Renewed interest in emerging market investments and the move from growth to value are reflected in Amplify fund manager Omri Thomas’s stock picks.
“While global markets look expensive, we still manage to find value in South Africa,” said Thomas, portfolio manager of the Amplify SCI Flexible Equity Fund and a director at Abax Investments, adding that the fund finds this value both in the hybrid space – with convertible bonds – and in some quality shares on the JSE.
The Amplify SCI Flexible Equity Fund’s biggest position is in the Royal Bafokeng Platinum convertible bond. Thomas said the Royal Bafokeng share has done so well that the share price has run through the convertible price resulting in substantial value in the convertible.
He said Royal Bafokeng had spent capital on expansion in the last few years but has yet to benefit from the cash flow emanating from the expansion.
“In the next couple of years, we are going to see strong cash flow from them and an expanding production profile. Royal Bafokeng is moving more of production towards a block where the rhodium content is much higher, and the rhodium price is extremely high at the moment, so the more they mine there, the higher the yields per ton.”
Thomas said Royal Bafokeng is “a very attractive takeover target, being contiguous to Northam and Implats, which both sit with substantial cash”. If that does not happen, there is a good chance Royal Bafokeng could use excess cash to buy back its convertible bond.
Another of the fund’s biggest positions, and “one of the best opportunities in our market”, is British American Tobacco (BAT). Thomas says the dividend has consistently grown, and the dividend yield is now over 8%. “In a world where we are not getting any yield, this is an attractive real return,” he says.
BAT has traditionally paid attractive dividends and used excess cashflow either to buy out other tobacco manufacturers or do share buybacks. BAT’s 2017 buyout of Reynolds led to an increase in debt, and while it continued to pay dividends, share buybacks have been on hold.
Its annual cashflow is £10 billion, and by the fund’s calculation, debt will decline from 5x EBITDA to 2x by 2024 or 2025, after which buybacks, which are earnings accretive, will resume.
A P:E of 8.5x implies a 16.1% internal rate of return, excluding any currency effects. Should it drop to a 6x P:E, the return is still 14%, and if it rerates to 14.5x P:E, the IRR would be 20.5%. BAT is a share “to buy and put in the bottom drawer and collect dividends along the way,” Thomas said.
At Naspers, another of the fund’s top stock picks and holdings, the discount to the sum of the parts keeps increasing.
The value of Tencent, Naspers’s major investment, is now significantly more than the Naspers share price. For every 10% that Tencent goes up, Naspers should go up by 15% to 20%, but it also goes up by 10%, and the discount widens, Thomas said.
Management is incentivised to close that discount, and at the end of last year, Naspers announced buybacks in Prosus and Naspers. “Each share they buy is accretive, and their economic interest in Tencent goes up,” he said.
The fund values the Naspers investments outside Tencent as the value at which it is trading, implying a P:E below 20x, which makes it attractive relative to global tech valuations. Tencent is currently trading at a 40x P:E, or 19x stripping out its investments, so if you invest in Naspers, what you are paying for Tencent is closer to a 10x P:E.
As the economic recovery continues, retailers have been announcing results that were largely better than expected, and the Amplify fund, which holds FirstRand and other banks, expects to see some uptick in banking.
Banks held back dividends in June 2020 and increased provisions. This may see them start to release excess capital, and investors could see dividends, share buybacks or some form of return of capital plus earnings recovery, while banks are relatively cheap currently.
However, he remains cautious on the domestic economic outlook and cautious about the environment of high investor risk appetite.
There has been a significant increase in the value of non-profitable (largely tech) companies where a lot of investor money has been flowing, irrespective of earnings. Another concern is retail investors entering the market, taking out options and speculating.
These trends have led to some disconnect, with consumer staples and some high yielding stocks, including tobacco and food, offering value.
South African stocks remain relatively cheap and attractive, especially given the serious warning lights in global markets. Knowing when the tide will turn for global growth stocks “is a nervous dance – leaving just as the last song plays”, said Thomas. As this is difficult to time, caution is necessary.