ALPHAWEALTH PRIME SMALL & MID CAP FUND COMMENTARY - JANUARY 2018
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ALPHAWEALTH PRIME SMALL & MID CAP FUND COMMENTARY – JANUARY 2018 1 February 2018 AlphaWealth (Pty) Ltd. Reg. No.: 2004/026495. An authorised financial services provider - FSP Licence No. 13808. www.alphawealth.co.za
ALPHAWEALTH PRIME SMALL & MID CAP FUND UPDATE. 2
GOOD START TO 2018
Following our poor performance during 2017, AlphaWealth Prime Small & Mid Cap (AWSM) Fund has bounced c.10% from
its pre-ANC NEC low in mid-December 2017. This bounce has continued to gain momentum during January 2018 and we
are happy to be reporting a +1.94% return this month versus our benchmark’s -0.56% return.
This is a good start to the year and, given that AWSM Fund is still on a Price Earnings of 11.0x and sees its earnings growth
of c.12% accelerating, we reasonably expect this positive performance to continue.
HOW ‘DAY ZERO’ MAY EFFECT US
It is highly likely that Cape Town and its surrounding regions will run out of water. Hence, at a recent Investment Committee
Meeting, we dug into the effects of the so-called ‘Day Zero’ and any impacts (direct and indirect) we could realistically
expect in the AWSM Fund. This was after extensive research and communication with the various companies that we are
invested in.
Figure 1: Western Cape GDP Versus South Africa’s GDP
Rest of South Africa
86%
Western Cape (Primary
Sector)
1%
Western Cape (Services
Sector)
10%
Western Cape (Rest)
3%
Sources: Western Cape Government Provincial Treasury, Cape Town Government, and AlphaWealth workings and assumptions
Our most directly exposed investments include a number of hotels held by City Lodge (CLH) and Hosken Consolidated
Investments (HCI) via its holding in Tsogo Sun (TSH). The latter is naturally diluted in terms of its actual weighting in the
portfolio. Also, both hold diverse hotel portfolios with the majority of them outside of Cape Town and the Western Cape.
In this sense, while they may lose occupancy in these regions, they may pick up extra in other regions as some Capetonians
temporarily move to other provinces (a good proportion of these migrants should use hotels). Tourism’s response to Day
Zero will be a swing factor here, but our two hotel exposures are both relatively contained in the portfolio and
predominantly service the domestic business—not tourist—markets.
Other investments potentially impacted include Rolfes’ (RLF) agricultural chemical sales and Calgro M3’s (CGR) Western
Cape housing projects. That said, both of these groups already saw a portion of the impact in the prior reporting season
and have mitigating strategies to swing activities into other projects, provinces and/or markets. Besides, Rolfes on a 8.9x
Price Earnings (PE) and Calgro M3 on an 11.2x PE are both so lowly valued that one could argue that this risk has already
been baked into their share prices.
That said, the majority of our companies do not have (material) direct exposure to this risk. Indeed, something like Tongaat
Hulett (TON) has its South African agri-operations exposed to KwaZulu Natal and (predominantly) Free State agricultural
markets (not mentioning its Zimbabwe and Mozambique operations). And, in this way, Tongaat Hulett is insulated against
the Western Cape drought. From a Mpumalanga-based coal miner to a global ICT integrator (i.e. Wescoal (WSL) to Datatec
J OH A NNE S BU RG | C A P E T OW N | D U RBA N | L OND O N | GE NE V A | MA U RI T I U S | MA L T A | H ONG K ONGALPHAWEALTH PRIME SMALL & MID CAP FUND UPDATE. 3
(DTC)), the rest of our portfolio is also quite shielded from any direct effects of Day Zero, but the knock-on effect on South
African GDP and potential societal impacts remain a worry to us all.
SOME PORTFOLIO CHANGES
Late last year we exited our investments in Torre Industries (TOR), PBT Group (PBG), AfroCentric Investment Corporation
(ACT) and Consolidated Infrastructure Group (CIL). While we have spoken at length about exiting CIL, we exited Torre, PBT
Group and Afrocentric for quite different reasons.
