The South Africa Diaries: Risked Skewed to the Upside

The ANC Elective Conference Election is expected to
take place from 16-20th December. Seizing the moment,
we embarked on an investor trip to South Africa to test
our investment thesis by gaining local insight into the
economic impact of the potential outcomes of the ANC
election and the macroeconomic challenges the country
faces.

Key takeaways:

1. The outcome ofthe ANC election has a key bearing on whether the country will address its economic challenges.

2. A positive outcome should see the close of the Zuma chapter and boost
sentiment

3. Strong institutions and resilient, highly adaptable companies are used to challenging conditions

4. There is strong potential for an election outcome that could kickstart recovery


Fund Manager Diaries – Mumbai, the modern and confident India

Mike Sell, Alquity Head of Asia Investments enjoyed an Indian Summer visiting 26 companies to assess how the economic reforms implemented by Prime Minister Modi were impacting our holdings and seeking out new opportunities for the Indian Subcontinent Fund. This trip report, split into three parts, provides a detailed assessment of this multi-year growth opportunity.

 

MODERN, CONFIDENT INDIA: THE FINANCIAL HUB OF MUMBAI

The city may only be an hour away from Ahmedabad by plane, but as India’s financial capital, the atmosphere is a world away. For example, the airport has a dedicated pick up area for Uber and Ola and as you drive along the expressway there are numerous advertising billboards for the latest stock market IPOs.

My meeting with Oberoi Realty gave me the opportunity to assess the impact of the Real Estate Regulatory Act on them and their peers. Stricter rules regarding payment collections from customers will result in fewer speculative projects, and thus lower overall supply. Consumer confidence has returned to the Mumbai property market, following the disruption from demonetisation, and I remain very comfortable with our investment.

Voltas, the air conditioning company, was additionally reassuring as management shared their view of the increasingly competitive environment and their strategy to counter it. The experienced management team has delivered to date; building a franchise that dominates with a 21% market share. We believe that air conditioning, like the automobile sector will see an acceleration in competition in the main cities. However, Indian companies will thrive due to their strong brand recognition, dealer networks and following Modi’s drive for rural electrification, increasing penetration into smaller cities and rural areas. Maruti, with whom we met in Delhi, still has a market share of almost 50% despite the entry of Hyundai, Toyota and Honda. I frequently spotted their dealerships on the road trip to Aligarh. As Voltas stated, there is wealth outside the major cities, and this is proven by car sales in these areas, which account for approximately 35% of Maruti’s total sales. This confirms that air conditioning is an affordable modern convenience and once reliable power is available, it becomes an accessible necessity.

Additionally, I scouted for new ideas in the construction sector as, anecdotally, Mumbai is currently building out the largest amount of infrastructure since India’s independence.

I had an informative introductory meeting with J Kumar Infrastructure, a major beneficiary of India’s focus on building metro systems in cities with a population over 5 million.

I also met with Sun Pharmaceutical, perceived as the market leader, to determine whether the intensified pressure on US generic drug pricing is adequately reflected in share prices and as a comparison to our position in Glenmark Pharmaceutical. The meeting reaffirmed our belief that whilst headwinds for the sector will persist for an extended period, Glenmark’s differentiated product offering and significant focus on environmental standards will result in continued profitable growth.

Similarly, I met with HDFC bank and LIC Housing Finance to ensure I understood the competitive environment in their respective segments. HDFC Bank is one of the best-run companies in India, and one I first met in the mid 1990s. As they reminded me, at that point the public sector banks’ market share was 90%, with international banks on 8% and private sector banks on 2%. 20 years later, the split is 68%, 5% and 27% respectively. In addition to the impressive growth this represents (including taking market share from international banks) there remains significant future potential for the private sector banks from not just India’s growing population and economy, but direct market share gains from the inefficient state owned banks.

Our long-term themes of urbanisation and demographics naturally lead us (but not exclusively so) to consumer related companies, and I met with four new potential ideas in Mumbai. Unfortunately, a number of these suffer from a lack of sustainable competitive advantage and so we will not undertake further analysis, but there is one potentially interesting addition to the portfolio in this sector.

