Troubled South Africa Spells Opportunity for Investors
Despite its sluggish economy, the country offers attractive stock picks from a corporate sector whose earnings have outpaced GDP growth.
At first glance South Africa looks like an unpromising investment prospect. Economic growth is tepid, with most forecasters calling for expansion of just above 1 percent this year. At 6.2 percent of gross domestic product in the second quarter, the country’s current-account deficit is the highest among the Fragile Five, whose other members include Brazil, India, Indonesia and Turkey; these emerging economies are deemed at risk of crisis as global monetary tightening makes it tougher to fund such imbalances.
“South Africa’s major growth problem is an export problem,” says Nazmeera Moola, economist and strategist with the emerging-markets fixed-income team at Investec Asset Management in Cape Town. “The country didn’t take advantage of the commodity boom because mining regulations meant that production was constrained.” Comparing South Africa with the U.K. during the 1970s, Moola says it has strong financial regulation and corporate governance but too much state control.
Other investors agree that politics lie at the heart of the country’s malaise. “South Africa has a lot of potential, but this is unfortunately completely mismanaged,” says Max Wolman, senior investment manager for emerging-markets debt at $550 billion Aberdeen Asset Management in London. Wolman blames a lack of reforms by the African National Congress, the dominant party since apartheid ended in 1994. “This is a big political power which has to keep everyone happy, so South Africa ends up with the status quo” — one that is unsatisfactory, he asserts. For example, industry faces electricity shortages because the might of state power company Eskom makes it hard for independent producers to build plants. In March, Eskom asked industrial customers to cut energy use by at least 10 percent in response to widespread blackouts; big companies switched to generators, but many smaller enterprises had no backup.
Still, there are good reasons to bet on South Africa. Moola of $123 billion Investec puts the sustainable long-term growth rate at 2 to 2.5 percent, low for an emerging market. But she believes the government could raise it to between 3 and 3.5 percent, largely by loosening regulations to boost exports. There are already plenty of policies that guard investor rights, Moola notes. In the World Bank Group’s ease of doing business index, South Africa ranks tenth in protecting investors.
One motivation for investing in troubled economies is that poor macroeconomic performance is already priced into stocks, presenting good bargains. This isn’t the case for the South African equity market overall, says John Chisholm, CIO of Boston-based, $63 billion Acadian Asset Management. At 20.5, its trailing price-earnings ratio is far above the emerging-markets average of 13.2, he notes. “From a valuation perspective the market is not particularly cheap,” says Chisholm, whose firm is slightly underweight South Africa. However, he does like stocks such as Sasol, the energy and chemicals company, now trading at a P/E of only 12.9; and Standard Bank of South Africa, which offers an attractive dividend yield of 3.6 percent.
Bond yields for local-currency debt are also high in South Africa, reflecting fears about the current-account deficit. Investors in its sovereign bonds acknowledge the risk-reward trade-off. Economic mismanagement will persist for the foreseeable future, Aberdeen’s Wolman predicts. But the rand is stable — the currency has traded at between 10.4 and 11.4 to the U.S. dollar for most of the year — and debt is worth the risk, he says. Although scarcity and high demand make South Africa’s dollar-denominated debt expensive, the yield on ten-year local-currency sovereign paper is 8.25 percent.
Another draw: Like some of their peers in beleaguered Japan, many South African companies have become detached from their home country. Investec’s Moola highlights the anomaly that corporate earnings have been strong despite the nation’s weak economic growth in recent years. “This might not last forever,” she warns, pointing out that there should be some relationship between corporate profit and nominal GDP growth. “But if an increasing proportion of profits comes from overseas, this can be circumvented.”
Moola cites South African companies’ growing presence in other African markets and beyond. Johannesburg-based MTN Group is Africa’s biggest cell phone operator, for instance. Aspen Pharmacare Holdings, the generic-drug maker, earned 71 percent of its operating profit internationally during the past fiscal year, when Asia-Pacific was its top revenue-producing region. Even if South Africa fails to excite, its multinationals can dazzle abroad.
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