The state of SA Inc
The sentiment at the Investment Forum varied from ‘SA is out of favour, so buy’ to ‘SA is stuffed, so invest elsewhere’, writes
IMost hotel groups saw their corporate lives flashing before their eyes during Covid
attended the Investment Forum hosted by The Collaborative Exchange just before copy submission close.
This is a conference where fund managers showcase themselves to the financial planning industry. Conspiracists and cynics often opine about such events, but I can safely say that widely differing views were submitted — and energetically and intelligently argued. There were managers who thought market prospects suck (and said so) while others hoovered up the supposed value on offer. People pay R12,000 for a ticket and expect quality for their time and money.
A third were panel discussions, and the balance were individual presentations. I will sacrifice depth for breadth in my column and amalgamate them to offer a range of ideas and/or facts, without necessarily wading into the debate.
The session opened with moderator Kevin Lings (good speaker — do attend one of his talks if you can) leading a panel discussion with the CEOs of Netcare, Southern Sun, Transaction Capital and Naspers on “Growth in all market conditions”. Inevitably, the recovery from Covid and damage by Eskom came to the fore.
Richard Friedland noted how Netcare cannot afford a flicker in power — at any one time its hospitals have up to 1,600 people on life support machinery. He claimed an internal rate of return of about 30% on Netcare’s green power investments, so its internal target of zero carbon by 2030 looks operationally prudent and financially worthwhile. (Quick aside for nonfinance types: remember that with a large capex, your starting base for returns is — simplistically — 100 not 0, so a 30% return is good, but not blistering.)
Most hotel groups saw their corporate lives flashing before their eyes during
Covid, but those that survived fiercely streamlined their businesses. Those that didn’t failed. Most of these businesses have done scenario planning for grid failure. The panellists were dissatisfied with the government’s comments about business being absent for interaction.
The tired observation about South Africans being resilient was batted around. Well,
Ukranians are also resilient. Neither country’s citizens have a choice or are happy about it. (Having to be resilient because of someone else’s uselessness is a huge waste of energy.)
Next up, a panel on multiasset funds — which are basically all “sleep at night” funds. Rory KutiskerJacobson of Allan Gray, Leonard Krüger of M&G Investments and Justin Floor of PSG Asset Management have handy offshore allocations, but none has used the full allocation of 45% for the stated reason that they believe South African equities offer value.
I have noted in past columns that offshore adds a significant forex risk overlay, and I daresay that is probably
an issue for these funds too. The MSCI world index is hugely overexposed to dollar assets by default: because USlisted assets are overweight relative to GDP, US companies tend to be relatively UScentric (even if global in scope).
There was debate on the blending of offshore and
South African portfolios. (I have previously noted how in active managers, home domicile delivers an advantage but, frankly, these types of portfolios should probably tilt passive anyway.) Still, SA is a small open economy exposed to the world, so local managers should take a global view.
The moderator asked:
“Why not hold cash with its high rates?” The fact is that cash returns are not good enough as they only match inflation before tax.
Neville Chester of Coronation debated on how to build robust portfolios for the decade ahead. He claimed the next decade would be for stock pickers, then wryly noted that’s what every stock picker would say anyway.
Still, every soaring bull market hardly necessitates stock picking; momentum from just buying the index does well enough — until, of course, it doesn’t. There are big changes in the recent drivers of the now
(somewhat) dead bull market. The end of free money has led to the first year since 2008 that central bank assets have declined. (Reduction in debt or fall in bond prices?) Bubbles such as special purpose acquisition companies have burst — now that money actually costs something, there are a lot of business models to fall away.
Several speakers noted the sea change — global equities managed passively exceed actively managed funds.
Active managers have long hoped that this would be the day this could start shifting returns back to active. (I think it would require a bigger skew before active beats the “free rider” advantage to passive.)
SA has a huge gap between winners and losers. Our lowgrowth environment tends to result in zero-sum games between our corporates, which are fighting for market share instead of growing markets. Consider the food retailers: the march higher of Shoprite was remorseless (in price and market share gains) and the change of CEO (when Whitey Basson retired) was a huge opportunity.
In apparel, retailers Pepkor, TFG and Mr Price all benefited from the massacre of Edgars over the years. All major life insurers have declining new business except Sanlam. Resources have a host of data points that require comprehensive analysis. Otherwise SA Inc needs to keep capital allocation tight and not squander the “A
Team” on poor offshore expansions.
Across presentations, the sentiment on SA varied from “SA is out of favour, so that’s an opportunity to buy” to “SA is stuffed thanks to halfwit politicians, so invest elsewhere”. Both are potentially valid theses, and only one will win. Still, even the “Alles sal regkom (Everything will be OK)” crowd seem to go for lots of rand hedges.
Having experienced a home invasion last October, I looked for any presentations that could counterbalance my somewhat jaundiced view of SA. Debra Slabber of Morningstar moderated a panel comprising Jacques Conradie (Peregrine), Rob Spanjaard (Rezco) and Wim Murray (Foord) on “Who thought local would be lekker?” A group that would lean to value investing, I’d think.
Replies to “What was key takeaway for 2022?” included “Diversification is the only free lunch” and “Temperament matters more than intellect”. Slabber looked to kick tyres for selected shares after classifying JSE listings into three categories: global earners; the China story; and SA Inc (see mostly rand hedges). Among global earners, Murray said that though AB InBev is highly geared, the very long-dated debt is almost all fixed. The huge cash generation can halve the debt in 10-odd years.
