients We have taken advantage of
During the quarter we enhanced some extraordinarily cheap asset
our communications with our valuations that have presented
clients and financial advisers themselves, and deployed capital
through offering in-depth into some high-quality assets at
client Q&A webinars with our generationally-low prices. While
CIO David Knee (covering the the March correction was painful
Prudential Inflation Plus Fund), for investors with exposure to
Head of Fixed Income Gareth “risk assets”, the wrong action
Bern (covering Prudential’s fixed would have been to sell those
income portfolios) and Senior assets after the collapse and miss
Equity Portfolio Manager Chris out on the subsequent rebound
Wood (covering the Prudential in performance.
Equity Fund). Our most recent
session in July dealt with the Although we have no unique
Prudential Balanced Fund and insights into the shape or timing
featured Michael Moyle, Head of the economic recovery that
of Multi-Asset, and Chris Wood lies ahead, clients should know
answering the questions sent in by that we are confident that our
a wide range of clients. We hope client portfolios are appropriately
the detailed information we have positioned to meet (and even
shared has proved valuable and exceed) their benchmarks from
shed some light on our thinking current valuation levels over the
and actions during this time of next three to five years. You can
high market volatility. Everyone learn more about our portfolio
Prudential Investment Managers ©
can access recordings of these positioning and outlook for
Consider this QUARTER 03 2020 Page 2
4
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LETTER FROM THE CEO
returns from the Table Talk article investment success is patience – we
by Pieter Hugo and the Michael know there will be much volatility
Moyle webinar included in this ahead in today’s highly uncertain
edition of Consider this. Also environment, and investors need
of particular interest are our to ride out the ups and downs of
articles on Listed Property and the financial markets. The past quarter
local Leisure sector by Portfolio
has been a perfect example of the
Managers Yusuf Mowlana and
necessity of patience, as we saw
Kaitlin Byrne, respectively.
a strong recovery across most
I’d like to remind you that an local (and global) asset classes.
important requirement for For example, over the April-June
3-Month Rand 12 Month Rand
Return Return
Prudential Unit Trust (A Class) (April-June 2020) to 30 June 2020
Net of fees Net of fees
Prudential Balanced Fund 20.3% -4.0%
Prudential Dividend Maximiser Fund 22.6% -4.0%
Prudential Enhanced SA Property 23.2% -40.7%
Tracker Fund
Prudential Enhanced Income Fund 2.9% 2.6%
Prudential Equity Fund 26.4% -6.4%
Prudential High Yield Bond Fund 12.9% -1.0%
Prudential Income Fund -0.4% 4.9%
Prudential Inflation Plus Fund 16.7% -5.4%
Prudential Global Balanced Feeder Fund 12.8% 18.2%
Prudential Global Bond Feeder Fund 8.0% 26.9%
Prudential Global Equity Feeder Fund 15.7% 18.8%
Prudential Investment Managers ©
Prudential Global Inflation Plus 10.9% 21.4%
Feeder Fund
Source: Prudential Investment Managers
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LETTER FROM THE CEO
period the FTSE/JSE Capped SWIX the Coronavirus pandemic, during
Index returned 21.6% and the the quarter the government
All Bond Index returned 9.9%, amended the existing regulations
while the MSCI All Country World to allow living annuity investors
Index returned 19.2% in US$ the opportunity to adjust their
and 16.0% in rand. So investors drawdown rates. From 1 June
have already been rewarded for to 30 September 2020, they will
staying the course over the short be able to either increase or
term, in the face of distressing decrease their annuity income
economic newsflow.
rate to between 0.5% - 20% p.a.
In the accompanying table you In addition, those who have a
can see that Prudential’s unit policy value of R125,000 or less
trust performance has reflected will also be able to withdraw the
these rebounds since April, with full amount as a cash lump sum.
our funds holding risk assets like
equities and property showing While we understand it may be
the strongest gains. necessary for some investors to
increase their income drawdowns
Although our funds have not fully to compensate for the sharp fall
recovered to pre-crisis levels, we in investment values, we would
do take heart from the short-term urge clients to avoid doing so
rebound in returns. Our portfolios if at all possible. Selling assets
are, in our opinion, positioned at this low-point will result in a
to deliver to their performance permanent loss of capital in your
objectives over the medium term, portfolio, which is detrimental for
with the probability distribution
its longevity and future returns. If
of outcomes strongly in favour
possible, try to live with a lower
of patient long-term investors.
income level temporarily. This
Adjusting your living annuity holds true even for investors
income not holding living annuities but
In a bid to provide some relief to still depending on some form of
those most impacted financially by income from their investments.
Prudential Investment Managers ©
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LETTER FROM THE CEO
Helping those in need building to help limit the damage
To end on a positive note, I would wrought by the Coronavirus.
like to say how heartening it
has been to see how so many As former Chairman and CEO
ordinary South Africans have of Starbucks Howard Schultz
rallied together to help those famously said: “In times of
most in need amid all the distress adversity and change, we really
and hardship of the past three discover who we are and what
months. we’re made of.”
At Prudential, we feel immensely As I mentioned in my last quarterly
fortunate to have been in a position letter, in uncertain times like
to help various organisations with these we wish to engage with
their relief campaigns on both a our clients even more than usual,
company level and on the part of so please reach out to us if you
many of our staff. In this edition of have any questions or require any
Consider this our Head of Human assistance with respect to your
Capital Israel Mqingwana shares investment portfolios.
a handful of the stories that have
emerged during the pandemic so Please remain safe and healthy.
far. We know that many others in Sincere regards,
communities around the country
are taking similar steps, and are
encouraged that so much is being
done in this spirit of nation-
Bernard joined Prudential in 2008 as Head of Institutional Business and was appointed as Chief
Executive Officer in 2010. With more than 27 years of industry experience, Bernard previously
worked at Alexander Forbes in a range of leadership roles, including Managing Director of the
Namibian business as well as Head of the Asset Consulting Division. Bernard holds a Bachelor of
Commerce degree in Maths and Actuarial Science from Stellenbosch University and is a Fellow of
Prudential Investment Managers ©
the Institute and Faculty of Actuaries and the Actuarial Society of SA.
