Saturday, April 26, 2025
Home Blog Page 174

The Fed shows its hand

Although we had a short week last week, some significant events happened. This included a rate hike by the Fed and an emergency meeting called by the ECB. Andre Botha, Senior Dealer at TreasuryONE brings us these insights.

The Fed showed its hand and hiked by 75 basis points to get rates back to neutral at a faster pace while also fighting the current inflation “monster” prevalent in the market.

We also saw an emergency meeting called by the ECB, at which a new tool was discussed to reduce bond market volatility as the Bank raises interest rates.

The Fed was always going to hike interest rates, so the question was whether they would do so by 50 or 75 basis points. With inflation picking up in the previous month, the smart money was on a 75 basis point hike, which Fed Chair Powell delivered.

The dot plots below demonstrate that the Fed expects the rate to be 3.5 per cent by December, implying that even if this occurs, there will be some significant increases in the coming months.

However, the market has begun to worry about the Fed raising interest rates causing a recession, and we have seen multiple signals that the market is concerned about this possibility. Oil prices dipped on Friday, especially in the Northern Hemisphere summer, where demand for oil increases. Stock markets are losing some ground as flows have started to move away from risky assets like stock markets back into safe havens like the US dollar. 

To address unwarranted moves in the bond market, the ECB called an emergency meeting, with many speculating that the Governing Council would reveal the tool mentioned above. Instead, the Governing Council agreed to direct APP reinvestments to the markets that require the most attention.

A portion of the statement reads as follows:

“The Governing Council decided that it will apply flexibility in reinvesting redemptions coming due in the PEPP portfolio, to preserve the functioning of the monetary policy transmission mechanism, a precondition for the ECB to be able to deliver on its price stability mandate.”

With that said, the US dollar was on the front foot immediately after the interest rate decision, but it lingered around the 1.05 level against the euro during the latter half of last week and the start of this week.

We must remember that the US was out of the market on Monday, which would have impacted the US dollar’s lack of momentum.

The rand had a rollercoaster week, fluctuating wildly between the R15.75 and R16.15 levels – appearing to want to break above the R16.15 level a couple of times but unable to sustain the break each time:

In the short term, we believe that the rand could come under some pressure as risky assets have come under pressure, and the rand could bear the brunt of it as it usually acts as a proxy currency for all emerging markets currencies

On Wednesday, Fed Chair Powell will give his semi-annual testimony to Senate Lawmakers on monetary policy. We expect the market to watch the testimony closely as the testimony is the main highlight of a very bare data and event cupboard and could cause some volatility in the market.

Should the Fed reinforce its hawkish stance, we could see emerging markets currencies under pressure, and this could be the catalyst for the rand to move above the R16.15 level that it has been tested so frequently. 

To find out more and to discuss your market risk needs (like forex) with the team at TreasuryONE, visit their website here.

Absa gives us more banking insights

Absa has released a trading update for the five months to May 2022 as well as a trading statement dealing with the six months ending June 2022. The banks have been stellar performers this year in a market that has inflicted pain on most people.

Regular readers of Ghost Mail will know that I’ve been talking about the banks quite a bit this year. With rising rates and demand for credit from both consumers and businesses, it’s an environment in which the banks tend to shine.

The bank share prices tend to be highly correlated when it comes to short-term moves, as they are impacted by similar macroeconomic realities. They may move together, but that doesn’t mean they have moved to the same extent this year.

Here’s a chart explaining what that looks like (note the gap between Nedbank and Capitec, despite the waves typically rising and falling together):

I must say, when I wrote on the banks just a few weeks ago, the share price gains looked a lot better in a similar chart.

In the Absa update, the bank notes that demand for customer loans was high single digits, with improved growth in the Corporate and Investment Banking (CIB) division. There was similar growth in Retail and Business Banking (RBB), which is driven by demand for home loans and vehicle and asset finance.

Customer deposit growth slowed to mid-single digits, with Absa noting that this was driven by a reduction in low-margin national government deposits. Deposit growth in the RBB division has been described as “solid” which is too vague to really give us insights.

Keep an eye on RBB customer deposit growth this year. People are saving less and spending more in my view, no doubt a function of the cost-push inflationary environment we find ourselves in. It’s good for banks when consumers are buying assets and bad for banks when they are buying petrol and food instead, as this lowers the credit quality of the average borrower. Absa hasn’t included any specific commentary on this – it is just common sense.

Revenue growth for the five months looks good, up by low double digits. This was driven by net interest income (which benefits from higher rates and loan growth) and non-interest income (assisted by a rebound in life insurance revenue and decent growth in fee and commission income as well as trading revenues).

This strong revenue growth resulted in improved margins. The bank talks about positive JAWS, which means income growth exceeded growth in operating expenses. The cost-to-income ratio improved to the low 50s.

Pre-provision profit over the five months grew by mid-teens. Below that, the bad news is that “credit impairments grew materially” though this was off a relatively low base. The credit loss ratio is above the through-the-cycle target range of 75 to 100 basis points.

Inflation is starting to bite I think, visible in higher vehicle and asset finance credit impairments. Be careful here – when the banks tighten up on lending for vehicle finance, the incredible numbers we’ve seen from car dealership businesses will falter.

On the plus side, the impairments in CIB decreased materially. Absa’s models are suggesting that companies are a lot better off than consumers at the moment.

Return on equity for the period has improved to almost 17% which is really good. To sweeten this deal even further for investors, the dividend payout ratio will increase from 30% to 50% as the core equity tier 1 ratio is very strong at 12.5%. Simply, this means that the bank’s balance sheet can easily support a higher dividend.

Normalised headline earnings per share (HEPS) for the six-month period will be at least 20% higher than the 1,019.7 cents in the first half of 2021.

