Key topics
- SA equities offer better value than Nenegate & Ramaphoria-era opportunities.
- Political risks remain, but ANC reform and the GNU signal a shift.
- Foreign policy tensions pose the biggest risk to investor confidence.
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By Simon Sylvester
Are South African Inc Equities cheap for a reason, or is the noise creating an excellent buying opportunity? SA Inc Equity is offering better value than Nenegate, at a better than Ramaphoria opportunity with lower political risk given the formation of the GNU and crumbling of hard left politicians. The below chart shows the average price earnings ratio for a custom basket of equal weighted SA focused companies listed on the JSE, and while simplistic, should be enough to make it worth digging into the details of the risk vs opportunity.
The negative sentiment in South Africa, exaggerated by US foreign policy and the delay in the SA budget, appears to be swamping investors’ thought process, resulting in Rand weakness and SA Inc Equity suffering a significant drawdown year to date. Between the Expropriation Act, Bela, US Trade and foreign policy tensions and AGOA, and the risk of the GNU falling apart, it might feel like the hope of last year was just a passing mirage. Indeed, emotions can run high as South Africans, and we have had to deal with a lot since Nenegate 10 years ago, but cutting through this emotion and looking at the facts exposes an investment opportunity in SA Inc equities offering roughly 15%+ returns through earnings growth and dividend yields, with upside from any potential rerating. Government bonds are offering returns of around inflation +6%. These are broadly consensus numbers, not some starry-eyed marketing pitch from a portfolio manager (we think our stock picks in SA Inc equity can return closer to 20% at lower risk and higher quality than the average).
What’s the risk, and why is SA Inc so cheap? Every investment case needs a counterview, and the weight of this counterview leans heavily on the current political risk largely excluded from the growth expectations mentioned.
The Evolving Political Landscape
Core to our argument is that the GNU is a symptom of internal ANC reform, a move within the ANC towards pragmatism and more centrist policy including private sector participation. We do not view the GNU as the protagonist but more the result of a long fought internal ANC battle. Eskom was fixed by the private sector and the ANC before the elections – the ANC realising their need for skills and capital from the private sector is a major shift.
South Africa has been working itself out of falling into the precipice of a failed state since Nenegate. It has been a long, tough and still incomplete journey for those within the political fight, be they business leaders, journalists, or even politicians. The best investment strategy over this period has been offshore, and the make-up of the JSE market capitalisation indices bears the scars of many years of no growth and deratings.
We have been cautious since Nenegate, unconvinced through the peak positivity of Ramaphoria. At that time when commentators were saying ‘the plane is about to take off for South Africa’, we argued it was in a ditch next to the runway. First Ramaphosa had to fix the ANC before he could fix the country. But the political landscape has now changed with sufficient confidence that our view also has to change, and failing to see this means failing to see the opportunity that lies ahead. Distracted by the noise, one can fall into this trap, and waiting for certainty means missing out on excellent risk adjusted returns. The plane is now on the runway, 7 long years after Ramaphosa’s election.
Evaluating policy risks and laws
The risk of a failed state was a bigger risk than anything we are currently dealing with, and the protagonists of the policies that would have taken South Africa down this road are now crumbling. Property rights are now more secure than eight years ago, even with EWC, because the political hard left has been decimated.
The law is one thing, political power is another.
As political power is changing, so too should our risk assessment on how laws might be implemented.
Furthermore, there is a good argument that these contentious acts, and the pushback they are receiving is the weaponry that Ramaphosa can use against his political opponents to further strengthen the reform within the ANC. It may be better to wait a bit longer before fixing some of the issues, and the ANC might prefer to focus first on the ‘restructuring’ in Gauteng and KZN. NHI is already on the drawing board, and is probably the most flawed of the three, it is only the severe implausibility of it that reduces angst.
