Reasons for SA investors to smile

Following the December ANC conference that brought winds of political change, the rand has rallied, the economic outlook is rosier and investor confidence is on the up. Yet the JSE All Share Index, which reached an all-time high of 61 684.77 in January, is down to around 56 000.
 
As Old Mutual Multi-Managers said in a recent investment note, “the contrast between the general sense of optimism on the streets and around the braai fires and the disappointing short-term investment returns couldn’t be more stark”.  

It is true that despite recent waves of optimism, South Africa is a long way off from solving some of its most serious challenges including poverty, joblessness, poor education, low economic growth, crime and corruption.

It is also true that South African companies are coming out of a period of low profitability and very little investment in their future growth. While global economies rallied, local investment fell off. 

But there has recently been cause for much hope that the country is starting on the long path to recovery.

Unlike his wrecking-ball predecessor, President Cyril Ramaphosa is aware of the critical importance of investment and, while he may need to pick up the pace, he has shown early signs of rallying the investment community to reignite the economy so that he can deliver on his promises and begin to tackle some of those serious challenges.

In fact, spooked as they might be from the stupor of the past decade, the more recent land reform issues and the Steinhoff debacle, South African investors have a lot to be happy about.   

1. Political change

Since he was sworn in as president on 15 February, Ramaphosa has made some sweeping changes aimed at restoring the country’s equilibrium and getting the economy back on track.

The appointment of Nhlanhla Nene (finance minister), Pravin Gordhan (public enterprises) and Gwede Mantashe (mineral resources) and the suspension of South African Revenue Service (Sars) commissioner Tom Moyane reflect the pace at which he is rectifying the situation and should sit well with investors.

So should the return of some form of sanity to state-owned enterprises (SOEs), particularly Eskom, which has the potential to nullify all other efforts to put the economy to rights.

The boards of SOEs like Eskom and Denel have been changed and public servants involved in corruption are being weeded out. 

Policy stability, probably the most critical influencer of investment decisions, is being sought with some urgency, particularly with regard to the Mining Charter and land redistribution.

The complexity of Ramaphosa's task is reflected in the latter, which resulted in widespread unrest, uncertainty and investor jitters, when the president announced expropriation without compensation – but failed to explain how it would play out. 

For the first time in over a decade, government is including business and investors in decisions it makes. They may not like the outcome, but their input will be welcomed and considered when these decisions are taken, as is evident with the Mining Charter, which is being reworked.   

Principled investors like to know they are working within defined, equitable boundaries and proper governance. Ramaphosa has made it clear that government will “not tolerate the plunder of public resources, nor the theft by corporate criminals”. 

Much of this political change is aimed at promoting investment in order to grow the economy, create jobs and increase exports, all of which provide fertile ground for investor confidence and interest.   

2. Economic indicators 

Although South Africa remains a sub-investment grade, deeply indebted country with crippling unemployment, there are many positive signs for the economy.

Barring external influences like another global crash or an escalating crisis following attacks on Syria, the economy is expected to pick up in 2018 – from 1.3% in 2017 to anything between 1.4% to over 2%, depending on the optimism of the forecaster. That is not nearly enough, but on the right track.

The rand has strengthened from around R13.50 to the dollar in mid-December to just over R12 currently. 

Inflation was 4% in February and is expected to be contained in the 3%-6% range until 2020. Interest rates continue to trend downwards, with the most recent cut bringing the repo rate to 6.5%.

Mining output has improved – growing 3.1% year-on-year in February but with surges in the production of diamonds, iron ore, manganese and coal.

Ratings agencies have held their ratings (Standard & Poor’s and Fitch on non-investment grade and Moody’s just one notch above) and have eased on their negative outlook.

The mining, agriculture, manufacturing and tourism sectors have been marked for special attention in order to grow the economy. 

3. Policy and regulation 

With the Mining Charter under review, and partial certainty provided by the courts over the “once empowered, always empowered” principle, there is some evidence that policy certainty will be expedited, although more clarity and certainty are needed before investors make the kind of long-term commitment they need to carry out in this sector.   

Deals with independent renewable energy power producers, which Eskom stalled for years, have finally been given the go-ahead, representing investment of R56bn. 

