One of the biggest themes on the JSE over the past five years has been how investors have shied away from companies that operate mostly in South Africa. Many of these ‘SA Inc’ shares have performed poorly since mid-2014.
This can be seen if one contrasts the performance of the FTSE/JSE All Share Index (Alsi) against the FTSE/JSE Capped Swix Index. As the below table shows, the 10-year returns of these indices are similar, but there has been a big divergence over the last half a decade.
|JSE Index returns|
|10 years annualised||5 years annualised|
|FTSE/JSE All Share Index||10.9%||6.2%|
|FTSE/JSE Capped Swix Index||10.8%||4.3%|
Source: Iress, 27four Investment Managers
The most significant difference between these two benchmarks is that the Alsi gives a higher weighting to rand hedge stocks like Naspers, Richemont and BHP Billiton. The Capped Swix, on the other hand, is more impacted by the performance of local companies like banks and retailers.
“It is thus very clear that there has been a strong bid for any shares considered to provide investors with exposure outside the borders of South Africa where skittish investors have perceived that sustainable long term earnings growth is on offer,” 27four Investment Managers noted in a recent commentary. “Conversely, this investor base has shunned domestic facing businesses believed to have poor growth prospects.”
Focusing on the big picture
It is not difficult to see why this has been the case. Many of these companies have struggled to maintain their profits in the difficult local economic environment. Investor sentiment towards South Africa has been extremely negative as the country has struggled for growth, its fiscal position has deteriorated, and economic policy has been unclear.
However, it is also the case that this approach has spared almost no one. With the notable exceptions of Clicks and Capitec, the shares of South African retailers, banks and industrial companies have all struggled.
As 27four notes, this is “irrespective of the earnings profile, management quality, cash generation, balance sheet quality or return on equity on offer”. All of these companies have been seen in the same light.
Based on the macroeconomic picture, investors have essentially made a generalisation about the prospects for these companies. Yet a closer look reveals that they are certainly not all the same.
Seeing the detail
The table below lists 10 JSE-listed mid-cap stocks that all delivered a negative return in 2019. Yet all of them, in contrast, reported headline earnings growth in their most recent results.
Given the mismatch between their earnings growth and share price performance, more than half of these companies are now on price-to-earnings (PE) multiples of less than 10. Similarly, more than half are trading on dividend yields of greater than 4%.
“With this grouping of companies delivering a more than respectable 11.81% increase in headline earnings growth at their latest results announcement, coupled with single digit PE multiples and a composite dividend yield above 4.5%, this stacks up exceptionally favourably when compared to the rand hedged component of the market,” 27four points out.
The average dividend yield for Naspers, Richemont, Bidcorp and Anheuser-Busch, on the other hand, is under 2%, and their average historic PE multiple is almost 23 times.
This doesn’t mean that these mid cap shares must go up in the short term, or that the rand hedges must come down. What it reflects is that there is value in a part of the market where a lot of people have stopped looking for it.
As investors have turned negative on South Africa, they have regarded all businesses that operate mainly in the local economy in the same way. However, the 10 companies listed above have continued to be profitable despite the environment.
That is an indication of their resilience. It should also be an indication that investors could treat this part of the market with a bit more nuance.
As 27four notes: “It would appear that these companies have become increasingly attractive investment opportunities, as their quality has not materially deteriorated while valuations have vastly improved.”