Finweek English Edition - - Companies & Markets -

IN­VESTORS HAVE for a long time failed to give the nec­es­sary at­ten­tion to in­dus­trial shares, the man­u­fac­tur­ers of goods and even providers of ser­vices in South Africa. First, there was the glit­ter of fi­nan­cial shares – fol­lowed by the nearly per­pen­dic­u­lar in­crease in the price of com­mod­ity shares. The strong rand, some­where be­tween US$1/R6 and US$1/R7 for a few years, also made things dif­fi­cult for SA’s man­u­fac­tur­ers.

Nev­er­the­less, quite a long time ago – more than a year – things be­gan go­ing bet­ter and bet­ter with such shares. For the past 12 months the listed Sa­trix Indi, with its 25 lead­ing in­dus­trial shares, has been do­ing bet­ter than the more il­lus­tri­ous Sa­trix Fini.

In fact, the graph of the Indi 25 ver­sus the Fini 15 shows that from May 2007 things started mov­ing clearly in favour of in­dus­trial shares. How­ever, the prices of those shares have also been hard hit since Au­gust 2007 by the im­pend­ing fi­nan­cial cri­sis, which has now de­vel­oped into a real mess.

There are quite a few rea­sons why man­u­fac­tur­ers and in­dus­trial shares may now be more at­trac­tive than fi­nan­cial shares and per­haps even re­sources. First, most of those com­pa­nies have ex­cel­lent bal­ance sheets. In­stead of bor­rowed cap­i­tal there are large de­posits. The bal­ance sheets are al­most too lazy. The value of the rand has weak­ened sig­nif­i­cantly over the past few months. Even on a trade-weighted av­er­age, SA man­u­fac­tur­ers are sud­denly en­joy­ing the ben­e­fit of a de­val­u­a­tion of be­tween 25% and 30% in the value of the rand and there­fore im­ported goods to be com­peted against.

That’s also one of the few, if not the only, falls in the value of a cur­rency that’s not di­rectly linked with higher inflation and in­ter­est rates. That cre­ates a par­tic­u­larly favourable cli­mate for man­u­fac­tur­ers, es­pe­cially if the on­go­ing high in­fra­struc­ture spending is also taken into ac­count.

Cur­rently, DIY in­vestors won’t do badly by sim­ply buy­ing Sa­trix Indi. In­vestors who like to buy in­di­vid­ual shares can make a se­lec­tion from the list.

Rather than fo­cus­ing on the usual earn­ings mul­ti­ple and div­i­dend yield of the in­di­vid­ual shares, let’s look at the peg ra­tio. That’s a func­tion of the cur­rent PE di­vided by the growth and it tells that any value of less than 100% – but es­pe­cially less than 75% – is good.

Prop­erly up­dated pegs of the fi­nan­cial sec­tor aren’t yet read­ily avail­able from McGre­gor BFA, as an­a­lysts are still hes­i­tant about build­ing the lower, if any, growth of bank prof­its into their cal­cu­la­tions. But if a bank with an earn­ings mul­ti­ple of eight warns its profit growth will only be 5%/year that trans­lates to a peg of 160%, far higher than the up­per limit of 100%.

In­vestors are ad­vised to steer clear of the banks’ ques­tion­able prom­ises and rather to look at the list of larger in­dus­tries in­stead of fi­nan­cial shares. Smaller in­dus­trial shares – even pen­ny­s­tocks – with a mar­ket cap­i­tal­i­sa­tion of less than R1bn are still very much worth in­vest­ing in. Small in­dus­tries are in a com­pletely dif­fer­ent en­vi­ron­ment from small banks, which in any case no longer ex­ist in SA.

Smaller com­pa­nies in the in­dus­trial sec­tor, many of which are now trad­ing at PEs as low as four to five with good growth prospects, now of­fer ex­cel­lent op­por­tu­ni­ties. In­vestors with a taste for smaller shares can now en­joy them­selves in that sec­tor in rea­son­able safety. How­ever, keep well away from ev­ery­thing that’s small – and even nearly ev­ery­thing that’s big – in the fi­nan­cial sec­tor.

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