Issues of overregulation, specifically for small businesses, are also in the spotlight.

There are also indications that problems at Sars and corruption will be dealt with to ensure that taxpayers’ money is not wasted and that investors can be sure they can rely on fair interactions and co-investments with government and its agencies.   

4. Incentives 

Ramaphosa has committed to promoting investment in key manufacturing sectors through incentives and other measures. This includes a localisation programme to benefit businesses operating in the textile, clothing, furniture, rail rolling stock and water meter sectors.   

Special economic zones will remain important instruments to attract strategic foreign and domestic direct investment. 

Government has acknowledged that corporate and personal tax are at relatively high levels and did its best not to weigh down companies under further onerous tax burdens.   

5. Investment   

Ramaphosa has committed to a number of investment-positive actions, including an investment conference later this year “to market the compelling investment opportunities to be found in our country”. 

He committed to addressing the decline of manufacturing capacity and re-industrialising “on a scale and at a pace that draws millions of jobseekers into the economy”.

He said government would focus on infrastructure investment and the implementation of new projects. 

The government would work with mining companies, unions and communities to grow the sector, attract new investment and create jobs and would take decisive action to realise the economic potential of agriculture.

Ramaphosa also announced a campaign to raise $100bn of investment in the next five years and appointed a team of envoys to sell SA to investors.

These include former finance minister Trevor Manuel, former deputy finance minister Mcebesi Jonas, former Standard Bank CEO Jacko Maree and Phumzile Langeni, the executive chair of Afropulse Group.

He has also appointed economist Trudi Makhaya as his economic adviser. 

Renewed confidence brought by political change leads to foreign investment, deal-making, and investment in new mines, plants, stores and products. This in turn flows through to company results and share prices, and some of these prospects have already been priced in.

The JSE does, however, react to global volatility, and the All Share’s performance is dominated by the performance of Naspers*, whose share price has been on a losing trend since the end of November.

This, and the difficult prospect of reigniting investment interest, may be behind the overall decline in share price performance.   

With economic recovery – and SA’s is tentative – some sectors lag behind others, so there is still value to be found.   

“Stability from a currency and political point of view creates a positive environment for foreign direct investment and for local business to start investing in the economy again,” says Zwelakhe Mnguni, chief investment officer and co-founder of Benguela Global Fund Managers. 

Unless some global issues emerge or the land reform question is not settled, South African companies should see improvement in profits, and we should be seeing prices following that, says Mnguni.  

Investment options 

Renewed confidence may lead to new deals but it is perhaps a little early to see them flow in.

One example of some action is Murray & Roberts (M&R), which is facing a takeover bid and recently announced it was awarded R3.8bn in new underground mining projects over the next four years in Australasia and North America.

The R4.7bn takeover bid by German investor ATM Holding for the 70% of M&R it does not hold, which caused the share to jump 50% at one point, has less to do with renewed investor interest than it does with Aton, which owns ATM, continuing its long-term quest to increase its stake.   

Similarly, the breakup of Old Mutual, which will see it return a chunk of its business to SA, has been years in the making.   

Nevertheless, we should expect to see more corporate action and more corporate success in the future.

With political change, investors price in the benefits that will happen in the future very quickly, says Casparus Treurnicht, analyst and portfolio manager at Gryphon Asset Management, as reflected in the rally of some share prices on the JSE since December.   

Mnguni says improved conditions will be very supportive to the retail and the banking sectors, mainly because they depend on employment and GDP to grow.   

Some retail stocks have already had a good run and future prospects are priced in to some extent, says Mnguni, but with banking there could be some movement. He warns that there could also be some lags, especially if there is no certainty on land reform.

“If it is not handled well it could create problems, it could be negative for banks and there could be lingering uncertainty. Banks, nevertheless, are still relatively attractive.”   

Treurnicht says investors should be in industrials and resources. “I would be looking at companies like Anglo [American] and BHP, or Glencore and maybe, but not yet, MTN.” 

Selecting stocks is crucial, as investments tracking the All Share Index reflect the price of Naspers, which, Treurnicht says, is vulnerable to what happens in China – and in the trade war, China has more to lose than the US.   

Treurnicht adds that with inflation having bottomed, it may be good to look “at thefood producers like AVI, Imperial, Bidvest and Barloworld”.

