Investment Focus: Equity choices don’t disappoint

Whether over the past three months or three years, the M&G equity team’s stock picks have consistently continued to add to our portfolios’ benchmark outperformance, for institutional and retail clients alike. Our combination of holdings across a wide variety of sectors -- chosen according to our rigorous, valuation-based approach, as always -- has added value despite the highly uncertain conditions. And while there have been detractors from performance as well, of course, our aim is to ensure that we have more winning calls (in both total value and volume) than losing calls out of a wide variety of smaller investments. This allows us to build up strong returns from many sources for clients over time. Here we examine some of our most successful stock picks in our best-view, unconstrained portfolios that have added alpha over both the past three months and three years (to end June 2023) and share our thoughts behind them.

Read on to find out more about MTN, Naspers and Prosus, SA banks, Glencore and Richemont.

MTN has been one of the stand-out contributors to our best-view portfolios over these periods, remaining the fasting-growing telecommunications provider in Africa. It has experienced earnings improvement from growing data and mobile money revenue in structurally high-growth markets in Sub-Saharan Africa, while its mature SA market earnings are expected to remain stable. It is benefiting from ongoing cost and capital spending efficiency programs, and lower finance costs from faster repayment of its debt thanks to good cash flows and sales of some of its non-core assets.

In June 2023, MTN Nigeria, which accounts for 40% of Group profitability, was impacted by the Nigerian Naira’s devaluation when Nigeria's multiple exchange rates were unified. Expected price increases, underlying high volume growth (in data and mobile money revenue) and cost cutting programmes will help offset the negative impact of the devaluation. MTN Group's valuation had already derated in advance of the devaluation, and while brokers’ earnings forecasts are being downgraded, a further derating is not expected as the market had already priced in the devaluation.

Severe load-shedding in recent months has placed pressure on MTN SA’s profitability. The lower guided EBITDA margin in MTN SA does not have a material impact on the Group’s earnings as MTN SA currently only accounts for 28% of Group profitability. Cost cutting initiatives, price increases and the implementation of the final phase of additional backup power solutions are expected to help offset lost revenue from loadshedding.

Our combined overweight in Naspers and Prosus shares has also proved to be valuable. We analyse the two companies together, as their investment cases are both linked to that of Tencent, in which Prosus has a 26% shareholding. Tencent’s growth ambitions of scaling gaming, advertising, payments and fintech revenue were negatively impacted by the detrimental economic impact of China’s three year-long hard lockdown, a pause in new game approvals and increased child protection measures in restricting time spent on gaming.

Tencent’s share price recovery and re-rating is due to increased gaming approvals and the opening up of the Chinese economy early in 2023. A return to double-digit earnings growth is expected as demand for Tencent’s services recovers swiftly.

Prosus and Naspers’ share prices continue to be supported by their respective open-ended multi-year share buyback program, which continues at the prevailing discounts. Prosus’s management has guided that its Ecommerce investment portfolio is expected to reach operating profit break-even in the first half of 2025 (through workforce reductions, selling loss-making divisions, acquisitions and scaling the various existing businesses such as Classifieds, Food Delivery, Payments & Fintech, Etail and Edtech). Reaching Ecommerce investment profitability, returning to double-digit earnings growth in their Tencent investment, disciplined capital allocation and continued share buy-backs are all factors supporting a continued reduction in the discounts at which Prosus and Naspers shares trade.

The recently announced intention to simplify the Group structure – by eliminating the cross-holding between Prosus and Naspers  – has aided in the further reduction of the discounts. Naspers' weighting has been reduced on the JSE through the creation of Prosus. The dual holding company structure (with Naspers listed on JSE and Prosus listed on AEX) allows investors from both developed and emerging markets access to the underlying Tencent investment.

Investec, Standard Bank and Absa have all contributed strongly to performance as SA banks have recovered from the weaker Covid period. Banks’ earnings continue to benefit from rising local interest rates as they receive higher interest on their loans, helping to offset rising client defaults. They have also experienced reasonably robust levels of asset growth in the past year, and have some ability to pass on price increases to clients, helping to improve topline growth. Along with cost-cutting, these factors have helped banks maintain or improve their return on equity (ROE), despite the difficult operating environment. With their robust levels of capital and extra provisioning on their balance sheets to offer protection, we believe they can weather the current uncertain environment fairly easily. Meanwhile, not only are they trading on attractive valuations, but they offer high-single-digit dividend yields. For those investors holding banking shares, patience should be very well rewarded.

Glencore has also been a consistently robust performer for our funds over these periods, thanks partly to generally supportive global commodity prices (particularly coal). Glencore's diversified commodity basket mix outperformed during 2022 due to strong energy markets, and this has provided earnings and free cash flow support. Equally, even though the coal price has weakened in recent months, our view is that we still have tight global energy markets, and prices remain elevated versus history. The group is also well-diversified through its high-quality marketing/trading business that can take advantage of dislocations in the commodity markets, and its large base metal exposure which will participate in the energy transition.

Looking at Richemont as a final excellent contributor to fund performance, the group’s sales were surprisingly resilient over the Covid period and have been growing well above expectations since then, especially at the watch and jewellery maisons of Cartier and Van Cleef and Arpels. We think these are exceptionally strong brands and that their brand value with consumers has never been higher. As travel gathers momentum and the Chinese market continues to open up post-Covid, we are likely to see even higher sales. The company has an exceptionally strong balance sheet with a substantial net cash position. We think that cash flows and dividends from Richemont will be significantly higher in five years’ time. After many years of restructuring the watch businesses inside the company, there is potential for it to surprise the market on the upside.

For the three years ending 30 June 2023, M&G’s Equity, Dividend Maximiser and SA Equity Funds were all ranked in the top 25 funds out of 150 in their ASISA SA Equity General category by Morningstar. To find out more, contact us.