As the news has been dominated by a barrage of negativity for SA investors on the one hand and catchy headlines of ‘roaring’ US equity markets on the other, it comes as no surprise that local investors are questioning whether they should remain invested in underperforming local equities or jump onto the offshore bandwagon.
This is one of the questions posed by Simbarashe Mangwiro, associate investment analyst at Morningstar Investment Management SA, in a report titled ‘Is investing in South Africa still worthwhile?’.
Other asset and investment managers, as well as private investors in shares, are asking similar questions about a share market that seems to offer fewer opportunities every year.
In fact, the JSE has been shrinking for decades …
A lot of investors can still remember the interesting days of the 1980s when investors and speculators could choose from hundreds of mining stocks, ranging from gold mines, mining houses and exploration companies to granite producers, chrome miners and a host of small and large diamond mines.
The individually-listed gold mines – the rich Kloof and Driefontein, the massive Vaal Reef, marginal Randfontein and all of Gencor’s mines – mostly merged into their respective management companies or disappeared due to rising costs. The same happened with the platinum mines that were all listed separately, in the days when SA was still a proud mining country.
In some cases, they evaporated due to bad luck, bad management, corporate fraud and corruption, such as Rand Mines, JCI and JMF.
The smaller independent mines made way for illegal informal miners, while diamond giant and everybody’s favourite share De Beers was delisted.
Overall, the total number of JSE-listed companies declined from more than 600 in 1998 to only 352 at present, comprising only 283 local companies (including 42 listed on AltX). The balance is made up by 72 foreign companies, mostly secondary listings or some kind of inward listed instrument.
Russel Loubser, CEO of the JSE at the time of the listing of JSE Ltd, called it in 2002 in the JSE’s first annual report as a listed company: “It’s worthy to mention the growing number of companies seeking dual listings on the New York and other stock exchanges through American Depository Receipt (ADR) programmes,” he wrote.
“This has heightened the international profile of these JSE-listed companies. We welcome this as it benefits trading volumes on the JSE and allows JSE-listed companies to achieve international valuations.”
But he then warned that this “trend is not to be confused with those SA companies which redomiciled to London prior to their listing on the London Stock Exchange (LSE). Trade in these shares on the LSE is effectively lost to the JSE”.
Fast-forward to 2020 and current JSE CEO Leila Fourie laments that the downgrade in SA’s sovereign debt to junk impacted on the bond market, after SA government bonds fell out of the World Government Bond Index (WGBI) during the rebalancing of the index in April 2020.
“According to National Treasury data, foreign investors own 37%, which is approximately R780 billion, of SA’s local currency bonds. The continued lack of confidence in governance in South Africa has undermined the investment case for the country,” she advised investors in her annual address to shareholders and the investment community at large.
She said capital-raising activity on exchanges worldwide lessened with a decline in global initial public offerings (IPOs) during the first half of 2019, recovering somewhat in developed markets with tech-related listings later.
“The JSE’s five listings [in 2019] were largely the result of unbundlings,” she says. Not much has happened in 2020.
“The equity market’s value traded was lower overall than in 2018, although we did see renewed activity in the second half of 2019. Activity, mainly on the part of internationals, picked up in the second half of the year.
“However, this activity reflected a drive by foreigners to reduce country exposure to SA. Local participants remained underweight in equities and foreigners sold down, resulting in a total net outflow of R114 billion, more than double that of 2018,” she says.
Where does this leave local investors?
Jacques Plaut, portfolio manager at Allan Gray, indicates that there are still ample opportunities for local investors on the JSE and in local companies.
“For sure, some companies have disappeared, but others have joined – think Ab InBev, Glencore, Sibanye and Quilter.
“Today there are 200 companies listed on the JSE with market caps larger than R1 billion. If you adjust for inflation, this number has been constant since 2000. In 2000 there were 209 companies with market caps larger than R348 million – R348 million being the equivalent of R1 billion today.
“There are currently significantly more really large companies, each with a market cap larger than R20 billion, than there were in 2000 and in 1995,” says Plaut.
He disagrees with the perception that the only companies worth watching on the JSE are a few large international companies. “There are more than 20 large companies on our market where the majority of the value is offshore. Then there are local rand hedges like Kumba Iron Ore, Harmony and Sasol. They are domestic companies but benefit from rand weakness.
“Several SA companies are likely to do well even if the overall economy continues to underperform: Cashbuild and Capitec, for example, could continue taking market share.
“Some will do badly if the economy continues to weaken, but the shares are pricing in a ‘dire’ outcome, and a merely ‘bad’ outcome could see the shares do quite well. Examples here are Nedbank and Old Mutual,” says Plaut.
“I think there are quite a lot of cheap shares on our market, be they international companies like Glencore that just happen to be listed here, or SA Inc shares that are pricing in a dire future.
“By contrast, I struggle to find cheap shares on the NYSE or the LSE.”
The Morningstar Investment Management report says that while SA investors have had a challenging time in financial markets lately, largely due to lacklustre returns from local equities, there are still opportunities for local investors.
Mangwiro advocates an approach of valuation-driven investing, saying that while it is somewhat counterintuitive to buy undervalued assets and avoid overvalued assets, the returns lie in buying shares at discounted prices.
“This often means buying assets that have underperformed and avoiding those that have done well. In the context of SA investors, this would imply avoiding the richly valued global technology stocks and buying the unloved and cheap local equities,” says Mangwiro.
He says that while this is likely to be the least comfortable in the short term, it will likely serve investors well in the longer term, as it also comes with a lower probability of capital loss given the current margin of safety on offer.
He makes a case for local financials shares, saying most of these are attractive from a valuation standpoint. “Financials have lagged from a performance perspective and continue to show a meaningful disconnect between pricing and fundamentals, particularly for the banking sector.
“This sector was sold aggressively in the wake of the Covid-19 outbreak, as investors fretted over potential increases in loan losses, as well as the inability of banks to grow earnings in a low- to no-growth environment.
“The market is, in essence, extrapolating the current tough economic environment in SA into the future. However, SA banks are well capitalised, as evidenced by the regulatory roll-back we have seen since the start of the Covid-19 pandemic.
“Domestic credit extension [had] also been constrained heading into the crisis, with most banking books exposed to higher-quality borrowers at reasonable loan-to-value ratios.
“In other words, South African banks have been very prudent about who they have lent money to over the past few years and have been incredibly well managed and therefore entered this crisis on a much stronger footing.
“This should provide a reasonable degree of comfort for investors,” says Mangwiro.
Mining and resources
Mangwiro also notes that some mining and resources shares might offer value.
“From a resources perspective, supply side discipline and capital allocation should continue to be key focal points for investors. Strong free cash flow generation should provide an underpin for shareholder distributions and we have seen encouraging evidence of balance sheet repair and dividend resumptions from platinum mining companies.
“The market seems to be cognisant of this, as is evidenced by current fund manager positioning and the sector’s performance so far,” says Mangwiro.
He concludes that mid-cycle commodity prices could continue to provide a tailwind for the sector and income return from dividends and/or buybacks should support investor returns, particularly from platinum and diversified mining shares.
Thus, while we can mourn the disappearance of some once-popular shares and the loss of others through bad management decisions or bad accounting procedures, the growing list of local unit trusts – outnumbering the number of listed shares by far – shows that the SA market indeed still offers opportunities.
In addition, the changes on the JSE have introduced a host of new investment opportunities with the listing of exchange-traded funds and preference shares, very few of which existed in the 1980s.