The issues do not seem to be what is written into the Bela and Expropriation acts making the current headlines, but rather what is said outside the law. The intent of land redress, the tense political discourse, what has been said in the past by politicians about land reform, attempts at changing the constitution. This is all the subtext. Arguing that ‘just and equitable compensation while considering public interest’ will lead to capital flight and a failing economy must rest more upon a substantial distrust of the governing authorities adjudicating what is just and equitable than simply the law as it is written. Similarly, government involvement in education (having some oversight of School Governing Bodies and taking the language of the community into consideration) would only be a major risk if the intervention is unfair and discriminatory, again the problem sits more with the authorities than directly with the law itself.
South Africans have good reason to question and distrust. The history of these debates and political fights is important, and some strong opponents of these contentious laws are patriotic South Africans who have been fighting ardently against corruption, criminal levels of incompetence, state capture etc. The ability of these good people to change gear must be difficult, and arguably not necessary – but in the investment world, flexibility, adjusting to the facts, is essential. Before the GNU the risk was extremely high for SA focused equities, and return expectations much lower – this equation has shifted dramatically.
Understanding where we are as a country now needs the context of the past, first to avoid naivety as investors, but more importantly to step back and put yourself in Ramaphosa’s shoes. With the hand he was dealt, controlling maybe half the ANC (itself losing support): what would be the best path for South Africa? Completely shutting down NHI, Bela, EWC and siding with the DA? Well then you might be hoping for a country run by those defeated politicians on the extreme left now struggling for political relevance. Justified mistrust of the ANC requires this context, and there is a lot of good work now being done that is not getting sufficient recognition. It is difficult as investors to adjust, offshore has worked so well both directly and via the JSE. South Africa is now in a much better position than some years back, but there is still a lot more to improve upon, and it is going to be tricky to navigate out of some of our past mistakes (especially the foreign policy ones).
Foreign policy tensions
South Africa’s foreign policy could be regarded as a disaster at best, and hopefully Joel Pollak is appointed and can help South Africa with a bit of the tough love it deserves in this area. The foreign policy grandstanding taken by the ANC, arguably to desperately win local support at a time when the US appeared softer towards SA, could come back to cost the country. We see this risk as the biggest by far compared to Bela, losing AGOA, expropriation etc. There are many available offramps to de-escalate, and maybe even opportunity to partner. We must remember that everyone is getting the ‘Trump Treatment’, and in some cases the issues are more structural in other countries whereas our issues can be solved politically. The US wants to draw Africa away from China more than it wants to get involved in local skirmishes. Even Russia is being offered a chance of forgiveness. Surely it is clear that the only reason someone like Joel Pollak would consider taking the job is if he can help South Africa while putting America first – in a transactional US government there is certainly upside to this appointment if the ANC can be flexible enough.
Final thoughts: Noise, opportunity and risk
As is normal when some bigger issues arise, some other non-events join the party. Losing AGOA for example is not a major issue on its own, although some kind of escalation would be. AGOA is very small, mostly relating to auto exports, and the US Auto import tariff ex AGOA is 2.5% – about the same as the volatility of the Rand. There are also worries about the GNU falling apart – we think it is getting stronger not weaker: the fighting is a basic requirement to keep it functioning. The risk is not zero, as is seen with uncertainty on passing the budget at the time of writing. It will take time for the ANC to learn more flexibility, while parties formerly known as the opposition learn to reduce their temptation for brinkmanship and grandstanding. Even mature democracies struggle with these types of issues. With the EFF and MK out in the cold, the DA surely are not interested in giving them their nice warm seats.
The time to panic is not now, it was last year and the years prior.
The risk was massive then: a substantial part of the population has been disenfranchised, and populism sells well. While this risk has substantially faded, it is still embedded in the price of assets, and base effect in earnings and growth. Exaggerated noise and overreaction to headlines provides the all-important counterview, creating exceptional value for those willing to take the unemotional longer term perspective from here.
Now is the time to step back and look at the opportunities ahead.
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