The net asset value per share at the end of 2021 was R149. The share price is trading around R169, which is a 13.4% premium to a number that is nearly six months out of date and would’ve grown accordingly, as this has been a strong period for the business.

We will only know once June results are released, but I would guess that the current price is probably at or slightly above the 1H22 NAV per share.

With return on equity of 17% (well above the cost of equity in South Africa), this creates an argument that Absa may be undervalued. The risks lie in overall consumer health, particularly if inflation drags spending away from durable assets and into the basics, like food and fuel.

Ghost Bites Vol 31 (22)

  • Omnia flooded SENS early in the morning with no fewer than three announcements. The easiest one was that Ralph Havenstein will be retiring as Chairperson, replaced by Tina Eboka as Chairperson-designate who has been on the board for over six years. Another short announcement gave investors what they wanted to hear: a meaty dividend! A final dividend of 275 cents and a special dividend of 525 cents have been declared. The total of 800 cents per share is over 10% of the current share price and will be paid on 1st August. The third announcement was the story behind the numbers, with the results for the year ended 31 March 2022. I wrote about it in detail in this feature article, including an important section about the dispute with SARS.
  • As Real Estate Investment Trusts (REITs) go, Stor-Age is one of the most dependable. The self-storage asset class has been resilient during the pandemic, bringing some stability to an incredibly volatile set of opportunities in the market. With results released for the year ended March 2022, the fund has posted a solid set of numbers. Investors need to form a view on the interest rate exposures and the impact of inflation when assessing Stor-Age. I’ve written on the company in detail in this feature article.
  • City Lodge Hotels has released a voluntary operational update and trading statement. The group achieved 47% occupancy in South Africa with all its local hotels finally being open. In March, that number increased to 58%. This was mainly driven by strong weekend and leisure occupancies, with increased business travel. Occupancies were down to 49% in April, negatively impacted by the weather. May increased to 52% in South Africa and 49% for the group, which was in line with pre-Covid occupancies in May 2019. In wonderful news for staff, salary reductions were suspended from May 2022, so there is some degree of normality returning. Looking beyond South Africa, the pending disposal of the East African operations is imminent and the long stop date has been extended to the end of June 2022. Those proceeds to be used to repay debt. City Lodge has had positive monthly cash flows since February 2022 and has access to R223 million of liquidity in short- and long-term facilities. The group is busy refinancing R600 million in debt to allow for facilities that expire in the next 13 months. City Lodge has guided an improvement of at least 75% in headline earnings per share (HEPS) for the year ended June 2022. As the prior period was a loss, this implies that the base expectation is to make another loss (albeit a much smaller one). The share price is down nearly 26% this year.
  • MAS is a real estate company focused on Central and Eastern Europe (CEE). The company holds properties in Romania, Bulgaria and Poland and has a development pipeline with its joint venture partner Prime Kapital. MAS has released a trading update and pre-closing statement, which includes some really bullish commentary on Romania’s GDP growth and its immediate prospects. MAS highlights that its properties have triple-net leases that allow for full indexation to base rents, which means inflation can be passed on. The group also points out that most of its debt has fixed interest rates. The properties proposed to be acquired from the joint venture have debt that is fully hedged via interest rate caps for the next seven years. Footfall in May 2022 exceeded pre-Covid levels and sales per square metre are way ahead of pre-Covid levels, helped along by inflation. The share price is down 5.9% this year.
  • Fortress REIT has issued a firm intention announcement regarding the exchange of Fortress A shares for new Fortress B shares through a scheme of arrangement. The proposal is designed to give Fortress A shares an 80% share of distributions and Fortress B shares the remaining 20%. The company believes that a simplified strategy is preferable in this market and that collapsing everything into a single share class significantly reduces the risk of loss of REIT status by not meeting distribution requirements. The announcement notes “divergent views” on a fair swap ratio among shareholders and there are some in the market who feel that the board is bullying them with the threat of loss of REIT status. An independent expert will need to be appointed to issue an opinion on this scheme. I don’t envy whoever will be appointed on this one. I also don’t envy the independent directors.
  • Gemfields has announced a record ruby auction result based on the aggregate outcome of seven mini-auctions held in Bangkok in recent weeks. The rough rubies are from the Montepuez Ruby Mining (MRM) operation in Mozambique, which is 75% owned by Gemfields and 25% by a Mozambican partner. Importantly, the records tumbled for the total auction result and the per-carat revenue, so this is a volume and pricing story. The group does caution that 24% of the total weight offered in the auction was not sold. Revenue for the first half of the year is now $181 million (driven by this auction and two emerald auctions), which is almost double the previous record of $93 million in the first half of 2018. Gemfields has noted that second-half revenues are unlikely to match a “remarkable” first half of the year.
  • Afine Investments, the REIT that invests in petrol stations, is buying properties in an entity that has a related party among its shareholders. For the deal to go ahead, an independent expert needed to opine that the terms are fair to shareholders of Afine. AcaciaCap Advisors was appointed to give this opinion and has determined that the deal is fair, so no shareholder approval is required for the transaction to go ahead.
  • Orion Minerals has not yet finalised its capital raising transaction, so the voluntary suspension of trading in securities will remain in place until Wednesday. This is an Australian Securities Exchange (ASX) rule, as Orion’s primary listing is in the land down under.
  • The mandatory offer by Glenrock to the shareholders of Universal Partners has now closed. Only holders of 1.12% of Universal Partners shares accepted the offer, which doesn’t surprise me given the offer price. Glenrock now holds 35.3% of the shares in issue.
  • Equites Property Fund is hosting a site visit and presentation in the UK and has made the presentation relating to the site visit available on the website. It is full of useful information on the UK portfolio and you can download it at this link.
  • A couple of directors of Dipula Income Fund have bought B ordinary shares in the company. The amounts are small though (just over R200k across both directors) so I’m not sure how much importance can be placed on this.
  • There’s also been a fairly small acquisition of shares in Hammerson plc by the alternate director to Des de Beer. The total value is £21.4k which equates to around R420k.
  • A director of Raubex has bought shares in the company to the value of R357k. There has been quite a bit of buying by directors recently, which is a strong signal.
  • A director of EPP, which is now a subsidiary of Redefine, has bought shares in Redefine worth over R1 million.