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TA B L E TA L K
TABLE
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TALK
PIETER HUGO
CHIEF CLIENT AND
DISTRIBUTION OFFICER
i KEY TAKE-AWAYS
Most local asset classes have been solution for long-term investors
trading well below their long- looking to beat inflation over time.
term value in recent months. Our
We believe the Prudential Balanced
analysis shows that a great deal
Fund has a very good chance of
of bad news has been priced into
delivering much higher returns over
our markets, which has presented
the next three to five years than its
a rare opportunity to invest across
historic averages, and investors are
different asset classes at very attractive
Prudential Investment Managers ©
likely to get the strong returns they
valuations simultaneously.
need from several different asset
Balanced funds with well-diversified classes, lowering total portfolio
exposure are therefore a sound risk.
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TA B L E TA L K
Q
I’m a long-term investor and worried about the
outlook for investment returns since South Africa
seems to be facing an extended period of low
growth. Even offshore, growth prospects are
much weaker due to the impact of the Covid-19
pandemic. Where does Prudential think I can get
the best risk-adjusted returns over the next five
to 10 years? For me it’s not just about getting
the highest returns, but also about managing the
downside risk after such a big downturn in March.
A
Despite the market understand that investors may be
volatility and uncertainty reluctant to consider these funds
around the outlook for given their recent below-average
South Africa’s economic performance, this is exactly why they
growth, you should be encouraged should be considering embracing them
to know that at Prudential we are even more at this point in time.
cautiously optimistic about investment
returns over the next five years or so. Our analysis shows that a great deal
This is particularly true for investors of bad news has already been priced
(like us and our clients) who have into our markets, which has presented
been able to take advantage of the a rare opportunity to invest across
excellent valuations we’ve seen across different asset classes at very attractive
most local asset classes in the past three valuations simultaneously. SA equities,
months.We believe it has been a very bonds and inflation-linked bonds
good time to invest in well-diversified have been trading very cheaply – as
balanced funds, and continues to be has SA listed property (although
so, especially for investors looking with much more associated risk). This
for solid inflation-beating returns means that balanced funds have a
Prudential Investment Managers ©
over the longer-term. While we fully very good chance of delivering much
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TA B L E TA L K
higher returns over the next three to For example, we have had the rare
five years than their historic averages, opportunity to add companies like
and investors are likely to get the Bidcorp to the Prudential Balanced
strong returns they need from several Fund. Bidcorp is a high-quality business
different asset classes, lowering total with geographically diversified
portfolio risk. revenues, as demonstrated by its
history of delivering attractive but
First, SA equities have given investors steady compound growth in profits
some excellent buying opportunities over time, as well as having a strong
due to the indiscriminate selling of all balance sheet. We have also increased
stocks during the March downturn, our holdings in Remgro and MTN
leading to very attractive valuations after their shares reached substantial
on offer: the FTSE/JSE ALSI ended discounts. Remgro had the additional
March at a price/book value ratio attraction of the unbundling of its
of around 1.1X, a 40-year low, and stake in RMH, while for MTN we saw
by the end of April it was trading at nearly 40% upside potential in its
only around 1.3X, in line with the share price, even after incorporating
Global Financial Crisis. Compared further allowances in our valuations for
to its long-term average of around future currency depreciation and other
2.2X, equities were initially offering potential negative developments.
a 50% discount! Prudential has taken Meanwhile, the fund’s top holdings
advantage of these cheap valuations, include global giants like Naspers,
while also being very mindful of the British American Tobacco (BAT) and
higher risks that have emerged for Anglo American, all of whose share
many companies. We have been careful prices held up relatively well in the
to select high-quality companies that past few months -- and should continue
should be able to weather the difficult to do so. Naspers’ online gaming
conditions ahead and deliver solid and other services benefited from
returns for our client portfolios going the global lockdowns, especially in
Prudential Investment Managers ©
forward. China, while BAT has solid, defensive-
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TA B L E TA L K
quality earnings and Anglo American’s exceptionally attractive levels of over
operations are highly diversified across 13% in March and were still trading
commodities and geographies. These over 11% in April, which we believe will
equity holdings, among others, give more than compensate investors for
the Prudential Balanced Fund potential the elevated risks involved. Assuming
to deliver above-market returns going inflation averages 4.5% (the mid-
forward. point of the SARB’s targeted inflation
range and a high assumption in the
While history never repeats itself
shorter term), they offer investors a
exactly, as an indication of the level of
prospective real return of around 6.5%
equity returns potentially on offer, the
p.a. over time – a level equivalent to
past 40-year history of the ALSI shows
that of equities, and with less risk.
that in the rare times when its price/
For example, the FTSE/JSE All Bond
book value fell to 1.5X or below, the
Index has already partly rebounded
index subsequently went on to deliver
between April and June, returning a
returns of between 14.5%-46.5% p.a.
total of 9.9% over the three months.
