PROSPERITYIN THIS CLIENT NEWSLETTER• Economic and market overview

• Global equities

• Local equities

AUGUST 2020

WEALTH PRIVATE CLIENT SECURITIES

AUGUST 20201

Many South African corporates were criticised in recent years

for “sitting on cash piles” – seemingly unwilling or unable to

invest in growing the local economy. In a twist of fate, the

solid balance sheets of many of the largest local companies

have come in very handy as shock absorbers for the collapse

in business activity due to the lockdown. The local financial

sector is also well capitalised – an all-important factor to

enable a recovery. In another strange twist, the contentiously

high government wage bill may actually be positive over the

short term. Government employees have been least affected

financially and any recovery in consumption will rely on these

wages being recycled back into the economy. Of course, this

can only help over the short term since these wages are not

adding productivity to the local economy and the wage bill,

together with the interest bill on government debt, are two

albatrosses hanging around SA’s neck.

SA government bonds continue to offer high yields relative to

other developing nations. The high yields reflect a perception

of higher risk and lack of demand. Foreign demand for SA debt

has been declining and unless demand returns, there will be

an increasing need for the local savings pool to absorb new

debt issuance. Next month’s mid-term budget represents an

important opportunity for government to outline tangible

plans to address the rise in SA’s government debt relative

to GDP. While our current account and foreign exchange

reserves appear fine for now, these are areas to watch since

an increase in dollar-denominated commitments will bring

additional risk to the country’s precarious fiscal situation.

SA is not an island and ultimately, the country is reliant on

a recovery in global economic activity. Whether or not this

recovery happens is not the issue, as a recovery will materialise

eventually. Rather, the key considerations are when, how

broadly, and how fast.

“Prediction is very difficult, especially if it's about the future!”

– attributed to Niels Bohr (Nobel laureate in Physics)

ECONOMIC UPDATEIn August each year, a central banking symposium is held in

the picturesque town of Jackson Hole, Wyoming, attracting

central bankers, academics and other policymakers from

across the world. The site was chosen in the 1980s to ensure

the attendance of then US Federal Reserve Chair Paul Volcker,

an avid fly-fisherman. This year, the conference was held

virtually, and current Fed chair, Jerome Powell, announced

the outcome of a major review of the central bank’s monetary

policy framework. While its twin objectives of price stability

(low inflation) and full employment are set by Congress,

the Fed has to decide how to interpret and achieve those

targets. As an example, in 2012 the Fed formally adopted a

2% inflation target.

At the conference, the Fed announced that it would now

target an average of 2% over time. While this change might

sound extremely subtle, it implies that interest rates will

remain low for longer. Since inflation has long been below

2% (in fact it has consistently undershot the 2% target since

it was adopted), the Fed will tolerate inflation above 2% to

raise the average. As a result, inflation of 3% or more will be

required for a sustained period. The Fed will therefore not

hike rates at the first sign of inflation breaching 2% or of the

economy recovering, as was the case in 2015 when it started

gradually raising rates from near-zero levels.

The Fed will also not hike rates when unemployment declines

rapidly. It has now given up the so-called ‘Philips Curve’, the

idea that low unemployment leads to higher inflation. Last

year, US unemployment fell to 50-year lows, a level the Philips

Curve would have predicted as being unsustainable. Yet, there

were no overheating nor meaningful inflationary pressures.

From now on, the Fed will only consider the unemployment

rate in so far as it is too high, not too low.

Powell explicitly tied this back to addressing inequality, not

something central banks have traditionally spoken about. He

noted the importance of a strong labour market to deliver

meaningful benefits to individuals with lower education

levels and racial minorities who often tend to be the last to

benefit from an upswing and the first to be retrenched in

a downswing. The goal now is not just low unemployment,

but a ‘broad-based and inclusive’ recovery.