Omnia: a special year

Omnia Holdings has bucked the trend this year in a big way. The share price is up over 15% at a time when the market has burned bright red. In a bear market, picking your stocks is important.

For the year ended March 2022, revenue increased by a juicy 30% and operating profit (excluding Zimbabwe) shot up by 123%. Headline earnings per share (HEPS) was 86% higher at 672 cents.

By all accounts, this was a strong year.

Omnia has made a song and dance about its cash and capital management and hasn’t been shy to pay large special dividends. This year, the ordinary dividend of 275 cents is 37.5% higher than the prior year’s ordinary dividend of 200 cents. The special dividend of 525 cents is 31.25% higher than the 400 cents special dividend in the prior year.

It’s not often that a company pays special dividends in consecutive years. Omnia has been rationalising its investment portfolio and has sold off certain parts of the group in both years. Some say there is more to come.

The cash position is 31% higher year-on-year, which is a growth rate that is similar to the increase in the overall dividend.

Agriculture segment

This segment contributed just over half of group revenue and operating profit.

Revenue was 41% higher and operating profit from continuing operations (the right way to view it vs. revenue) was 17% higher, so there has been a margin squeeze here. Omnia attributes this to higher operating costs (obviously) and a fixed-price contract in Zambia.

The company reminds us that results from Zimbabwe are subject to hyperinflationary earnings volatility. The group also operates in Australia and Brazil, both of which posted solid results.

Investors should remember that the drivers of this great revenue result (like a good crop harvest and higher commodity prices) are volatile by nature. Primary agriculture is a tough place to play and Omnia is directly exposed to this industry.

Mining

The mining segment contributed nearly a third of group revenue from continuing operations and just over a quarter of group operating profit. Revenue was up 29% and operating profit jumped by 79%, so margins went in the right direction here.

Revenue was driven by increased sales volumes and a higher ammonia price. Margins improved thanks to a focus on operational efficiencies, market expansion and larger contracts, which simply tells me that economies of scale are coming through in this segment.

There are important structural underpins to the result, like demand for specialist chemicals and services in the battery metals and PGM markets, both of which are really important going forward as the world focuses on emissions.

Still, Omnia is once again exposed to a cyclical industry here, so investors must be cautious when forecasting growth.

Chemicals

The chemicals segment contributed almost 15% of group revenue from continuing operations and nearly 9% of group operating profit. Revenue was up only 2% and operating profit jumped by 41%, so the revenue mix made all the difference here in improving margins and driving profit growth.

The balancing numbers

Those of you with a strong feel for the numbers might be thinking that these segments don’t add up to the group total. The balancing numbers relate to head office costs and discontinued operations, like Umongo Petroleum which Omnia sold during the financial year.

SARS audit

In case you thought everything was perfect at Omnia, think again. The group is dealing with a SARS audit related to its transfer pricing practices between 2014 and 2016. SARS has raised an additional assessment of R415 million and understatement penalties of R165 million. If that isn’t bad enough, there’s also an interest amount of R365 million.

So, that’s a fight with the tax authorities worth R945 million, which is a huge number. Operating profit for this financial year excluding Zimbabwe was R1,726 million, so this is a critical battle.

Omnia has raised an objection with SARS and the receiver has until 30 September 2022 to respond. In the meantime, a payment of R207 million was made to SARS in December 2021 and interest continues to accrue on the rest.

Omnia believes that the most probable outcome is an Alternative Dispute Resolution process.

Outlook

Omnia has been working hard to simplify the group and optimise supply chains and manufacturing capabilities. It’s great to enjoy the benefits of being at the right point in the cycle (e.g. in mining) but experienced hands are well aware that these conditions are usually here for a good time rather than a long time.

The group has done well in its core operations but it needs to resolve the SARS issue to give investors certainty around that matter.

My major irritation is that the short-form SENS announcement doesn’t mention the SARS problem and this isn’t the first time that Omnia has buried it deeper in the presentations and reports. You have to read the full results booklet to find information on it. This really isn’t good enough from a disclosure perspective and it gives a poor impression of the company’s attitude towards shareholders.

Putting your money in Stor-Age

In theory, property is supposed to be a defensive asset class. The pandemic demonstrated that many types of property aren’t nearly as defensive as people thought.

For a detailed look at the South African property market, last week’s update from Growthpoint is well worth a read. I wrote a feature article on it that deals with all the important insights into the retail, office and industrial property sectors, along with a reminder of what a gem the V&A Waterfront is.

Stor-Age has managed to give investors somewhere to hide over this period.

It’s not the kind of company that is likely to give incredibly high returns. Importantly, many see it as unlikely to fall over, as the self-storage asset class has been resilient throughout all the challenges. It also helps that Stor-Age enjoys geographical diversification, with R4.9 billion in local assets and R5.3 billion in UK assets under the brand Storage King.

The fund has now released results for the year ended March 2022 and declared a cash dividend. Distributable income increased by 7.5% year-on-year, so now you understand why I believe it is a solid but not necessarily spectacular place to put your money.

