The best investment returns are born in times of fear and uncertainty, says Mikhail Motala, assistant fund manager at PSG Asset Management, and there is a prevailing negative narrative on South Africa.
Business confidence is close to 40-year lows and recent financial results commentary from JSE-listed companies reveals just how tough the economic environment is. SA Inc businesses are experiencing some of their most testing times. The FTSE/JSE Mid Cap Index, which serves as a good proxy for SA Inc companies, is trading at lows last seen in 2002.
“Valuations closely follow business confidence, as both are proxies for investor sentiment,” Motala says. “Depressed valuations signal that the market has very low expectations for future earnings growth. “It is therefore not despite but because of the tough economic environment that local mid-cap shares present attractive opportunities. Many of the fears about South Africa’s economic woes appear to be priced into these shares. “So even if economic headwinds persist for longer than expected, shareholders can still expect to make decent returns. “If, however, a ‘normal’ cycle unfolds and some of the headwinds abate, the resultant earnings recovery could be dramatic.
“In this scenario, shareholder returns could be highly attractive.”
While it’s difficult to predict if or how an economic recovery may take shape, and market participants should by no means underestimate the challenges the local economy faces, Motala believes there are a few encouraging factors to consider.In some South African industries, such as infrastructure and energy, there is pent-up demand from the so-called “lost decade” - the economic stagnation experienced over the past 10 years.
Growth follows investment. Investment into emerging markets generally is at cyclical lows. Within emerging markets, South Africa has taken a bigger knock than many of our peers. Generally, South African corporate balance sheets are strong.
Key local institutions such as the National Treasury and the SA Reserve Bank have been thoroughly tested over the past 12 months and have proved their mettle. Despite a recession and an inquiry into state capture, there has been a peaceful and democratic change in the leadership of the ruling party.
Even some larger, more global South African companies are starting to look attractive. Nkareng Mpobane, chief investment officer of long-only fund management at Ashburton Investments, says that even though lacklustre South African earnings growth has been the main drag on equity returns over recent years, bargains are emerging in great stocks that have been “thrown out with the bathwater”. “We’ve had consistent downward revisions to earnings expectations, which explains the market’s relatively flat long-run performance.
“This poor performance has resulted in higher dividend yields, but lower earnings growth is likely to hold back any real improvement in price-earnings multiples on a forward basis. As it stands, price-earnings multiples remain at their long-term historical averages.”
For South African investors, however, valuations in some shares look very attractive, with some of the JSE’s leading names trading substantially below long-term valuations. “For patient investors, great stocks can be had at very attractive prices,” Mpobane says. Some of these companies are Vodacom, Aspen, Shoprite and Mr Price.