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November 2005
INVESTMENT OUTLOOK
CONTENTS
Discovery - Buy
Our Model Portfolio
The Performance of Anglorand Asset Management Private Client Portfolios
Desmond Esakov, Portfolio Manager.
Gary Cahn, Technical Inputs
Discovery (2100 cps current price) - Buy
Introduction
Discovery operates in the health and life assurance markets. The company specialises in
financing and managing health related risk.
Table 1: Discovery Group Structure
Discovery
Discovery Health Discovery Vitality Discovery Life Destiny (USA) Pruhealth (UK)
The table above shows the current structure of Discovery. It consists of 5 businesses. Discovery
Health, Discovery Vitality and Discovery Life. These are the South African businesses. Destiny
and Pruhealth are the offshore operations based in the US and UK respectively.
Group Financial Results Review for 2005
Group revenue increased 9% from R3.7bn to just over R4bn
Diluted HEPS increased by 28% from 77.4 cps to 99.2cps
Annualised new business increase by an impressive 35% to R4.3bn
Embedded value on diluted basis increased by 32% to R17.03cps.
Operating profit increased by 11% to R787mn from R708mn in 2004. The operating profit of
the South African operations was R1, 022mn compared to R842mn in the previous year. The.
overseas operations made an operating loss of R235mn
Cash flow remained strong with Cash flow from operations increasing to R420mn from R92mn.
Cash and equivalents stood at R1075bn which amounts R1.94 per share (fully diluted) Cash
generated by operations increased by70% from R337mn to R585mn
Business Review
Discovery Health experienced strong growth in new business, infrastructure and competitive
position, with operating profit growing by 8% to R563m. Its size, product range and operational
sophistication positions it well for future growth. Discovery health increased membership by
12% to 1.8 million during the 2005 financial year.
Discovery Life's performance exceeded expectation and operating profit grew by 55%to R421m
(2004: R271m). It continues to hold a leadership position in the pure protection market and also
entered the investment market with the retirement Optimiser. Discovery Life continues
developing its UK joint initiative with the Prudential plc, set to roll out in 2006.
Vitality's performance was pleasing and the new launch of the Discovery Card was successful
with more than 200 000 cards issued. The Card's role is to provide Discovery members with a
Anglorand Securities: Investment Outlook –November 2005 Page 2 of 8
tangible and immediate reason to better manage their health and the new Health Plan Account
will help to build on this
Destiny Health new business increased 64% to R809m (2004: R494m), but it generated a higher
than expected operating loss of R87m for the year as additional costs were incurred with the
transition of Destiny's back-office to South Africa. Discovery however, feel that Destiny is
uniquely positioned to capitalise on the rapidly emerging US consumer-driven health insurance
market and are looking to pursue a more aggressive expansion strategy in the short term.
PruHealth progressed as expected, with start-up and operating costs in line with our business
plan. The annualised recurring new business production amounted to R35 million with 10 000
new lives.
Fundamental Analysis
Table 2: Earnings Analysis
A method we use to identify undervalued companies is by calculating the PEG ratio. The
PEG ratio is defined as the ratio between the current PE of a company and its estimated
future earnings growth. In general the lower the PEG the more value a company should
offer to the investor. AS a rule of thumb a value of 1 indicates the share is over priced. A
value of between 0.8 to 1 indicates to us the share may be fairly valued while a PEG value
below 0.8 is considered to be undervalued.
According to our model Discovery’s PEG ratio is 0.6.
Despite the company having a high PE we feel that the expected future growth in earnings
more than compensates for the high rating that the market has assigned to the company. In
fact if the performance of the offshore operations are striped out or assume they break even
then Discovery would be trading at a PE of around 15.5X.
Discovery is currently trading on a PE of 21.3X but is on a forward PE of 13X.
The Groups current Embedded Value is 1700cps. The share price is trading at a 23%
premium to Embedded this (2100cps). Given the groups significant growth potential we feel
that such a premium is warranted.
Since listing Discovery has traded at an average PE of 20. Should the market continue to
rate Discovery at such a level our fair value estimate is R32 for the share. Using a more
conservative PE of 16 however, we value the share at R26. This represents a 24% premium
to the current price of R21.
Anglorand Securities: Investment Outlook –November 2005 Page 3 of 8
Technical View
Discovery has been in a consolidation phase for the last 9 months and will probably stay in the
range close to the release of the next set of results. There is support at 2050cps.
Prospects
Discovery management is very positive on the outlook for the Group. Management feels that all
Discovery’s businesses are well positioned in the markets in which they operate and strong
growth is expected going forward.
Conclusion
Discovery although on a historical PE of 21 appears expensive. However, given the company’s
potential growth prospects we think such a rating is warranted. When future earnings are
analysed Discovery looks far more attractive. According to our analysis Discovery’s forward
PE is 13 and has a PEG of 0.6.
Using a conservative earnings multiple of 16X we estimate a fair value of R26 for the share.
We feel a PE of 16 is conservative given the tremendous growth potential of the company.
We therefore recommend long term investors buy the share.
Anglorand Securities: Investment Outlook –November 2005 Page 4 of 8
Our Model Portfolio
MTN has been added to the portfolio as we believe the company has excellent growth potential
going forward.
Nampak has been sold out of the portfolio
We have increased our weightings in Amplats, Sasol amd Remgro. Weightings have been
reduced in Standard Bank and Billiton.
Anglorand Securities: Investment Outlook –November 2005 Page 5 of 8
The Performance of Anglorand Asset Management Private Client Portfolios
Private Client Asset Management Services
Anglorand provides portfolio management services for individual clients. Our investment philosophy aims at long-term
accumulation of wealth with special attention to the needs of the individual client. More specifically, our portfolio
management aims to deliver a return in excess of JSE All Share Index.
The figure below shows our performance since we joined Anglorand Securities on a typically managed portfolio. This performance
shown is net off all charges such as management fees, brokerage and admin
Anglorand Managed Portfolio vs. JSE ALSI
205
185
Anglorand Performance net of all fees
165
145
125
105
ALSI
85
65
Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05
For more details please contact:
Desmond Esakov
Tel: (011) 484 7440
Cell: 083 285 0863
desmond@anglorand.co.za
Anglorand Securities: Investment Outlook –November 2005 Page 6 of 8
SENIOR STAFF
David Palmer (Director/Head Dealer); Adriaan Kamper (Financial Director);
Yulindi Taljaard (Compliance Officer/Settlements Manager).
THE INVESTMENT COMMITTEE
Richard Bonnichsen; Desmond Esakov, Gary Cahn, Richard Palmer, Nicolas Kunze.
ANGLORAND SECURITIES
Tel: (011) 484 7440 • Fax: (011) 484 6647 • Website: http://www.anglorand.co.za • Email: info@anglorand.co.za
Address: 1st Floor, Broll Place, Sunnyside Office Park, 32 Princess of Wales Terrace, Parktown.
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