 

CONCLUDING THOUGHTS

In total, I met with 26 companies during the trip and my clear conclusion is that the investment case for India remains on track with expectations, if not actually ahead due to the impact of GST. None of our existing holdings disappointed, and thus none will be exited from the portfolio. We also have some potentially great new ideas to consider adding to the portfolio over the coming months.


Fund Manager Diaries – Going Deep in India

Mike Sell, Alquity Head of Asia Investments enjoyed an Indian Summer visiting 26 companies to assess how the economic reforms implemented by Prime Minister Modi were impacting our holdings and seeking out new opportunities for the Indian Subcontinent Fund. This trip report, split into three parts, provides a detailed assessment of this multi-year growth opportunity.

 

THE MULTI-YEAR GROWTH OPPORTUNITY: OFF THE BEATEN PATH TO ALIGARH AND HATHRAS

Whilst face-to-face company meetings at their offices is a key part of our work, it is also vital to view their products or services outside the big cities, where their stated competitive advantage can be assessed for real.

Map

Thus, I journeyed three hours outside Delhi to Aligarh, a city with a population of 872,000 in the state of Uttar Pradesh. Although greatly improved since my first visit here, large parts of the highway still need upgrading and my car had to contend with oil tankers on the wrong side of the road, carts pulled by oxen, and the ubiquitous five people on one scooter. However, it is fascinating to see India literally rising from the fields as new estates and suburbs are built in the greater Delhi area.

My first goal was to investigate the threat from e-commerce and e-banking outside the major cities. This disruptive threat has been much discussed recently, and so I attempted to visit four of the leading “clicks and mortar” exponent’s stated locations in various villages and towns such as Junedpur and Bulandshahr, as well as those in Aligarh. These are meant to act as hubs for parcel deliveries and banking transactions. From what I saw, the reality does not match the hype and, at this stage, we will not be investing in this company. Additionally, the competitive advantage held by Vmart in smaller cities does not face significant risks in the near future from this new channel.

Secondly, I wanted to better understand the physical competitive retail environment for Vmart. In Aligarh, there are two other chain stores, as well as a huge number of independent stores. Vmart was certainly busier than both Vishal Mall and Pantaloon, with Vishal Mall suffering from a terrible retail experience and poor product availability. Pantaloon was more ordered and modern, but this was reflected in substantially higher prices. One key difference with shopping in an equivalent developed city was the open sewer along the side of the street, whilst the contrast with the shopping experience back in Delhi was equally stark.

Moving on to Hathras, a city of 136,000 people a further hour away, Vmart has even less competition. The store is located in the city centre, in an area that looks like an old bazaar. There are a few modern Mom and Pop stores, but they do not have Vmart’s extensive product range. Most competition is from traditional stores, that look unchanged in generations, with the proprietors seated on the floor in open storefronts with merchandise stacked around them. Vmart clearly has a significant opportunity as consumer tastes develop.

Turning to banking penetration, despite Aligarh’s size, there was only one branch for each of the private sector banks that we invest in, namely Indusind, Yes and Kotak Mahindra Bank. In Hathras, HDFC Bank, the largest private sector bank was the only one with a presence. This again vividly illustrates the under penetration story of India, and the multi-year opportunity the banking sector provides.

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A FLYING VISIT TO AHMEDABAD

Following Delhi, I embarked on a day trip to Ahmedabad, Prime Minister Modi’s hometown, to visit our holding in Astral Poly Technik. Since we initially invested in March 2016, several sell side brokers have also identified the opportunity here, driving the share price higher.

Driven by urbanisation, an improved rural economy and continued investment in new technology, processes and capacity, we expect 15-20% volume growth and margin improvement building on Astral’s existing 30% market share in pipes. Their entry into the adhesives segment, through earlier acquisitions in India and the UK, provide a second growth driver. As their major capital expenditure investment programme is now complete, Astral should also see a rising ROCE and will become debt free in the next 2 years leading us to conclude that the valuation is still attractive.

