EQUITY PORTFOLIO COMMENTARY QUARTER ENDING JUNE 2020 - CONTENTS - Argon ...
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EQUITY PORTFOLIO COMMENTARY
QUARTER ENDING JUNE 2020
CONTENTS
■■ Market review Page 02
■■ Portfolio performance review and positioning Page 03
■■ Concluding remarks Page 08
Mpandekazi Maneli
Portfolio Manager
B Com Accounting, UCT
B Com Honours (Accounting), University of Natal
“Every storm eventually runs out of rain” - Maya Angelou
MARKET REVIEW
The equity market started the second quarter in the eye of the storm- the sustainability of its subsequent recovery during a pandemic
and possible recession has surprised many.
With the lockdown still in its infancy in South Africa, concerns abound, thanks to the storms we faced from the economic reality of a credit
ratings downgrade, to the anxiety of a pandemic ensuing - it stands to reason that the second quarter started with the equity market in the
eye of a storm.
The past quarter was awash with multi-decade declines and lows, increasingly attributed to the lack of global activity from both demand
shocks and supply disruptions as lockdown restrictions globally were largely still enforced. The surprising turn of the events were the
recoveries and highs, thanks to unprecedented policy responses, promising developments relating to Covid-19 vaccines and treatments,
and among others optimism relating to China and some regions relaxing lockdown restrictions during the quarter.
Although the quarter may have started with concerns about how much downside was left in the bear market seen in the first quarter, the
storm quickly abated. We saw a stellar recovery that has left with what many may argue, a cautious view on the sustainability of the recovery.
The highs were plenty and were largely positive developments, but some disheartening data was also present:
■■ Gold reached a nine-year peak of almost $1 800, reaching new peaks when measured equally against the world’s four most important
paper currencies, namely the US dollar, the euro, the yen and the yuan.
■■ Sasol continued to recover, delivering a total return of 258%.
■■ The S&P 500 achieved a quarterly return of 25%, its best quarter since 1998.
■■ From an environmental perspective, Global Carbon projected that daily global CO2 emissions fell by 17% at the peak of global lockdowns,
thanks to measures taken in response to Covid-19 – the biggest decline since 1970 when they started collecting data.
Page 02
The lows were fewer, although steep in magnitude, and included the following:
■■ Central banks across the globe cut interest rates in unison. At home, the SARB has cut the repo rate by 2.75% this year – the fifth
biggest reduction by a central bank globally.
■■ South African business confidence plunged to its lowest level in 45 years, falling to 5, and surpassing a previous low of 18 in 1985.
■■ We saw steep earnings downgrades, as dividend pay-outs were suspended or delayed, accompanied by outlook statements that were
revoked as uncertainty mounted.
■■ Unfortunately, there were peak negatives too - unemployment also rose, the domestic rate for Q1 2020 climbed to a record 30.1%,
with the expanded definition that includes discouraged work seekers - the ratio rises to an eye watering 39.7% with most economists
expecting the figure to deteriorate in Q2 2020.
■■ Daily Covid-19 infection rates remained unabated reaching new highs in Chile, Peru, South Africa, Brazil and the United States of
America.
South African equities delivered a strong performance over the course of June
The FTSE/JSE SWIX surged by 9.6% over the month (in US dollar terms), outperforming both the MSCI World Index up 2.7%, and the MSCI
Emerging Markets Index up 7.4%. For the quarter, MSCI South Africa was the second-best performing country within the MSCI Emerging
Market universe, returning 27.5%, while the MSCI World delivered total returns of 19.5% and MSCI EM 18.2% (all in US dollar terms). In
rand terms, the FTSE/JSE SWIX returned 22.1%, while the FTSE/JSE All Share Index (ALSI) delivered 23.2%. Resources and Industrials had
another good quarter, rallying 41.2% and 16.6% respectively, while financials lagged at 12.9%. Year-to-date, the ALSI and the SWIX have
declined by -3.2% and -6.3% respectively, with financials taking the brunt of the decline (-31.7%).
