/ 14 December 2012

Investors take JSE by the horns

Stocks of companies in developing countries such as South Africa are being snapped up by savvy investors.
Stocks of companies in developing countries such as South Africa are being snapped up by savvy investors.

The top 10 JSE-listed performers this week were British American Tobacco, SABMiller, BHP Billiton, Anglo American, Richemont South Africa, MTN Group, Sasol, Naspers, Vodacom and Kumba Iron Ore.

Some of the biggest earners, such as British American Tobacco and Richemont South Africa, have no exposure to local markets and zero revenue coming from South Africa. It means the economy or negative press and downgraded ratings will not affect these companies. In short, some of the leading performers that have pushed the JSE to 17-year record highs have little or no exposure to the South African economy.

Market observer David Shapiro, of Sasfin, said SABMiller had only about 15% to 25% of its operation in South Africa, British American Tobacco  0%, BHP Billiton about 2% to 3% and Richemont South Africa also 0%. On the other hand, the bulk of Naspers's earnings came from its pay-TV division, but its market capitalisation came from Tencent, China's top internet company by market capitalisation, and Mail.ru, the largest internet company in the Russian-speaking world.

Quite a few of the companies that influence the top 40 have small percentages of their earnings coming from South Africa, but Shapiro does not see this as a lack of confidence in the country. "All the companies I have spoken to have indicated that they will remain listed here because this is their historical base. There are signs that, in years to come, we will see a move away from regional markets, so where those companies are based will no longer be significant.

"It was actually the South African stocks that dragged us down on the JSE, such as Telkom, ArcelorMittal and Goldfields, as well as the construction companies. Basil Read saw its share price drop by 35%, Aveng by 16% and Murray and Roberts by 17%. Telkom was down 48% and Astral Foods 18%," Shapiro said.

Cannon Asset Managers said a review of the JSE All Share Index showed that the highs were led by "relatively few shares". Bella Shongwe, speaking for Cannon's retail business development, said: "In the months where the index rises, only a few shares outperform the index. In months when it falls, the majority of shares outperform the index. This tells us that the bull market is driven by few shares, with most of them lagging behind the index."

Lower growth in developed economies such as the United States and Europe have led investors to chase higher returns in emerging markets. Andrew Newell, head of business development at Cannon, said: "Investors are looking for great opportunities that they cannot get in their markets and they need to find the next great thing. South Africa is still seen as the gateway to Africa with a liquid investment market."

Accurate average
Newell said the expansion plans of the JSE-listed companies into developing markets, or markets where there seems to be room for growth such as China, were an important drawcard. Cannon research showed that of the 79 firms on the JSE that were dual listed, 38% of their earnings came from outside South Africa. But this could exclude earnings from Africa because of the way companies report.

"When making these kinds of estimates, it's important to bear in mind that some companies report South African and non-South African revenue separately but others include Africa in the South Africa count, so it's hard to provide an accurate average, particularly for the top JSE companies."

According to analysts, the main drivers of the JSE's impressive performance are strong expansion plans into Africa or other emerging markets, limited exposure to South Africa by some top performers because their earnings come from elsewhere and confidence in leading South African companies such as Woolworths.

Investors like what they see in leading JSE-listed companies – little debt, good profit margins, record earnings, money in the bank and a strong focus on expansion into emerging markets.

This includes the banking and retail sector. Many of these top companies have directed their growth strategy towards emerging markets – African, Asian and the Brics (Brazil, Russia, India, China and South Africa) or South America. These include MTN, Naspers, Mr Price, Woolworths, Sasol, Shoprite, SABMiller, Old Mutual, Absa, Discovery and Sappi.

Stanlib chief economist Kevin Lings said bigger companies had realised the need to diversify and were constantly striving to do that, so in that regard South Africa's top companies were not unusual. "Companies that have been successful in diversifying are Old Mutual, Shoprite and South African Breweries, and MTN has been very successful in emerging markets.

Commodity boom
"At first glance there appears to be a disconnect between newspaper headlines, which are all about political uncertainty and things like increased electricity prices, and the good performance of companies on the JSE," said Lings.

"In the United States there are fears of a double-dip recession; there is the fear of the break-up of Europe. In many cases, companies are doing well but economies have not done as well, so fund managers, pension funds and the professional investor will follow the earnings. They will look at how companies are doing, how indebted that company is, or is that company vulnerable – and the answer is that South African companies look very good. They have very little debt, most have lots of money in the bank, good profit margins and are seeing record earnings."

The JSE's record-breaking runcomes despite the fact that commodity prices are somewhat lower than during the commodity boom.

Shapiro said the resource sector, "with the exception of BHP Billiton which has little exposure to South Africa", did not perform as well relative to other top JSE-listed companies. The political and policy climate, to some extent, as well as the view that there are lucrative expansion opportunities in developing countries as well as Asia and Australia, have seen companies being more conservative, choosing not to expand in South Africa or increase the number of people they employ. This means South Africa's much needed jobs will not come from large corporations.

The positive side of expansion is that it is a boon for pension funds and wealth managers as well as a return of money through dividends. But Shapiro warned that shareholders might not benefit for a while from the expansion of local companies into African markets, because profits might initially be used to fund that expansion.

Government indebtedness
Newell believes the JSE top 40 are expensive and may not reach the growth targets that is expected, which may result in a backlash as disgruntled investors go elsewhere. His suggestion is that investors look at the smaller listed companies, because there is still value there.

For Lings the concern is that the government, rather than the corporate sector, is driving employment. It is being done through increased government employment and grant systems, which is providing the spending money being used by consumers to support local companies. "Companies in South Africa have taken a very conservative position. They are not expanding here or employing people, but they still benefit from the money being paid out by the government – which consumers are using to buy things."

Lings said this was not sustainable and increased government indebtedness could lead to the government being downgraded once again.

"There needs to be some kind of catalyst to encourage companies to expand in South Africa and employ people. This would probably be less rhetoric and more certainty for companies and a real move to gear up the infrastructure programme."

He believes the performance of JSE-listed companies in South Africa will be seriously affected should the government cut down on spending and the consumer runs out of unsecured credit.




Pick of the rest


It is not that there are not a lot of good small-cap and micro-cap companies on the JSE, according to Canon Asset Management's Andrew Newell. It is just that they are not receiving the same attention, even though they are actually better priced.

Sasfin's David Shapiro said that some of the best performers were neglected because their contribution was so small. "The top 40 have a huge weighting on the JSE, so the influence of international stocks is greater than local economy stocks. Woolworths, for example, is doing very well with an 80% increase in share price, but it actually has very little influence on the overall index and the same can be said for some companies in the financial sector."

Cannon's Andrew Newell said the composition of the stock exchange had also changed. "It used to be dominated by resources and now there is more interest in financials and industrials. This is not surprising because most retailers, in particular, have growth plans in Asia and Africa, which is seen as a very positive factor."

Shapiro said there had been a big foreign investment appetite for retailers and therefore growth in the share prices of Woolworths (80%), Truworths (33%) and Mr Price (66%).

"The management of our retailers is world class and they have done well, with the exception of Pick n Pay, where managers are trying to turn things around, but they came in a bit late with a good business plan."

Shapiro said healthcare companies such as Life Healthcare (with its share price 50% higher) and Netcare (23%) had also done well, as did most insurers, including Liberty (33% higher) and Old Mutual (43%).

However, every story has a cautionary tale and the JSE performance might not be sustainable for a variety of reasons. Shapiro warned that labour legislation and poor infrastructure could affect growth. "Retailers may find that high wages and other issues may see them being less competitive, which will make it harder for them to compete with foreign competitors."