It’s important to remember that distributable income doesn’t include the increase in value of the underlying portfolio, as you can’t pay an unrealised gain as a dividend. If that is included, the total return for the year was 16.5%. That’s an excellent accounting return that isn’t being reflected in the share price, which is trading at the same levels as June 2020.

The business model is great. Same-store closing occupancies were over 90% in the SA and UK and the loan-to-value (LTV) ratio is 27.9%, which is the right sort of number for a property fund. An LTV of over 40% is where property executives start to have a few sleepless nights.

Stor-Age continues to grow its portfolio, having acquired 11 trading properties and completed three developments. There’s a development pipeline of 14 properties, four of which are already in progress with Stor-Age’s joint venture partners (Moorfield in the UK and Nedbank in South Africa).

The company is also taking a leaf out of the hotel industry’s book, offering a third-party management solution to other storage businesses. This lets Stor-Age generate additional revenue without needing to invest capital, which is exactly how hotel groups (e.g. Hyatt) operate once they have a proven model. It’s early days with this offering but I do find it rather interesting.

Stor-Age also raised a seven-year £21 million sustainability-linked loan from Aviva Investors. If you want to learn more about sustainability-linked loans, check out this great feature written by the Ghost Grads.

There is R2.9 billion in gross debt on the balance sheet, of which R1.28 billion is local and R1.62 billion in in the UK. In terms of interest rate hedges, 71.5% of local gross debt is hedged and 77.7% of UK debt is hedged. The effective interest rates are 6.65% in South Africa and 3.41% in the UK.

The equity side of the balance sheet also received some love, with a R575 million oversubscribed accelerated bookbuild in January 2022. This is a way of raising money that is a bit like releasing concert tickets to legions of adoring fans who fight over the right to part with their money.

The full year dividend of 111.90 cents is 5.4% higher than the prior year and is a yield of 7.9% based on the closing price the day before this announcement. I must remind you that dividends from Real Estate Investment Trusts (REITs) are taxed like normal income, not dividends, so you need to apply your marginal income tax rate to this number (which varies whether you hold shares through a company or in your own name).

The net tangible asset value per share is R13.59 and the share price was trading at R14.17 before the announcement came out, so Stor-Age is still trading at a premium.

The key risk here is rising yields and the impact on distributable income, as a decent chunk of the debt isn’t hedged. The question then becomes whether Stor-Age will be able to increase rental rates if we head into more economic difficulties. Will people finally get rid of that extra stuff as budgets become tighter, especially if storage rates increase? Or is the business so strong that there will be enough demand to keep the units full?

I’ve held shares in the company before but I don’t currently have a position.

Ghost Bites Vol 30 (22)

  • Novus Holdings has released results for the year ended March 2022. The printing and packaging company is only down 2% this year and paid out a special dividend in February of around 17% of the start-of-year share price, so it has way outperformed the market this year. Revenue for the year is 6.2% higher and headline earnings per share (HEPS) swung heavily into the green, posting a profit of 53.2 cents per share. The share price is only R2.30 and the closing cash position is R567.9 million vs. the market cap of nearly R800 million. It’s not all a bed of roses though, with the company noting that Covid inflicted permanent damage to the print industry e.g. magazine titles that are gone forever. The company is now facing a gauntlet of global pulp and paper shortages and excessive price increases, which is why the share price performance has been modest when viewed against the improvement in profitability. No final dividend has been declared, which is another clue that the board is playing a cautious game here.
  • Capital & Counties Properties Plc and Shaftesbury Plc have reached agreement on the terms of an all-share merger, so this is a deal recommended to shareholders by the boards of both companies. This is a far better scenario than a hostile takeover. The structure is that Capital & Counties will own 100% of Shaftesbury if the deal goes ahead, paid for through the issuance of new shares in Capital & Counties. The existing shareholders of Shaftesbury would hold 53% of the combined group with the existing shareholders of Capital & Counties holding the remaining 47%. It’s important to note that Capital & Counties already holds 25.2% in Shaftesbury. The merged portfolio would be 670 buildings in London’s West End. The split would be 35% retail, 34% hospitality and leisure, 17% offices and 14% residential. The loan-to-value ratio would be 29% and there would be GBP500 million of available liquidity in the group. JSE investors will be pleased to learn that Capital & Counties will retain its listing on the JSE, so the merged group is something that local investors can participate in. The deal is expected to become effective by the end of 2022 if all goes to plan and shareholders should look out for the circular to be issued within 28 days.
  • The CEO of Equites Property Fund has sold shares in the company worth R5.3 million. The COO isn’t far behind, having sold shares worth R1.4 million. When top executives in the company are selling at the same time, it sends a pretty strong message to the market about the share price. Equites is down 16.6% this year and is slightly up over 12 months.
  • Glencore released a trading update on a day that was extremely painful for investors in the resources sector. The share price fell 5.8% but that was in line with the bloodshed across the sector. Coal prices are through the roof and government is a major beneficiary of that, with higher royalties as a result. There’s substantial inflation in input costs like energy and logistics as well, so the unit cost has also risen significantly. Glencore’s Marketing segment is expected to achieve $3.2 billion in interim adjusted EBIT, at the top end of the through-the-cycle guidance. That’s good news for investors, though you would never say it by looking at the share price.
  • Having sold its petroleum assets to Woodside and its stakes in Carrejon and BHP Mitsui Coal in prior transactions, BHP has been reducing its exposure to fossil fuels. The company has announced that it will retain New South Wales Energy Coal in its portfolio, with a plan to extend its mining licence until 2030 (it is due to expire in 2026). BHP tried to sell this asset and ran a process to receive offers, but they weren’t satisfactory, so this is Plan B. Once the mine is shut down, there will be a 10 – 15 year rehabilitation process. The provision for this process was $700 million in the 2021 financial statements.
  • Marshall Monteagle Plc has released a trading statement for the 18 months ended March 2022. This is a weird reporting period that is a result of the company changing its financial year end from September to March. The group has swung into the green, with headline earnings per share (HEPS) over the period of $7.90 cents. Keep in mind that you can’t use this in calculating a price/earnings multiple as this number covers an 18-month period (rather than a 12-month period).
  • Vodacom’s B-BBEE scheme YeboYethu is separately listed on the JSE and has released results for the year ended March 2022. The total dividends declared for the year were 213 cents per share, so the scheme is trading on a dividend yield of around 5%. The share price has ended up flat over the past year, so the dividend has been the only return for shareholders.
  • Steinhoff Investments has released results for the six months ended March 2022 and there’s a very important nuance here: this is the subsidiary that has issued listed preference shares, not Steinhoff International Holdings which is the ordinary shares that most Steinhoff investors hold. A gross dividend of 293.55308 cents was declared for the period, so the interim dividend yield was nearly 3.8% and the annualised yield would be double this number. The preference shares trade under the ticket JSE: SHFF and the ordinary shares are JSE: SNH.
  • Royal Bafokeng Platinum shareholders will be pleased to note that the legal risks related to the Maseve deal from 2017 have been put to bed. Royal Bafokeng acquired the Maseve assets for $70 million and was subsequently on the receiving end of legal proceedings by Africa Wide Mineral Prospecting and Exploration (holder of 17.1% of Maseve prior to the deal) that sought to have the transaction declared unlawful and invalid. The arguments were based on consents needed for the deal. The High Court wasn’t buying that story, dismissing the proceedings with costs.
  • In case you’re itching to travel to Eastern Europe (or invest in property there), NEPI Rockcastle has been hosting a property tour and has made the presentation available online. It includes a useful overview of the company and many details about the underlying properties. You can find it at this link.
  • Montauk Renewables is now being included in the Russell 3000 Index. It was also recently added to the MSCI Global Small Cap Indexes within the MSCI USA Small Cap Index. This is important because it means that index tracking funds will need to buy the stock in proportion to its weighting in the index.
  • Randgold & Exploration Company has announced that its legal fight with certain minority shareholders of the company has been fully and finally settled among the parties.