over the next five years. Some of these
returns have already been realised
Looking at offshore assets, we do
for investors who remained invested
believe it’s important to continue to
in these assets: during the April-June
hold foreign equities for their exposure
market recovery the FTSE/JSE Capped
to faster-growing economies and as
SWIX Index delivered a total return
an excellent diversifier. However, the
of 21.6%.
valuation of the MSCI All Country
Turning to the Balanced Fund’s bond World Index fell to a price/book value
exposure, it has been overweight SA ratio of only around 2.0X at its March
government bonds for some time now, low, near its longer-term average and
and within this has been holding mostly not offering an attractive discount
long-dated bonds with maturities compared to SA equities. With the
of 20+ years. This positioning has rand’s sharp depreciation, we opted
Prudential Investment Managers ©
contributed to the fund’s returns over to trim our overweight position in
the past three years. We added to this foreign equities and add to SA equity
long-dated positioning as yields rose to and SA bond exposure. Still, foreign
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TA B L E TA L K
equities are priced to produce a real have been able to buy a wide range
return of around 5.5% p.a. over the of assets, we are confident investors
next five years, we believe, a very in the Prudential Balanced Fund will
solid return that will also help lower benefit from very attractive prospective
portfolio risk. returns – and with much lower risk
than equities – over the next five
Lastly, cash is the one SA asset class years or so. Of course these future
where prospective returns are now returns won’t be delivered evenly
much lower, due to the 2.5% cut or in a straight line – investors can
in interest rates by the SA Reserve expect high volatility to continue as
global and local conditions evolve and
Bank over the past three months.
the impact of the Covid-19 pandemic
Although investors have earned good
becomes clearer for each country,
real returns on cash investments in the
including South Africa. Those who
last three years or so, cash returns are understand this and can patiently ride
no longer beating inflation, and this is out the ups and downs of the market
likely to continue for the foreseeable should be rewarded over time, and
future. So investors should consider Prudential Balanced Fund investors
reducing their exposure to cash where will have the added advantage of
appropriate - the Prudential Balanced careful diversification to help lower
Fund has very little cash exposure. this volatility. Now more than ever
balanced funds should make up
Based on this positioning and the the core of a long-term investment
excellent valuations at which we portfolio.
Pieter joined Prudential in 2015 as Managing Director of Prudential Unit Trusts and Head of Retail
Business. In November 2019 he was appointed as Chief Client and Distribution Officer. He has
21 years of industry experience, having previously worked at another large investment manager
in various senior roles. Pieter holds a B.Comm degree in Mathematics and is a qualified actuary
(holding a fellowship with the Institute of Actuaries in the UK and the Actuarial Society of South
Prudential Investment Managers ©
Africa). He also completed a General Management Program at Harvard Business School.
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A N A LY S I S
In the eye of the storm:
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SA hotels, casinos and
restaurants
Kaitlin Byrne
PORTFOLIO MANAGER
i KEY TAKE-AWAYS
In the Coronavirus pandemic, the and managing room portfolios,
share prices of hotels, casinos and restaurants have been negotiating
restaurants have been among the hard with landlords, and casinos
worst punished, with some hotel appear to be managing their debt
counters losing around 70% of their levels responsibly with funders.
value at their worst levels in March.
Prudential doesn’t believe all these
Based on our analysis, the sell-off
companies will be permanently
has been overdone based on the
damaged by the pandemic, although
Prudential Investment Managers ©
fundamentals and future prospects
their survival may well depend on
for the leisure sector.
external factors such as the ability and
Among other remedial actions, hotels willingness of debt and equity funders
have been aggressively cutting costs to continue to support companies,
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A N A LY S I S IN THE EYE OF THE STORM
and how long the economy takes three were already facing risks of
to re-open fully and pick up again. their own, but a complete shutdown
for months was certainly not on the
S ince the outbreak of the Coronavirus cards for any one of these sectors at
pandemic and economic shutdown the beginning of 2020.
in South Africa in March 2020, three The accompanying graph shows how
sectors in particular have found companies like City Lodge, Tsogo Sun
themselves in the eye of the storm: Gaming, Sun International and Spur
hotels, casinos and restaurants. The have seen their share prices fall much
share prices of the companies in further than the overall market (as
these sectors have certainly felt the measured by the Capped SWIX) during
pain, underperforming the FTSE/JSE the downturn and have struggled to
Capped SWIX Index significantly. All recover to the same extent as the rest of
Leisure sector share prices hit hard
Based to 100
Prudential Investment Managers ©
SOURCE: Refinitiv Datastream/ Prudential Investment Managers
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A N A LY S I S IN THE EYE OF THE STORM
the market. Tsogo Sun and City Lodge severe drought in 2018, which took
have been particularly hard-hit, losing its toll not only on international
around 70% of their value at their tourism, but interprovincial travel as
worst levels from the start of the year. well. 2020 was meant to be the year
Spur was somewhat more resilient, where Western Cape hotels finally
with a decline of around 30%. This recovered from one of their toughest
dire performance is understandable trading years and started to return to
if we consider some of the drivers more normal occupancy levels, while
behind it, but has the sell-off been also hopefully regaining the ability
overdone based on the fundamentals to price their rooms above inflation.
and future prospects for the leisure City Lodge compounded its struggles
sector? in South Africa by completing a multi-
year expansion into the rest of Africa
Hotels: Aggressively cutting costs
where they have invested over R1bn.
and managing room portfolios
They are more likely to see losses than
The listed hotel space in South Africa
profits from this expansion in the next
has three companies with pure hotel
few years.
