Investors thinking of getting back into small caps should take note

Recovery in earnings and share prices might take years.
Bargain hunters need to be cautious. There are often reasons for the large declines seen in share prices. Image: Moneyweb

While the main indices show that the JSE has largely recovered from the sell-off in February and March when the market dropped by nearly a third, the prices of individual shares tell a totally different story. The apparent recovery in share prices was mostly limited to those of large international companies, assisted by a weaker exchange rate.

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The damage among smaller companies remained. No fewer than 130 shares are still reflecting declines of more than 30% relative to their annual highs, and an astounding 20 shares ended July more than 80% lower than their best prices during the past 12 months.

Share prices at July 31
compared to 12-month high
Share Price 12m high Decline
Ecsponent 1 18 -94%
Astoria 21 249 -92%
Nampak 116 1130 -90%
Adcorp 280 2400 -88%
CIL 35 297 -88%
MC Mining 112 880 -87%
Phumelela 41 300 -86%
City Lodge 1598 11550 -86%
ArcelorMittal 38 259 -85%
Brait 278 1819 -85%
PPC 78 499 -84%
Ascendis 80 505 -84%
Accent 8 48 -83%
African Dawn 16 95 -83%
ELB Group 180 1000 -82%
Sephaku 33 178 -81%
Sun International 964 5138 -81%
Luxe 229 1200 -81%
Adapt IT 133 694 -81%
CSG 13 65 -80%
Novus 80 400 -80%
Tsogo Sun 325 1522 -79%
HCI 2344 10800 -78%
Comair 100 399 -75%
EOH 486 1825 -73%
Hulisani 420 1550 -73%
South Ocean 22 80 -73%
Kibo 10 36 -72%
Massmart 1955 6200 -68%
Alviva 550 1700 -68%
Telkom 2895 8850 -67%
Motus 2840 8598 -67%
Net1 UEPS 5000 14800 -66%
Mpact 800 2357 -66%
Hulamin 99 290 -66%
Tongaat 452 1321 -66%
Invicta 858 2499 -66%
AEEI 70 201 -65%
Calgro 284 800 -65%
Merafe 45 122 -63%
THL 180 484 -63%
Lewis 1405 3700 -62%
Wescoal 65 170 -62%
Trellidor 169 440 -62%
ISA 65 169 -62%
Eastern Platinum 328 850 -61%
Jasco 19 49 -61%
TFG 6962 17931 -61%
Curro 889 2241 -60%
Reunert 3167 7918 -60%
Stefanutti Stocks 30 75 -60%
Primeserv 80 199 -60%
M&R Holdings 580 1441 -60%
Mazor 30 74 -59%
PFB 81 199 -59%
Finbond 157 385 -59%
Kore 23 56 -59%
Sasol 13624 33163 -59%
ENX Group 505 1220 -59%
Nedbank 10498 25124 -58%
Nuworld 2100 5000 -58%
Famous Brands 4183 9696 -57%
Sasfin 1512 3484 -57%
Unicorn 10 23 -57%
Stadio 136 297 -54%
Grinship 5254 11462 -54%
Conduit 62 135 -54%
Absa 7928 17206 -54%
KAP 260 559 -53%
Advanced 27 58 -53%
Distell 6762 14490 -53%
Sappi 2450 5196 -53%
Ethos Cap 375 790 -53%
Zeder 243 509 -52%
MastDrill 538 1125 -52%
Nictus 48 100 -52%
Steinhoff 100 205 -51%
Rex Trueform 916 1865 -51%
Insimbi 58 115 -50%
Truworths 3263 6440 -49%
Barworld 6621 12858 -49%
Woolies 3173 6151 -48%
Caxton 408 790 -48%
InvLtd 3324 6434 -48%
MTN 5914 11445 -48%
Pepkor 1006 1943 -48%
Aforbes 326 627 -48%
Quantum 606 1157 -48%
Clientele 874 1650 -47%
Imperial 3354 6300 -47%
Brimstone 480 900 -47%
CMH 1240 2300 -46%
York 100 185 -46%
Grand Parade 208 380 -45%
Lib Hold 6875 12532 -45%
Old Mutual 1147 2089 -45%
Huge 349 630 -45%
FirstRand 3882 6990 -44%
Kaydav 50 90 -44%
Spur Corp 1610 2880 -44%
Cashbuild 15990 28500 -44%
Stanbank 10861 19330 -44%
Advtech 740 1309 -43%
Bell 600 1050 -43%
Bluetel 275 475 -42%
Bidvest 13192 22617 -42%
Hudaco 6998 11984 -42%
Omnia 2728 4656 -41%
Cafca 100 170 -41%
Trematon 171 290 -41%
Dis-Chem 1729 2930 -41%
Capitec 88412 149756 -41%
Datatec 2245 3797 -41%
Sebata 366 615 -40%
Gemfields 131 220 -40%
AME 1875 3100 -40%
Astral 13699 22252 -38%
Pick n Pay 4507 7299 -38%
AB InBev 94044 151318 -38%
Vivo 1679 2700 -38%
Super Group 1900 3049 -38%
Kaap Agri 2310 3700 -38%
Homechoice 2500 4000 -38%
PSG 15429 24681 -37%
Remgro 9243 14666 -37%
E Media 350 550 -36%
Netcare 1360 2132 -36%
Mustek 599 934 -36%
Mr Price 12669 19646 -36%
Shoprite 10457 15955 -34%
Metrofile 206 314 -34%
Life HC 1737 2600 -33%
Italtile 990 1450 -32%
PSG Konsult 700 1000 -30%

Source: Published share prices, Moneyweb calculations

A quick look at the list immediately raises a list of questions, the first and most important is whether there are any shares that will recover quickly.