I met with an interesting provider of high-end steel piping which will benefit from planned refurbishments of Indian refineries to meet tighter emission regulations. Finally, before flying to Mumbai, I met with Gruh Finance. This is a very well managed company, providing housing loans to lower income customers, with non-performing loans consistently below 1%. We will need to do more due diligence on these prospects over the coming months.


Fund Manager Diaries – Delhi, India’s Growth Engine

Mike Sell, Alquity Head of Asia Investments enjoyed an Indian Summer visiting 26 companies to assess how the economic reforms implemented by Prime Minister Modi were impacting our holdings and seeking out new opportunities for the Indian Subcontinent Fund. This trip report, split into three parts, provides a detailed assessment of this multi-year growth opportunity.

 

Travelling to India is always an experience, even after 20 years. More recently, the dramatic improvements in efficiency and infrastructure are particularly impressive. After touch down in the early hours of the morning, I breezed through the surprisingly busy Delhi airport with its vast duty free store and was kerbside within 20 minutes. Of course, this being India, I was immediately confronted by a stray dog running through the drop-off area and a bus that had beached itself on a speed bump and was blocking the road! Given the strong performance of our portfolio, the objective of my trip was threefold:

    • To review our holdings and ensure that their growth outlook is in line with our expectations.
    • To identify new potential candidates for inclusion in the portfolio.
    • To travel off the beaten track to review the retail environment and potential for disruptive change in the smaller cities and semi-urban areas.

 

THE GROWTH ENGINE: THREE DAYS IN DELHI

Delhi, or rather the satellite city of Gurgaon, is fast catching up with Mumbai and other Asian mega-cities in terms of ease of doing business. Certainly, the traffic can be awful as the city continues to dig up roads in order to build a metro and the best way to find an address still tends to be to ask a local stallholder. However, in terms of architecture and mindset, this area has more similarity to Canary Wharf than the old Delhi. Many international companies such as Google have set up base here, Uber works efficiently and increasingly companies are beginning to employ professional investor relations staff that are both knowledgeable and shareholder-friendly.

 

I met a range of companies across the automotive, cement, transportation and retail sectors including our holdings Astral Polytech, Vmart and Heidelberg Cement. The resounding message on Goods and Service Tax (GST) implementation was that it had been relatively straightforward and the benefits, such as a 20% reduction in journey time, as no more queuing is required at state borders, were already being felt. Margins will be further boosted over time as warehouses and supply chains are rationalised. Additionally, after several quarters of disruption from demonetisation and GST, the growth outlook is clearly improving.  Management were consistently more positive and less guarded about their future sales and profitability than has been the case over the previous three years.

 

It is also clear that India’s growth journey is just beginning. As an example, Vmart, a retailer whose share price is up over 200% this year, estimates there are 5,000 cities large enough to accommodate one of their  stores. Despite being one of the largest organised retailers in India, they are currently in only 150 cities, with a market share of just over 3% in those locations. Given their strong free cash flow generation, which increased substantially in the last financial year, they are now considering accelerating their store opening plans. As we have seen elsewhere in Asia, the ongoing shift from the unorganised “Mom and Pop” stores to organised businesses is a key structural driver across many sectors in India.

Source: Alquity, Bloomberg, Company Data
Source: Alquity, Bloomberg, Company Data

 

Whilst the potential of India in terms of demographic advantage and the impact of Modi’s reforms have received significant media coverage, the scope of this shift towards the organised sector is not fully appreciated by investors. This factor alone provides an inherent longevity to the Indian investment case. The introduction of GST, acting as an accelerant as all businesses are now required to provide proper documentation and to pay tax, removes the previous cost advantage from smaller and unorganised entities in every sector.

