South Africa’s Coronation Fund Managers has rewarded its shareholders. What’s the crowning touch?
Coronation Fund Managers Ltd. (CMLJ.J), based in Cape Town, is a fund management company serving both institutional and retail clients. Its market value has more than tripled in just the last two years and has grown 47.2% in last 12 months (excluding dividends). That blew away the benchmark JSE All Share Index, which rose 19.8%.
Source: Eikon
Active management can be rewarding in South Africa
In South Africa, it has not only been rewarding to own shares of an active asset manager, it’s also good to be one. As we mentioned in our recent Telkom story, a portfolio constructed of companies with top-decile StarMine Value-Momentum (Val-Mo) scores and rebalanced monthly would have generated pre-expense returns of 39%, nearly double that of the JSE All Share index. With the right tools, it seems like investors in South African stocks have a greater chance of finding alpha than they might in a market like the U.S., where less than one-quarter of active mutual fund managers typically beat the market index over a 10-year period.
A Val-Mo score of 91 puts Coronation Fund Managers (CML) inside that top decile. So it would currently be included in that hypothetical portfolio that performed so well over the past year. The StarMine Val-Mo model incorporates two valuation models: the StarMine Relative Valuation and Intrinsic Valuation models along with two momentum signals: Analyst Revisions and Price Momentum to capture changes in analyst and market sentiment. Undervalued and overvalued stocks tend to revert toward fair value over time; the momentum signals help with timing these trades. We’ll next look at the intrinsic value of CML.
Source: Eikon/StarMine
Building a better measure of valuation
Despite the strong appreciation in the company’s share price, expectations still appear reasonable. The StarMine approach to intrinsic value improves the accuracy of traditional dividend discount model methods by using more-accurate growth estimates as an input.
We start with the StarMine SmartEstimate®, which improves on the accuracy of the consensus by placing more weight on the most recent estimates and more accurate analysts. Our research found that there is pervasive bias in analysts’ estimates (typically an optimism bias). This is especially true for fast growing companies and for farther-out estimates. It is just more difficult to maintain abnormal growth rates than most analysts (and investors) must assume.
The good news is that this behavior is predictable and systematic, so one can adjust for it. The optimism bias adjustments can be seen in the screenshot below. The resulting set of EPS estimates drive what we call the SmartGrowth forecast. In the case of CML, the assumed growth based on adjusted sell-side analysts’ projections ends this 5-year period at 8.3% and results in a 5-year compound annual growth rate (CAGR) of 12.9%.
Source: Eikon/StarMine
Great expectations?
Using the set of assumptions shown above, 15 years to maturity and a 6% steady-state growth rate after that, the model calculates fair value to be approximately 13,000 ZAR (South African rand)– about 30% higher than its last closing price. We also reverse this model, plugging in the current price and solving for growth. This market implied 5-year CAGR is 7.9%, below both downward adjusted analyst projections, the industry market implied CAGR, and the company’s historical growth. Use 7.9% as a benchmark for comparing your assumptions to what’s already priced in. This is a useful tool for comparing your expectations to market expectations.
Source: Eikon/StarMine
Quality matters
We next turn to another StarMine model – Earnings Quality (EQ). This model is useful both as a means of helping with the heavy lifting of fundamental financial statement analysis, and to assess the sustainability of companies’ sources of earnings. Companies whose earnings are coming mostly from sustainable sources receive high scores. At 91, CML ranks in the top 10% of all companies in our Emerging Markets region. Cash is king – or at least a sustainable source of earnings. This model favors companies whose earnings are backed by underlying free cash flow. You can see CML gets a Cash Flow Component score of 96 out of a possible 100. The model also favors companies that efficiently convert assets into earnings. CML ranks well on this measure, too.
Source: Eikon/StarMine
Bear? What bear?
The Operating Efficiency Component examines both operating profit margin (or net margin for financial services companies) and asset turnover. The chart below shows CML’s Net Margin over the last 10 years compared to the median for its industry. While the industry is just beginning to recover from a plunge in profit margins, CML sailed through the financial crisis and ensuing bear market mostly unscathed. Net margins have been ticking upward ever since and now exceed the industry median by a large amount.
Source: Eikon/StarMine, Reuters Fundamentals
Bull markets are a wonderful thing
Beyond what we’ve just shared, we haven’t looked into what’s behind the sharp appreciation in the value of CML’s shares or what’s driving the high StarMine model scores. It could be a strong bull market in South Africa helping most investment firms; positive fund flows into emerging markets or perhaps superior fund performance or good operating management, among other possibilities. But, if we were poking around South African companies looking for interesting candidates for additional research, this would be one we’d put on the list.
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