Chart 1: JSE All Share Index vs MSCI World Index
62500 2550
60000 2450
57500 2350
55000 2250
52500 2150
50000 2050
47500 1950
45000 1850
42500 1750
40000 1650
37500 1550
35000 1450
32500 1350
30000 1250
2020/01/16
2018/01/30
2020/05/21
2020/01/23
2018/02/20
2020/3/05
2020/03/12
2020/03/19
2020/03/26
2020/04/02
2020/04/09
2020/04/16
2020/04/23
2020/04/30
2020/05/07
2020/05/14
2020/05/28
2020/06/04
2020/06/11
2020/06/18
2020/06/25
2020/02/06
2020/02/13
2020/02/27
JSE All Share Index (LHS) MSCI World Index (RHS)
Source:
Source: Bloomberg
Bloomberg
Page 03
PORTFOLIO PERFORMANCE REVIEW AND POSITIONING
Chart 2: Argon SA Equity Fund performance to 30 June 2020
30%
25%
20%
15%
10%
5%
0%
-5%
-10%
3 months 6 months 1 year 3 years 5 years 7 years Inception
Portfolio 24.02% -6.96% -4.40% 2.63% 2.46% 8.39% 9.48%
Benchmark (SWIX) 22.09% -6.33% -6.09% 2.00% 2.08% 7.05% 9.07%
Excess 1.93% -0.63% 1.69% 0.62% 0.38% 1.35% 0.41%
Performance numbers are gross of fees
Source: Argon Asset Management
Chart 3: Portfolio attribution – three months to 30 June 2020
Alpha contribution Active position
APN 0.67 APN 2.05
SOL 0.65 SOL 0.59
CLS 0.61 CLS -1.22
PAN 0.29 PAN 0.72
BVT 0.25 BVT -0.90
CPI 0.22 CPI -0.77
EXX 0.20 EXX 1.28
PIK 0.19 PIK -0.40
LHC 0.19 LHC -0.53
TBS 0.19 TBS -0.62
DRD -0.15 DRD -0.15
OMU -0.15 OMU 1.06
CCO -0.15 CCO 0.25
HAR -0.17 HAR -0.35
MNP -0.17 MNP 0.98
BID -0.19 BID -1.72
AMS -0.27 AMS -0.67
BTI -0.50 BTI 4.98
GFI -0.53 GFI -1.25
HMN -0.56 HMN 0.38
-0.80 -0.60 -0.40 -0.20 0.00 0.20 0.40 0.60 0.80 -3.00 -2.00 -1.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00
Sources: Bloomberg & Argon Asset Management
Our portfolios delivered a stellar performance over the quarter
We generated considerable alpha, which meaningfully narrowed the portfolios’ underperformance for the year-to-date. We are confident
that our bottom-up stock-picking fundamental analysis and investment philosophy is robust. Its resilience will continue to enable us to
deliver alpha that has been sustained over a 1-, 3-, 5- and 7-year period, including since inception.
Our biggest alpha generation came from our active positions in Aspen, Sasol, Pan African Resources and Exxaro. These were complemented
by our underweights in Clicks, Bidvest and Capitec, to name a few. We elaborate on the performance and positioning below, with the
different analysts from our team contributing their thoughts on individual shares and sectors.
Page 04
Industrials (underweight)
Pharmaceutical exposure has been a meaningful contributor to alpha this quarter
Aspen has steadily been a good performer for our funds this year. The company has successfully continued to navigate its balance sheet
concerns through selling assets, lowering capital expenditure and unwinding working capital.
More recently, Aspen’s earnings power has also improved thanks to their diversified portfolio. Declines in elective procedures due to hospitals
prioritising Covid-19 patients have been countered by increased hospitalisation rates and a surge in healthcare product demand from their
regional business. Management is projecting that earnings for the 2020 financial year will exceed the reported earnings for 2019, which is
a great feat given the rest of the market’s outlook and recent negative updates.
The announcement of a drug trial for using Dexamethasone in the treatment of Covid-19 patients who require respiration support buoyed
Aspen’s price over the quarter. Aspen has confirmed the ownership of product rights and distribution in several regions. According to the
company, the government has contacted Aspen to source the drug not only for the domestic market but also for the rest of the continent,
with orders from the World Health Organisation, UNICEF and other bodies adding to the demand.
From a pharmaceutical retailer perspective, our underweight position in Clicks also contributed to alpha for the quarter. Our bottom-up
analysis showed that Clicks’ earnings were resilient. However, the valuation was pricing in lofty earnings given South African consumers’
financial health and position, especially against the backdrop of the economic headwinds the country has been facing.
General retailers (non-food) have been experiencing diminishing returns, slower sales growth and margin compression for several months,
even before the pandemic. We have therefore been underweight the sector. Although one of the contributors, we don’t believe Covid-19 is
the sole reason for the underperformance of non-food retailers. The South African consumer has been under immense pressure for a while
now, with low wage growth, increasing retrenchments, rising unemployment and above-inflation increases in most household expenses. The
combination of these factors will inevitably reduce household disposable income, making it extremely difficult to generate sales for those
who deal in consumer discretionary products (such as non-food retailers). We are not expecting a strong post-Covid-19 boom or recovery, as
we expect the fundamentals for non-food retail to remain negative for the short to medium term.
The detraction for the quarter can be mainly attributed to our overweight positions in British American Tobacco (BTI), Old Mutual and
Hammerson.