Of inflation, interest rates and bear markets

The chair of the US Federal Reserve (The Fed) announced last Wednesday 15th June that the Federal Open Market Committee (FOMC) had decided to increase the US federal funds rate by 75 basis points. It’s probably too little, too late and markets have already baked in a significantly higher interest rate environment by year end. But will it be enough to contain inflation? Perhaps not. Chris Gilmour explains.

The late Archie Shapiro told me decades ago that if you’re bullish and you’re wrong, people will forgive you. Conversely, if you’re bearish and you’re wrong, people remember and never let you forget it. Ever since then I have tried wherever possible not to be bearish on markets, even when my gut told me it was the wrong approach.

And of course this is not just a South African phenomenon; it applies to all financial markets worldwide. 

But lots of other people have been expressing bearish sentiment recently, notably Jamie Dimon, CEO of JP Morgan Chase, who predicted a few weeks ago that an economic “hurricane” was about to hit US financial markets. He cited loose monetary policy, massive fiscal stimulus by the US government and the impact of the war in Ukraine on food and fuel prices as the main factors feeding this hurricane.

South African-born Tesla CEO Elon Musk fears an imminent recession in the US and has “a super-bad feeling” about the economy. This is why he feels it necessary to cull 10% of the group’s workforce. This was just after he issued a blunt warning to workers to return to workplace in person or consider themselves as having resigned.

And John Waldron, President and COO of US investment bank Goldman Sachs echoed the warnings, citing a series of concomitant unprecedented factors hurting the economy, including a commodity shock (mainly oil and gas) and an unprecedented amount of fiscal and monetary stimulus.  

One of the most authoritative voices out there is former US Treasury Secretary Larry Summers, who accurately predicted last year that inflation in the US was getting out of control and that if the US Federal Reserve didn’t act quickly, it would get a lot worse. Now, with inflation at a 40-year high of 8.6% in the US, Summers is sounding even more alarmist, suggesting that only a full-blown recession will be able to tame inflation.

The research at the National Bureau 0f Economic Research (NBER) can be read in its entirety in a free download at this link, but the essence of it is that Summers and his co-authors claims to have found a better way of analyzing inflation than using the CPI method. Using this alternative method, Summers and his co-authors reckon that current inflation levels are much closer to past inflation peaks than the official CPI series would suggest.

One of the biggest divergences between the Summers et al method and the traditional CPI method is the way in which housing inflation in calculated. The NBER paper states that prior to 1983, the CPI did not correctly account for consumer spending on housing, including either the final home purchase value or the value of mortgage rates spread out over 30 years. The pre-1983 index included both home purchase prices and the total outlay of mortgage payments, despite mortgages being paid out gradually over several years. By including both, the CPI method effectively double-counted housing inflation between 1953 and 1983. The net effect was that inflation measures before 1983 looked artificially high at the start of the tightening cycle but they dissipated artificially quickly.

Applying the NBER methodology, the current inflation rate in the US is eerily close to a period in US history when there was considerable financial distress and the and the only way to cure it, according to Fed chair at the time Paul Volcker, was to crush it with extremely high interest rates.

In 1980, the official CPI inflation rate was 13.6% but applying the NBER methodology, that would reduce to 9.1%. Volcker raised interest rates in the US to over 20% in the early 1980s, a move that tipped the US into the most severe recession since the Great Depression of the 1930s. Unemployment soared to almost 11%, but the end goal of taming inflation was achieved.

