ARE THERE OPPORTUNITIES IN SA INC. STOCKS?
As fund managers, we are always on the lookout for opportunities that can generate good returns. This is true even — or perhaps especially — when sentiment is at its worst. An area of the local market that has received a lot of attention lately for its historical cheapness are ‘SA Inc.’ stocks. Portfolio manager NANCY HOSSACK takes a closer look at prospects for this segment.
SA Inc. stocks are companies whose earnings are predominantly linked to the South African economy, such as banks, insurers, retailers, construction companies and SA-focused industrials. This categorisation excludes companies with significant offshore earnings, as well as resources companies. Of course, resources companies may be impacted by SA-specific factors like power outages or wage inflation if they have mining operations in the country. However, their earnings are more influenced by exogenous factors such as the whipsaw of international commodity prices and exchange rates.
SA Inc. stocks are currently trading at very low valuations compared to their history. The FTSE/JSE Mid Cap Index (which is predominantly SA Inc shares) is trading on an eight-times price earnings multiple, the lowest in its 20-year history, although we did briefly touch that level in 2008 during the Global Financial Crisis. There are several reasons why these stocks are so cheap. Firstly, there has been fifteen years of economic stagnation, brought on by underinvestment in fixed capital. Secondly, investors are using high discount rates to assess the present value of future earnings of SA Inc. stocks. This is because the country risk rating is understandably very high compared to history. Finally, investors are naturally worried about the outcome of the 2024 national government elections and are not paying a premium for stocks that might be most affected.
As a result, the market has heavily marked down almost all SA Inc. stocks. This offers fertile ground for long-term stock pickers. We believe there is opportunity in companies that can expand market share despite the tough economic environment, and in those that deal in staples as opposed to discretionary goods. Additionally, industries where competition has dwindled could offer opportunities for the remaining players. Finally, companies with the ability to pass on inflation costs, especially in an inflationary environment, or those capable of keeping costs lower than competitors, are also worth considering.
However, we should guard against ‘betting the farm’ on the sector just because it is cheap. Concerns for the political and policy making environment after the 2024 national elections are genuine. And South Africa's fiscal issues are undeniably escalating — which may worsen the prospects of SA Inc. companies. As always, diversification of correlated risks is critical.
At the time of writing, the Foord Equity Fund has about 40% of its portfolio in SA Inc. stocks. With a high cash weighting at 14% of the fund and a small exposure to gold to protect against local and foreign risks. About 45% of the portfolio is invested in companies that earn a significant portion of total earnings in offshore markets. Potential for a sovereign debt crisis and adverse outcomes in 2024 cannot be ignored and we will aim to protect capital in that event.
Despite the gathering storm clouds, astute investors should always look for inflection points. Change is the only constant and South Africans have a long history of looking over the precipice and saying, “not today”. If the JSE can adjust its trajectory, it will create a lot of wealth for investors. So, while we are in protection mode currently, we remain cognisant of the possibility of outsized gains and open minded in our positioning.