 

In terms of idea generation from Delhi, two companies justify a deeper analysis as potential investment candidates. Firstly, PNB Housing Finance, which listed in November 2016 and is a major beneficiary of the government’s drive to increase affordable housing through tax breaks for both developers and households. Housing affordability in India is the highest it has been for 20 years. Secondly, Somany Ceramics, which has restructured its business model over the last few years, also provides exposure to the theme of urbanisation, through both their tile and sanitary ware divisions. The company has risen from sixth place in 2011 and is now the second largest in the sector. Over the last three years it has increased margins from 6.7% to 11.5%, and ROCE from 15.5% to 21.3%.  Our preliminary ESG analysis indicates that these companies will meet our behaviour and quality standards, although we require a more detailed investigation.


Fund Manager Notes from Egypt

Earlier this summer our Africa investment team undertook a research trip to Egypt, just over six months since the authorities floated the Egyptian pound and initiated a reform driven agenda.

Since the removal of currency restrictions and the removal of subsidies, which helped Egypt secure a US$ 12bn IMF loan, both its debt and equity markets combined attracted inflows of US$ 7.7bn; US$3.7bn from foreign investors and US$4.0bn from domestic investors. The government also tapped the global capital markets raising US$ 7bn in Eurobonds, and the central bank’s 700bps increase in domestic interest rates attracted more than US$ 13bn into its Treasury Bills. This resulted in Egypt’s reserves reaching over US$ 36bn, covering almost eight months of imports.

These vast efforts by the government have now set the economy up for a recovery.

The purpose of the trip was to enhance our understanding of how the corporate sector was coping with the new environment and assess investment opportunities in the country, which we believe is at the beginning of a new growth cycle.

The following report outlines the team’s findings and prospects for the economy.

 

MACRO: FROM DISTRESSED TO STABLE

Egypt’s government, institutions and economy were in a distressed position as recently as 2016. This led to an IMF intervention, with a USD 12bn bailout package on the condition of a sweeping set of reforms.

The central feature of these measures was the elimination of Egypt’s currency peg, which was clearly unsustainable for a net importer of energy and soft commodities, with a dependency on diaspora transfers and credit markets. In the following period, the country’s exchange rate has therefore been determined by market forces, with the adjustment resulting in a downwards repricing of the Egyptian pound in the order of 50-60%.

Other reforms undertaken by the Egyptian government include the implementation of a transaction tax (VAT) and the passing of a new investment law to cut energy subsidies, the combination of which will improve fiscal revenue. Moreover, the new government is now mostly made up of technocrats, and although institutions remain fragile, the quality of administration is improving.

During our visit, both Domty, a branded cheese producer, and Edita, the largest bakery goods company in the country by market share, told us that they increased the prices of their product to consumers by more than 100% over the past year to compensate for rising input prices and its impact on their cost structure. There is no doubt that the economy is still adjusting to the new exchange rate, and inflation increases are hitting consumer’s disposable income.

The 700bps rate hike by the central bank since November last year (to an 18% deposit rate) is also positive news, which will help anchor inflation and attract portfolio flows to support the currency. This is unlikely to crowd out investment as the economy is underleveraged, with private credit to GDP at 34% at the end of 2016 vs a high of 55% back in 2002.

The Egyptian economy is now stabilising and is no longer distressed; all the companies we talked to were incrementally more confident about the future.

 

MICRO: GLOBAL & DOMESTIC LEADERS

We assess country risk in terms of economic health and institutional and government quality. It is clear that Zuma has been a disastrous leader for South Africa. However, 2017 holds the prospect of change as the ANC are electing a new chairman. So a real prospect of a positive leadership change, alongside a strong central bank could mark the beginning of a reform driven agenda, triggering a return to faster economic grow.

 

A World-Class Leader: Edita

Edita is the leading baked snack food company in Egypt, owning the country’s leading brands in croissants (60% market share), cakes (57%), rusks (47%) and sweets (20%).

