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Cape Town - When dark clouds appeared, Steinhoff was brought down by a weak balance sheet. On the other hand, despite negative reporting from Viceroy and attention from short-sellers, Capitec, with a strong balance sheet, held its own.
So when is a balance sheet strong?
The golden thread running through strong financial statements is CASH, says Overberg Asset Management (OAM) in its weekly economic and market overview.
"Cash is king. The three crucial figures in a balance sheet health check are the level of debt and of cash on the balance sheet and the level of cash flow in the income statement.
"First, a strong balance sheet has more assets than debt, the more the better. Second, if a large portion of the assets is held in cash, this is better still. Third, a strong balance sheet is supported by a strong income statement.
"A company should have the ability to generate strong cash flows from its operations. The cash will flow from the income statement to the balance sheet."
The analysts at OAM say an optimal share portfolio is constructed around companies with a long-term competitive advantage and good corporate governance.
"While the valuation of the investment is a key factor, a sound balance sheet is essential. Strong balance sheets protect wealth." (See Bottom line below for more.)
South Africa economic review
• Despite global concerns over rising trade tensions and geopolitical conflict, net investor inflows into South African financial markets remained positive in the week ended 13 April to the tune of R3.53bn. While the bond market suffered a mild net outflow of R0.93bn the equity market gained a net R4.46bn.
Net investor inflows have been well above the seasonal average since the start of the year. Year-to-date net foreign investor inflows into the South African equity and bond markets are extremely positive, measuring R33.29bn and R22.64bn, respectively, a total of R55.95bn.
The net equity inflow marks a substantial turnaround from the total net equity outflows of R43.1bn in 2017, R124.8bn in 2016 and R1.9bn in 2015. The year-to-date equity inflow is almost level with the R36bn inflow recorded in the whole of 2010, the year South Africa hosted the FIFA World Cup.
• Mining production increased in February by a stronger than expected 3.1% year-on-year. Although up from 2.9% in January the improvement was not sufficient to arrest the 2.4% quarter-on-quarter decline in the 3 months to February. Nonetheless, the upturn is encouraging and should gain further momentum as the year progresses, supported by strong global demand and rising international commodity prices.
Meanwhile, a more constructive dialogue between government and the private sector should contribute to increased investment in mining capacity. The production of diamonds increased 42.9% on the year contributing 2.0 percentage points to overall growth.
Other contributors were iron ore, which grew 10.5%, coal 3.9% and other non-metallic minerals 16.5%, each contributing 1.5, 1.0 and 0.9 percentage points respectively to overall mining production growth. On a month-on-month basis mining production increased 0.9%.
• Manufacturing production was surprisingly weak in February, falling by 2.4% month-on-month pulling the year-on-year growth rate down to 0.6%, well below January’s 2.3% growth rate and the 2.6% consensus forecast. On an annual basis there were sharp declines in six of the ten major manufacturing categories.
The “petroleum, chemicals, rubber and plastics” and “wood, paper, publishing and printing” categories showed the heaviest year-on-year declines, of 2.8% and 3.1%, respectively.
On the plus side, the production of “food and beverages”, “glass and other non-metallic mineral products”, and “motor vehicles and other transport equipment” increased by 4.3%, 12.9% and 5.5%, respectively.
On a quarter-on-quarter basis to end February manufacturing production increased just 0.2% signalling a negligible contribution to first quarter GDP growth.
However, forward-looking sentiment indicators suggest manufacturing activity will show a gradual recovery over the course of the year aided by healthy export markets and improving domestic demand.
The week ahead
• Consumer price inflation (CPI) has come in at 3.8%, Statistics SA announced, 0.2% lower than in February. This is the lowest rate for an annual CPI increase since February 2011.
On average, prices increased by 0.4% between February 2018 and March 2018. TreasuryONE said in a snap note that the CPI data was lower than the 4.1% economists expected. The rand reacted positively, but remained ranged-bound.
• Retail sales data due on Wednesday is expected to have shown nil year-on-year growth in February, according to consensus forecast, marking a slowdown from the 3.1% growth posted in January. The slowdown is due to the base effect of strengthening comparable readings last year.
Over the course of 2018 retail sales growth should remain supported by improved consumer confidence, low inflation, falling interest rates and increased credit extension.
The BER retail business confidence index, which measures the outlook for the retail, wholesale and motor trade sectors, increased sharply in the first quarter from 29 to 42, signalling a substantial improvement in retail trading conditions.
Technical analysis
• Having broken the key resistance levels at R12.50/$, the rand has returned to its appreciating trend, targeting a break below R11.00/$ over coming months.
• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
• The British pound has broken above key resistance at £1.35/$ promoting further near-term currency gains to a target range of £1.40-1.50/$.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken decisively above key resistance at 2.5%, targeting the next key resistance level at 3.0%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 8.6% indicating a new target trading range of 8.0-8.5%.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price has broken above key resistance at $60 and likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• The break in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.
Bottom line
• An optimal share portfolio is constructed around companies with a long-term competitive advantage and good corporate governance. While the valuation of the investment is a key factor, a sound balance sheet is essential. Strong balance sheets protect wealth.
• The five companies with the strongest balance sheets in the world are Berkshire Hathaway, led and founded by Warren Buffett, Apple, Alphabet (formerly Google), Microsoft and Tencent, one third owned by Naspers [JSE:NPN].
• Let’s look at Apple. To say that the three crucial figures for Apple are strong, is a massive understatement. First, it has $269bn in cash. Second, it has "only" $97bn of debt. Third, Apple generates annual cash flows of $51bn.
The company’s debt of $97bn can easily be settled within two years from the strong cash flows. Or it can simply "pay back its debts" from the cash in the bank. A war chest of cash is a great asset.
• Closer to home, a company with a strong balance sheet is Mr Price [JSE:MPR]. First, cash in the bank is a healthy R1.8bn. Second, debt is low at a comparatively negligible R50m. Third, the annual cash flow is R427m (2017). Mr Price can use cash flow to settle its entire debt within just two months! This is faster than Apple’s two years. At Mr Price, cash is king.
• When dark clouds gather, it is vital to own companies with strong balance sheets. These companies will have several strategies to not only manage and survive but also to benefit from economic downturns.
In the end, they are in the enviable position of being able to "bleed" their competition out of business or to buy them out at bargain prices.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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