Picking shares that will weather an economic downturn is no easy task — especially when the very notion that there are "recession-proof stocks" on the JSE has been shattered.
Back in the day, there were certain classes of shares that were regarded as recession proof or "defensive".
If we look at the JSE it is certainly possible to insulate a portfolio against SA’s daunting economic challenges simply by considering the numerous global counters listed on the JSE. Think of heavyweights such as AB InBev, Richemont and British American Tobacco (BAT) to the mining giants like Glencore, BHP Billiton and Anglo American, through to homegrown global ventures like Naspers, Aspen or specialist counters like Trencor and Montauk, as well as a slew of global property companies.
Finding shares that are largely rooted in SA and can withstand a prolonged economic downturn is a trickier proposition. Typically, recession-proof shares would incorporate companies involved in the "sin sectors" — booze, cigarettes and gambling. But recent results from liquor giant Distell and the local gaming counters Sun International and Tsogo Sun certainly show the ravages of curtailed discretionary spending by consumers.
Fast-food companies and food producers, which are normally reliable generators of inflation-beating profit growth, have also taken serious strain of late.
Even private education, one of the JSE’s hottest sectors, has shown vulnerability to the tighter economy, casting doubt on the premise that parents would always pay to get a decent education for their offspring.
Reliable counters that have proved their worth through thick and thin have also recently shown there is a point at which even the tightest ship takes on water. These would include specialist industrial services group Howden Africa, plastic packaging specialist Bowler Metcalf, building supplies conglomerate Afrimat, technology group ISA Holdings and Coronation Fund Managers.
Lentus Asset Management chief investment officer Nic Norman-Smith says the recession-proof tag might need to be applied differently to the JSE. He argues that a defensive company at an expensive price can’t possibly rank as a defensive stock. This could apply to private education, where both AdvTech and (in particular) Curro Holdings trade at demanding earnings multiples.
It could also include companies that have performed more robustly in the trying economic conditions – like AVI (20 times multiple), Discovery (19 times), Spar (19 times), Sasol (21 times), Mondi (18 times), Mr Price (19 times) and Clicks (33 times).
Norman-Smith says: "It is ironic that most recession-proof stocks are businesses that are actually not recession-proof. Rather, these are shares where the market has already priced in bad news because of tough trading conditions. The trick is to look for defensive companies trading at defensive prices."
Veteran fund manager Shawn Stockigt says investors looking to avert recessionary ravages need to focus on companies that offer services and products that are nondiscretionary.
He believes private hospitals and private education — and possibly food manufacturers and grocery retailers — should offer some insulation against recessionary conditions.
"But, for me, I would look to buy some of those good businesses that may get beaten down because of the perception that the bad times will last forever."
Picking robust stocks that can thrive in uncertain economic times requires a handful of key considerations.
The FM would prefer companies with low or no gearing, reassuring net operational cash flows, brands or services that offer compelling value as well as some operational diversity.
Investors might also take note of companies that are using brittle trading conditions to consolidate key sectors by making smart acquisitions at modest prices; or continuing to invest in operational efficiencies or to scale-up production to win additional market share.
Canvassing opinions from professional investors last week, there were diverse views of what might pass as a portfolio of recession-proof, or at least recession-resistant, stocks.
Counters cited included health-care retailer Dis-Chem, document storage specialist Metrofile, technology group Reunert, ceramics retailer Italtile, restaurant franchiser Spur Corp, gaming group Tsogo Sun, fishing group Oceana, retail conglomerate Pepkor, private education group AdvTech and small packaging group Transpaco.
The FM’s recession portfolio would include eight counters, listed here.
Astral Foods
This robust poultry company has lost some flavour in recent months after perching briefly at R335. At current levels – reflecting an undemanding trailing earnings multiple of seven – Astral offers good value. No-nonsense CEO Chris Schutte is fixated with cost efficiencies and Astral is the cheapest bird producer on the continent.
Schutte has also indicated a willingness to invest heavily in production capacity over the next few years — a development that looks likely to coincide with Astral clawing more market share in the higher-margin, quick-service restaurant segment. The business converts profits to cash at a reassuring rate and pays succulent dividends. Medium-term performance should be steady, perhaps helped by the weaker rand making imported chicken cuts less attractive.
Adcock Ingram
Year to end-June results showed this pharmaceutical group in rude health, thanks mainly to continuing investment in well-established brands and improved factory efficiencies as well as a determined focus on customer service and product quality. This should not be surprising, with inspired conglomerate Bidvest ranking as Adcock’s biggest shareholder. Cash from operations was a healthy R855m (equivalent to nearly 500c a share) — underpinning the confident 24% increase in the annual dividend to 172c a share. Significantly, Adcock will look for more affordable pharmaceutical and health brands, and also focus on expanding the nonregulated portfolio to limit the impact of a volatile exchange rate and a frustrating SEP (single exit pricing) environment. Adcock is positioned well with an array of essential health brands, which should lead to profits calmly ticking over for the medium term.