We admire how they have built a portfolio of strong brands, whilst managing a business with sound financial metrics. Their ability to adapt to the recent challenging environment of rising cost pressure was illustrated in their marketing strategy, where they introduced volume/value offerings whilst increasing prices overall. The combination resulted in a limited fall in overall sales and minimal impact to profitability. Our visit focused on an assessment of their operational execution at their main bakery manufacturing sites.
It is our judgement that the company’s operations compare favourably with production plants across the emerging and developed world, not least Bimbo, the world’s largest baked goods company, and a holding in our Latin America Fund. Moreover, the facility is run by an impressive management team, all of whom were former global FMCG professionals at firms such as Coke, PepsiCo and P&G. These individuals bring global best practices from the production process to branding strategies and revenue management. This was particularly evident across their manufacturing facilities, which met Western European safety and efficiency standards and benefitted from modern design and technical specifications. The application of these best practices results in Edita having ISO 22000, ISO 9001, ISO 14001 and OHSAS 18001 certifications. Likewise, Edita’s internal communications in terms of corporate values, product branding and health & safety standards were like any other world class operator.

 

Global Exporters: Oriental Weavers

One of our largest investments over the past year was Oriental Weavers, a significant Egyptian exporter of rugs and carpets.

The FX adjustment of 2016 resulted in solid investment returns over the past twelve months, with Oriental Weavers up more than 20% in USD from the beginning of 2016 to our visit in mid-May. This is in comparison to MSCI Egypt, which was down 10.1% over the same period.

Over the course of our visit we were impressed by the mind set of constant improvement in their manufacturing processes. For example, we took a tour of Oriental Weavers’ weaving facility, where we saw their newest generation of manufacturing technology in action, and software which they co-developed to deliver one of the highest productivity weaving machines in the world. These developments were driven by a need to keep pace with client requirements (firms such as IKEA, Lowe’s, Target and Intercontinental hotels) and international competitors.

Oriental Weavers’ net income rose 128% YOY in Q1 2017, as its export-business flourished (dually boosted by recovering volumes and a weaker Egyptian Pound), while its local margins were protected by price increases. It is also worth mentioning their brand new state-of-the-art storage warehouse. Using the latest software and hardware technology for triage, storage and management, they have increased capacity by up to 50%. This makes Oriental Weavers the world’s largest carpet producer with no human intervention, with one of the lowest error rates in the world in their warehouse management supply chain.

 

Domestic Leaders: Cairo Poultry, Domty, Obour Land, CIB, Cleopatra, Integrated Diagnostic

The third bucket of companies we met during our trip were domestic leaders in its booming food and healthcare sectors. The past year severely impacted domestic consumption, a market which was recovering from a tough environment since the Arab Spring. However, looking beyond the economic adjustment, we believe these companies offer one of the more compelling growth opportunities globally.

Egypt has tremendous potential due to its demographics and economic informality. Egypt is a country of nearly 95m people, with a median age under 25 yrs, 2% annual population growth, and 85% of small & medium sized classed as informal. Its young and growing population has the potential to provide years of consumption growth for branded food companies, and a sound economic reform plan can accelerate the formalisation of the economy, thereby broadening the tax base and improving the country’s fiscal accounts.
Beyond the consumer industry, we met with health care companies such as Cleopatra, a hospital operator, and IDHC, a diagnostics company. Both have international expansion aspirations, which bring opportunity and complexity. In our view, we believe the domestic opportunity is large enough for them to focus their attention, as an international venture adds risk to their business with lower synergies and potentially greater execution risk.

 

ESG IN EGYPT

There is no better way to evaluate Environmental, Social and Governance (ESG) factors than on the ground research.

The ESG standards of the companies we visited met our minimum requirements to be investable. Indeed, a number showed evidence of global best practice and quality. This is, of course, a reflection of our pre-selection, and doesn’t represent the overall assessment of ESG in Egypt. In general, we find transparency to be extremely limited, with a great deal of engagement required to gain sufficient insight.

