How to save for retirement?

Please note that this blog is not intended for use as financial advice. It is merely for educational purposes (specifically for South African residents). Please consider consulting a financial advisor before making any financial decision.

Saving for retirement. This isn’t the first article on it, and certainly won’t be the last. Here is my take on how one can go about doing it:

Many of us have heard of how important it is, but how many of us actually save money each month for our retirement? If you have to retire at 65, and you live until the age of 95, that’s 30 years where you won’t be earning a salary each month. If you’re currently 25, you only have 40 years to save up for 30 years-worth of income. Scary thought, right? But with car repayments, mortgages and holidays to the coast, saving for retirement is, dangerously so, at the bottom of most people’s priorities.

Saving for retirement is not an exact science. A rule of thumb is to save 15% of your gross income (pre-tax) if you start at the age of 25. However, the more you save, the more comfortable your retirement will be. To illustrate this, the table below shows what the impact will be if you start saving R2 000 a month invested at a return of 7% per annum with an assumed retired age of 65:

Starting age Capital invested Value at 65 years old
25 R960 000 R5 249 627
30 R840 000 R3 602 109
35 R720 000 R2 439 942
40 R600 000 R1 620 143
45 R480 000 R1 041 853

It’s simple, the earlier you start, the better.

So now we get to the question of where to put your savings? There are two things you need to keep in mind here. This is a long-term goal and you must not draw down on these savings. With that said, here are some options available:

Retirement funds:

Your first option is to contribute towards a retirement fund. Most employers out there have some sort of offering, allowing you to elect to contribute a certain percentage of your salary to this fund. Retirement savings in South Africa also have a tax benefit. Contributions to a retirement fund are tax deductible (within certain limits) which means that at the end of the day, you’re paying less tax for saving your money. In certain circumstances, you’re also only allowed to access this money after the age of 55. This forces you leave that money untouched when you feel like taking a quick holiday. Although I’m slightly adverse to investing in retirement funds; a debit order goes off each month which, once again, forces you to save.

Tax-free savings account:

Tax-free savings accounts (TFSA). This is one of the few gifts the South Africa Government has given us. You can contribute R33 000 a year to your TFSA, with a lifetime limit of R500 000. There’s no income tax, no capital gains tax, no tax on interest and no dividends withholding tax! There are limitations to what you can buy through your TFSA (typically Exchange Traded Funds (ETF’s). See ‘ETF’s’ below). ETF’s are very basically a ‘basket of shares’. For example, a Top 40 ETF would track the movements of all the Top 40 companies in South Africa (i.e.: Naspers, MTN, Absa, etc).  Personally (as a younger individual), I would invest in an aggressive product for my TFSA. The greater the risk, the greater the return, and the less tax you will be paying on this return. Leave the conservative investments for your retirement fund. Most banks have a TFSA offering, however, have a look at Easy Equities (see my post about them here: https://what-the-finance.com/2019/02/25/how-to-buy-shares/ ).

Maxing out your TFSA contributions as soon as you possibly can is in your best interests.

ETF’s:

Beyond retirement funds and TFSA’s, ETF’s are a great investment vehicle. These are known as ‘passive investments’. You don’t need to have background in investing and you don’t have to actively manage your investments. You quite simply contribute an amount each month, and the rest is taken care of. There are plenty companies out there (i.e.: Satrix, Sygnia, 10X, etc.) which have a variety of ETF products.

Remember that consistency is key, and if you’re aiming at investing the minimum amount possible, ask yourself: “What if you outlive your savings?”.

This is a just a brief introduction to saving for retirement and the above list of investment options is not exhaustive.  If you have any suggestions, thoughts or completely different ideas, let me know!

Why is Santova so cheap?

(Disclaimer – as at the time of posting this article, I own shares in Santova)

When determining a growth rate in your valuation of a stock, there are essentially two ways in which a company can grow. Through investing into new assets (e.g.: acquisitions) or through improving efficiencies on existing operations. In times of economic slow-down (such as that being experienced globally), cost cutting and improving efficiencies is your go-to option. One such way of doing this is looking at your company’s supply chain. And who can help you do this? Santova.

