For shareholders in SA Inc stocks (those companies who earn most of their revenue and profits in South Africa), the past few years have been frustrating. The performance of SA Inc has been poor both in absolute terms as well as relative to other equity markets, thereby making the case for owning these companies increasingly more challenging.
The question one must ask is why these shares have underperformed and whether this underperformance is likely to continue. Banks, insurers, retailers and industrials have all struggled against a backdrop of weak economic growth. Eskom and Transnet’s failures have resulted in anaemic GDP growth which has starved companies of a much-needed tailwind. Topline growth has struggled for companies given flat per capita GDP growth over the past couple of years, meanwhile costs have expanded at rates faster than inflation due to loadshedding. The good news is that both Eskom and Transnet seem to have started their turnaround journey and while the days of 4-5% GDP growth are a thing of the past for South Africa, it is feasible that the country could return to 2% over the next year or two.
While earnings have suffered for SA Inc companies, so too have multiples. In fact, during April many of the banks were trading at the same valuation that they had during Nenegate or the middle of Covid. There are numerous factors which have contributed to this. Firstly, the South African Reserve Bank increased the offshore limit for SA funds from 30% to 45%. As global markets outperformed the JSE, local asset managers came under increasing pressure to move a greater portion of their assets towards the 45% limit regardless of valuation differentials.
Additionally, foreigners have continued to sell SA equities. Foreigners who want emerging market exposure are willing to accept emerging market risk for emerging market growth rates. Unfortunately, as discussed above, the growth part is missing for South Africa. This year the foreign selling has been most pronounced in quality companies, such as Clicks and Shoprite. Our assumption is that foreign investors are cautious about the upcoming general election and are derisking ahead of this event. The record of multiparty democratic elections in Africa is patchy and this election will likely be the first where the ruling ANC falls below 50% of the vote. South Africa only constitutes 2.9% of the MSCI Emerging Markets Index and being underweight into the event will not cost any portfolio managers their jobs.
The continued selling pressure on SA equities has seen them derate to levels where the cash yield on these companies is enticing. Even low single digit growth in earnings will make for attractive returns going forward. Most local managers are close to the 45% offshore limit and the wave of selling pressure is likely to dissipate. The election is likely to be a non-event, although it will remove the tail risk of an ANC-EFF coalition. Therefore, the future looks less gloomy for an asset class that is priced for disappointment.