exposure - City Lodge, Tsogo Hotels and
Hospitality Property Fund - although Upon the announcement of the
most of the value in Tsogo Hotels is complete Level 5 lockdown in mid-
attributable to its 59% holding in March, all the hotel companies
Hospitality Property Fund. Before prepared to close their entire portfolios
the shutdown in March, all the hotel and embarkedm on drastic cost-cutting
companies had been struggling with measures to save cash. Focus was put
depressed occupancy levels, and as a on employee costs, lease expenses and
result, an inability to increase their room cleaning and laundry, as well as debt
rates by more than inflation. Sandton service costs which can be a large part
hotels had been hit with oversupply of non-operational costs.
from new rooms added in the last
few years, combined with a weak While City Lodge didn’t have a high
local macroeconomic environment. amount of debt on their balance sheet
The Western Cape saw major declines at the outbreak of the pandemic, it was
Prudential Investment Managers ©
in occupancy levels as a result of the certainly higher than previous years
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A N A LY S I S IN THE EYE OF THE STORM
due to the African expansion and the hotels that are focused on international
losses from the African hotels, which travellers remaining shut.
had started to impact their results. To
manage this, they have been able to In March, City Lodge shut down
get debt covenant waivers from their all 62 of their hotels, then initially
lenders for their debt repayments due opened seven in order to provide
in June and December 2020, as well as accommodation for essential workers
securing additional liquidity. However, for some businesses, some for tourists
they have experienced additional not able to return home, and some
troubles stemming from a R750m loan for quarantine purposes. They are
guarantee to their BEE partners. As currently sitting with 21 hotels open,
City Lodge shares were held as security undoubtedly at reduced occupancy
for this loan, trouble lay ahead as the levels, and should continue to slowly
share price of City Lodge tumbled. As open more as the economy starts to
the share price fell, so the guarantee re-open.
to lenders kicked in. As a result, City
Lodge have now announced a R1.2bn In general, the hotel groups have done
rights issue to cover the bulk of their a very good job reducing cash costs as
outstanding debt, as well as the BEE much as possible while their properties
loan guarantee. have been closed, and planning the
reopening of their portfolios in the
Meanwhile, Tsogo Hotels have most cost-efficient way. Funders have
successfully agreed on delaying debt also been very supportive so far,
repayments coming due in September which is also the advantage of having
2020, with lenders recognising that it a portfolio of hard assets (i.e. fixed
was difficult for the group to make property) which can be used as security
payments when their hotels were for borrowings.
not trading. More recently, now that
provincial travel is allowed for business Restaurants: Negotiating hard with
purposes, Tsogo Hotels are re-opening landlords, opting for delivery-only
key hotels in each of the main cities, in the interim
but will more than likely be watching The restaurant industry also came
Prudential Investment Managers ©
their cash burn rate very closely, with under significant pressure when the
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A N A LY S I S IN THE EYE OF THE STORM
lockdown came into effect. In mid- have been able to be very firm in rental
March the restriction on the number negotiations with landlords, since
of people allowed into a restaurant having such a large store footprint
had already created severe pressure in the group gives them an element
for restaurant earnings. Although of bargaining power. They have also
one would think that some business given their franchisees relief in the
is better than no business, this is far form of their monthly franchise fees
from the case. As Spur later announced and marketing contributions.
to the market, the full lockdown
almost came as a relief to the company Spur are starting to slowly re-open
because operating with the same cost restaurants that are able to operate
base but fewer customers is more profitably under a delivery-only
damaging than operating with no method, such as those where the rental
customers at all, but with the ability negotiations have been favourable,
to significantly lower costs. despite earning a lower margin
compared to sit-down restaurants.
Spur operates a franchise model, The one advantage that should come
meaning they receive a set franchise fee from this crisis is that the restaurants
based on revenue from the franchisee that are able to survive should be the
who owns the restaurant. Spur have financially stronger restaurants that
over 600 restaurants which include the are more rational with pricing. This
popular brands Spur, Panarottis, Hussar should allow the remaining restaurants
Grill, John Dorys and Rocomamas. to regain some pricing power in what
The group is in a positive net-cash should be a less-competitive industry
position and therefore doesn’t face going forward, as we have seen the
the same level of financial pressure likes of Dominos and a number of
as hotels and casinos, but they do smaller restaurants close their doors.
face the risk that earnings would be
permanently lowered should several Casinos: Managing higher-than-
of their franchisees go bankrupt. usual debt levels after large
Therefore, it is in the group’s best expansions
interest to ensure that franchisee The casino industry is known for its
Prudential Investment Managers ©
health is maintained, which is where multitude of risks, all of which are
the real financial pressure is felt. They well known to industry operators, such
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A N A LY S I S IN THE EYE OF THE STORM
as the potential for the government Tsogo Gaming and Sun International
to impose gaming tax increases, VAT had completed their large capital
increases that can’t be passed on, and spending projects, and had planned
a smoking ban within the casinos. to focus the next few years on strong
However, no one ever anticipated a cash generation to pay down the debt
risk like a pandemic that would see associated with these expansions.
casinos, whose doors are barely ever
closed, facing months of no revenue However, the advent of the pandemic
with a large fixed cost base. meant this was no longer possible.
Both casino groups had to close all
Sun International and Tsogo Gaming their casinos, as well as their limited
(split from Tsogo Hotels in 2019) are pay-out machines (which are placed
South Africa’s large, listed casino in bars and restaurants), and found
companies, with Peermont being themselves in a tight space in terms
the third (unlisted) casino company. of debt levels. Both Tsogo Gaming
This shut down came at a bad time and Sun International submitted
for both Sun International and Tsogo plans to funders on how they would
Gaming in terms of how much debt manage the crisis and cash levels, and
they carried on their balance sheets. most have been supportive thus far,
Tsogo Gaming had purposefully taken waiving covenants in the near term.
on more than their share of debt Sun International have announced
when they split from Tsogo Hotels, another rights issue to raise R1.2bn
given that the casino business is more more in capital, which will help them
cash-generative than hotels with their weather this period of very low cash
heavy capital spending; therefore they flows, and most likely keep debt
should have been able to repay the funders more comfortable.
debt over a reasonable time period.
