One of the notable characteristics of PSG Asset Management portfolios at the moment is their large exposure to SA Inc shares. In an environment where the local economy is undeniably weak and many asset managers are steering clear of these stocks, PSG is taking a clearly contrarian stance.
As Justin Floor, co-manager of the PSG Balanced fund noted, however, this is not because the firm has a positive top-down macro view of South Africa’s prospects.
“We are as concerned about anyone else about the deep structural issues in this country,” said Floor. “They are very real, very challenging and it’s very uncertain how they are going to play out.
“But within the SA Inc universe, you’ve got a lot of variety. You have companies who are a lot more resilient, and whose earnings and cash flow drivers are actually more decoupled from South Africa’s macro situation than you might think.”
Observations from history
He added that, historically, buying SA Inc shares at points where confidence in the local economy was low has actually proven to be profitable.
Floor noted that business confidence in South Africa has been at cyclical lows four times in the past – 1993, 1998, 2002 and 2009. Following each of these periods, the performance of a basket of SA Inc shares – AVI, Standard Bank, AECI and Hudaco – has been exceptional.
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“Buying those shares at that point would have seemed very risky,” said Floor. “But from times of low confidence your returns can be very good, because markets have this habit of getting too fearful and baking too much pessimism into share prices. When things normalise a little bit, some of these shares can do very well for you.
“We are in a situation now which is probably an order of magnitude worse than those times. But we think that if you can invest in a carefully selected basket of shares, where there are intrinsic competitive advantages that the market is missing, and which are managed by conservative, high-integrity management teams that allocate capital in a judicious way, you could do very well.”
Floor emphasised that he believes that stock selection is critical in this space, particularly considering the additional risks that the Covid-19 pandemic has introduced to the local economy.
“There are a couple of areas we are under-represented in,” he said. “Two big areas we are probably a bit more cautious on than some of our peers are retailers and banks. Those are probably the two areas that are likely to take the biggest hit.”
For some time, PSG has also steered away from local listed property. There have been a number of reasons for this.
“The Reit structure in itself is reasonably inflexible,” said Floor. “It was was our observation that companies were distributing too much cash – they were looking for non-recurring methods of distributing it – they were using debt too aggressively, and they had a habit of issuing equity like it was nobody’s business.
“Additionally you had a big supply side issue, with a lot of supply, particularity in retail and office, coming in to the market over many years. And the problem with property is that it doesn’t disappear very quickly. If you’ve built an hotel or office what do you do with it when nobody wants it any more? It becomes a bit of an enduring supply side problem.”
The Covid-19 crisis only highlighted the fragility of the local sector, which resulted in property stocks being sold off across the board.
These dramatically lower prices may, however, have made parts of the market attractive again.
“We are actually looking at it with quite a lot of interest,” said Floor. “Our process gravitates to pain because we think that is often where the best opportunities are. If you can buy under-appreciated quality, we think you can do very well.”
There are still elements within the sector that PSG is worried about – notably high debt levels, and the fact that the Reit structure forces property companies to distribute cash so that it is difficult for them to naturally de-gear themselves. However, there are some opportunities.
“Some of them will escape, and some of them will be very good investments,” said Floor “We are looking at the sector with interest, nibbling a little bit at what we think are the better counters. And over the next three years I think you will do well buying the right companies.”
Patrick Cairns is South Africa Editor at Citywire, which provides insight and information for professional investors globally.
This article was first published on Citywire South Africa here, and republished with permission.