Edita most impressed us with respect to its standards of ESG. Their industrial bakery met global best practice in terms of quality of industrial machinery, quality control, hygiene, health and safety standards and staff professionalism. In addition, they displayed consistent evidence of innovation via which they increased productivity and created cost savings, while decreasing their environmental footprint. This was apparent by the implementation of a new wafer line, which helped new product introduction, whilst at the same time increasing productivity, lowering costs, and reducing waste.
Elsewhere, companies like Domty, Egypt’s leading branded cheese producer, showed a desire to improve their ESG adherence and will benefit from the support of Tetra Pak in their endeavours. They showed us their brand-new facility, which was in the final stages of construction and geared towards greater production scale and energy efficiency.

We focused on understanding the extent to which the firm had a culture of energy saving, health and safety initiatives and food safety standards. Their brand new manufacturing facility was designed with Northern European specifications, with particular regard to industrial engineering flow and waste reduction. We shared our experiences of other production facilities in France and Mexico, specifically regarding Health & Safety communication and implementation procedures. This was not visible to us during our visit compared to its wide visibility in facilities we’ve seen elsewhere. Domty’s management assured us that this is being taken on board.

 

CONCLUSION

Overall, we returned with an extremely constructive view on Egypt, a country implementing the IMF’s reform driven agenda, an agenda embraced by the private sector and well understood by the ‘man on the street’. The companies we met with were well prepared for tough times, and are even better prepared for the next growth cycle, which we believe is ahead of us driven by the execution of a well-structured reform programme designed to reduce the fiscal budget and decrease inflation. The next economic cycle has the potential to generate significant returns for investors.

The Egyptian market is trading at rock-bottom valuations and incremental FX risk is now limited due to a 700bps hike in interest rates. This is to say, the Egyptian Pound devaluation is now behind us, with growing portfolio inflows since November 2016.

As the country’s institutional and macro-economic frameworks stabilise, it is easy to imagine international investors getting excited again about Egypt over the next few quarters, and as such, there could be strong tailwinds for our holdings. With a 90m, young population that is growing rapidly, only a few economic improvements are necessary to unleash foreign and domestic investment, as well as triggering a boom of consumption led by a growing middle-class.


south arica

Investment Process in Action: the South Africa Diaries

Recently our African investment team visited South Africa as part of their continuing management of existing investments and pursuit of new opportunities. The trip provides a clear snapshot of our investment process in action.

 

Our unconstrained universe

In January 2016 our fund exposure to stocks in South Africa was 33%, today it’s 60%. We had spotted a deeply undervalued currency and a country concerned about the unpredictable behaviour of President Zuma. Flash forward to today and we find its enduring institutional strength helped maintain its investment grade rating, the currency appreciated over 20% and the external positioning continues to improve with the recovery of commodity prices. Our non-benchmarked approach enabled us to build our position in companies with the potential to deliver great returns over the next 3-5 year cycle, not just from a short-term bounce in sentiment.

 

Prospects for improving country risk

We assess country risk in terms of economic health and institutional and government quality. It is clear that Zuma has been a disastrous leader for South Africa. However, 2017 holds the prospect of change as the ANC are electing a new chairman. So a real prospect of a positive leadership change, alongside a strong central bank could mark the beginning of a reform driven agenda, triggering a return to faster economic grow.

 

The “Tail”Winds of Change

As we anticipated, we are now witnessing the headwinds being replaced by cyclical tailwinds with inflation falling, exports rising, and business confidence improving.

At Alquity, we focus on the cycle of profitability with the primary aim to invest in companies towards or close to the bottom of their cycle and where our expectations are significantly greater than the market. One such company is KAP Industrial Holdings, a leading supply chain logistics and manufacturing business. As the South African economy faced headwinds the business maintained its profitability but the market punished its share price, implying a structural change in outlook. As the economy improves, KAP is therefore well positioned to capture growth and increase profitability ahead of market expectations.

 

Hidden Gems with sustainable competitive advantage

South Africa is a complicated place to do business, which makes it an unlikely destination for direct investments. This allows savvy domestic operators to build world class operations with sustainable competitive advantages. A good example is the clothing & food retail operator Woolworth, that developed its own supply chain and branded food company. Recently it removed all plastic microbeads from its private label beauty and personal care products, making it easier for consumers to avoid being part of an environmental problem that is causing worldwide concern. This reflects their strong supply chain management and responsiveness to consumer trends.