Sun International still had a high Casinos are, by nature, very cash-
amount of debt on their balance generative businesses if they do not
sheet following their construction overspend on capital projects; however,
of Menlyn Casino in 2017 and 2018, they are geared to the economy to
where revenues turned out to be a degree. The recent announcement
Prudential Investment Managers ©
significantly weaker than expected, that casinos would be allowed to
resulting in a rights issue in 2018. Both open up again at 50% occupancy is
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A N A LY S I S IN THE EYE OF THE STORM
very positive, despite the reduced companies during this period of high
occupancy levels . The companies plan financial stress; and how long the
to manage costs carefully to ensure economy takes to pick up again. To
they are cash-positive, even at a lower date none of the companies have
occupancy level. encountered problems in either having
their debt terms eased or raising extra
Any permanent damage dependent
capital through rights issues; investors
on external factors
and creditors have still deemed it
At Prudential we are cautiously
attractive to support them.
optimistic about the medium-term
future of these industries. We don’t
Even now, three months after the
believe all these companies will be
worst of the market crash, we still
permanently damaged by the impact
see significant value in some of these
of the Coronavirus pandemic, but
companies like Sun International on a
we acknowledge that they are most
three- to five-year basis, even taking
certainly high-risk businesses given
the level of high operating leverage into account further capital or debt
as well as the high financial leverage raisings. We are very cognisant of the
prevalent in some of them. Their high level of risk involved in investing
survival may well depend on several in these companies as well, and are
external factors, such as: government’s therefore cautious about the overall
decisions around the timing of the size of the exposure to these three
full reopening of these sectors; the sectors, as well as to any one of these
ability and willingness of debt and companies individually, in our client
equity funders to continue to support portfolios.
Kaitlin joined Prudential in May 2015 as an Equity Analyst and was appointed Portfolio Manager
in early 2020. She is primarily responsible for covering South African and African stocks within
the Gaming and Leisure sector.Prior to joining Prudential, Kaitlin completed her articles at Ernst
& Young, where she was responsible for auditing companies in the Finance, Gaming and Leisure,
Real Estate and Manufacturing sectors. She currently has five years of industry experience. Kaitlin’s
Prudential Investment Managers ©
qualifications include B.Acc (Stellenbosch), CA (SA), and CFA.
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A N A LY S I S
iStock-181871164
Things we can know and the
futures we cannot
Aadil Omar
HEAD OF EQUITY RESEARCH
i KEY TAKE-AWAYS
It is very difficult to make decisions in a outcomes, as investment managers
complex world when you cannot know do. This involves having specific
the future. Even when recognising attributes you are seeking in your
intellectually that predicting the outcome, and identifying the trade-
future is impossible, people still crave offs involved.
Prudential Investment Managers ©
certainty.
Constructing portfolios embedding
You can approach decisions concerning the attributes that would do well
the future probabilistically, and work in many possible futures requires a
to improve your odds of getting better nuanced and insightful appreciation
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A N A LY S I S THINGS WE CAN KNOW AND THE FUTURES WE CANNOT
of risk. This approach means fighting If you said it would happen and it did
your natural instincts to predict the not, you were wrong.
future. At Prudential we aim to
identify the plethora of possible Mental processes recruited for decision-
outcomes that tomorrow might making appear to operate in a similarly
bring, and assess those outcomes in clunky fashion. Ultimately, we’re
search of the mispriced opportunity. forced to decide in a black or white
way; either to do something or not to
do it, buy or don’t buy a stock, invest
M ost people agree the future is
uncertain, and trying to find
precision in the world of tomorrow is
or spend. Overlaying the outcomes we
experience to the decisions we make
reinforces the binary paradigm.
near impossible. They agree you should
approach decisions concerning the
Although the decision-making process
future probabilistically and work to
is hardly distinguishable from one
improve your odds of better outcomes.
event to the next, the conditions
They may even offer the truism that
and circumstances under which we
good decisions might yield unlucky
decide can vary widely. One way to
results, while you might get a lucky
think about decision-making in an
break despite making a poor decision.
uncertain world is to contrast the
But most people don’t seem to operate frequency of a decision against the
probabilistically in the real world; range of outcomes that decision might
most people want certainty. yield: in other words, how often you
make this decision versus what are
People want to know the future the possibilities. The accompanying
Despite all intellectual claims to the graph simplistically illustrates this in
contrary, people desperately crave regard to common life decisions.
knowledge of the future. Perhaps
we’re hardwired to view the world in At one extreme, there are decisions
a right or wrong paradigm because we make repeatedly, such as getting
that’s how we’re judged. a haircut or deciding what to order
at your local deli. Often the recurring
Prudential Investment Managers ©
If you said it would happen and it decisions are embedded in a stable
did, you’re right. or slow-moving micro-environment
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A N A LY S I S THINGS WE CAN KNOW AND THE FUTURES WE CANNOT
Graph 1: Decision-making in an uncertain world
SOURCE: Bloomberg
and have a fairly narrow range of choosing a career. Calibrating these
outcomes (there is a whole separate novel decisions is more difficult since
discussion that can be had on the we lack reference points. Also, the
significant cumulative impact of small outcomes of these decisions only
decisions, but we will leave that for become apparent in the fullness of
another day). These decisions can be time, leaving little opportunity to
optimised for the best outcomes in course-correct. They therefore embed
time; if you did not like your previous a wide range of possible outcomes and
haircut, you can get a different haircut are cloaked in degrees of complexity.