In Torre and PBT Group’s cases, these reasons included liquidity considerations as we rotated into maximum cash ahead of
the ANC NEC. Afrocentric’s exit was more opportunistic as we felt it had matured as an investment.
Following the positive ANC NEC outcome, we have deployed this cash balance into some existing investments and added
two new ones. While we will not go into detail on our investment cases, here follow our summaries of these two new
investments:
City Lodge Hotels (CLH): Superb hotel operator on a low valuation
City Lodge holds a geographically-diverse, well-branded chain of hotels for the price-sensitive traveller. They predominantly
service business travellers but are also well-positioned to cater for public sector trading down.
The Group’s financial and operating metrics are superb, while the post-ANC NEC economic recovery is expected to help
macro variables that the Group cannot control (occupancy and room rates).
While AirBnB may be a background threat, two key variables offset this risk. Firstly, the majority of business travellers do
not want the added burden that comes with AirBnB bookings and like the turnkey (pun intended) solution a professional
hotel offers. Secondly, AirBnB may work in densely populated residential areas in South Africa but it struggles in outlying
areas and it is nearly impossible to implement en masse in darkest Africa. City Lodge’s portfolio extends into regional African
markets where AirBnB—or similar such models—are unlikely to become a threat anytime soon.
These background fundamentals combine with a cheap-to-reasonable valuation to make for a great small cap investment.
The Group’s forward dividend yield is comfortably in the 4.0% range. Thus—compared to cash that yields c.5% and will
drop as the SARB likely lowers rates this year—City Lodge offers free upside against its portfolio’s value, little sacrifice in
yield and an asset that stands to benefit on the interest rate downside risk in South Africa.
Adcock Ingram Holdings (AIP): Defensive healthcare business swinging into growth mode
Adcock Ingram Holdings (AIP) saw a spurned takeover bid, negative publicity and dramatic management change a number
of years ago. Since then, the new management team (and strategic shareholder, Bidvest Ltd) has knuckled down and quietly
turned the ship around. Early this year, the Group’s trading update showing HEPS were up at least +27% y/y is a further
indication that this process is complete.
At its core, Adcock Ingram offers a predominantly South African customer a range of healthcare products from chronic
offerings and generic medicines to OTC and complementary products. Many of these products have top-tier brands that
are well entrenched in our domestic market, from Panado, Compral, Corenza C, Citro-Soda, ProbiFlora and Bioplus to a
range of generics and ARV’s.
With high regulatory barriers to entry and brand name competitive advantages, Adcock Ingram is a formidable and highly
profitable business. Now that the Group’s internal focus on turnaround is complete and its balance sheet is relatively
ungeared, we expect Adcock to become a lot more external and growth-orientated. This has already begun with a small
domestic acquisition of a complementary business. We expect more of this and see Adcock Ingram entering an exciting
period of growth over the medium-term.
J OH A NNE S BU RG | C A P E T OW N | D U RBA N | L OND O N | GE NE V A | MA U RI T I U S | MA L T A | H ONG K ONGALPHAWEALTH PRIME SMALL & MID CAP FUND UPDATE. 4
While the Single Exit Price (SEP) mechanism and the importation of Active Pharmaceutical Ingredients (API) add elements
of complexity to Adcock Ingram’s business model, the underlying remains robustly inelastic, competitive and stands to
actually profit from a stronger (and strengthening) Rand.
All in all, we believe that now is a good time to invest in this unique healthcare company. As an added benefit, after exiting
Afrocentric, we no longer had any direct healthcare exposure. Hence, Adcock Ingram injects a degree of diversification to
AWSM Fund as well.
The beauty of these portfolio changes is that they both improve the individual and collective quality in the AWSM Fund’s
portfolio and they improve its liquidity while maintaining a very high implied forward return.
TAX FREE SAVINGS ACCOUNTS REMINDER
Just a reminder that the end of February (this month) is also the end of the tax year. Hence, those who have Tax Free
Savings Accounts (TFSA) invested in the AWSM Fund should maximise your allowance by topping it up to the maximum
amount before tax year-end. Likewise, those who send lump-sums into their TFSA can capitalize by readying their lump-
sum for March (i.e. the next tax year). The sooner this is done, the less potential slippage you may have from positive
market movements and the time value of money.