In summary, as a country with strong institutions, great companies and abundant resources it is not surprising that a recent Bloomberg article revealed that South African equities have delivered the highest average return in US Dollars, for any equity market, over the past 100 years.


Peru: Cementos Pacasmayo and Ferreycorp – two world-class teams

A two-week trip to Latin America, travelling through Argentina, Chile and Peru, gives our fund management team food for thought as change is underway in the region.

 

Piura is located about 400km north of Lima with a population of 500,000 people. We came to Piura to visit Cementos Pacasmayo’s brand-new cement plant and Ferreycorp’s workshop.

Our day began early, and we woke up at the crack of dawn to avoid the sweltering heat, with our journey taking us through the city’s main retail artery. It was mostly populated by local retail operations characterised as simple stores, though the regional behemoth and a holding in our fund Grupo Falabella, was well represented with Tottus, its supermarket operation, and Falabella, its department store.

Driving out of the city involved dodging the swarm of three-wheeler taxi cabs, which we learned was the most popular taxi type and an easy alternative for self-employment. Upon exiting the city we were surrounded by the desert environment of Piura, a perfect location for a cement plant due to the expansive and uninhabited location.

Retail sites in Piura
Retail sites in Piura

The plant took 3 years to build costing US$ 370million. Using the most advanced German technology the plant was built with the goal of limiting its environmental impact. It sources its raw material from a nearby quarry, avoiding having to import clincker (a critical binding agent for cement).

The 1 million square meter operation was truly impressive. Health and safety procedures were evident from the moment we entered the facility as each one of us had to pass a breathalyser test to ensure we would not put anyone at risk. Cementos Pacasmayo has been on our watchlist since the launch of the fund, as a high quality company benefiting from a local dominance and high barriers to entry.

By the time we ended our visit the temperature had risen to 30C, so a good time to make our way in an air-conditioned minivan to Ferreycorp’s regional offices. We were welcomed by the group treasurer, who travelled especially to Piura to host our visit, and the local sales and operations team.

The sales team presented the firm’s positioning in Piura, which is endowed with a high level of industrial diversity in the form of agricultural, mining, fishing and infrastructure activity. The past few years have been lean years for the sector, with many players exiting and/or lacking commitment to the local market. Ferreycorp’s long term commitment and strategy led to them increasing their regional market share to 70%. The presentation was followed by a visit to their parts supply room, not only was this a superbly organised meeting, it also showed their adherence to ‘just in time’ practices with carrying parts that they know will be in demand according to their programmed maintenance schedule of the regional fleet of machines. One of their key comparative advantages is having highly skilled personnel that undergo significant amount of training throughout their Ferreycorp careers. Being a 5-star rated Caterpillar dealer is one of the major reasons why companies select Ferreycorp and reinforces their market leading position. We currently have 2.9% of the fund in Ferreycorp and we estimate it is currently selling at a 35% discount to intrinsic value.

Meeting the Ferreycorp team
Meeting the Ferreycorp team

We left Piura with a better understanding of Pacasmayo’s long term vision and Ferreycorp’s regional opportunity. Continuation of the city’s development will come through the development of its natural resources, both in the soft commodity and bulk materials area. Its low cost profile and high productivity potential will continue to attract entrepreneurial investment, which we believe will lead to a strong and sustainable level of growth.


Chile: time for Bachelet to be substituted?

A two-week trip to Latin America, travelling through Argentina, Chile and Peru, gives our fund management team food for thought as change is underway in the region.

 

After 4 years of poor political management, corporate Chile is eagerly looking forward to a new political cycle. Based on our discussion with company managers, clients and bankers, the last local elections outcome and Bachelet’s approval rating of less than 15%, we can safely say that change is on the horizon. Their hope is that the elections this year will extend the structural political swing from populist left to a more pro-business right, following in the footsteps of Argentina, Peru and Brazil.