(or hairdresser) the next time. Luck plays a much bigger role in how
things turn out with these decisions.
At the other end of the spectrum are
the decisions we get to make very Investment strategy is an endeavor
few times in our lives (sometimes only that occupies a space somewhere
Prudential Investment Managers ©
once), like deciding who to marry or between the extremes. Decisions
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A N A LY S I S THINGS WE CAN KNOW AND THE FUTURES WE CANNOT
around investments are made routinely, • A business with a durable competitive
but the compounding nature of the advantage;
endeavor leads to a wide range of
possible outcomes - especially in • Run by competent and trustworthy
actively managed portfolios. Also, managers; and
being too skittish about an investment
• Trading at a reasonable valuation.
often robs the position of crucial time
to take effect and add value, while a When Warren Buffett seeks companies
poor strategy left too long could result meeting his exacting criteria, he’s
in a permanent and irredeemable loss looking for investments that have a
of value. It’s a balancing act that’s tendency to perform well over time.
difficult to optimise. Spread over a number of stocks (i.e. in
a portfolio), and provided the fullness
Seeking attributes
of time, those attributes have the
There’s a natural limit to how much
ability to manifest into something
experience we can accumulate in novel
extraordinary.
or near-novel decisions; occasions
to practice simply do not happen “It is remarkable how much long-
that often. And even with years of term advantage people like us have
experience, investment decisions are gotten by trying to be consistently
fraught with risk because they deal not stupid, instead of trying to be
with events in the future, and the very intelligent.”
world is a dynamic place (see recent
events related to the global pandemic — Charlie Munger
if you require further evidence that
things can change suddenly and in A corollary to improving your
unknowable ways). We can, however, investment outcomes by prioritising
hope to confront this uncertainty by attributes, is that companies with the
seeking attributes. right attributes also tend to stay out
of trouble. This might seem a trite
Warren Buffett is famed for pointing observation, but it is often missed in
out the attributes he seeks when modern portfolio theory. Indeed, the
Prudential Investment Managers ©
evaluating investment opportunities: Capital Asset Pricing Model (CAPM)
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A N A LY S I S THINGS WE CAN KNOW AND THE FUTURES WE CANNOT
statistically compares expected expectation of receiving something
returns to stock risk (as measured more in the future. We stand to lose
by beta) – higher-beta stocks should if we are wrong, but gain if we are
outperform lower-beta stocks when right – that is the trade-off. But the
the market return is positive. Alas, this face-value trade is only one part of
simplification is myopic, often missing the equation.
key attributes of better-performing
Concentrating your bets on a specific
investments through time.
future produces fantastic results if that
Trade-offs future comes to pass – in common
“A bird in hand is worth two in the judgement, you were right. It also
bush” produces very poor results if that
future does not unfold. This is the
– Medieval proverb black-and-white nature of outcomes.
But there are shades of grey that we
The above proverb has its origins in can explore to better manage risk
medieval falconry and refers to the beyond the simple black-and-white
idea that the bird in hand (presumably paradigm.
a falcon) was worth at least two birds
in the bush (the prey). Although this Constructing portfolios embedding
phrase dates to the 17th century, there the attributes that would do well in
are earlier variants dating as far back many possible futures requires a more
as the first century AD. While simple in nuanced and insightful appreciation
prose, the proverb succinctly highlights of risk. It requires us to both view the
the idea of trade-offs. If you want the future as probabilistic and behave in
two in the bush, you must be willing a manner that recognises this view.
to risk the bird in hand. There’s also This approach means fighting your
the nuance of how many birds in the natural instincts to predict the future.
bush should you be expecting? A more insightful practice might be
to identify the plethora of possible
Like the decisions we make, investment outcomes that tomorrow might bring,
risk can often be seen through the and assess those outcomes in search
Prudential Investment Managers ©
lens of trade-offs. We assume risk in of the mispriced opportunity.
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A N A LY S I S THINGS WE CAN KNOW AND THE FUTURES WE CANNOT
This is not a simple task and not the
way most people behave in the real
world. At Prudential we try to embrace
the idea of a probabilistic view of
the world and follow a team-based
approach incorporating a multitude of
world views. We take a risk-conscious
approach to portfolio construction,
always seeking out the most attractive
attributes against the risks. We remain
ever-vigilant of the tendency to get
lulled into expecting specific futures
and constantly revisit our assumptions.
Most people agree the future is
uncertain and that trying to find
precision in the world of tomorrow is
near impossible. We hope to practise
what most people agree on.
With 14 years’ investment experience, Aadil joined Prudential in July 2013 as an Equity Analyst.
In August 2018 he joined a global equity hedge fund in London, before returning to Prudential
in January 2020 as Head of Equity Research and joint-Portfolio Manager of the Prudential Equity
Fund. He holds a BCom degree (Hons, cum laude) from the University of Pretoria and a Masters in
Prudential Investment Managers ©
Finance degree from INSEAD. He is also a CFA charterholder.
Consider this QUARTER 03 2020 Page25
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VIDEO
The Prudential Balanced Fund:
Positioned to deliver in a
post-Coronavirus world
i KEY TAKE-AWAYS
With global equities, and particularly Given the increased risks facing
the US market, becoming more SA listed property companies, we
expensive relative to South African reduced our already-underweight
equities, Prudential opted to reduce exposure to this sector in the Balanced
the Prudential Balanced Fund’s Fund.
exposure to global equities and
increase its holdings in SA equities We increased our overweight in
and SA bonds. SA nominal bonds due to the very
attractive yields available relative
Prudential took the opportunity to the risk, while also preferring
of exceptionally cheap SA equity longer-dated 20+ year instruments
valuations to add exposure to certain due to their stronger upside return
high-quality stocks such as Bidcorp, potential.