Although BTI was our biggest alpha contributor in 2019, it was the biggest detractor this past quarter. The market rewarded the downtrodden
during this quarter, while the defensive shares suffered. We continue to hold BTI as our core holding, since Covid-19 has a relatively minor
impact on the business. We prefer industrials that offer us rand-hedge earnings with relatively muted earnings risk from Covid-19. BTI is
undervalued, trading at almost 50% of staples globally, while boasting a dividend yield of 7%.
Page 05
Property
Property has been one of the hardest-hit sectors
Property has been among the most hard-hit sectors as many countries across the world entered, or sustained some form of lockdown during
the second quarter. All asset types have been affected: from retail assets that were forced to close their doors or faced lower footfall as a
result of social distancing protocols, to office assets, which faced a rapid decline in demand as many employers adopted a work-from-home
approach. During the quarter, many property companies experienced significant top-line pressures as a result of rental concessions and
lower collections from tenants.
The listed property sector was already under pressure heading into the second quarter. However, this was exacerbated by a combination of
the pandemic (and subsequent lockdown implications) and the high use of leverage across the sector in general, causing most real estate
investment trusts (REITS) to fall to new lows during March and April. This low base, coupled with positive news flow regarding lowered interest
rates, higher-than-expected collections during the lockdown, and relaxed debt covenants, supported the rebound of several REITS during the
quarter. On the local front, we retained our conviction in our overweight position in Growthpoint given its scale and diversification. During the
quarter we also took a small risk-adjusted overweight position in Hyprop, which we believe is undervalued. Our investment case in Hyprop is
underpinned by a large margin of safety and its portfolio of high-quality South African assets.
Our offshore property positions unfortunately detracted from performance over the quarter
We felt that Capital & Counties had held up well relative to other property shares despite facing similar headwinds - we decided to trim our
overweight position.
We have long favoured Hammerson as our anchor offshore property holding given its high-quality retail assets, geographic diversification,
access to fast-growing retail outlet assets and relatively lower balance sheet risk (with loan-to-value ratios of below 40%). Hammerson
was one of the bigger active positions in the fund and our conviction was underpinned by the portfolio of high-quality assets (determined
by physical site visits), adequate debt covenant headroom, successful track record of asset sales and our in-house scenario analysis of
potential asset devaluations. In our view, the news that the retail park disposal deal is off significantly increased the financial risk for
Hammerson. The proceeds of the sale were going to be used to reduce debt levels and allow for enough covenant headroom, given falling
asset values. As a result, the probability of a deeply discounted rights issue had increased significantly given the market cap of about £400
million at the time relative to the net debt of £3.8 million. Given all the information available to us at the time, we believed that Hammerson
faced an existential risk and that there was not enough upside to compensate for the significantly elevated level of risk. We subsequently
sold out of our entire holding, which we believe was prudent and in the best interests of our clients.
Page 06
Resources (overweight)
Commodity prices have fallen year-to-date, except for gold, platinum group metals (PGMs) and iron ore
Given the market dynamics over the quarter highlighted earlier, it’s no surprise that the resources sector was the star for the quarter. Our
underweight position in gold played a meaningful role, as precious metals’ safe-haven status strengthened. Gold rose to its highest level in
more than seven years, and the PGM fundamentals remained intact. Demand shock for the PGMS was met with supply disruptions from
lockdown restrictions. Nevertheless, the metal’s price continued to rise despite supply increasing operating rates in South Africa from 50%
in May to 100% in June, while underground mines were still operating at 60-80% capacity. The platinum sectors outperformed, which bode
well for our portfolios.
We benefitted from the surge in the gold price through our holding in Pan African Resources, which returned 71% – the best-performing gold
stock in the sector year-to-date. We like Pan African Resources due to the de-risked nature of their operations. However, Goldfields, in which
we have an underweight position, also benefitted during the period, despite hedging 47% of production at a gold price of less than $1 500.
We preferred the free cash flow inflection and quality of AngloGold to Goldfields. Goldfields has hedging constraints that limit their ability to
gain from the gold price surge, and its Salares Norte capital expenditure made us cautious. Nevertheless, it has benefitted from its main
regions of operation where mining has been designated as an essential service (Australia), including jurisdictions where mining has been
uninterrupted despite recording positive Covid-19 cases (Ghana). Most of their operations are mined from open pits.
We believe Sasol’s risk profile has increased significantly and will monitor developments closely
Sasol’s share price has staged a remarkable recovery from its lows of around R22 per share in March when the oil price collapsed, investors
were pricing in a worst-case scenario and a rights issue. Subsequently, there has been no material new information to give cause to this
price action, besides reiterated trading statements and only a gradual oil price recovery to around $40 per barrel.
The price has been very volatile and reflects the difficulty in establishing a fair value for Sasol with so much uncertainty. Sasol has always
been a complicated company with many moving variables. Now, however, with the ramping up of the Lake Charles Chemicals Project (LCCP)
operations in a very weak chemicals market and the indebtedness of the group, the company’s risk profile and complexity has increased
materially.