What is it that Santova does? Amongst other services, they primarily co-ordinate the movement of goods across the entire supply chain for clients from transportation to storage by making use of third-party providers. For example, they will get DHL to move your products from Johannesburg to Durban via truck, put them on a DSV ship to go to Australia and then employ the likes of Aramex to take it from the harbour to your warehouse in Perth. But why use Santova instead of doing this yourself? Santova can achieve economies of scale which individual companies cannot. The process of moving goods across the supply chain is also considerably time consuming which detracts from you being able to focus on your core business.

Santova is also non-asset based. They don’t physically own any trucks/warehouses/ships etc that are used in transporting goods. They make use of third-party providers. This means that their cost structure is almost entirely variable. So, in tough times, there’s very little fixed costs which they have to cover. This allows them to run a lean business, better enabling them to weather most storms.

I also like entities where management have a large stake in the equity. Management hold 19% of Santova’s shares. This means that the decisions they make are probably aligned with those of the shareholders and long-term value creation is at the top of their priorities instead of cutting corners to inflate short term results to meet profit/bonus targets.  

With all the shenanigans going on in South Africa from corrupt politicians to load shedding, many investors are looking to buy into shares which act as a hedge against Rand volatility. You could invest in an offshore ETF, or you could buy shares in Santova. Over 50% of Santova’s revenue is earned in foreign currencies from their operations in the UK, Australia, Europe and Hong Kong.

With a very low debt to equity ratio, being significantly geographically diversified, showing consistent growth and providing a niche service, it’s difficult to see why they’re trading at a PE of 5.21.

So, what is it worth? When doing a valuation, it’s difficult to remain objective and keep your emotions out of it when you go into a valuation with a pre-conceived notion about the company being good or bad. To avoid this, I like to do a bit of a sensitivity analysis/sense check by calculating a ‘worst case scenario’ value to make sure that I’m not getting too carried away. I try being as prudent as I can be and assume the worst. My worst-case scenario value for Santova is R5.28. It’s currently trading at R2.45. This would suggest that it should be at a PE of 11.7, which to me doesn’t seem unreasonable at all, or perhaps I’ve completely lost the plot.

Why is it so cheap? As I mentioned with AdaptIT (see here: https://what-the-finance.com/2019/02/21/why-is-adapt-it-so-cheap/) I believe it boils down to small cap stocks being ‘too risky’ for investors’ appetite in the current market conditions.

With that said, Santova is one of my favourite stocks and I’m trying to pick up as many shares as I can at this price. If you think otherwise, drop me a comment or if you want to see how I got to this value, let me know!

(And a thank you to Michael Casey for the input)

How to value a share?

After my last blog, I’ve had a few people ask me how to actually value a share? (when I say a few, I really mean two). However, two caveats before we get started:

  1. Thousands of research papers, University seminars and online courses dedicated to valuations and corporate finance indicate just how topical valuation methodologies are. Therefore, I’m just going to cover the absolute basics to give a high-level overview of valuations.
  2. There’re plenty of ifs and buts in valuations and there is no right or wrong answer. If there were, that would mean we live in a perfect market…which we don’t. It’s also not rocket science, just keep it simple!

I’ve also included a link at the bottom of this blog to an excel document I’ve put together which illustrates a very basic valuation using everything I discuss below.

With that said, let’s get stuck into it:

Valuation Techniques

There are several techniques you can use to value a stock. One of the most widely used ones (and arguably the most accurate) is known as a discounted cash flow (DCF) which discounts free cash flows to equity investors and that is what the rest of the blog is going to cover.

In doing a DCF, you predict the entity’s free cash flows into the future. Then discount those cash flows back to today by using a rate you would expect to earn on this stock as an investor. This gives you the value of the entity’s equity which you divide by the number of shares and voila, there’s your value per share.