Over the last few years, the companies we’ve met have scaled down investment in Chile, using their highly cash-generative domestic base to re-invest in more investor-friendly and growing markets in the region: namely Peru, Colombia, Mexico. For example our holding Falabella has increased its share of business in Peru, Colombia, Argentina and Mexico combined, from 26% in 2009, to 45% in the latest 2015 results.

Chile is not a typical emerging market; it enjoys first-world type of infrastructure, has sophisticated consumers and world-class industry. Our tour of Las Condes, the Costanera Center and Valparaiso provided ample evidence if this was needed.

Our holdings in Chile are supported by very strong fundamentals and capable managers leading world-class operations as illustrated by our visit to the Embotelladora Andina plant a few miles away from Santiago (3rd largest bottler of Coca-Cola in Latin America, with concessions in Chile, Argentina, Paraguay and Brazil). With a strong track-record of capital allocation over several cycles, delivering good returns to shareholders like us. All this comes at an undemanding valuation as they suffer from the “Bachelet discount”, despite most of their growth coming from neighbouring countries.

Visiting the Andina Plant in Chile
Visiting the Embotelladora Andina Plant in Chile

The election later this year may well be a catalyst for a re-rating of Chilean Equities after 4 years in the doldrums (-9% as measured by the MSCI Chile over the last 4 years in USD). But this will just be the cherry on the cake as the fundamental earning power of the multi-latinas will keep delivering over the long term.


Argentina: Macri, the “Messi” of the Argentine economy?

A two-week trip to Latin America, travelling through Argentina, Chile and Peru, gives our fund management team food for thought as change is underway in the region.

 

Touring the Bohemian area of Palermo Soho in Buenos Aires, with its eclectic collection of trendy shops and restaurants, it doesn’t feel as though the country is in a recession. It’s been over one year since Mauricio Macri was elected president of Argentina and we came to meet with industrial and consumer companies to gauge the position of Argentina’s economic recovery.

buenos aires
The view over Buenos Aires

Since Macri took power he has reached an agreement with sovereign bond holdouts, removed capital controls and amended the regulated tariffs. This has allowed institutions to regain trust and begin to act responsibly, by being transparent about fiscal challenges and the real economy.

This move away from the farcical “Kirchner” economic model is increasing business confidence and  willingness to invest in growth. For example, the country’s largest mall operator is looking to finally receive municipal approval for a 10 million square meter residential project, for which they’ve been waiting more than 10 years.

The economic adjustment is well underway and was further confirmed by meeting with our holding Pampa Energia, whose electricity distributor Edenor, saw its electricity tariffs increase allowing them to capture a proper return on assets and invest to expand. The average household’s electricity bill in northern Buenos Aires rose from US$3/month to US$16/month, but is still among the lowest in Latin America. We hold 4.5% of the fund in Pampa Energia, and its value has climbed 350% since we initiated our investment.

The consumer sector in Argentina is not doing well, in large part due to the high level of unemployment (8.5%), and a still high, though declining, level of inflation.

Both these factors are symptoms of an economy going through its cyclical adjustment. The main factor to follow, which will over time improve both employment and consumption, is a resumption of infrastructure investment. This is crystal clear to Macri and will be the pathway to prosperity.

The economic adjustment is well underway and was further confirmed by meeting with our holding Pampa Energia, whose electricity distributor Edenor, saw its electricity tariffs increase allowing them to capture a proper return on assets and invest to expand. The average household’s electricity bill in northern Buenos Aires rose from US$3/month to US$16/month, but is still among the lowest in Latin America. We hold 4.5% of the fund in Pampa Energia, and its value has climbed 350% since we initiated our investment.

The consumer sector in Argentina is not doing well, in large part due to the high level of unemployment (8.5%), and a still high, though declining, level of inflation.

Both these factors are symptoms of an economy going through its cyclical adjustment. The main factor to follow, which will over time improve both employment and consumption, is a resumption of infrastructure investment. This is crystal clear to Macri and will be the pathway to prosperity.