The key unknowns that we are scrutinising are:
■■ management’s response strategy;
■■ the outcome of their self-help measures;
Page 07■■ an extremely weak global chemicals market;
■■ the current low oil price;
■■ the rand/dollar exchange rate;
■■ production issues in core legacy operations because of Covid-19;
■■ the successful ramp-up of the LCCP; and
■■ covenant leniency.
The above unknowns result in a matrix of very diverse possibilities. This is exacerbated by a very weak and unproven management team
at the helm. The extreme range of outcomes span from very generous upside for the share price to the need for a rights issue and selling
of crown jewel assets. We believe the risk premia have increased materially for Sasol and therefore believe that a reduced active position
is prudent despite the upside potential. We have decided to maintain our current position and will re-evaluate the opportunity at the time,
should a rights issue be required. We are also considering the volatile share price, and if the opportunity arises, we are ready to alter our
active position with the information available at the time.
Financials (overweight)
Although the banking and insurance sectors have been hard hit, the outlook is less dire for insurers
The last few months, since the first announcement of lockdown in South Africa, have been turbulent times for the JSE. As can be expected,
no sector was left untouched, although a few companies (e.g. in the technology and gold sectors) ended up being net beneficiaries of the
uncertainty that ensued. The performance of the financial services sector is generally correlated to economic growth and to the volatility
of listed markets, so it comes as no surprise that the banking and insurance sectors have been affected negatively. However, on a relative
basis, the insurance sector has been less hard hit than the banks, which might at first sight seem counterintuitive.
Our insight into the sector has been informed by several trading updates released over the last few weeks. The first quarter of 2020 was
marked by the precipitous fall of the equity market, with the JSE closing down 22% and the insurers falling between 28% and 40%. In that
period, the South African 10-year government bond yield increased from 8.2% to 11.0%. Given that insurers have a high percentage of
assets invested in these markets, this had quite an impact on the valuation of assets and on shareholder portfolio returns. However, it was
only after the first phase of lockdown that we started to see the impact of the pandemic in other areas. The inability of agents to interact
directly with clients meant that sales fell, in some cases declining up to 90%. In addition, some clients were given payment/premium relief
in various forms. Insurers with guaranteed products in their books also felt the pain due to funding levels decreasing markedly.
In the second quarter, the JSE staged a recovery with the ALSI up 23% and the insurers rerating by between 6% and 34%. This should provide
somewhat of a cushion to market-related earnings. However, we anticipate that for as long as economic growth remains tepid and economic
activity repressed, total insurance earnings growth will be significantly subdued, growing to modest rates, at best. Of great comfort is that
the insurers have stress tested their solvency levels using protracted scenarios, even worse than experienced in April and May, and they
remain solvent. This is testament to the rigorous regulatory environment and supervision enjoyed by the banks and insurers in South Africa.
CONCLUDING REMARKS
Our investment philosophy and process remain focused on growing the wealth of our clients by delivering alpha through the cycle. The
year-to-date has introduced the world to new norms, which we are all still navigating at the time of writing. There will be winners and losers,
with advancements that may render some old methods null and void. We believe our disciplined stock-picking process that seeks to invest
in companies that are trading below their intrinsic value will help us identify and monitor opportunities that will deliver long-term returns
for our clients. This is underpinned by our portfolio construction methodology that seeks to protect capital and outperform the respective
benchmarks.
Page 08Luyanda Joxo, CFA
Deputy CEO
+27 21 670 6576
+27 84 701 1271
luyanda@argonasset.co.za
Jeremy Jutzen
Client Relationship Manager
+27 21 670 6592
+27 83 703 8523
jeremy@argonasset.co.za
+27 21 670 6570
info@argonasset.co.za
Website www.argonassetmanagement.co.za
Disclaimer
Information contained herein is for information purposes only and is merely illustrative. It is not deemed as advice as defined in
the Financial Advisory and Intermediary Services Act (FAIS Act). Argon Asset Management (Pty) Ltd and its employees shall not
be held responsible for any losses sustained by any person acting based on the information. Past performance of any of our
funds is not indicative of their future performance. Persons are advised to contact Argon directly should they wish for Argon to
conduct an analysis with a view to facilitating investing in any of our funds. Argon Asset Management (Pty) Ltd is an independent
investment management company registered in South Africa, company registration number 2002/016801/07 and an authorised
financial services provider under the Financial Services Board (FSB) registration number 835 as well as the FSB’s section 13B
Pension Funds Act ; administrator registration number 24/434. The main business of Argon Asset Management is the provision
of investment management services to institutional clients and retail investors. Argon Asset Management’s domestic product
range includes an equity fund, bond fund, absolute return fund, domestic balanced fund, flexible income fund and a money
market fund. The offshore product set consists of a range of global equities, global fixed income and the global balanced/multi
asset class funds.You can also read
