/ 15 July 2008

Massacre on Maude Street

Headlines have focused on the fact that since May the JSE all-share index has fallen 16% from an all-time high close to 33 000. That is nothing compared with the massacre that has been taking place over the past year in the shares of companies that trade in the domestic economy.

Resource shares have surged ahead since last year — up 56% in the past 18 months — which has masked the fact that domestic shares such as banks and retailers have plummeted over the past year. Since their respective peaks Standard Bank, Absa and FirstRand Group have fallen dramatically, halving in price in the case of FirstRand. Massive retailers such as JD Group and Foschini are now worth a third of what they were in 2007.

The massacre has also hit industrial companies such as Imperial and Bidvest, both of which have halved in value. So while our market as a whole may still look expensive and this is not a time to invest in the entire all-share index, John Biccard, portfolio manager of Investec Value Fund, argues that there is unbelievable value in some domestic stocks.

In the past six months resources have outperformed banks by 60%, the highest level of outperformance recorded in such a period. However, while the banking sector has become more stable, resource shares have become more volatile.

Biccard says that the price of the banks a few weeks ago, before a moderate rally, indicated the bottom of the market, with FirstRand touching R12,80 and Standard Bank falling to R72. Biccard says that in previous cycles, banking stocks have always dropped to price-to-earnings ratios of six or seven at the bottom of the market.

Paul Hansen, director of retail at Stanlib, says that the banks’ current share prices could present a “once-in-20-years buying opportunity”, with dividend yields the highest in 19 years.

However, investors will have to have some patience. “There is no catalyst to get them going up at the moment … they are a medium-term buy. They won’t fall below [current] levels but we need something to go right, such as good news on inflation. This is not likely to happen in the next six months,” says Biccard.

The key to shares that are sensitive to interest rates is that the second the market gets a hint that the rate cycle has reached its peak and that the next move will be down, shares tend to re-rate very quickly. Investors who sit on the sidelines usually miss out on the initial run-up.

Kevin Lings, economist at the asset manager Stanlib, says he thinks there may not be a further rate hike in August. Although inflation figures will continue to rise for several more months, other indicators such as agricultural prices have begun to level off and producer food prices look set to follow. This will eventually feed into consumer food prices. The price of food in shops, which currently makes up 42% of our total inflation “basket”, should then start to rise less quickly.

Moreover, in January next year the inflation basket will be reweighted and Lings says this should reduce the inflation figure by 2%. He says inflation could re-enter the government’s target range by the end of 2009 without further interest rate hikes being necessary. Lings says the Reserve Bank should have some patience and wait to see if the previous rate hikes have been enough.

If Lings is right, this could be the catalyst that Biccard is waiting for. Lings also believes that the economy is unlikely to go into a recession. He argues that current levels of fixed investment will guarantee at least a 2% growth rate.

Even if fixed investment, which is driven by massive infrastructural developments such as the Gautrain and 2010 stadiums, slowed from its current 15% growth to 10% , this would still result in a 2% growth in GDP, as the sector makes up 20% of South Africa’s economy.

Where to invest
Hansen says a smart investment strategy right now would be to slowly invest through a monthly debit order into funds with exposure to property, financials, industrials and small caps — shares in companies with low market capitalisation. These are the sectors that are showing the most value and which would benefit the most from interest-rate cuts.

Top-value picks from Biccard include Standard Bank, FirstRand and African Bank, which is currently on a dividend yield of 11%.

His favourite industrial shares include Bidvest, whose share price has halved despite a low exposure to consumer spend and a strong offshore business, Steinhoff, which has 60% of its business offshore, and Tiger Brands, which has now dealt with its messy price-fixing shenanigans and is trading at the cheapest level in its history.

Although retailers carry more uncertainty around future earnings, Biccard favours Foschini and Mr Price. Even if Fishing’s earnings were to fall by 15% over the next two years it would still provide a dividend yield of 7%. Mr Price is a cash business with no exposure to the credit crisis, but nevertheless the share price has fallen by 60%, offering excellent value.