Why free cash flows (FCF’s) you may be asking? FCF’s to equity investors are essentially the core output of the entity’s operations. It’s what’s left over to pay to shareholders. Everything the entity does on a day to day basis results in cash flows.

Here are the 8 things you will need:

  1. The entities latest financial statements

How do you get the FCF’s? Financial statements have to comply with certain accounting rules (broadly known as IFRS – International Financial Reporting Standards). To get to the FCF’s of an entity, you first need to remove all the accounting quirks. The simplest way is to start is with a figure called net income which you will find in every entity’s financial statements. You then add back the accounting quirks such as depreciation which are non-cash items.

Now in this net income figure, there are certain numbers which are not included which we must add/deduct to get to the entities FCF’s. These range from movements in working capital (e.g.: when debtors reduce, that means a debtor has paid me, which means I’ve received cash) to capital expenditure (e.g.: when I buy a new computer for my company, that will result in a cash outflow).

In the attached excel workbook at the bottom of the page, I’ve listed a few common ‘quirks’ you need to add/deduct from the net income figure to get to your FCF’s.

2. Growth rate

Now that you have your FCF’s, you need to predict by how much they will grow by in the future. This is where a lot of ifs and buts come into valuations. You will have to use your own judgement to determine this. A good starting point is to look at the entities historical compounded annual growth rate (CAGR) of revenue (once again, there are far more accurate ways of doing this, but a historical growth rate is used for the sake of simplicity).

You can then start adjusting this figure for various scenarios. For example, is the company launching a new drug soon? Is the new CEO the next Steve Jobs? Do you believe the new competitor’s product is far superior? Just on a side note; try not to get too carried away with adjusting your growth rate. Fiddling too much with your rates/cash flows is where things can start to go very wrong!

3. Risk free rate

As I mentioned earlier, you need to discount the future FCF’s at a rate you would expect to earn on this stock as an investor. But what is this rate?

Well a good starting point is by looking at a risk-free rate. What rate of return would you be willing to accept if there were zero risk associated to the investment? The benchmark for a risk-free rate is government bonds (e.g.: in South Africa, one of the common bonds is known as the R186). Why government bonds? Your returns are almost guaranteed, and thus “risk-free”.

Now that you have a risk-free rate, what additional return would you expect for taking the risk of investing in this stock? This is known as an ‘equity risk premium’ (see point 4 below).

(Food for thought, are government bonds really risk free if there’s a chance that a government can default on their debt? Think the Greek government debt crisis in 2008).

4. Equity Risk Premium

One of the core principles of valuations is risk vs return. If you invest in something ‘riskier’, you would expect a higher compensation for taking on this risk, right? The equity risk premium is a measure of ‘how much’ extra return you would expect as a return for a riskier investment, or, the return you expect less the risk-free rate.

To get this rate, you can either look backwards or forward. Looking backwards is probably the easiest (although not the most accurate). If you take historical market returns (i.e.: what has the JSE returned historically), less the risk-free rate, you end up with your equity risk premium.

Please note that there are arguably far more accurate ways to determine an equity risk premium (i.e.: taking mature market risk free rates and adjusting these with country specific risk based on credit default swaps).

5. Beta

Beta is essentially a measure of relative risk. It tells you how risky a stock is relative to an average risk stock. It’s calculated by running a regression on the returns of a stock vs the returns on a market index. A high beta stock (i.e.: greater than 1) means it’s more volatile than the market. A lower beta stock (i.e.: less than 1) means it’s less volatile than the market.

There are alternate ways to determine beta (which take into account the industry, entity debt levels, proportion of fixed costs to variable costs, etc) and I’m fairly adverse to using regression beta’s, but it’s the simplest way to determine beta.

6. Cost of Equity

The cost of equity is the rate that you’re going to use to discount your future cash flows to todays date. The simplest model to determine the cost of equity is known as CAPM – Capital Asset Pricing Model. It’s denoted as:

Cost of equity = risk free rate + beta (market risk premium-risk free rate)

All the inputs into this calculation have been discussed above.

