JSE in Sandton. Picture: Itumeleng English/ Independent Newspaper.
Mikhail Motala
Since South Africa’s 29 May 2024 general election and the formation of a Government of National Unity (GNU), sentiment has turned positive, as seen in rising asset prices and a stronger rand. While the GNU’s economic growth potential is an appealing explanation, the drivers behind asset price movements are more complex and multifaceted.
The recent rally in South African markets has been driven primarily by local investors, with foreign participation still subdued. South Africa remains one of the most underweighted markets among emerging markets (EMs), which themselves hold a minimal share in global portfolios due to the strong performance of US equities.
While foreign inflows have ticked up slightly since the election, net foreign flows over the past 12 months to September, 30 2024 reflect outflows totalling R124 billion, a stark contrast to the ‘Ramaphoria’ period in early 2018 when net inflows exceeded R30bn.
Local investors had also been avoiding the South African stock market
Fears around election outcomes prompted a risk-off stance among local investors in early 2024, continuing a broader trend of underweight positioning in South African assets over recent years.
Sentiment has been dampened by persistent issues, including the load shedding crisis with fears of grid collapse, Transnet’s widely publicized struggles and ongoing weak economic growth. Additionally, amendments to Regulation 28 of the Pension Funds Act, which raised offshore investment limits from 30% to 45%, resulted in local investors moving further capital abroad.
Reversing the underweight position has led to a scramble for South African assets
Roughly only half of the South African stock market can be classified as “SA Inc” companies, while the remaining 50% is evenly split between JSE-listed rand hedges (such as Naspers, Prosus, Richemont, and British American Tobacco) and the resources sector.
Within the “SA Inc” segment, many peer portfolios are heavily concentrated in three sectors: banks, retailers, and consumer staples (including drug and grocery stores and food producers). This concentration is largely due to the relative size and liquidity of companies within these sectors compared to others.
There are attractive investment opportunities residing across this SA Inc landscape, but discretion is required. Valuations, growth prospects and capital return potential (dividends and share buybacks) differ considerably.
Comparing the JSE Capped SWIX Index to the PSG SA Equity Fund, which only invests in shares listed on the JSE, we have SA Inc exposure of 69%. However, more importantly, we have differentiated positioning within SA Inc. In the banks sector, as an example, we choose to avoid fund exposure to the more expensive counters.
Within the retail sector, the fund has preferred to own out-of-favour counters over market darlings, looking for price-to-earnings ratio discounts where possible. Our SA Inc exposure outside banks, retailers and consumer staples amounts to 47% of the portfolio vs 20% of the index.
We built our position in SA Inc well before the advent of the GNU, when prices reflected heightened fear in South Africa. Our investment in the construction sector, particularly through stakes in Wilson Bayley Holmes-Ovcon (WBHO) and Raubex Group, serves as a case study. Following the boom of the 2010 World Cup, the South African construction industry endured over a decade of challenging conditions and both these companies’ share prices have basically remained flat for more than a decade.
PSG Asset Management began building stakes in the construction sector not in spite the poor state of the industry, but rather because of it – for two primary reasons:
– Shares in the sector were trading at multi-year low valuations.
– Favourable supply-side conditions emerged as several high-profile competitors exited the market.
While we couldn’t predict the exact timing of a turnaround in construction demand, we were confident that infrastructure investment would need to increase. This view was based on South Africa’s low gross fixed capital formation as a percentage of GDP, both historically and relative to emerging market peers. We believed the remaining construction firms in South Africa were well-positioned to capture any future rise in demand.
Post the elections, we’ve seen the Minister of Public Works and Infrastructure place an infrastructure build at the heart of an economic recovery plan. This has driven up the share prices of WBHO and Raubex by between 55% and 60% since the elections in May. We see significant scope for earnings growth from these companies as the infrastructure build comes to fruition.
More upside to come from SA Inc shares
We believe that tailwinds from an improved economic backdrop, off a very low base, will continue to provide an earnings underpin to SA Inc shares. Given the low valuations these shares were trading on until recently, they still offer value compared to other areas of the global market.
It should also be kept in mind that once foreign investors regain confidence in local equities and return to our markets, it could provide a further boost to our market’s performance.
However, to benefit from strong performance from SA Inc shares, investors have to ensure that they obtain true SA Inc exposure. We believe many of the best opportunities reside in overlooked (and less popular) parts of the market. As always, partnering with a manager with a proven track record of selecting future winners will be key.
Mikhail Motala, Fund Manager PSG Asset Management
BUSINESS REPORT