Just how local is JSE? Collocott examines foreign earnings as % of total earnings.

It’s a question many investors should ask themselves, just how local is the Johannesburg securities exchange. And by this we mean how much local currency is earned by the listed entities.

Given the number of companies holding onto their cash, and with most spend happening outside South African borders, the numbers may not surprise.

Below is a fantastic in-depth analysis from Charles Collocott, which unpacks this question further. The research also makes more sense of which way the local market may venture depending on the strength of the rand against the US Dollar. The article was first published on Sharenet. – Stuart Lowman

By Charles Collocott*

The movement of the Rand versus other currencies has a major effect on the JSE. Exactly how much exposure the JSE has to foreign exchange is a difficult question to answer and the below is a summarized version of my research in an attempt to answer this question.

Close to 65% of the JSE’s Top 40 earnings comes from foreign currencies and as the below table below shows, just over 50% is from the top 10 largest companies alone.

My method in determining the above was to extract what relevant data I could from each company’s latest financial statements. A lot of it came from different line items such as headline earnings, revenue, normalised earnings, etc. Added to this I wasn’t able to study in detail the footnotes which may or may not have held material information.

I assumed the resource companies revenues were all in USD as commodities are priced in USD.

I also tried to avoid double counting regards crossholdings of shares and I also excluded the following stocks:

• Remgro – majority of its capital seems to be holdings other Top 40 companies,

• Investec – Investec and Investec present the results and financial position of the combined group under International Financial Reporting Standards,

• Mondi – African operations and primary listing on JSE (Plc on LSE), and

• RMB Holdings – 34% holding in FSR.

So according to my research the JSE Top 40 has just over 64% exposure to foreign currencies. What does it mean?

Unfortunately I did not have the luxury of time to determine which currencies and how much of each the companies have exposure to so I have focused on the US Dollar and Euro.

Fortunately as will be seen below, while the JSE Top 40 shares have exposure to an array of foreign currencies (one need only consider Naspers and SABMiller) a lot can be deduced by looking into the JSE’s relationship with the EURZAR exchange rate because Europe as a block is South Africa’s biggest trading partner.

The below graph shows the JSE Top 40 (LHS) as well as the USDZAR and EURZAR exchange rates (RHS) from roughly the beginning of the latest bull market until 09 May 2016:

The table and bar graph below shows the correlation between the JSE Top 40 returns and the two exchange rates. The rows labelled USDZAR-6 is the correlation between the USDZAR and JSE Top 40 returns 6 months later. The rows labelled USDZAR-12 is the correlation between the USDZAR and JSE Top 40 returns 12 months later. The same applies to the EURZAR.

Over all the different periods the correlation was never lower than 0.87 signalling a significant relationship between the two exchange rates and JSE returns. And the highest correlation occurs when one uses JSE returns 6 months later. One might assume that this is because the changes in the exchange rate have had time to reflect in the company’s next reporting period and the market has rewarded or punished the share for it.

The correlation between the two exchange rates and the Top 40 became strongest when the bull trend consolidated in 2012 and 2013. But once the Rand began to strengthen against the Euro and stabilise against the Dollar in 2014, the correlation turned mostly negative the market faltered just over 6 months later.

This suggests that market participants did not foresee the lower company earnings that would result because of the Rand’s strength against the Euro.

The correlation continued to be negative in the second half of 2015 despite the Rand beginning to weaken against both the Euro and the Dollar from the first quarter of 2015 and this was due to the Chinese slow down weighing on all markets, especially commodity intensive markets such as the JSE.

And almost as an aside, let us look at what happened during the latest bear market. As one might have assumed, from beginning June 2008 until end March 2009 the correlation between JSE returns and USDZAR and EURZAR respectively was -0.88 and -0.62. There was always going to be very little chance of a positive correlation during dramatic equity market moves as in a bear market.

• Charles Collocott, CFA, CFDs & Securities Manager, Sharenet

• Earnings in this case refer to what relevant data I could extract from each company’s latest financial statements. A lot of it came from different line items such as headline earnings, revenue, normalised earnings, etc. I also assumed the resource companies earnings were all in USD.

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