Growthpoint and Remgro.
Prudential Investment Managers ©
Watch here
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VIDEO
Michael Joined Prudential Investment Managers in May 2007 and is currently the Head of Multi-
Asset. He is also the co-Portfolio Manager of several Prudential funds which have won Raging Bull
and Morningstar awards, as well as a member of Prudential’s Asset Allocation Committee. With 23
years of industry experience, Michael’s qualifications include: Masters in Engineering Mechanics
(University of Texas); MBA (UCT); and CFA.
Chris is a Senior Portfolio Manager and former Head of Equity, a position he held for five
years before handing over the role in early 2018. With 20 years of experience in investment
management, he joined Prudential in 2004 as an Industrial Analyst. He is jointly responsible for
managing the Prudential Equity Fund, which has won several Raging Bull and Morningstar Awards.
His qualifications include an MBA from UCT; BSc in Civil Engineering from UCT; and CFA.
Prudential Investment Managers ©
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A N A LY S I S
iStock-1177328383
Treading carefully in
a cheap SA listed
property market
Yusuf Mowlana
PORTFOLIO MANAGER
i KEY TAKE-AWAYS
Since the March market crash, reward for investors, based on their
presented with a plethora of valuations in the very different market
seemingly “bargain basement” share conditions prevailing since the onset
prices, the Prudential investment of the pandemic.
team has been conducting careful, Caution is required when investing in
Prudential Investment Managers ©
in-depth analysis to determine which the sector as the risk is high for some
companies have offered the best companies with the most exposure
combination of potential risk and to the weak hotel and retail property
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A N A LY S I S T R E A D I N G C A R E F U L LY I N A C H E A P S A L I S T E D P R O P E R T Y M A R K E T
sub-sectors, and others with weak leverage (as measured by their loan-
balance sheets. to-value ratios). Property owners and
managers in the hospitality and retail
We have identified certain companies
(including Real Estate Investment sectors have been particularly hard
Trusts (REITs)) we believe will hold hit for obvious reasons. In contrast,
up well in the weaker growth the self-storage and logistics sectors,
environment that have offered to the extent they have not been
excellent value, and have taken exposed to affected industries, have
advantage of this to increase our been relative outperformers.
exposure to them within our multi-
asset portfolios like the Prudential As we can see from Graph 1, the
Balanced and Inflation Plus Funds: Investec Australia Property Fund has
Nepi Rockcastle, Stor-age REIT, RDI performed relatively well, with its
REIT and Equites. year-to-date return at 7.0%, partially
due to a weakening of the rand versus
the Australian dollar, but also due
A mid the economic fallout from
the Coronavirus pandemic and
its global and local lockdowns, the
to the company having no exposure
to retail assets and also low levels of
leverage. At the other extreme, Vukile
South African real estate sector has
Property Fund, Hyprop Investments
been among the worst affected in
and Redefine Properties all have lost
financial terms. For the year to the
over 50% of their value thanks to
end of June the All Property and SA
high levels of debt (relative to their
Listed Property Indices have returned
assets) and substantial exposure to
-38.3% and -37.6% respectively. This the retail sector.
compares to returns of -10.7% for the
FTSE/JSE Capped SWIX All Share Index In the months since the March market
and 0.4% for SA bonds. The share crash, presented with a plethora of
prices most impacted have been those seemingly “bargain basement” share
property companies whose operations prices, the Prudential investment team
have been adversely affected by the has been conducting careful, in-depth
widespread halt in business operations, analysis to determine which companies
Prudential Investment Managers ©
and those with higher-than-average have offered the best combination of
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A N A LY S I S T R E A D I N G C A R E F U L LY I N A C H E A P S A L I S T E D P R O P E R T Y M A R K E T
Graph
Graph 1:1:Performance
Performanceofofthe
thetop
top1010stocks
stocksin
in the
the
SASA
AllAll Property
Property IndexYTD
Index YTD(30
(30June
June2020)
2020)
20.0%
10.0% 7.0%
0.0%
-10.0%
-20.0% -12.6%
-30.0% -25.4%
-27.3%
-40.0% -35.0% -34.1% -33.3%
-38.3%
-50.0%
-60.0% -56.2%
-60.4% -60.1%
-70.0%
nd
s
s
le
s
x
it
nd
IT
d
d
tie
tie
tie
de
un
Fu
Lt
Lt
st
RE
Fu
er
er
ca
er
In
nd
ts
ty
-A
nt
p
p
op
ck
en
ty
ty
er
ro
ro
Fu
ie
er
Ro
er
Pr
m
op
T
sP
tP
sil
EI
p
ty
p
st
e
Re
ro
Pr
PI
tie
ro
sR
in
er
fin
ve
NE
sP
po
lP
op
lia
un
In
es
de
Al
te
ra
th
Pr
rtr
Co
op
Re
ui
st
w
Fo
ile
pr
Au
Eq
ro
l&
k
Hy
G
Vu
ta
ec
pi
st
Ca
ve
In
Source: Bloomberg
SOURCE: Bloomberg
potential risk and reward for investors, Eastern Europe (CEE). The company
based on their valuations in the very has an excellent history of rental and
different market conditions prevailing dividend growth, both in absolute
since the onset of the pandemic. Below terms and relative to property peers.
we examine the prospects for four of CEE countries appear to have suffered
the property companies in which we lower infection rates than Western
retain overweight exposures within Europe, and as a result the company
our multi-asset portfolios like the has indicated that approximately
Prudential Balanced and Inflation 94% of its gross lettable area would
Plus Funds: Nepi Rockcastle, Stor-age be operational by the end of June,
REIT, RDI REIT and Equites. including outdoor restaurants.
