Daniel Malan of South African Regarding Capital Management (RECM) sat down for an interview with Value Investor Insight earlier this month. RECM manages around $2.2 billion in assets and searches for “cheap entry points into sustainable businesses managed by ethical, sensible people who understand how to allocate capital in the pursuit of long-term shareholder value creation on a per-share basis and are appropriately incentivized to do so.”
Also see David Herro’s recent interview with VII
Daniel Malan avoiding “franchise businesses” right now
Daniel Malan emphasizes that RECM’s “goal is to invest in absolutely cheap assets anywhere in the world offering the best prospective returns to our clients.” He admits that this has sometimes led to a “heavier concentration in “franchise” businesses like Estee Lauder, Nestle, Coca-Cola, Swatch and Johnson & Johnson, because that’s where we were finding the best values.” He continues to say, however, that such franchise businesses are not always the best values.
Daniel Malan goes as far as to say: “If the only cheap assets in the world were a “net-net” baskets of Japanese microcaps trading below cash per share, that’s all we’d own.”
The South African fund manager also notes that big names are “an easy sell to investors, and doing so has worked very well over the past five years.” He says it pretty easy for analysts, portfolio managers and salespeople to defend owning Nestle or Unilever because everyone has heard of these companies’ brands, but the stocks are all widely owned by professional investors and are usually a part of major stock indices.
Daniel Malan says these “safety net” stocks might not really be so safe today. “The commercial risk of being wrong all on your own is very low. But many of these high-quality companies trade at high earnings multiples on all-time-high profit margins. Revenue growth is anemic, at best. So we think the odds today are increasingly stacked against investors in these stocks. If things go well you’re unlikely to make much money, but if anything goes wrong with profit margins or stock markets become a bit unstuck, watch out.”
Positions closed in last 18 months
RECM has recently sold off most of its pharmaceutical and medical-device positions, which no one wanted a few years ago, but now are highly regarded. The fund is also largely out of positions in large-cap information technology companies like Intel and Hewlett-Packard.
Daniel Malan also noted that RECM “bought into Wells Fargo and Bank of America well after the financial crisis ended, but are now very much in the harvesting phase with those.”
He also highlights French retail giant Carrefour an “interesting case study in market optimism and pessimism.” He points out that the retailer really hasn’t performed that well from a fundamental standpoint since RECM first bought shares five years ago, but the share price is up almost 300% from last investment in 2009 to when the fund started selling out earlier this year.
As we have noted recently, value investors have diverged on Russian stocks – Daniel Malan is in the bull camp (sort of) telling VII:
From a bottom-up sector perspective, the world is just screaming to us that cyclicals and resources have completely fallen out of bed. From a geographic perspective, our various filters are producing investable new ideas in places like Russia, China, South America and Japan. Relative to things like cosmetics, toothpaste and watches, it’s not exactly what one would consider polite dinner conversation. In energy, we believe the market is overshooting on the downside in large diversified E&P companies like BP [BP] and Total [TOT]. Our view is that such primary oil and gas producers have in fact been remarkably stable businesses over the course of a full business cycle, with significant ability to manage their costs down when energy prices fall. As a result, they’re much less volatile as businesses than oil prices are as a commodity. The same definitely cannot be said of energy service providers, whose stocks have been absolutely taken apart. We’re very careful about those at the moment.
People do think we’re completely crazy to be spending a lot of time on Russia. We haven’t really bought into it in a big way yet – we own small stakes in Sberbank [SBER:LI], the large commercial bank, and in energy company Gazprom [OGZD:LI] – but I’d expect us to be more aggressive there over the next six to twelve months. There’s obviously considerable geopolitical risk, but what we often find when fear levels are so high is that you don’t need to have a broad economic correction or a massive recovery in a company’s profitability for investments to work out well.
When something gets completely overcooked on the downside, purely a shift in sentiment that everything isn’t burning down can result in much higher stock prices as the market starts to discount a recovery. Our experience in southwestern Europe over the past four years has been indicative of that.
One very important point to make, however, is that we take into explicit consideration that buying into distressed, capital-intensive sectors like steel, platinum, energy and aluminum is a minefield, with plenty of companies that can easily go bankrupt or end up being long-term value traps. So we’re focused at the top of the food chain, on companies with sustainable cost advantages, geographically and operationally diverse assets, net cash or very low financial gearing, readily monetizable assets if need be, sensible and correctly incentivized leadership, and strong controlling shareholders. Those are the types of things that provide staying power through the full commodity cycle.
