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Why you should re-fall-in-love with these spurned market darlings

by , 08 July 2016
Why you should re-fall-in-love with these spurned market darlings
Last year was a rough year for markets. The All Share Index only managed to eke out a measly 5.22%, almost a third of its long-term average return. It was also a year in which we witnessed the spectacular fall from grace of two the JSE's former market “darlings”.

MTN which delivered 136.23% between 2010 and 2015, ended the year down -36%, after getting smashed on the news of its Nigerian fine.

Aspen's decline on the other hand was more like a slow puncture compared to the MTN blowout. It ended the year down -23% after returning 475.95% for the previous 5 years.

Now, it's certainly not part of our strategy to go digging through mountains of muck for the single gems, but I do believe there are very good reasons these former diamonds will regain their shine. Read on to find out why I'm back in love with MTN and Aspen…
 
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MTN today is very different from MTN six months ago

 
There is no question MTN was due for a sell-off. And perhaps the -36% drop last year was justified. After all, the standard telecommunications business model is under pressure.
 
We’re seeing structural changes to the way telco companies make money.  Revenue from “voice” is declining rapidly, although this is being offset to some degree by an increase in data consumption.
 
Group margins declined by 3.5% in FY2015. This was exacerbated by MTN Nigeria’s decline of 5.6%. Remember MTN Nigeria makes up almost half of group earnings. But, while some argue demand in Nigeria is under pressure, the biggest risk factor has been the regulatory environment. Investors are rightly concerned about a company operating in a country where the regulator can dish out fines of $5.2bn for failing to switch off unregistered mobile phone customers.
 
But the best opportunity is often found in adversity. Looking at the true mega-wealth created over history more often than not it was created in frontier markets. Look at Rockefeller, Carnegie even South Africa’s De Beer family. And, while the frontier is full of risk it’s also where fortunes are made. 
 
So why should we bet on a turn-around in a frontier telco like MTN?
  • Iran Sanctions have been lifted – the removal of sanctions in Iran will see significant opportunities to expand digital and EBU services to the existing 46.1 million subscribers which showed 90.2% growth in data revenue for FY2015.
     
    MTN is also working towards remittance of approximately R15.9 billion in the first half of 2016. This will help to maintain the R7 per share dividend guidance by management. 
  
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  • Nigerian fine squashed and the peg lifted – The monolithic $5.2bn fine hanging over the share in 2015 has, with the help of former US Attorney General Eric Holder, been revised down to just 330 billion naira. That equates to just over $1 billion at today’s exchange rate. Since the announcement we’ve seen a limited reaction from markets as Brexit and other macro concerns took center stage.
     
    The removal of the Nigerian currency peg and the naira’s move to a free floating currency is very positive for the Nigerian economy longer-term. It has also lessened the fine in dollar terms (although we also expect there to be a translational effect on rand reported earnings).
     
    The unpegging will go a long way to solving the USD liquidity issues facing the country.
     
  • The potential listing of MTN Nigeria on the NSE should enhance and broaden the depth of participation by Nigerian investors. This local ownership will likely reduce the political will to see future regulatory fines implemented.
     
  • New management team to guide growth – The appointment of experienced ex-investment bankers will help to shake off MTN’s reputation as a stock with limited growth prospects. Already there is speculation this could signal a move by the company into the fintech space.
     
    Fintech has proven to be a resilient revenue stream for rivals such as Safaricom and a move in this direction is likely to increase group profitability.
     
  • The share price has a higher margin of safety relative to peers – With a 230 million plus subscriber base, MTN is four times the size of its biggest rival in Vodacom, yet at current market capitalization, the companies are worth around the same amount.
     
    The reason: MTN stock is a lot cheaper than Vodacom. MTN trades on a forward multiple of 11.81x while Vodacom sits on 17.13x forward earnings. 
     
    With all the changes taking place we believe MTN has far greater prospects over the longer term period. This company is by no means risk free but we believe most of the downside is currently priced while significant upside remains.
   
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Aspen re-jigs its debt

 
Aspen is South Africa’s largest supplier of branded and generic pharmaceuticals and is active in more than 150 countries across the world. It also supplies consumer and nutritional products in selected territories. In 2015,
 
Aspen shareholders saw a significant re-rating in the stock price. The stock fell -42% from its all-time high to the near-term low. Why the panic?
 
The collapse was primarily sparked by the strengthening US dollar. Last year’s USD rally was a double-edged sword for Aspen, increasing its net financing cost on USD denominated debt as well as pushing up USD based input costs.
 
This eroded free cash flows and lowered the expectations of future earnings. As a result of the counter shifted from trading at a 43x historic earnings to the current 26x. But this re-rating could soon become a blip on Aspen’s otherwise uninterrupted upward trajectory.
  • Aspen has announced the refinancing of the debt package. Aspen’s debt has been an issue for investors over the last 18 months, as the bulk of the initial debt was USD denominated with almost no sales in the US. Most of the company’s international sales are in euros.
     
    While not yet announced, we can safely assume the new interest rate on this new debt package is significantly more favourable than the old US debt package.
     
  • Aspen’s management team has almost doubled the group’s revenue every five years. This dynamic team is known for their ability to do unbelievable deals. After a quiet patch, corporate activity has ramped up in the past few months. 
     
    The agreement with AstraZeneca fits well with the group’s strategy to expand into complementary “niche” categories. This latest acquisition is strongly earnings accretive and our sell-side analyst estimates this will add a further R1 billion to operating profits in FY2017.
     
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  • The acquisition of the intellectual property of Hydroxyprogesterone Corporate (HPC) will provide an exclusive distribution and supply agreement with ANI Pharmaceuticals.
     
    This will allow Aspen to supply the finished dose form and ANI will be responsible for marketing and distribution in the US. We believe that this product is likely to gain significant traction in the US market.
     
  • Aspen’s share price has held up well during the Brexit shock and looks to make new 52 weeks high as the group continues to offer investors exposure to a variety of geographies where it commands a strong market share.
     
    We continue to back this exceptional management team to deliver superior returns through further suitable earnings-enhancing acquisitions and strong organic growth.
While these companies are not related from an operational point of view, both are large emerging market players. With a lot of uncertainty still surrounding the developed market thanks to “Brexit”, emerging markets plays could be net beneficiaries.
 
Most central banks have pledged further accommodative monetary policy measures. The Federal Fund futures are now actually pricing in the possibility of a rate cut in for the first time in 2016. And with developed market treasury yield curves flattening, it’s very possible capital will begin to flow back toward the emerging markets as investors hunt for returns.
All of this will be net positive for these unloved former market darlings.
 
Regards,
 

Gary Booysen for The South African Investor

P.S. If you are interested in building up a portfolio of long-term equity in companies with economic moats the ones mentioned in this article – please do not hesitate to contact us directly.


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