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The mid cap opportunity on the JSE

Are investors ignoring the fundamentals?
Investors may look at companies that operate mainly in SA with a wary eye, but some have continued to be profitable despite the environment. Image: Shutterstock

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.

Source: 27four Investment Managers

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.

The opportunity

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.

Read: Could one of the best global investment opportunities be on the JSE?

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.”

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Confidence in the SA goverment is very low.
To regain this confidence, we need to see the architects of the looting of state resources in jail,
Unless people like Jacob Zuma are put in yellow overalls, sane people will avoid shares that have the majority of their income locally.
looking at how Zuma is handled with kid gloves by the Zondo commission and the justice system,and protected by the ANC it’s going to be a long wait.
The corrupt leaders of the ANC are in a continuous state of underhanded warfare, and the judiciary seems to be collapsing- The Porrit case, dragging on for 10+ years, is but one example.
I hold Capitec shares, and I am seriously considering bselling them and moving those profits to EFT’s like the S&P 500.

I also think article like this are shallow and misguided. Just look at SA’s fundamentals and economic position. Borrowing well over 60% of GDP (a red flag for a 3rd world (“emerging” ha ha) country), economic growth maybe just better than zero, population growth low but many times economic growth, already massive unemployment, tiny, fragile tax base and massive (and growing) number of government grant recipients, an ANC politicized, bloated (as well as incompetent and corrupt) civil service, flawed and corrupt SOE’s all losing buckets of money with no end in sight, deeply bankrupt and corrupt municipalities. Whew.

Now add an ongoing electricity supply shortfall and organised blackouts (“load shedding” ha ha), the threat to steal property without compensation and the introduction of an unaffordable NHI. Then a little cabal of spineless, venal, self interested “leaders” supposedly running the show. I’ll pass thanks.

Venezuela’s Caracas stock exchange (IBVC) is even BETTER VALUE than the JSE.

It dropped 94% of value in 2018. Gained like 200,000% (thanks to hyper-inflation) in 2019.

….then I hear people say “We avoid investment in Venezuela”.
I say, “Why not? It’s cheap!”

Same argument for SA, considering in which direction SA economy is going? (future growth will depend on Eskom’s reducing availability ratio, bring a ever lower growth ceiling)

The difference between Venezuela’s stock market & SA is:

“Venezuela had a violent blow-out, while SA has a slow-puncture leaking since 2015” with JSE ALSI moving sideways.

Opportunity on the JSE?

Is that even a thing anymore?

Foreign investors will stay away as long as the corrupt are not prosecuted and put in jail. Meaningfully.

Until then, it won’t matter how cheap the JSE looks, they will continue to put their investments elsewhere.

Anything that generates a ZAR income, or is based on a ZAR capital base is not an ‘opportunity’ but a ‘risk’

Have noticed the JSE has moved countless times over the last few years from early 50000s to late 50000s and back and forth.Is there not perhaps market manipulation going on here?

Looking at the numbers looks like Assore is a good buy but just weary of getting my assore.

At the moment I am extremely negative concerning the JSE. I’ve been pummelled by the ups and downs of the JSE to many times.

To look at latest earnings and past 12 month share price movement is just lazy analysis.

Share price may very well have been overvalued in the first instance, Italitile looks expensive still on 12x earnings…

There may very well be other factors that has driven the shareprice, Hudaco tax issues.

Of the stocks listed, most if not all are significantly exposed to currency risk.

End of comments.

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