If you do not yet have a TFSA invested in AWSM Fund (for either you and/or your nearest and dearest), then I encourage
you to look into doing this.
Consider this article where I touch on the merit of both the TFSA and how the AWSM Fund is perfectly positioned for such
an investment. In summary, a TFSA’s biggest advantage is that you avoid Capital Gains Tax and AWSM Fund’s biggest
attribute is its positioning for long-term capital gains. Hence, these two things are a match made in heaven.
Contact us to open a TFSA today.
CONCLUSION & THANKS
In conclusion, we continue executing on our mandate in the AWSM Fund. We have had a good start to 2018 and we consider
the AWSM Fund to be well positioned for the long-term.
As a reminder, the AWSM Fund strategy remains the following:
Quality: Above all else, we try to find good quality, fast-growing, listed small cap businesses.
Value: We invest in the cheapest of these, though limit our investments to different industries and/or
geographies to maximize diversification.
Concentration: Finally, we limit the number of stocks we hold to only the very best fifteen to twenty positions.
In this way, we like to think that AWSM Fund holds a diverse, relatively lower-risk collection of only-the-best small cap
investments out there and that it holds these investments in sufficient quantity to be really meaningful to us as investors.
As a co-investor into our Fund with the majority of my liquid net worth, I have absolute conviction in what we are doing
and I am confident in our Fund’s future.
Kind regards
Keith McLachlan CA (SA)
Fund Manager of the AlphaWealth Prime Small & Mid Cap Fund
J OH A NNE S BU RG | C A P E T OW N | D U RBA N | L OND O N | GE NE V A | MA U RI T I U S | MA L T A | H ONG K ONGALPHAWEALTH PRIME SMALL & MID CAP FUND UPDATE. 5
Disclaimer: Collective Investment Schemes in Securities are generally medium to long-term investments.
Different classes of units apply to these portfolios and are subject to different fees and charges. A schedule of fees and charges and maximum commissions is available on
request from the Company. Commission and incentives may be paid and if so, would be included in the overall costs.
The price of a participatory interest is a marked-to –market value. Forward pricing is used. The purpose of the money market yield is to indicate to investors a compounded
annual return for all money market portfolios on a comparable basis. The yield calculation is not used for income distribution purposes. A forward looking yield is used. This
means that the last seven days’ yield (less the service charges, including VAT) is taken and is annualised for the next 12 month period, assuming the income returns are reinvested.
Yields for money market funds are published daily.
The value of participatory interests may go down as well as up. Past performance is not necessarily an indication of future p erformance. Performance numbers and graphs are
sourced from Global Independent Administrators (Pty) Ltd are calculated on a NAV to NAV basis and do not take initial fees in to account. The Company does not provide any
guarantee either with respect to the capital or the return of the portfolio’s.
Income is re-invested on the re-investment date. Actual investment performance will differ based on the initial fees applicable, the actual investment date and the date of
reinvestment of income. Dealing prices are calculated on a net asset value and auditor’s fees, bank charges and trustee fees are levied against the portfolios. The total return to
the investor is made up of interest received and any gain or loss made on any particular instrument. This will have the eff ect of increasing or decreasing the daily yield but in
case of abnormal losses it can have the effect of reducing the capital value of the portfolio. Excessive withdrawals from the portfolio may place the portfolio under liquidity
pressures where a process of ring-fencing of withdrawal instructions and managed pay-outs over time may be followed.
CIS are traded at ruling prices and can engage in borrowing and scrip lending. The manager may borrow up to 10% of the market value of the portfolio to bridge insufficient
liquidity.
Prime Collective Investment Schemes Management Company (RF) (Pty) Ltd is a registered Collective Investment Scheme Manager in terms of Section 5 of the Collective
Investment Schemes Control Act and is a wholly owned subsidiary of Prime Financial Services (Pty) Ltd, a member of ASISA. 0105942100.
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