Revenge of the black label

by Christian DeHaemer

Imagine a land surrounded by crystal blue water, where warm Pacific breezes stir the tropical flora. It’s a place with its own ecosystem, where people live comfortably without air conditioning or heat.

It’s also a place where you can buy a four-bedroom house right on the beach for US$100,000. The people are friendly, worldly and sophisticated. They speak English. The food is ranked among the best in the world. And the harbor surrounded by mountains can only be likened to Hong Kong or Rio de Janeiro.

In short: Paradise. Nirvana. Valhalla. (If you’re into easy living, that is.)

Unfortunately, there’s a hitch. Your little paradise also has the highest number of rapes per capita in the world. It’s a place where one in four young men has AIDS and will be dead before he turns 30. The unemployment rates run north of 30%. And local politicians look for inspiration to the likes of Robert Mugabe, president of neighboring Zimbabwe, who’s in the process of exterminating both European settlement and a viable economic base for good…

Ah, South Africa

After September 11, the South African currency, the rand–never a paragon of stability in the first place–fell some 30% against the dollar. The blame for the selloff is multifaceted. A portion can be attributed to the Argentina debacle. There has also been trouble in the neighborhood, as Mugabe’s thuggish racism in Zimbabwe is increasingly regarded a portent of things to come to South Africa.

Still, there is something to the old adage that South Africa has a first-world economy in a third-world country. That is true. The economy’s fundamentals are strong. It has transparent accounting (arguably better than the U.S.–see Enron, P&G, et al.).

Ever since I went to South Africa two years ago, I’ve felt a certain connection with the place. I understand why people have been fighting over this jewel of the African continent for the past 500 years.

I also understand why its markets vacillate between joy and despair.

In fact, here at Taipan I’ve put this knowledge to use. We’ve played South African Breweries (SAB.L) twice over the past few years for substantial gains. (The last time around, we generated 31% gains in the first two quarters of 2001.)

The method is simple. Buy low, sell high. You get in when the market is falling apart and get out when things settle down–simple as that.

Back in black label

SAB is one of my favorite companies. They have been profitable every year for the past 106 years. Ever since SAB was listed in London, however, it has started reporting earnings in dollars and pounds, while still earning most of its revenues in rand. This is the worst of both worlds.

The depreciation of the rand will benefit the country’s export market, which is currently growing at the third-fastest rate in the world.

The obvious way to profit from this situation is to buy companies whose revenues are dollar-denominated and whose costs are in rand.

Tarnished gold

Most people would buy a South African gold company, which will benefit from cost savings even if the metal remains at US$270 an ounce. The same is true for other commodities, like platinum.

That said, these metals must be pulled out of the ground by workers who will demand more money to cover the cost of raising inflation. This will negate any short-term cost improvements.

But export-driven companies such as chemicals firm Sasol and paper maker Sappi should see rand earnings boosted even while international prices are sliding. The South African prices of its products relate closely to what they will obtain in the dollar-denominated global market.

Sassy Sasol

If you are a long time reader of Taipan, you are familiar with Sasol (SOSAY:NASDAQ). Sasol is a manufacturer of diversified fuel and chemical products.

It is known for its synthetic fuels derived from coal, which the company converts into value-added hydrocarbons through the Fischer-Tropsch process. Sasol is also involved in other exports, such as crude oil refining and chemicals production.

For the fiscal year ended 6/25/01, revenues rose 60% to 41.29 billion rand. Net income increased 72% to 7.03 billion rand. Export sales increased 137%. Dividends per share increased 45% in rand terms.

Sasol has fat 17% profit margins and trades at 8 times earnings. That’s fantastic for any company. Especially for one that is growing at 72% per annum. In fact, that gives you a PEG ratio (price over earnings growth) of 0.11. That’s as good as it gets, folks.

The obvious problem with Sasol is a catalyst for upside share price appreciation. We’ve all bought great international value plays, only to have them remain at a P/E of 5 for years.

There are several factors that make Sasol a buy. First, the steady devaluation of the rand will drive export sales and make Sasol the world’s low-cost producer of synthetic fuels. High growth and quality products will garner respect and foreign investors.