Not mentioned, of course, is that if the Fed has thus far failed

to get inflation to 2%, there is no reason to believe it will

succeed in getting inflation above 2%. It will not stop trying,

however. Its big fear is that people expect inflation to always

remain around 1%, which in turn impacts their behaviour and

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becomes self-fulfilling. Economists refer to this as anchoring

inflation expectations. By way of example, if you believe that

inflation will always be at 1%, you will accept a similar salary

increase, rental escalation or price increase. Japan has had

zero to mildly negative inflation for two decades, meaning a

whole generation has grown up with the notion that prices

do not change. While the Bank of Japan has valiantly fought

to raise inflation to 2%, no one has accepted this and there

is still no prospect of success. The Fed, and the European

Central Bank (and others) desperately want to avoid this fate.

The Fed is the most important of all central banks and

its actions will have global ramifications. For us in SA, the

main implication is that dollar interest rates are likely to be

below inflation for some time, representing an unattractive

investment. More broadly, it sets the scene for a weaker dollar

(already down 6% this year on a trade-weighted basis) and

more sustained capital flows to emerging markets. This in

turn should reduce downward pressure on the rand and

upward pressure on our government bond yields. It should

be possible for SA to fund its deficits as long as we can

demonstrate progress with economic reforms. Expectations

are so low that the possibility of an upside surprise is higher

than the pessimists realise.

MARKET UPDATEAugust produced impressive global equity performance as

optimism returned to markets and economies opened up

around the world. The Dow Jones gained 7.4% and the S&P

500 ended the month 6.8% higher, representing its strongest

August since 1986. Global economic growth figures, however,

disappointed with negative growth being registered in most

economies in the second quarter in 2020.

Local equities struggled as the JSE All Share Index ended

0.4% lower, dragged down by financials and property stocks.

The continued impact of COVID-19 on the SA economy will

remain for some time as businesses struggle to recover

sales and trade while limiting the damage caused during

the lockdown. The US dollar lost 1.4% against its major

counterparts as US interest rates remain on a downward

path. After an early slide to R17.75, the rand strengthened

towards the end of the month to close at R16.93.

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GLOBAL EQUITIESAlphabetAlphabet reported second quarter results that, although showed a slight decline in revenue, surpassed the markets’ expectations on both revenue and earnings. Group revenue declined 2% year-on-year (y-o-y) to US$38.3bn. The decline was driven by lower advertising spend due to the impact of COVID-19 and weaker global economic activity. Positively, as the quarter progressed, Google observed a gradual return in user search activity to more commercial topics, followed by increased spending by advertisers. The decline in advertising revenues over the quarter was partially offset by continued growth in Google Cloud and other non-advertising revenues. As guided, the combined effect resulted in net income declining by 30% to US$6.9bn.

During August, Alphabet issued US$5.75bn in sustainability bonds, marking the largest sustainability or green bond issuance by any company in history. The proceeds from these bonds will fund ongoing and new projects that are environmentally or socially responsible, including energy efficiency, clean energy, green buildings, clean transportation, circular economy and design, affordable housing, commitment to racial equity (via financing for businesses in black communities and funding for black creators), and support for small businesses and COVID-19 response efforts.

FacebookDespite facing some controversy during the year, Facebook reported decent second quarter results. Revenue (+11% to US$18.7bn) was well ahead of consensus estimates, but below prior years’ growth. This slowdown in revenue growth was not the result of a single factor and can be attributed to a combination of platform and product changes, a relatively more mature market in North America and Europe, and the economic impact of COVID-19 as advertisers tend to spend less. Interestingly, other revenue grew 40% to US$366m, driven primarily by Oculus and Portal products as we see these product categories start to gain traction as people look for further ways to engage. Net income declined 9.6% y-o-y to US$5bn, beating consensus estimates by a wide margin.

Across the Facebook suite of products, daily and monthly user engagement increased by 15% and 14%, respectively, as all platforms saw growth due to global lockdowns. However, average revenue per user was flat on the prior year as ad pricing came under pressure. At US$1.80, earnings per share was 9.5% lower than the prior year due to a decline in average price per ad.