Volcker was a single-minded civil servant who just got on with the job of running the Fed, which he did extremely well over two terms and two administrations. He was very different to his successors such as Alan Greenspan, Ben Bernanke, Janet Yellen and now Jerome Powell who have all used a variety of tools to attempt to keep prices stable. Volcker understood the power of interest rates. Period.

Here is a chart of the United States average monthly prime lending rate:

And here is a chart of the United States core inflation rate:

To raise interest rates to the levels that Volcker did back in the 1980s would have devastating effects on the real economy. This is the last thing that Powell or president Joe Biden needs and neither of them probably have the intestinal fortitude to go down that road.

Another way of looking at this issue is to examine how the Fed has handled the COVID-19 pandemic. With the benefit of hindsight, it is now clear that Powell and his FOMC made a disastrous decision to throw so much money at the situation and not expect inflationary consequences. Powell exacerbated the situation with his stubborn insistence until relatively recently that the inflation that had been generated was only transitory and would soon evaporate.

He and his team completely missed the consequences of massively disrupted supply chains, for example.

Now the US finds itself in the unenviable position of having a Fed that is still relatively accommodative, despite the recent rate increases, coupled with supply chain disruptions that are likely to persist well into next year and beyond and the war in Ukraine is just making everything much more expensive.

This is a perfect inflationary storm.

Reading Powell’s statement after the rate increase announcement, it is clear that he genuinely believes that inflation will be back to much more manageable levels by 2024. The clue lies in the wording. It seems reasonable to agree that inflation will indeed be more “manageable” within two years but it may not necessarily have been tamed.

No matter, at least it should be going in the right direction. We need to be realistic.

While a return to a Volcker-type approach appeals to the fundamentalist in me, I have to admit that the cost in terms of financial wipeout would probably be too great to bear. Back in Volcker’s day, life was far simpler. Today, everything is far more connected and as a consequence, perhaps more fragile.   

At the time of writing, the S&P 500 was down 23% from its peak. Put another way, its market capitalisation is 23% below its all-time high of just over $40 trillion in early January this year. So, about $10 trillion has been wiped off the value of US stocks in this current rout.

That in itself will provide a substantial deflationary effect to the US economy, so pervasive is share ownership in America, and if sustained for any period of time will result in the Fed not having to do an awful lot more in the way of further tightening.

Powell and his peers in central banks across the globe must tread a very fine line between attempting to contain inflation and preventing the real global economy from stalling. So once again, a repeat of the Volcker-type approach to tightening may not be required. If this line of thinking becomes conventional wisdom, it may not be too long before we reach a bottom in the S&P 500 and even in the tech-heavy Nasdaq.

Where it goes from there, however, is anyone’s guess.

A period of going nowhere slowly for a couple of years would seem likely. As another old-timer on the markets also said to me many decades ago:

“Nobody rings a bell at the top of the bull market or the bottom of the bear market”

Chris Gilmour writes wonderful opinion pieces for Ghost Mail every Monday. His most recent pieces on Russia and China were extremely popular reads and you should make time for them if you haven’t done so already.

Securing portfolio stability during anxious times

Warren Buffet famously advised, “Rule No. 1 of investing: Never lose money. Rule No. 2: Never forget rule No. 1”. While many investors bias their decisions towards higher returns and a search for alpha, diversification and the inclusion of lower risk options remain an important part of the mix.

With the world in a constant state of flux and uncertainty, investors are increasingly needing to review their investment portfolios to ensure a balanced asset allocation and risk profile based on their individual needs. Even seasoned investors find themselves scratching their heads when it comes to making prudent investment decisions, especially when facing the prospect of financial loss.

When it comes to future-proofing portfolios, structuring a robust, diversified portfolio that can withstand volatile market fluctuations is key. A well-diversified portfolio with a suitable asset allocation strategy can help investors mitigate potential market losses and smooth out the bumps in the road.

However, with traditional fixed investments providing subpar returns, which are often further diminished by layers of unnecessary fees, investors need to dig deep to find products that complement their portfolio and suit both their long-term and short-term investment needs.

With so much proven volatility in the markets, Fedgroup Secured Investment provides investors with a measure of certainty by offering full capital security and inflation-beating returns. Since inception of this product over three decades ago, no investor has ever lost capital or the interest due to them. Equity investors riding events such as the 2008 crash or the COVID-era volatility would have experienced some peace of mind with the Fedgroup Secured Investment as a portion of their broader portfolio.

Strictly regulated and governed by the Collective Investment Schemes Control Act, Fedgroup Secured Investment is not subject to short-term market fluctuations. Rather, it offers a fixed interest rate over a five-year term, along with flexibility that allows investors to structure the offering in a way that suits their unique needs.

Investors have a choice between having the monthly interest paid out, reinvested for growth, or a combination of both. Because of this, Secured Investment has found favour with a large array of investors, as evidenced by the fund’s recent high growth to over R5.5 billion AUM in 2022.

Of all the unique aspects of this product, of note is the lack of any fees charged to investors. No ifs, no buts, no “qualifying products”, and no hidden clauses. Thanks to simplified financial structures and Fedgroup’s commitment to value creation, investors enjoy a market-leading rate on maturity of 11.7% p.a.* without unnecessary fees eroding returns.

Few other providers offer a better rate at comparable low risk.

Gone are the days of having to choose between capital preservation and competitive returns!

And because it’s available via the Fedgroup App or through a financial advisor, investing a lump sum of R5 000 or more for a five-year period has never been easier. No red tape, no unnecessary jargon, no problems.