One can argue that as the U.S. markets stagnate, investors will look to emerging markets for growth. We can already see this in South Korea, up some 61% this year. And Taipan’s select global investments like Turkcell (up 117%) have also performed nicely.

As you wait for the investment to achieve fair value, you can pocket the 4.7% dividend yield.

Happy Sappi

A second South African export play is Sappi (SPP:NYSE), maker of various kinds of paper products. Sappi managed to turn a profit despite a cyclical downturn in paper. Paper pulp prices started the year at US$710 a ton and ended the year at US$450 a ton. Production cuts resulted, and today inventories stand at a five-year low–very bullish.

Obviously, the time to buy a commodity producer is at the bottom of the business cycle, when costs are dropping in dollar terms and the buyers are picking up.

As you can tell by this chart, Sappi has been in a decided uptrend since the start of the year.

It still trades at 0.57 times sales and 17 times this year’s earnings (remember, this was a bad year). The company has about US$500 million in cash and a market capitalization of US$2.32 billion. If you net out the cash and look to the improving markets, you could do worse than riding along with Sappi.

Sell Turkcell–book 213% profits

Turkey has a mean history as a volatile market. When you risk hard currency in Turkey, you can’t look long-term. You buy at the bottom and sell in the middle. Remember the old Wall Street adage: "Bears make money, bulls make money, but pigs get slaughtered." Leave the top to the fools.

The good news is priced in

Turkey is the only Muslim country in NATO and is therefore picking up leverage with the World Bank and the IMF. Colin Powel has been discussing possible forgiveness for a US$5 billion dollar military debt.

Turkcell has successfully won a battle against the bureaucrats and stifled an agreement on nationwide roaming that would have bitten into the company’s top line.

The chart shows a great run over the past few months.

There is a good chance that we’ve hit a short-term top. I expect that the chart will come back and fill the gap at US$16. All of the good news is priced in for the medium term. Sell Turkcell and lock in gains of 117% if you bought at US$8.50. Or a stunning 213% if you were lucky enough to buy at the September 17 post-terror lows of US$5.90… as we recommended in the Taipan Group’s 247profits e-Dispatch during the Week the Markets Were Closed.

Waiting for a buy

Back on October 8, 2001, we issued a sell recommendation on our favorite Indian pharma giant, Cipla. Having entered the position at about 875 rupees per share, we took profits at 1,088 rupees… for gains of 24%. You may call this premature, since Cipla has been range-bound between 1,100 and 1,200 rupees for the past few months–rewarding those Taipans who took their own sweet time acting on our action alert… and frustrating those among us who are looking to buy on the cheap again at 1,000 rupees and below.

How come Cipla is so stable? For crying out loud, the stock actually GAINED in the days after a bunch of clueless Muslim fanatics waged holy war against the gardener and unarmed watchmen of the Indian parliament in December.

Here’s why: Uncertainty in the region and a high valuation have been balanced against positive news. Recently, the U.S. gave Cipla’s American marketing partner, Andrx Corp., approval to sell off-patent omeprazole. This blockbuster anti-ulcer drug is sold under the brand name of Prilosec. Andrx will sell the first generic form of this drug.

Andrx has arranged to source omeprazole–the key ingredient in the drug–exclusively from Cipla. Prilosec raked in annual global sales of US$6.3 billion last year, with US$4.3 billion coming in from the U.S. alone.

It will take a major crisis in India to depress Cipla back into our buying range. Any escalation in the smoldering conflict between Pakistan and India over Kashmir might just provide this window.

We are now updating the daily close of Cipla in the Taipan Group’s 247profits e-Dispatch… yet another reason why this free service to our Taipan members is increasingly becoming the most coveted e-letter in the investment world!

(As a member, you can sign up for this daily service… supervised and written by Taipan publisher J. Christoph Amberger himself… at our Taipan homepage: www.taipanonline.com. Or read the daily message posted at the Taipan Group’s service portal at www.247profits.com.)