7. Terminal value

If we grow the entity’s FCF’s at the growth rate determined from point 2 above forever, the entity would be come unrealistically big. Think of it this way, if your growth rate is larger than the growth rate of the economy, it will reach a point where the company you’re valuing is larger than the South African economy (highly unrealistic).

Therefore, after we’ve predicted our future FCF’s for a period of 5 years (5 years is a rule of thumb) at the growth rate we determined, we grow the remaining cash flows into perpetuity at a stable growth rate. This figure gives us the ‘terminal value’.

8. Number of entity’s shares

You will be able to find the number of issued ordinary shares in the entity’s financial statements.

Putting everything together

If you’ve reached the end of this post and are still reading, well-done!

To see how to put all the information from 1-8 above into a DCF calculation, see the attached excel document here:

dcf-templateDownload

You might also be asking yourself, “Daniel this is all good and well, but where do I find this information?” As I feel like this post is already becoming a bit lengthy, I will cover this in another blog.

And as usual, if you have any questions, comments or critiques, please do let me know!

Bitter Taste Holdings

In my last blog on Motus (see here: https://what-the-finance.com/2019/02/22/maybe-motus/ ) I mentioned why I don’t like entities that take on too much debt. And Taste (which went from trading at R5 to R0.1) is a prime example why. So, lets have a closer look at what happened.

Taste has two main divisions, namely luxury goods (NWJ, Arthur Kaplan and World’s Finest Watches) and food (licences Starbucks and Dominos and owns The Fish & Chip Co and Maxis) with the main shareholder being the Riskowitz Value Fund. The rest of this blog is mainly going to cover Starbucks and Dominos as this is where things started going a bit pear shaped.

Starbucks

Being a coffee addict, the news that Starbucks was coming to South Africa got me very excited. But Starbucks hasn’t been doing too well. Why? Well firstly, to set up a store, it requires a considerable capital outlay of approximately R15mil. Starbucks success is also based on the concept of it being a place people will be when they’re not at work or at home. Their cafes have lovely décor, relaxing music and fantastic free Wi-Fi which you can walk into on your way to work. But does this work in South Africa? Starbucks target market are working individuals, most of whom in South Africa drive to work (and don’t walk past a Starbucks on their way to work). Now I don’t know about you, but I’m not going to stop at Mall of Africa on my way to work, pay R10 for parking, spend 20 mins getting lost in the mall to find Starbucks and pay a premium for a coffee which doesn’t taste (no pun intended) any better than a coffee at Seattle or Vida.

Domino’s

One of the main reasons to Domino’s success was the ease of which one could order a pizza off their mobile app. Over the years they’ve built considerable customer loyalty and brand reputation. It also hasn’t been doing too well in South Africa, but why? Well before Domino’s came to South Africa, we already had the likes of Mr. D and Debonairs (and more recently, Uber Eats). So, if Domino’s isn’t competing on ease of delivery and their pizza doesn’t taste any better than the likes of Debonairs, then why would I pay a premium for their pizza?

Going forward…maybe

Now based on the above, Taste took on too much debt to try and fund rolling out Starbucks and Domino’s which they could not afford with their existing cash flows. This ended up with them having to make a rights issue of R398mil to settle their debt (after breaching covenants), restructure their Board of Directors and relook at their strategy. Will this work? Their latest SENS announcement states that they need R700mil over the next 7-8 years before they start generating “positive” free cash flows! They also mention that they’ll need 150-200 Starbucks Cafes and 220-280 Domino’s Restaurants. With a company that can’t generate any positive cash flows from their operations, where are they going to a find a minimum of R1.5 billion just to establish 150 Starbucks Cafes alone? I doubt any bank will want to finance them, another rights issue seems unlikely and just how deep is the Riskowitz Fund’s pockets to keep on financing them? A delisting is becoming to seem inevitable.