Spanjaard noted Aspen Pharmacare’s beautiful deleveraging debt of R46bn five years ago is now about R16bn. Conradie noted that for British American Tobacco, next-generation product (vaping) is 15% of product sales and is expected to rise to 30% in the next five years. Most agreed that the China case has moved from beautiful 10 years ago to hopeless last year to middling now.
Spillover sentiment on resources was quite positive, but Spanjaard said many Chinese used real estate as a pension fund. President Xi Jinping has stamped out this practice, so don’t look for a real estate rebound in Chinese GDP.
With regard to SA Inc, Murray said they like bad news that is transitory, but be wary of excessive debt, because these companies get forced into locking in bad news.
Spanjaard likes Discovery (12 p:e and earnings per share growth of 20%) and banks (excellent prospects for loans to power projects).
Ninety One’s Malcolm Charles gamely took on the “SA: perception vs reality” presentation. I think I should pre-empt hisses and boos by noting that some positivity is a necessary mindset for an income manager, because you need to come up with
Cash returns are not good enough as they only match inflation before tax
answers, no matter what. He kept emphasising not to translate bad news flow in SA to an erroneous reaction that will damage your investment plans.
He focused on four key headings: narrative that President Ramaphosa has done nothing; Eskom challenges; South African economic prospects; and the rand outlook.
Ramaphosa started with rebuilding state institutions such as the South African Revenue Service, Special Investigating Unit and the National Prosecuting
Authority. Asset forfeiture and corruption arrests form part of that narrative. In the recent cabinet reshuffle, the biggest disappointment was no change in law and order and no clear lines of accountability for Eskom. (Party ideological fault lines are unhelpful in achieving a higher velocity of change.)
With Eskom’s R254bn debt restructuring, the National Treasury will take over the balance sheet and cash will go directly into debt servicing. With concessioning out of generation, the grid will be the core of new Eskom. National photovoltaic capacity is already at 4GW and he noted more private generation and renewable energy.
Supposedly Vietnam’s similar investment levels cleared its power problems in two years. (Let’s hope.)
Growth will struggle under stage 5 and 6 power cuts. Global growth seems supportive (including China reopening and the EU dodging deep recession), though a US landing is still in question. Government finances are stable (ignoring the S&P downgrade), big tax takes have been used to retire debt, and bond issuance is subdued. Inflation is controlled by the Reserve Bank.
The rand has traded in line with an emerging-market forex benchmark, but a gap has only opened up since load-shedding seriously got going in November. The basic upshot was that you ignore government bonds at your peril: nine-year bond yields are at 10.8% vs cash at 7.2% and inflation at 6.5%. The high starting yield provides an excellent underpin.
This position on South African bonds was not unique. Warren Buhai of Stanlib noted a preference for South
African bonds over South African equity on a riskadjusted basis. Lyle Sankar of PSG opined that South
African bond yields priced for two years of loadshedding at stages 4 to 6, whereas South African bonds almost never deliver a loss over one year. Preference shares are giving an 11% dividend yield.
Duncan Artus of Allan Gray sounded an important cautionary note on South African bonds — yes, they are cheap, but SA’s cost of capital keeps getting higher. (The country flailing from one selfinflicted crisis to another would do that).
Sankar’s discussion on inflation and bond markets noted that the US disinflation narrative is probably overoptimistic, and the Fed is still behind the curve. (This is the most hotly contested discussion point in markets today, and this conference was no exception.) He expects Japan to be the next key market to be punished. Core inflation is at 3.5% while bond yields are at 0.5% and the labour market is very tight.
Japan has a new Bank of Japan governor, trade and budget deficits, high debt to GDP and weak yen (a weak yen insults national pride). It’s a cocktail for trouble. He noted that US bond casualties tended to be big lenders to tech and crypto. That US President Joe Biden was looking to increase the US corporate tax rate from 21% to 28% was an unwelcome aside for me. (The handy bull market at the start of Donald Trump’s presidency was built on the exact opposite move in taxes.)
The presentation by M&G’s Krüger on “The skill to navigate uncertainty” said war, interest rate resets and the resurgence of social capital require changes in thinking. After pandemics, for example, labour tends to get the upper hand over capital. He said capital allocation in SA indicates attractive valuations.
South African share buybacks are at historic highs, and increasing (even if you set the Naspers/Prosus buybacks aside). Meanwhile, the first day’s proceedings came to a close when Artus asked whether investors or central banks should pivot.
The table here certainly supports the assertion that whatever worked for the past 10 to 20 years won’t work in the next 10 to 20 years!
It’s an energy-short, divided world, where we don’t know if inflation is transitory or secular. However, huge past credit creation allowed the creation of zero cost funding models which now need serious reassessment, such as business models like food delivery, where someone else’s savings subsidises your food delivery.
Higher rates are very bad news for geared assets. Artus said to watch out for risk to steel and iron from China gross domestic fixed investment. (The one comment he made that I don’t agree with was that ESG has peaked. The reason is that Mark Lacey of Schroders said at a presentation last week that the absolute best reason for green power is global oil and gas production. Alternative power is no longer a feel-good thing — it’s a necessity.)
In the recent cabinet reshuffle, the biggest disappointment was no change in law and order and no clear lines of accountability for Eskom