Tenants were trading very well prior
Nepi Rockcastle is the largest single to the lockdown, with the company
Prudential Investment Managers ©
owner of shopping malls in Central and experiencing high single-digit sales
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A N A LY S I S T R E A D I N G C A R E F U L LY I N A C H E A P S A L I S T E D P R O P E R T Y M A R K E T
growth among the tenants it is able yield, the company should handsomely
to measure (unfortunately its grocery beat inflation over the medium term.
anchor tenants do not submit sales
data). Though the lockdowns will Stor-age REIT (Real Estate Investment
have impacted the strong operating Trust) is a specialist self-storage company
momentum the company was with operations in both South Africa
experiencing, investors are currently and the UK. Self-storage has proven to
paying for an implied 8.3% initial be a resilient class of property globally,
yield on the portfolio, the highest as demand for storage space is driven
since 2010, as shown in Graph 2. by life events such as moving homes
Its moderate loan-to-value ratio of and our propensity to accumulate
32% allows the company to absorb more material possessions than we can
valuation movements in the portfolio store in our homes. Resilient demand,
without placing the company in any coupled with the specialised, niche
distress. At a 12.3% historic dividend nature of the properties have allowed
Graph 2:
Graph 2: Nepi
Nepi Rockcastle
Rockcastle offering
annualised property
attractive yield
8.3%
unlevered property yield
9.0%
8.1% 8.3% 8.2% 8.3%
8.0% 8.0% 7.8%
8.5% 7.6%
7.3%
8.0% 6.8% 6.7% 6.8%
7.5%
7.0%
6.5%
6.0%
5.5%
5.0%
4.5%
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Implied
at spot
Prudential Investment Managers ©
SOURCE: Bloomberg, Prudential
Source: Bloomberg, Prudential
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A N A LY S I S T R E A D I N G C A R E F U L LY I N A C H E A P S A L I S T E D P R O P E R T Y M A R K E T
the company to grow its rentals and RDI REIT plc is a diversified UK REIT,
expand its number of locations in listed in both the UK and South Africa.
both South Africa and the UK. The company owns an eclectic mix of
properties, with 29% of its portfolio
Its “stores” are used to store anything invested in limited service hotels
from unused furniture to motorcycles in the UK, 28% in retail properties
and the inventory of small and in both the UK and Germany, 20%
medium enterprises. The properties in distribution and industrial assets
themselves are no more than multi- in the UK, 13% in London serviced
level storerooms of varying sizes, offices and 10% in conventional office
which makes the cost of maintenance properties, mostly in London.
fairly negligible in the long term.
This is unlike the conventional sub- Investors in the UK property sector
would be aware of how property
sectors of retail, office and industrial
valuations can differ very materially
properties which require more regular
from where the stock market may value
refurbishments to keep them in line
the assets. This has been especially
with modern standards. Maintenance
true for companies that own assets
costs are not accounted for within
where secular trends, such as online
property company dividends, and as
retail, have proven to be disruptive
a result most property companies pay
to existing business models. As a
dividends to shareholders well in excess result, the net asset values (NAVs) of
of the amount that is sustainable in companies have proven to be a poor
order to maintain their operations. This measure of intrinsic value in recent
is less true for Stor-age. Although its years. In the case of RDI REIT, the
dividend yield of 8.2% is at a premium market is fortunate to have a recent
to the property sector’s average yield, marker of value in the midst of the
the low loan-to-value ratio of 30%, pandemic, in that Starwood Capital
the superior quality of earnings and Group, a US real estate private equity
niche asset class give the company a firm, bought a 29.5% stake in the
reasonable likelihood of delivering company from Redefine Properties at
real returns to investors over the 95 pence per share. Our sense is that
Prudential Investment Managers ©
medium term. Redefine Properties was a motivated
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A N A LY S I S T R E A D I N G C A R E F U L LY I N A C H E A P S A L I S T E D P R O P E R T Y M A R K E T
seller, so the 95 pence may be an residential, which is higher than their
underestimate of fair value. current value-in-use.
In terms of RDI’s properties themselves, The company’s remaining retail
the hotel and retail assets were more exposure is mostly to retail parks as
adversely affected than the other opposed to shopping centres. Retail
sectors as a result of the lockdowns. In parks tend to aim their offering at
the case of the hotels, we are optimistic convenience and bulky goods retailers,
that the worst is over as the majority such as furniture retailers, which
of hotels have resumed operation. are more insulated from online
Though we are unsure whether or not competition — it would be very costly
media predictions of reduced business to have a couch or bed delivered only
travel will materialise, fortunately the to find that you needed to return it.
hotels have an alternate use, namely RDI reports that both footfall and
Graph 3: RDI’s share price trading well below NAV
Graph 3: RDI’s share price trading well below NAV (as of 30 June 2020)
(as of 30 June 2020)
200
180 172
160 153
140
120
95
100
81
80
60
40
20
0
Current share price Starwood Capital Sell-side NAV forecasts Reported EPRA NAV
(pence per share) Group purchase price - August 2020 - February 2020
Prudential Investment Managers ©
SOURCE: Bloomberg, Prudential
Source: Company reports, Bloomberg data
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