Valuation

Valuing Taste is a seemingly impossible task, but I’m going to give it a go. Valuations of entities with negative earnings become a bit more tricky. We have to start making assumptions that the entity will resolve all it’s problems or whether it will go bankrupt. Assuming the Board of Directors will miraculously be able to turn it around, I’ve come up with the following:

I’ve determined a cost of equity using a beta of 1.5 (beta is essentially a measure of relative risk. It tells you how risky a stock is relative to an average risk stock) a risk-free rate of 6.21% (the RSA186 bond rate adjusted for default risk) and applied a country risk premium for South Africa of 3%. Assuming positive free cash flows will be generated, and revenue growth/margins will normalize after 7 years, I’ve come to a value of 3 cents per share. This is a lot less than the current share price of 14 cps.

Conclusion

It’s always easier to see where things went wrong with the benefit of hindsight. Would I buy shares in Taste? No. Perhaps I’ve missed something in the valuation above, but I just don’t see how they’re going to turn this one around.

If you have any ideas, comments, recommendations or any questions on how I did the valuation, let me know!

How to buy shares?

Disclaimer – this is not a sponsored blog and Easy Equities has no connection to it whatsoever (although a sponsorship would be great? 😊) 

It’s all good and well blogging about these valuations, but how does one actually go and buy shares? Surprisingly, Googling this topic doesn’t yield much. Most banks have some sort of offering but charge ridiculous fees and have minimum investment amounts. This isn’t ideal for someone who wants to buy a couple hundred Rands worth of shares.

The answer? Easy Equities (https://www.easyequities.co.za/). They allow you buy fractional shares (i.e.: you can buy 0.01 shares in Naspers if you so wish). It’s the most user-friendly platform I’ve come across and registering with them is fairly straight forward. They also offer a wide range of ETF’s. All you do is register, deposit your money, click-buy and you’re good to go. There’s no monthly admin fee and transaction fees are minimal. They even have a ‘demo account’ functionality which allows you to buy/sell shares without using your own money which I think is a great way to get started!

Before you go and buy shares, please understand the risks involved and do your own research. Investing and gambling are two completely separate things.

Maybe Motus…?

Motus is a company that was unbundled from Imperial Holdings and operates in the automotive industry. To give my valuation a bit of context, here some background on them:

They have four main business segments, namely:

  • Import and distribution –

They’re an exclusive importer/distributor of Hyundai, Kia, Renault and Mitsubishi. This also means that you’re at the whim of the car manufacturers. You have zero control if they make a car that customers like or not. In addition to that, despite having long standing agreements with these manufacturers, the potential of losing the right to import/distribute their cars could have a huge impact. As an example, Honda just closed their facility in Swindon which has been operation since 1989. Regardless of whether it was due to Brexit or a struggling car industry, these things do happen.

  • Retail and rental –

This segment is the largest contributor to revenue. Motus has 356 dealerships in SA, 112 dealerships in the UK and 30 dealerships in Australia. This all sounds very grand, but also means high fixed costs. One also doesn’t even have to even mention the threat to the retail and rental industry from the likes of Uber, We Buy Cars and Mobility as a Service.

  • Financial services –

Motus is manager and administrator of service, maintenance and warranty plans to 730 000 clients. Whilst this is fantastic annuity income, the entire division makes up less than 5% of total revenue. It is also highly dependent on the performance of the retail and rental division.

  • Aftermarket parts –

Motus is the distributor, wholesaler and retailer for parts for out of warranty vehicles. Whilst I do like this business (especially for parts for Renault), it also makes up a significantly small portion of total revenue.

From the above, you can start to see that Motus basically operates the full value chain. However, I still have some qualms about the entity.

South Africa has a considerably immature parc. But with recent economic conditions and unemployment rates in South Africa, I don’t see the motorisation rate changing any time soon. South Africa’s average car parc for passenger and commercial vehicles is roughly 9.5 years, which is fairly old for any vehicle. This is great for short term results, but in the long term waiting on each replacement cycle to put out decent results is hardly a growth strategy.

