Despondency over SA is overdone?

The mood of despondency in South Africa, amplified by months of daily power outages, appears to be overdone.

That’s the view of Junaid Bray, portfolio manager at Laurium Capital, adding that the recent easing in the load-shedding crisis has illuminated the upside potential in the local equities market, which appears under-priced relative to other emerging markets.

That’s not to say the load shedding crisis is behind us, rather that we can look forward to incremental improvements in power stability over the course of the next 12 to 24 months. That on its own will boost confidence in the economy.

“We were hit by a perfect storm over the last year, with high inflation, rising interest rates, a weaker rand, our not-so-neutral stance on the Russia-Ukraine war, weak consumer spending and, of course, load shedding,” says Bray. 

“That pushed stock valuations below where we believe they should be, and that’s an opportunity for investors.”

South African-focused companies are trading at price-earnings multiples of nine, against an emerging market average of 12 and an MSCI World average of 17.

SA equity valuations were further depressed by global inflation that has persisted for higher and longer than originally expected. Central banks were forced to respond with multiple interest rate hikes, and that in turn doused consumer spending.

“Sentiment in SA has been at historic lows in recent months, and we think this was overdone,” adds Bray.

“This is reflected in the overshoot in the rand which nearly touched R20 to the US dollar in May, before coming back to its current level around R18,30. It’s not uncommon for the rand to overreact to news, either good or bad, so we saw some domestic stocks appreciating as much as 10 percent as the rand strengthened in recent weeks. 

One of the factors behind this recovery in confidence is the improved load shedding situation.

“Share prices have rebounded somewhat but are still pricing in perpetual load shedding for some companies. We disagree with that. We see load shedding getting better in the next 12-24 months as more private power comes online and the country starts to reduce its reliance on Eskom. We expect it to reduce to stages 1-3 over the next 12-24 months. SA can function at stages 1-3, but this is much more difficult in stages 6-8.”

Laurium Capital, which manages the Nedgroup Investments SA Equity Fund, sees some surprisingly good opportunities in banks, selected consumer goods companies, and rand hedges such as British American Tobacco (BAT) and Anheuser-Busch.

Standard Bank recently published a positive trading update to reflect higher than expected interest as well as non-interest income, notwithstanding higher credit losses. Standard Bank is trading at a price-earnings multiple (PE) of seven, with a dividend yield of close to 8 percent. Absa is trading on a PE of about six, with a dividend yield close to 9 percent.

On the consumer goods side, Bray says Foschini looks attractive, given its diversification across income groups and geographies, with about a third of earnings coming from outside SA.

Motus, with a market cap of about R19 billion, is an interesting play in the automotive sector, given its diversification into the UK and Australia, and its high cash flow yields. Its share price took a knock in the early part of 2023 but has started to rebound in recent weeks. It trades on a PE of less than six and offers a dividend yield of more than 6 percent.

The five major holdings in the Nedgroup Investments SA Equity Fund are Prosus, BAT, FirstRand, Absa and Anglo American. The fund is invested exclusively in SA-listed equities.

Companies with large debt on their balance sheets are taking strain due to rising interest rates, and it’s unlikely that we have seen the full impact of these increases.

“I think we are close to the peak of the current interest rate cycle, though we might see another 25 basis point increase. We have already seen signs of inflation easing towards the 6 percent target range,” says Bray.

“Central banks are being cautious, and they want to see inflation coming under control before they start dropping interest rates. That may only happen in the second half of 2024. Credit losses in the banking sector are therefore likely to move higher before then, but we believe our banks have made sufficient provisions for these losses – hence, we expect a rerating in this sector.

“If you are trading at a PE of six and it goes to seven or eight, that’s quite a rerating and offers generous return potential.”

Bray says the group is cautious about the retail sector, but sees good value in stocks like Foschini, Pick n Pay and Motus.

In the mining sector, platinum stocks are likely to benefit from lower supply, and an expected rebound in vehicle production, supported by a higher mix of hybrid vehicles which – unlike pure electric vehicles – require more than the normal platinum group metals (PGMs). In addition, the emerging hydrogen economy is expected to drive demand for platinum over the longer term. Moneyweb