Over the period, Facebook has come under scrutiny due to the platform’s handling of hate speech and misinformation. Management came out strongly against these acts and reiterated that they have taken many steps to limit this on the platform. Management also highlighted that its top 100 advertisers now account for 16% of ad revenue and when we consider that there are now over nine million advertisers on the platform, it is not likely that the ad boycott will have a material impact. Further to this, we believe the boycott to be transient, as the return on investment due to Facebook’s scale and ability to target their audience is too high for businesses to turn their back on advertising on the platform for an extended period. However, we continue to monitor developments in this regard.

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L’OréalL’Oréal reported that sales fell by 11.7% to €13bn during the first half of 2020, significantly impacted by various store closures due to COVID-19 related lockdowns and reduced commercial air traffic. Professional and Luxe product sales were particularly affected as hair salons and beauty parlours closed. Active Cosmetics continued to outperform, growing sales, earnings and market share during the first half of the year. Encouragingly, L’Oréal outperformed the global beauty market, leveraging its digital leadership in order to gain market share as e-commerce sales accelerated 64.6% across the group’s brands. L’Oréal highlighted that total sales activity has begun to increase and the group has implemented an acceleration plan for the second half of the year focused on three priorities: accelerating the pace of innovation, “Back to Beauty“ initiatives, and the intensification of media investments to stimulate demand across all geographies.

Founded in 1909, L’Oréal has become the world’s top selling cosmetics group, housing 36 brands within 150 countries. The beauty market is forecast to grow at mid-single digits over the medium term, driven by growth in luxury products and active cosmetics. L’Oréal has consistently outperformed the market in terms of earnings and volume growth, being the only company active across all beauty categories.

DiageoDiageo reported full year results that were significantly impacted by COVID-19 and the resultant widespread closure of bars and restaurants around the world, as well as the disruption to global travel. The company reported a 54% decline in earnings per share. Net sales were down as volumes declined by 12%. Although all regions experienced volume declines, North America was able to grow net sales because of strong off-trade sales (sales from liquor stores and not within pubs, bars and restaurants). As a result of the significant impact of global trade restrictions, Diageo recognised exceptional operating items to the value of £1.3bn against specific markets and regional brands. These included impairments, exceptional operational items in the form of COVID-19 relief efforts (“Raise the Bar” programme to support pubs and bars, alcohol donations for sanitiser production) and inventory write-offs (£30m).

Diageo is the world’s leading branded spirits manufacturer and second largest alcoholic beverages company, with an attractive, diverse portfolio of brands that include Johnnie Walker blended scotch, Smirnoff vodka, Crown Royal Canadian whiskey, Captain Morgan rum, Bailey’s Irish Cream ad Guinness stout. In addition to their own brands, Diageo own 34% of premium champagne and cognac maker Moët Hennessy, a subsidiary of French luxury-goods maker LVMH Moët Hennessy – Louis Vuitton. We expect Diageo to grow the spirits category in under-represented regions with the support of established brands and global marketing scale. Additionally, the group’s premiumisation strategy will continue to enhance margins in developed markets over the short to medium term. Supported by strong cash generation and a stable balance sheet, there remains scope for bolt-on acquisitions to incorporate fast-growing niche and craft brands.

Berkshire HathawayAmerican multinational conglomerate, Berkshire Hathaway reported a weak second quarter performance reflecting the impact of COVID-19 related lockdowns on economic activity. With the exception of the insurance division, the group’s operating businesses reported volume declines, particularly in businesses exposed to commercial aerospace, automotive retail and trade. Overall, operating income was down 16%, however, earnings per share was up 90%, driven by a US$40bn fair value gain on the group’s equity investment portfolio, now valued at US$207bn. The group’s cash and liquid investments continued to increase in the absence of a large acquisition. Berkshire has put some of that cash to work through a US$6.7bn share buyback over the six months to June 2020, already exceeding the volume completed in 2019, repurchasing over 1% of Berkshire’s issued shares.