‘Bargains’ abound

There are a lot of well-known and (sometimes) popular shares on the list that are trading at a fraction of their 12-month best prices, such as Nampak, City Lodge, ArcelorMittal, PPC, Sun International, Novus, Lewis, Reunert, Telkom, Massmart and a couple of SA’s large banks.

However, bargain hunters need to be cautious. There are often reasons for the large declines seen in share prices.

Stephán Engelbrecht, fund manager at asset manager Anchor Capital, warns that the outlook for the global and SA economy has changed dramatically over the past 12 months and, unfortunately, “for the worst”.

“The Covid-19 pandemic and the subsequent lockdowns across the world have had significant implications for many listed companies,” he says.

“Although it appears as though equity markets have recovered when looking at the index, the recovery has been driven by very specific companies that have been beneficiaries of the lockdowns, like gaming, media, e-commerce industries and precious metal miners. Most companies listed on JSE, and even in the US, are still significantly below their previous highs.”

Engelbrecht points out that smaller companies in particular have been laggards across the globe during this market recovery, adding that Anchor is in no rush to buy SA-listed companies just because they are trading significantly below their 12-month highs.

Earnings impact 

“We believe their earnings will be severely impacted by the contraction in the economy due to the Covid-19 lockdown. Many pundits believe that the SA GDP will only recover to the 2019 level in 2023 and some of these companies may take even longer to recover,” he warns.

“We believe that the share prices of these companies will remain volatile with a dearth of buyers due to the lacklustre SA economy not really providing any incentive for investors to rush in to buy.”

Engelbrecht says that a few shares might look attractive with a medium to long-term view in mind.

Shares to watch

“Companies like Alviva, Telkom and Reunert have been hard hit as investment in the SA economy dried up. We believe that unless you believe that SA will forever remain in a recession, investment will recover eventually.

“Reunert should benefit from an improvement at Eskom, but unfortunately this will not happen overnight. Alviva and Telkom have been hard hit as corporates tightened their belts and focused on cost-cutting, but you can only cut that much,” says Engelbrecht, “and the digital revolution could benefit Telkom and Alviva.”

He says other strong performers from the past, like Curro and Foschini, are also starting to look interesting. “These counters were hard hit due to excessive debt – forcing them to raise new capital. But their business models are sound and they should still benefit from structural changes within the SA economy over the long term.”

He indicated that Anchor will continue to avoid companies exposed to the leisure, travel and gaming sectors until things improve.

Sentiment

Andrew Dittberner, chief investment officer at Old Mutual Wealth Private Client Securities, says that identifying shares that may recover as the lockdown eases requires one to identify areas of the market that have been hardest hit in recent times on the back of the economic lockdown, and then having a resolute belief that the economy will turn around and recover.

“The mood is very depressed with regards to the local economy and most companies that are geared towards local economic growth have seen rapid declines in their share prices.

“We have learnt from the Ramaphoria trade of 2018 that share prices do react very quickly to a change in sentiment, and thus any sign of recovery is likely to be met with many of these SA shares appreciating rapidly,” says Dittberner.

“What is very difficult to do, however, is to firstly invest in such an environment and then to have the patience to wait out a recovery.”

Any to avoid?

Moneyweb posed the question if there are any shares that should be avoided totally.

Dittberner answered that one should start by assessing any company’s financial stability. “This is even more important today, given the current economic environment. Shares to avoid in these times would be shares whose chances of survival are questionable,” he says.

“Investors must be cautious of being lured on the pretence of cheapness alone. There are many parts of the market that look very attractively priced at the moment, particularly when comparing valuations to longer-term valuations. Unsurprisingly, it is the parts of the market that are exposed to the local economy.

“Large capitalisation multi-national industrial shares and resources have generally done very well of late. A stagnant economy for many years have seen valuations grind lower, and the uncertainty surrounding Covid-19 and economic lockdowns have pushed valuations even lower.

“A clear example is banking shares. While banks trade below book value, one needs to ask the question whether the headwinds, which are many, are going to dissipate any time soon,” says Dittberner.

The list of shares that have fallen hard includes many smaller companies, which a lot of investors usually find interesting, sometimes irresistible.

“No company is too big to fail,” says Dittberner, “but size does bring an element of safety that small companies simply do not possess. Larger companies can typically withstand the gravitational pull of the economy given they typically have access to credit lines, the ability to raise capital in the market, larger bank balances and assets to sell should it be necessary.

“Small caps, on the other hand, can be more agile than their larger counterparts. But they need to be able to survive first. Small caps thus do present an opportunity, but investors really need to get their hands dirty and ‘kick the tyres” to ensure they understand what they are investing in and the associated risks thereof.”

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The one that baffles me is Datatec which went from R30 per share at the start of June to R22 at the start of August.

And if im not mistaken haven’t their last couple of sens’ been positive ?

Small caps have gained a bit of a reputation for being volatile, just as they are known for falling out of favor with investors ever so often.

They aren’t called small caps for nothing!

“There are often reasons for the large declines seen in share prices.” Always ….

The takeaway here, after looking at this huge list of many excellently run companies, is that when you are locked into an economy run by kleptocrats who are efficient only in corruption, with legislation which makes your life as a business and creator of wealth and employment very difficult, is that things will take much, much longer to get to a level of functionality than anyone ever thought.

And to get back to that level is going to require an employed population with cash to spend.

End of comments.

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