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The JSE delisting trend has continued unabated into the new calendar year as the investment pool on the local bourse continues to slide. There are several reasons for this, including political instability, burdensome listing requirements and a generally more favourable environment to do business as a private entity. As outlined below, Marius Strydom puts pen to paper on this issue and adds two more interesting reasons behind the pace of this trend. Foreign ownership and analyst coverage, both important characteristics of a healthy equity market, have been declining for the last few years. Is there anything that can be done to reverse this trend? – Justin Rowe-Roberts
Declining JSE offshore ownership and coverage weighs on market caps
By Marius Strydom*
While the JSE has staged a healthy recovery from the large Covid-19 declines it experienced in March 2020, there is little to cheer about when comparing it to other world markets, especially over the long-term. US markets have doubled over the past five years and from their Covid-19 lows while the JSE All-Share Index has done less than 10% and that in rand terms. The reasons why South African investors have had to be satisfied with substandard returns for the longest time are varied, including pedestrian economic growth putting pressure on earnings and a slew of credit downgrades pushing the country into junk status. There are however other factors that are making the situation even worse, namely a huge reduction in analyst coverage of JSE listed companies and a meaningful decline in offshore ownership in recent years.
Analyst coverage is very important for the JSE as it increases visibility, introduces and creates interest in JSE companies for existing and new investors and provides comfort for investors assessing the attractiveness of the market and its companies. Similarly, the JSE is very dependent on offshore shareholding to support the ratings of its issuers. SA exchange controls and strong domestic investment by the PIC and black economic empowerment (BEE) shareholders create a natural floor in the demand for JSE-listed companies that are domiciled in SA. This amplifies the importance of offshore investors and inbound portfolio flows in driving incremental demand for JSE stocks, hence the rating of the constituents of the bourse. Offshore investors, especially emerging market fund managers, are spoiled for choice when allocating their capital and rely heavily on analyst research among other screening tools in distilling their large investment universe to a manageable portfolio of stocks.
In-depth research by Austin Lawrence Gidon (ALG) and its partners of the top-80 locally domiciled JSE companies has highlighted a 26% reduction in analyst coverage since June 2018 and a decline in offshore shareholding from 39.5% to 36.0%, representing a loss of around R220bn in foreign ownership. This period also coincided with a meaningful decline in the rating of the JSE, with the ALSI PE declining from 12.0x to 10.9x, which is a significant discount to the S&P500 (26.1x) and the FTSE100 (14.4x).
Although many factors reduced the JSE’s attractiveness to offshore investors, we have seen analyst recommendations steadily being upgraded, highlighting the underlying value in the bourse. Using a one to five scale, where one represents a strong buy and five a strong sell, the weighted average recommendation for the top 80 SA-domiciled issuers according to Refinitiv improved by 11% over the three years, from 2.4 (mid-way between a hold and a buy) to 2.1 (just below a buy). However, the upgrades to recommendations coincided with a marked reduction in analyst coverage. Over the three-year period, the top 80 companies under consideration saw analyst coverage decline by a quarter from 632 analysts at 30 June 2018 to only 469 analysts at 30 June 2021 according to Refinitiv.
The decline in coverage was almost universal, with only the listed real estate sector increasing its number of analysts over the three-year period. On a relative basis, the main winners were real estate, food, beverages and tobacco, with the main losers being healthcare and chemicals.
Global bourses experienced an initial sharp decline in research coverage with the introduction of MiFID II in 2018. However, this trend was partially reversed as alternative research models, including sponsored research, started to proliferate. JSE issuers have been slow to adopt the sponsored research model, but this service is increasingly on offer. The meaningful reduction in JSE research coverage poses a serious challenge for the bourse and its issuers, although alternative research solutions may help to reverse the trend.
- This article has been created by ALG and its international partner, Edison Group, in collaboration with Singular Systems.
- Marius Strydom is the CEO of ALG.
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