Berkshire is a diversified group that operates over 90 businesses including insurance, railroad, energy, manufacturing and other consumer services. The group has a reputation of increasing its commercial value, and its competitive advantages across both its insurance and non-insurance businesses. Berkshire’s substantial cash reserves should further support growth by enabling bolt-on and large acquisitions, as well as continued investment in its equity investment portfolio.

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MedtronicLeading medical device manufacturer, Medtronic delivered first quarter 2020 results that, despite the challenging operating environment, beat expectations on both revenue and earnings. First quarter revenue was down 13.2% to US$6.5bn, while earnings per share declined 50.8% y-o-y to US0.62c per share. The better-than-expected performance was driven by double-digit sequential improvements across the Cardiovascular and Restorative Therapies Groups, which both experienced rebounds in procedures and market share gains on the back of continued product launches.

As the world’s largest medical device manufacturer, Medtronic is fast growing into holistic patient treatment. With a geographic footprint that spans 150 countries and a treatment range that covers Cardiac, Minimally Invasive Therapies, Spinal and Brain ailments/procedures and Diabetes care, we believe Medtronic is suitably positioned to benefit from the demographic trends driving global healthcare demand. Innovation is key to Medtronic’s growth, with organic growth achieved via internal Research and Development as well as acquisitions. Medtronic targets growth across the largest emerging markets including China, India and Brazil. Emerging markets make up 15% of total revenues with double-digit growth recorded over recent years. This is expected to continue into the foreseeable future as these markets are far from maturation and there is significant potential for penetration. Medtronic’s balance sheet is strong and it maintains attractive cash generation characteristics. This provides flexibility for acquisitions, research and development and marketing support for product launches.

LOCAL EQUITIESAnglo AmericanDespite government-enforced lockdowns and production restrictions that removed 20% of workable hours, Anglo American delivered resilient interim results, supported by strong performances from Minas-Rio iron ore and Collahuasi copper assets. Group revenue and underlying EBITDA (earnings before interest, tax, depreciation and amortisation) decreased by 16% and 39% to US$12.4bn and US$3.3bn, respectively. Lockdowns across southern Africa affected production at PGMs, De Beers, Kumba and Thermal Coal, with production also affected by operational issues at Metallurgical Coal and PGMs. From less than 60% after March, production has increased to 90% at end June. Even with efforts to limit the impact of operational restrictions, underlying earnings and earnings per share decreased by 56% and 54% to US$886m and US$0.72 per share, respectively.

Despite the setbacks experienced over the past six months, Anglo has not changed its strategic intent and maintains attractive growth. Most recently, the group acquired a 100% interest in Sirius Minerals Plc, which is now accounted for as a subsidiary of the group and reported as the Crop Nutrients segment. The Crop Nutrients business specialises in mining POLY 4 fertiliser, which serves as a critical input for industrial scale agriculture. The group is also progressing with the restart of the Qullaveco copper project that was suspended for three months to July 2020. Overall, the schedule for completion remains on track and unchanged with first production at 2022. The Quellaveco copper project will grow Anglo’s copper output by 150% over the first five years of operation.

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QuilterUK-focused wealth management group, Quilter Plc reported first half 2020 results that were better than expected, but weaker than the corresponding period in the prior year. Revenue for the period was down 4% versus expectations of a 10% decline. Adjusted profit before tax was down 20% to £71m, ahead of consensus expectations of -30%. On a per share basis, earnings were down 15% due to the group’s share buyback programme, which resulted in a lower number of shares in issue. Profit during the period was impacted by the challenging market environment that is best illustrated by the pressure on revenue margin as a result of clients moving to income and passive solutions. Positively, assets under management and administration (AuMA) were largely unchanged at £107.4bn, while net client cash flow for the period was £1.1bn versus £0.3bn in the comparative period. The group declared a final dividend of 1.0 pence per share, which is at the lower end of management’s pay-out ratio guidance and 40% lower than the prior year. The board decided to be cautious with the interim dividend and will review the full year pay-out ratio early next year depending on market conditions.