He agrees with Mnguni that retailers have run quite hard, but he thinks banks are “pretty safe at the moment”. 

“Up to now, the economy has not been in favour of smaller companies, which need real economic growth and higher disposable income to grow.

“Even if we want to really see blue chips going forward, we need to see the economy growing, 2% or even 2.5% the next year,” Treurnicht adds.   

Vestact portfolio manager Michael Treherne says investors should continue to look at South African companies that offer more international exposure, like Discovery, which continues to do well offshore and is launching its bank this year, and ADvTECH, which is building up its presence in the rest of Africa.   

What investors do not want to see is any evidence of potential problems. They have learnt from Steinhoff that where there is smoke, there is fire, says Treurnicht, and want to see the evidence of years and years of good governance and management. 

He recommends that investors look at companies like Shoprite, which has a track record over many years and has good managers coming thought the ranks.

“Investors like to see those instances of good track records and a culture of managers acting in shareholder interests, and for all stakeholders.”   

The return of investment interest is still likely to favour South African companies that have successfully broadened their horizons offshore, but also companies that have performed poorly offshore and are now renewing their focus on their core South African businesses.   

“South Africa still looks relatively good compared to the US,” says Mnguni, “mainly because if you look at the likes of Facebook, and indeed most companies in the US, the CEO is the CEO and chair, while we have the roles separated, so there is a big difference from a governance point of view.   

“There may be issues specific to some companies and individuals, but our governance is good,” he adds. 

Where local management teams could be criticised is that they have been in flight mode from SA, Mnguni says: “Under the previous administration there was uncertainty, but generally what is needed is a commitment to find solutions in the economy.

“We saw recently Netcare exiting the UK – after 10 years that deal means nothing. If they had focused on a partnership in an African country as a test, it would have paid off a lot better for less capital.

“The same applies to companies like Steinhoff and Woolworths. To buy businesses in markets that are efficient takes superhuman effort and skills, but South African businesses should be looking to innovate locally,” he says. Investor sentiment may now make this possible.   

A major weakness of South African CEOs is that “they don’t fight but choose flight”, Mnguni comments.

Conditions are now favourable, and there will be more certainty: “It is not that the opportunities are not there, it has had more to do with leadership saying one thing and doing another.”

Investment options will also improve when things start looking better.

This may take time to flow through but we have already seen the potential listing of glassmaker Consol, consumer goods company Libstar, which produces brands like Denny Mushrooms and Lancewood cheese, and, more problematically, Sagamartha.

This is an overvalued “tech” company whose listing, should it happen, is unlikely to provide any fillip for investor confidence in South African companies.   

Stumbling blocks  

Investor sentiment is good but remains precarious until investors start to see more evidence of the promised changes.   

Old Mutual Multi-Managers said SA has been boosted by tailwinds, which include the prospect of improved governance and the return of sensible policymaking, the progression of the global economy and the benefit to local consumers of lower inflation and interest rate cuts. 

But global equity markets “have experienced a torrid time in the first quarter as volatility returned after a long, quiet stretch in 2017” and the JSE has followed. 

Old Mutual Multi-Mangers also cited the sudden pressure on “the high-flying technology sector” and the global tech sell-off’s effect on Naspers. The potential trade war between the US and China was its other major concern.   

All of these issues bring uncertainty back to the markets, it said.   

For South African investors, the overriding problem remains a lack of choice. The government’s focus on boosting investment in mining, agriculture, manufacturing and tourism serves to reflect just how far behind the curve SA is when it comes to Fourth Industrial Revolution investment options. 

Facebook’s stumble may prove their uncertain nature and volatility, but investors would be fools for not thinking that the word’s future will be influenced by technology and artificial intelligence as well as biomedical and genetic advancement.

Investors may have to look elsewhere for these, but that does not mean South African companies don’t have a lot to offer. 

At the moment, however, local investors will have to focus on tried and tested traditional companies if they want to make the most of the wave of positive sentiment and promises of better times ahead.

*finweek is a publication of Media24, a subsidiary of Naspers.   

This is the cover story that originally appeared in the 26 April edition of finweek. Buy and download the magazine here. Subscribe to our weekly newsletter here.