Your update on financial marketsPrivate Client Asset Management Newsletter September 2015

Dear Client

This This month we look at the wonderful world of renewable energy and how it is likely to change our energy consumption patterns in years to come. This is the first part of a three-part series on renew-ables. We also look at the positive results from Barclays Africa Group and take a view on the likely direction of our beleaguered currency. We hope you find these subjects stimulating and inspiring and invite you to send feedback on any of the stories. Kind regards, Christopher GilmourAnalyst, Private Client Asset Management, Wealth and Investment Management

Renewable Energy to the RescueChristopher Gilmour: Analyst,Private Client Asset Management, Wealth and Investment Management

This is the first of a three-part series of articles on renewable energy.

Global energy is currently at a crossroads; after more than 150 years of fossil-fuel dominated energy, renewable energy is making a strong comeback, with some observers even suggesting that renewable energy could be the primary form of all energy consumed on the planet by the middle of this century. And South Africa is already far down the road to a greater renewable future, which means that the current Eskom woes may be much less of a problem come the next decade.

According to REN21, renewables already accounted for 19% of global energy consumption and 22% of global energy production in 2013. Of the 19% of consumption, 9% comes from biomass (wood, crops, agricultural waste, etc.), 4,2% from heat energy (non-biomass), 3,8% from hydroelectric power and 2% from a combination of solar, wind and geothermal. By the end of 2014, renewables accounted for 27,7% of global power generating capacity, enough to supply an estimated 22,8% of global electricity.

30 countries around the world already derive more than 20% of their energy requirements from renewable sources. Iceland leads the pack with 100%, predominantly from a combination of hydroelectric and geo-thermal energy. Germany gets 24% of its energy from renewables, mainly wind and solar, while Denmark manages in excess of 50%, mainly from its vast wind farms.

Variable renewables such as wind and solar are achieving high penetration levels in a growing number of countries. Australia, Europe, Japan and North America have seen significant growth in the number of residential “prosumers” electricity customers who produce their own power using photovoltaic (PV) panels on their roofs or wind turbines and selling their surplus production back into the grid via a mechanism called “feed-in tariffs”.

Bloomberg New Energy Finance estimates that trillions of US dollars will be invested in renewable energy between now and 2040? and identify six key paradigm shifts behind this move: Solar power prices keep plummeting, investment in solar power rises exponentially, the solar revolution will be

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decentralised i.e. on people’s rooftops, global electricity demand is declining, the natural gasconsumption boom is likely to only be temporary and lastly but perhaps most importantly, global warming is advancing at an alarming rate and only the greatly enhanced use of renewable energy can arrest and eventually reduce this advance.

The Rocky Mountain Institute in the US, an independent think-tank, believes that, by the year 2030, not a single household in the southern states of the US will be linked to utility grids; instead they will derive their power from rooftop PV arrays and store the energy in new technology batteries such as the ones being developed by Elon Musk’s Tesla Corporation. This solar plus battery approach is referred to as “grid defection” and, over time, is obviously bad news for large scale utility companies unless they radically change their business models to incorporate the inexorable advance of renewable energy technology.

So where is South Africa in all of this? Many people are surprised to learn that SA is, in fact, at the vanguard of renewable energy advancement and already has a substantial amount of installed renewable energy plants mainly solar and windcapacity. It is estimated that SA’s current installed capacity of renewable energy is approaching 5 500Mw or roughly 1/8 of Eskom’s total (theoretical) installed capacity. But much of this capacity is not able to be connected to the Eskom transmission/distribution grid, due to the profound instability of the grid. Currently, it is likely that less than a quarter of the 5 500Mw is actually finding its way onto the grid.

This should, however, be seen as a temporary setback and as soon as the grid has been stabilised to accept the inherently intermittent nature of renewable electricity, it should start making a meaningful contribution. The DTIhas set a target of 20% renewable energy as a proportion of total by 2020.

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Barclays Africa Group recently released their interim results for 2015. Headline earnings per share increased by +11% to 797cps, slightly higher than market expectations, and they declared a healthy half-year dividend of R4,50. Results were helped by lower cost growth, up only five per cent, and a reduction in the credit loss ratio as revenue growth was subdued at only 6% up. Barclays Africa management saved on key areas such as property costs, IT expenses and other expenses such asa R59m reduction in fraud and losses.

The overall result was negatively impacted by lower than expected non-interest revenue which only increased +2% in SA and +4% overall.Wethink this disappointed the market a bit. Net interest income grew by 7%, driven by an improvement in the net interest margin to 470bp. Non-interest revenue growth remains a key challenge in achieving high single digit topline growth that is desperately needed to drive the cost-to-income ratio down into the low 50s (1H2015 it was 55,9%).

At about 12,3%, Barclays Africa remains well capitalised compared to peers, although excess capital may likely be used in the purchase of Barclays Egypt and Zimbabwe. The market might have been a bit concerned about the potential short-term dilutive impact of the possible acquisition of Barclays Egyptian and Zimbabwean operations which together are quite sizable (R5,5bn), however, the current executive chairman of the Barclays Group has placed more weight on Africa being a growth engine. The original Barclays Africa deal with the 10 countries was done at a price to book of about 1,7 times and Barclays Africa management have said that they will use this valuation level as a benchmark and won’t be forced into a deal at the wrong price.

Barclays Africa seems on track to meet the consensus FY2015 earnings forecast of about 1700cps (+10%) and Barclays Africa 2016 targets as set out in their results should be achievable.

Barclays Africa Group Interim Results CommentVaughn Webber: Portfolio Manager, Private Client Asset Management, Wealth and Investment Management

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As the external value of the rand has fallen in recent months, a heated debate has ensued as to whether or not the currency is under-valued and if so, by how much.

The weak rand may go even weakerChristopher Gilmour: Analyst, Private Client Asset Management, Wealth and Investment Management

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The red line is US CPI divided by SA CPI, hence the line slopes downwards from left to right. The blue line is the actual USD/ZAR rate. Both series have been indexed to a common starting point of 100 in 1995, the year in which the financial rand was abolished.

Criticisms levelled at this exercise include a) the result can differ markedly depending on the starting point and b) the method of compiling CPI data can differ markedly between countries. Nevertheless, it can be seen that a long-term downwards trend is intact, reflecting a generallydeteriorating currency.

The main virtue of this exercise lies not in attempting to ascertain an absolute value for the currency but rather to look at where the ZAR is now in relation to where it has been in the past. The divergence between theoretical and actual values is large at this point in time but is nowhere near as large as it was in 2001/02, the year when the currency REALLY fell out of bed amid conspiracy theories initiated by Kevin Wakeford of SACOB. The divergence is approximately the same as it was in 2009/10.

At current levels, the rand is seriously under-valued but it has been far worse historically. The latitude for it to weaken further seems self-evident, given a general dislike for EM currencies, our continuing twin deficits and our exquisite ability to keep on scoring own goals, metaphorically speaking. Just as a matter of academic interest, the USD/ZAR rate in Jan 1995 was 3,53. Theoretically, according to this graph, it should be trading at 47% of that figure, or R7,41/USD.

This commentary is not, nor is it intended to be, advice as defined and/or contemplated in the Financial Advisory and Intermediary Services Act, 37 of 2002 (“FAIS”), or any other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever (“advice”).

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