Quilter’s core offering is advice-led, using financial advisers to target affluent customers with sizeable investable assets. We believe that the group’s diversification and vertically integrated value chain differentiates it relative to peers, a competitive advantage that is not easily eroded. The UK pension market is currently undergoing a phase of consolidation brought about by structural and regulatory changes such as a growing advice gap, increased demand for financial products and a shift to defined contribution pension solutions. All of these factors present Quilter with a supportive environment for business growth.

MondiMondi produced half year results that, although depressed, exceeded expectations on both revenue and earnings. While the general lack of economic activity affected volumes, lower market prices had the most significant impact, with revenue down 8.5% to €3.4bn while operating profit declined 22.8% to €524m. As a result of the weaker pricing environment, earnings per share declined 24.8% to 72 euro cents per share. Notably, Mondi resumed dividend payments on resilient cash flows and astute capital allocation.

Mondi, primarily through acquisitions, continue to make progress transitioning to Consumer Packaging-focused business lines. The defensive nature of Consumer Discretionary and Staples spend adds a great diversification element to Mondi’s product mix and positions them for the rise of middle-income consumers in developing regions.

The group drives organic growth through innovation and cost control, which has seen them maintain significantly higher margins relative to peers over the past five years. The group’s growth prospects are predicated on a recovery in Europe, increased global consumer and business sentiment and diverse operational and revenue bases. Mondi maintains healthy cash generation, manageable debt levels and a strong investment pipeline, signalling a strong position from which to finance future growth.

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BHP GroupBHP Group, the world’s largest miner, produced full year results with revenue slightly exceeding and earnings slightly missing expectations. Revenue and earnings declined 3.1% and 4.7% to US$42.9bn and US$22bn, respectively. Unit costs (excluding COVID-19 impact) were broadly lower across the portfolio, reflecting efficiencies at Escondida, improved capacity utilisation and further reductions in overheads. The total financial impact from COVID-19 was US$348m, which included an exceptional charge of US$183m for 2020. This charge represents lower volumes, temporary shutdowns at non-operated assets and additional costs including temporary relocation costs, screening and hygiene.

Full year 2021 production is expected to be marginally lower than 2020 due to a reduced workforce (affecting Copper and Escondida more materially) and petroleum natural field decline. Medium-term guidance for these commodities remain in line with 2020 output.

BHP Group continues to make progress in increasing shareholder value through balance sheet management, portfolio rationalisation and astute capital allocation. With a rationalised portfolio of mining assets, the group maintains financial strength to pursue organic growth opportunities and further expand the project pipeline, within a more focused capital allocation strategy. Additionally, the Group’s medium-term intention of exiting thermal coal should free up capital to be spent on commodities with better growth prospects and less negative environmental impact. BHP Group’s portfolio, although still dominated by iron ore, shows an increasing focus on petroleum and copper, with these commodities seeing the largest capex contributions over the recent past. This portfolio has a strong consumer and emerging markets tilt, with all four major commodities linked to growing middle-income consumers. This is a long-term theme that we believe BHP Group is better placed to benefit from.

Standard BankStandard Bank, Africa’s largest banking group by assets, posted a result highlighting the severe impact of the COVID-19 pandemic. The constrained macro-economic environment, particularly in SA, led to a decline in headline earnings of 43%. While earnings fell significantly, they were 9% ahead of consensus estimates as losses at Liberty (-12% impact to earnings) were somewhat offset by an improvement in ICBCS Plc (+7% impact to earnings).