Life Healthcare
In the past three years this private hospital group’s share price has declined nearly 30%, with the market taking a jaundiced view on a substandard investment in India (which will hopefully be exited soon), a disappointing venture into Poland and regulatory issues hindering prospects for the core SA operations.
Still, a cursory examination will show Life is strongly cash-generative, with its most-recent set of interims showing cash generated from operations up 37% to R2.7bn. It was also encouraging to see the SA operations finding top-line traction — albeit at slightly lower margins (25%).
Most of the "bad news" is probably already factored into Life’s share price, and there will be an increasing realisation that private hospitals will continue to play a key role in government’s new health-care blueprint.
The FM believes Life has the operational footprint and specialist brands to sustain solid profits and dividends, even if the pulse of the economy slows further.
Cartrack
There’s been a reversal in the share price of this vehicle tracking and fleet management specialist, possibly because of a pending change to the (generous) dividend policy to accommodate new growth initiatives at home and abroad. But Cartrack remains a slickly managed business with a captive market (especially in crime-ridden SA and Africa).
Obviously, there will be some misgivings about a decision to invest more actively in growth initiatives in such tremulous economic times. But we’d be inclined to give the group’s executive team the benefit of the doubt, based on past efforts at capital allocation. With growing annuity income streams and persistent growth in subscriber numbers, Cartrack should comfortably ride out further bumps in the economy.
Remgro
This investment behemoth offers an enticing discount on a sprawling portfolio of top-quality listed and unlisted companies — including defensive counters such as private hospitals group Mediclinic International, liquor group Distell, food conglomerate RCL and insurance hub RMI. Remgro, in truth, is not going to shoot the lights out — but further recoveries in larger holdings such as Mediclinic, coupled with the steady plod of financial services interests such as RMB, could secure steady growth in the all-important intrinsic value. Remgro’s portfolio generates streams of cash, and the group’s habit of hoarding a substantial cash pile also means dividend flows are not at risk for at least the medium term.
The possibility of corporate action, most likely involving Distell and RCL Foods as well as unlisted Dark Fibre Africa, adds a dash of excitement to proceedings.
Sea Harvest
This Brimstone-controlled fishing counter is primarily a hake specialist. But it has diversified more recently through snagging control of Mareterram, a listed seafood specialist in Australia and more recently by acquiring Mossel Bay-based Viking Fishing (which also offers a foothold in the aquaculture sector). There has been a move into the dairy industry through a takeover of Ladismith Cheese. The core frozen hake brand is a household staple and market leader, while the weaker rand should benefit Sea Harvest’s large export offering.
The company has also invested heavily in vessels and production plants in recent years, which should help fatten margins in a tighter trading environment. Cash flows are compelling and the balance sheet stout. The X-factor is that as a properly empowered enterprise, Sea Harvest might stand to benefit not only from the 2020 fishing rights awards but also further corporate action leading up to that event.
Stadio
Unlike the private schools business (which has suffered learner losses for financial reasons in the past 18 months), this fledgling tertiary specialist might well benefit from recessionary conditions. At this point demand for university places far exceeds the current capacity of traditional universities. Stadio, headed by former Curro CEO and founder Chris van der Merwe, wants to offer a host of accredited degree courses at affordable fees to the many learners not able to gain entrance at mainstream universities. AdvTech’s vibrant tertiary offering already confirms there is sufficient demand for courses relevant to school leavers.
It is still early days for Stadio but learner numbers are growing steadily ahead of the launch of the first "multiversity" campus in Durbanville. Cash flows from acquired brands were also better than expected in the interim results to end-June, and profits look likely to comfortably exceed the prelisting forecasts for financial 2018.
RECM & Calibre
Though gaming counters (specifically casinos) have lost their recession-proof status, these operations do still churn remarkably good cash flows. RECM & Calibre (RAC) is a diversified investment company that holds a controlling stake in alternative gaming specialist Goldrush as its biggest investment.
Goldrush (in stark contract to casinos) has shown extraordinary growth in the past few years, mainly through its electronic bingo terminals (EBT). These are widely regarded as mini-casinos sans the exorbitant development and upgrade costs.
The RAC share price offers a margin of safety in trading at a substantial discount to an already conservatively valued portfolio — which includes a kingmaker stake in global investment vehicle Astoria. Indications are that Goldrush could be listed on its own in the near future, offering investors a sprightly alternative to stodgier casino businesses.
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