Motus faces a significant forex risk associated with importing vehicles and parts. Hedging forex risk is complex and expensive, especially when your reporting currency is as volatile as the rand.

I’m rather adverse to entities that take on large amounts of debt. Yes, debt is cheap financing and arguably necessary to achieve decent growth but taking on too much poses massive financial risk. The pre-listing statement mentions a targeted net debt to equity ratio of 55% to 75%. This is quite a vast range and, in my mind, a net debt to equity ratio of 75% is high for any company.

I could go on about the multitude of risks they’re exposed to. Highly competitive market, rental market is heavily dependent on tourism, disruption risk of alternate business models (like we buy cars, Uber, Mobility as a Service as mentioned previously), development of public transport infrastructure (perhaps a bit farfetched in South Africa) a global movement to more eco-friendly transport (perhaps more applicable to UK market), increase fuel costs make owning a car less affordable, etc, etc.

Based on the above, I’ve already got a negative feeling towards Motus and thus performed a bit of a napkin DCF just to get a feel of whether or not I think the share is over/under valued. Instead of valuing each segment separately, I’ve taken a simplistic approach and assumed that they’re all subject to similar risk (i.e.: if consumers don’t like the new Renault Sandero, Motus won’t sell as many, people won’t want to hire them, there will be less consumers to finance, and thus less aftermarket parts to provide as less cars will be around that need them). I ended up at a figure of R85 a share, which approximates the value of R80.5 it’s currently trading at.

I feel like I may have gone on a bit of tangent, but to conclude, would I buy it? No. This doesn’t mean that it’s not a good stock to invest in; it’s just not my cup of tea.

Let me know what you think!

Why is Adapt IT so cheap?

Disclaimer – As at the time of writing this article, I own shares in Adapt IT.

During times when we’re facing economic downturn, it’s not easy to stick to your investing strategy and one starts to doubt their valuations. With that said, I’m going to write down my thoughts and opinions on my valuation of Adapt IT and reflect back on this a couple of years down the line to (hopefully) prove that I haven’t gone insane and that investing in value rich companies is not a thing of the past.

In a nutshell, Adapt IT is a specialised software business, with a large chunk of that being in-house developed software. The biggest advantage of this? Scalability. Once the software is developed and ready for use, the costs to implement said software at a new customer would be relatively small. This also largely mitigates the reliance risk placed on entities such as Microsoft cancelling their license agreement with you (think EOH).

How often do you hear about a company switching IT Systems? From IT to finance to operations, it’s an absolute nightmare. So how often would you expect existing customers to switch from using Adapt IT’s software? Once a contract is tied down, it’s almost guaranteed annuity revenue. Regardless of what economic conditions are, revenue should be fairly constant. Furthermore, their software is highly customisable and thus brings about a niche offering to their clients. As far as I’m aware, there aren’t any other big ICT players in the market who are able to provide this offering.

After considering the above, I’ve started plugging in the figures into my DCF and got to a value R13.26 a share, which seems like a bit of a stretch seeing as the share is currently trading at R5.6….but hear me out. I’ve applied a very conservative growth rate of 6% (CAGR in revenue adjusted to account for the economic recession and the fact that it is a small cap which implies higher risk) and applied a cost of equity of 15%. With a gearing ratio of 29% and the entity being highly cash generative, one could perhaps even argue that my above assumptions are overly prudent? With a PE ratio of 7.45 and interim results showing 4% growth in revenue during a technical recession, I‘m struggling to see the downside here.

So why is the share trading at a 142% discount? Your guess is as good as mine, however, assuming my valuation is correct, my guess is that it boils down to negative market sentiment over small-caps in the current market conditions (and SA Inc. as a whole) and Adapt IT being constantly labelled as ‘another EOH’. Unless something fundamentally changes, I continue to hold shares in Adapt IT.