The group’s local banking operations reported a 72% y-o-y decline in headline earnings as the weak operating environment led to significant credit impairment charges. The resulting return on equity (ROE) was 4.1% compared to 15.2% in the prior year. The rest of Africa performed better as lockdown restrictions were less severe. Headline earnings for the Africa region came in 7% higher, supported by strong trading flows, which led to an 18% increase in non-interest revenue. Net interest income for the group came in flat for the year as lower interest rates negatively affected margins. While costs were controlled over the period, higher credit impairments in both Personal and Business Banking (PBB) and Corporate and Investment Banking (CIB) divisions highlight the weak operational environment. Credit loss ratios increased to 1.69% from 0.76% the prior year, which is lower than banking peers, but management have highlighted a better-than-expected collection in the PBB division. No dividend was declared. This is in line with the South African Reserve Bank’s guidance.

Standard Bank is a very well capitalised bank, as is the rest of the South African banking sector. This will not only ensure survival through difficult economic times such as those that we are currently enduring, but will also allow the bank to return to previous profitability levels in a recovering economy. Standard Bank is also very well diversified with meaningful on-the-ground presence in 20 sub-Saharan African countries. About a third of banking profits are derived from African countries excluding SA. Earnings visibility from non-SA is low and adds complexity to the investment case, but also provides geographic diversification and exposure to faster growing Rest of Africa regions.

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BidcorpAs a result of the COVID-19 lockdowns across the world, food services group Bidcorp reported weak full year 2020 earnings across all divisions. Revenue for the period was down 6.3% to R121.1bn while headline earnings per share fell 48.7% to R7.39. While the performance was weak, this was in line with management’s recent guidance and reflective of the severe restrictions in many of the group’s operating geographies. As a result of the uncertainty still posed by the pandemic, the board did not declare a final dividend, resulting in a full year dividend of R3.30 that was announced at the interim period - a decline of 48.4% for the full year. On a positive note, management pointed out that overall activity levels across the business have returned to between 85% - 90% of pre-COVID levels, with several businesses now achieving greater growth than the comparative period a year ago. As one of the largest food services businesses globally, Bidcorp remains well positioned to weather the current difficulties and is already seeing market share gains as competitors without the financial strength of Bidcorp are struggling or exiting the industry.

As the largest food services business outside the US, Bidcorp boasts the most diversified footprint. In the regions where the group operates, they have a leading (top three) market share, which we believe is a competitive advantage within food services. We believe that the continued benefit from scale and exposure to fast growing economies will support earnings growth going forward. The group’s stated strategy of exiting low cost operations, achieving the correct customer mix and providing additional value added services supports our expectation that margins will continue to improve in the coming years. Bidcorp is highly cash generative and has low gearing. We believe this leaves room for the continuation of the current strategy of acquiring independent operators as bolt-on acquisitions or for management to make a larger transformative acquisition either in a new market or to bulk up existing operations.

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CAPE TOWN

PINELANDSTEL: 021 524 4678ADDRESS: 4th Floor, Block A, Old Mutual Wealth, Mutualpark, Jan Smuts Drive, Pinelands, 7405 | PO Box 207, Cape Town, 8000EMAIL: PCS@omwealth.co.za

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JOHANNESBURGTEL: 011 245 3805ADDRESS: 1 Mutual Place, 107 Rivonia Road, Sandton, Johannesburg, 2196EMAIL: PCS@omwealth.co.za

PRETORIATEL: 012 369 7236ADDRESS: 43 Ingersol Road, 3rd Floor, Podium at Menlyn, Lynnwood Glen, 0081EMAIL: PCS@omwealth.co.za

KWAZULU NATAL

UMHLANGATEL: 031 581 0699ADDRESS: 61 Richefond Circle, 2nd Floor Ridgeview Building, Ridgeside Office Park, Umhlanga Ridge, KwaZulu-NatalEMAIL: PCS@omwealth.co.za

KLOOFTEL: 031 767 7300ADDRESS: 74 Old Main Road, Unit 7, Kloof, KwaZulu-NatalEMAIL: PCS@omwealth.co.za

CONTACT US

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