Q Why did investor confidence falter as the year progressed?
There was widespread optimism during the early months of 2019 as discussions about cleaning up leadership at strategic enterprises like the state-owned entities, South African Revenue Service, National Prosecuting Authority, Special Investigating Unit and PIC gained momentum. Commissions of inquiry into state capture and better corporate governance also provided some comfort that South Africa’s ills were being addressed. Unfortunately, there has been a lot of talk and not many results yet. Besides the public sector headwinds, many companies had earnings disappointments due to poor economic conditions. Consumer real wage growth has been under pressure; consumer confidence has been struggling; and an uncertain government policy framework prevails. Because of this, it has been a tough year for retailers, food producers and listed property companies in South Africa.
Q What does 2020 hold for SA equities?
An improvement in the macroeconomic environment would help to restore much-needed investor and consumer confidence. As institutional reforms continue, and we confront our economic cyclical and structural challenges, we should expect capital expenditure and job creation to follow. If we get this right, we could expect some cyclical recovery going into 2020.
We think earnings expectations have been reset lower and a lot of the bad news is already priced into the market. Currently, banks are trading on a price-earnings ratio (PE) of between 8x and 10x, with earnings growth of approximately 7-10%. On top of this earnings growth, banks provide a dividend of 5-6%. So, you could potentially get a double-digit return from a financial institution/bank in South Africa over time and you buy that at a very reasonable price today.
The valuations of many local retailers reflect how the market has priced in a lot of negative news. Some retailers have managed to navigate the tough environment well. Revenue growth has, however, been slower than cost growth leading to negative operating leverage. In a better pricing environment, you can expect revenue to benefit from volume growth. And as inflation becomes a tailwind, operating leverage and earnings should start improving. So, we do see some opportunities in this sector, given the attractive valuations and the potential for earnings to surprise on the upside into 2020.
Q Are there any other sectors that you find interesting?
We are finding some opportunities in the resources sector and remain very positive on platinum stocks. The supply/demand dynamics in the platinum group metals (PGM) sector are very supportive for the earnings profile of these companies. While supply is in decline due to underinvestment, demand is growing. The rise in vehicle-emission standards globally is increasing loadings of PGMs in emission-control systems. We also view diversified miner, Anglo American, as a good investment opportunity.
Select global industrial rand hedge stocks are attractive. We like brewing giant Anheuser-Busch InBev (AB InBev). The company has successfully integrated SABMiller into the stable and is reaping the benefits of this acquisition. AB InBev’s volume growth has started to recover, and its balance sheet is looking healthier, as the debt position has improved.
Naspers and Prosus are key holdings. We believe both offer investors access to some of the world’s most attractive consumer internet and technology assets at a net asset value (NAV) discount. Tencent remains the jewel in Naspers’s crown. Our channel checks indicate good news on the gaming front for Tencent.
Q What do global equity markets have in store for us in 2020?
Because of the narrow SA equity market, exposure to offshore markets provides much-needed diversification for South African investors. We are finding attractive opportunities in global markets and view Europe as an alpha-rich destination. The political environment in Europe has also become more constructive than a few months ago. In many cases, European companies offer better earnings growth prospects and valuations than US companies. We’ve also seen a material improvement in the debt profile of European companies due to improved free cash-flow generation.
In Asia, including Japan, there are interesting growth opportunities where valuations are low and earnings have substantial upside over the medium term. Thanks to capital market reforms, it has become much easier for foreigners to invest there. These markets show a low correlation to South African equities, and we believe some Asian equity exposure makes sense from a risk-reward perspective.
All investments carry the risk of capital loss.