Given all these advantages, it becomes apparent why an increasing number of investors regard the Fedgroup Secured Investment as the foundation of a balanced investment portfolio.
Click on this link for more information.


*Rate on maturity if the interest is reinvested over a five-year period at a fixed nominal rate of 9.25% p.a.
Rates represented at the time of publication are subject to change.

Is ESG coming to a home loan near you?

Sustainability-linked lending has been around since 2017, with corporates tapping into pools of debt that get cheaper as ESG targets are met. This brings out the best and worst of humanity, of course, as you never have to look far to find opportunistic behaviour. Still, there are great examples of this type of lending in practice. Will it end up being offered to retail banking customers one day? Two of the Ghost Grads (Jordan Theron and Kreeti Panday) bring us this overview of the sustainability-linked lending industry.

In 2017, Dutch bank ING became the first financial institution to extend what we now know to be a sustainability-linked loan. Considering the world has become obsessed with ESG in recent years, the bank doesn’t make it a secret that it pioneered this approach.

The €1 billion loan to Philips had an interest rate (or cost of debt) that was designed to fluctuate based on the company’s sustainability performance. As we will explore, this is different to a “green loan” or specific bond issuance to raise funding for a particular project, like a solar farm or social housing development.

Estimates are that over $800 billion has changed hands in global sustainability-linked loans. Companies love borrowing money and banks love dishing it out, so this encourages corporates to spend time on designing and implementing sustainability measures that will warm the hearts of the banking credit committee.

Show me the metrics and I’ll show you the money

Those measures are the key in this industry. Sustainability-linked loans are structures that allow companies to borrow money at lower interest rates on condition that they meet certain ESG KPIs (Key Performance Indicators) as set out in the loan agreement.

If the targets aren’t met, the rate usually ratchets higher.

The borrower benefits from paying an interest rate that is often lower by 50bps – 100bps. It may not sound like much, but you need to remember that we are talking about billions in debt. On a R2 billion loan, a 100bps reduction is R20 million per year in interest savings.

That’s enough to pay for a beautiful ESG-inspired billboard advert and some extra bonuses for executives. Ok, the ever-cynical Ghost possibly wrote this part.

50 Shades of Green

Although the lines have blurred and will blur further, traditional “green funding structures” require the company to use the money to fund specific “green” projects, whereas the proceeds from sustainability linked loans can be used for general purposes.

An example of the former is Harmony’s R1.5 billion agreement with Absa Corporate and Investment Banking to fund Phase 2 of their renewable energy rollout. Harmony is just as tired of Eskom as we all are, so they are planning to create the capacity to produce up to 137MW of energy for their operations. Everyone wins in this scenario: the environment can breathe a bit better, the company enjoys lower energy costs and the rest of us in South Africa have slightly more table scraps from Eskom to power our homes and businesses.

The Harmony structure is interesting in that it also includes sustainability-linked loans – three of them, to be exact! These are based on renewable energy and water consumption targets and include KPIs that have been independently verified using the Sustainability Linked Loan Principles issued by the Loan Market Association. The ESG industry has become big business for professionals.

There’s a lot of marketing going on here

Inevitably, an argument is made for the correlation between corporate performance and sustainability measures. You don’t have to look far to find research in support of this view. Of course, investment firms offering sustainability-themed investment products (like ETFs) are quick to use these findings as well.

Whilst there is little doubt that a business run on sustainable principles has better long-term prospects than a business that doesn’t have this thinking embedded in the management teams, there’s also a correlation vs. causation discussion here.

Is it the case that sustainability is driving the increased profits, or do more successful companies simply have deeper pockets and flexibility to plan for the future, not least of all in a way that looks good in glossy integrated annual reports?

To give you an example of the type of research in this space, Accenture claims that high levels of innovation, without an emphasis on sustainability and trust, result in a negligible increase in operating profits. In contrast, high levels of innovation combined with sustainability and trust, resulted in a 3.1% increase in operating profits. Read into that what you will.

Whether you are rushing off to buy an ESG-weighted index or not, there’s no doubt that corporates are tapping into financing that uses these metrics and they are enjoying lower costs of funding as a result. The banks believe that these are better-quality clients, as a sustainable business is a good business.

Real-world examples

Research suggests that the US accounts for over 30% of global sustainability-linked issuances. We know that climate change is top of mind for corporates and politicians, so this has led to their largest banks (including Citi, JP Morgan and Bank of America) leading the charge towards a greener future, incentivising corporates along the way with climate metrics in ESG loans.

There are pools of capital looking for impact beyond just environmental measures. For example, Anglo American’s $100 million loan agreement with the International Finance Corporation included targets of providing three off-site jobs for every on-site job by 2025.

South Africa is barely a rounding error when it comes to our percentage share of global issuances. In our view, this is a growing opportunity though.

With Eskom seen as a business risk as much as a climate risk, renewable energy investments will likely drive demand for sustainability-linked loans. South African companies will be seen as embracing the change, eager to get their carbon-heavy feet in the door.

As with US lenders though, there are great examples of local companies raising sustainability-linked financing with metrics that go beyond just renewable energy targets.

Sea Harvest dove head-first into the green waters of sustainability-linked loans, having secured R700 million in financing from Standard Bank in November 2021, subject to KPIs and sustainability performance targets.

In June 2021, Woolworths became South Africa’s first retailer to engage in sustainability-linked financing, taking out an R1.15 billion loan from Standard Bank. The terms include a rise in local sourcing of fashion, beauty, and home products, a focus on sustainable food supply and a reduction in the use of electricity in stores. These things just sound like intelligent business practices, don’t they?

Mondi is also tapping into sustainability-linked financing with a 5-year revolving multi-currency credit facility agreement. There were no fewer than 10 relationship banks involved! Mondi’s Action Plan to meet its ambitious 2030 sustainability goals (called MAP2030 by the marketing department), shines a green spotlight on three areas described as “circular-driven packaging and paper solutions, created by empowered people, taking action on climate.”

Coming soon to a home loan near you?

The trend of sustainability-linked financing does seem to help more than it hinders. Banks want to be seen as doing the “right thing” and corporates are thrilled to reduce the cost of debt.

Soon enough, it is possible that we may even see this kind of financing extended not only to companies, but consumers too.

Can you imagine enjoying a lower interest rate on your bond if you achieve electricity reduction targets, thereby reducing carbon emissions in your daily life?

Perhaps it’s time to teach your children to switch the lights off when they leave a room, in this case because it might one day save them money on their bonds rather than because Eskom will do it for them if they don’t!

The Ghost Grads are four talented students who have joined me for an internship during their studies. I’m thrilled to have them and you can look forward to many more great articles from them.

Ghost Bites Vol 29 (22)

  • Growthpoint has released an update covering the nine months to March 2022. The South African property recovery has stumbled. In this market, I prefer having exposure to concentrated property funds rather than those with broad exposure across the market. Read this detailed feature article and see if you agree with me.
  • EOH shareholders will be relieved to learn that the conditions related to the disposal of the Information Services business have all been met. EOH has received R422 million in proceeds, including R25 million in interest. The proceeds net of costs are R374 million and will be used to reduce the R1.2 billion bridge facility. After this repayment, group debt is R1.33 billion, comprising a R500 million three-year bullet facility and the remainder of the bridge facility. The share price is still languishing in the mid-R5s and I’m glad I got out of the way when I broke-even at just over R7.
  • Tongaat Hulett is still reeling from the Takeover Regulation Panel’s ruling that the waiver of a mandatory offer related to Magister Investments is a nullity. This throws the recapitalisation plan out the window and puts the company into significant difficulty in finding a solution for the balance sheet. Against this backdrop, it’s not surprising that the company is not going to meet the deadline to release financials for the year ended March by 30 June 2022. They can’t finalise results unless there is a plan, otherwise the “going concern” assumption becomes a little difficult.
  • Naspers and Prosus released trading statements for the year ended March 2022. The Prosus share price is down nearly 37% this year and Naspers is down almost 28%. In this period, Prosus invested $6.2 billion right at the top of the venture capital / tech cycle in growth verticals like EdTech and Food Delivery. I still have major question marks about the unit economics of many of these business models. Headline earnings per share (HEPS) is down this year because of lower fair value gains, investment in ecommerce businesses (i.e. ones that lose money) and increased net finance costs. The board of Prosus suggests using core HEPS as the best performance indicator, down between 14% and 21% this year. I’m happy to not have a position here.
  • Sephaku Holdings has released a trading statement for the year ended March 2022. HEPS has skyrocketed to between 17.20 and 17.78 cents vs. 6.09 cents in the prior period. The share price is down 28% this year and was trading at R1.33 before the announcement was released after hours on Wednesday. Let’s see how it reacts.
  • If you are interested in Santova, the JSE small cap that offers solutions in global supply chains, you should check out the investor presentation that was delivered on Wednesday. It gives a thorough overview of the company, its strategy and some of the risks it faces.
  • Southern Palladium is going to be one of those mining companies that makes everyone wish they had studied geology before reading the announcements. In what sounds like a Marvel movie, there are helicopters and gamma rays in the latest update. Based on management’s commentary in the announcement, the Total Magnetic Field survey aimed to confirm the structural integrity of the inferred mineral resource and investigate loss-of-ground disruptions. The aims were achieved and Phase 1 drilling can now commence with a targeted start date of July 2022.
  • Raubex and Bauba Resources have announced the final results of Raubex’s mandatory offer to Bauba shareholders. The offer was accepted by holders of 10.59% of the issued shares in Bauba, representing 39.40% of shares held by minority shareholders.
  • Separately and importantly, a prescribed officer of Raubex has invested a substantial sum of R4.5 million in the company’s shares.
  • Alphamin, the tin miner in the DRC, has confirmed that the recent closure of the Bunagana border post between the DRC and Uganda has no impact on its operations. Alphamin’s exports move through border posts with Uganda that are 1,000km north of the Bunagana town where rebels and DRC government forces are fighting.
  • Afrocentric is acquiring the remaining interest in Afrocentric Distribution Services. This is a small related party transaction and required an independent expert to sign off on the terms as being fair to shareholders of Afrocentric. Mazars Corporate Finance was appointed and has provided such an opinion, so the deal is going ahead.
  • Advanced Health has announced that it is undertaking an internal strategic review of the business. I always shake my head at these types of announcements. If the company isn’t doing this type of work as part of business as usual, then what are executives being paid to do? I may as well announce that I’m sitting down to write something.
  • In another reminder of why attempted arbitrage trades on large corporate deals are often a bad idea, Distell has had to extend the timing of the implementation for the Heineken deal. Distell originally hoped to get approval by the end of June but is now only expecting it before the end of 2022. I always suggest taking a cautious approach when assuming the timing of a regulatory approval from the Competition Commission, especially on landmark deals.
  • Despite leaving the business soon, the CEO of Altron has elected to retain the shares that have vested under the incentive plan, other than those sold to cover the tax liability. That’s an encouraging message about the company.
  • An entity related to several directors of Ninety One has acquired shares in the company worth over £900k.
  • Trustco has managed to miss the deadline for the release of its interim financial statements and has promised to release them by the end of June. This company has made it known publicly that it dislikes the listed environment and missing deadlines is just part of that overall attitude.
Verified by MonsterInsights