South Africa's surging stocks and sluggish economy
While Johannesburg is home to at least a dozen companies that boast world-class management teams and an uncanny talent for squeezing out shareholder value, the latest surge in equity prices raises hard questions about Africa’s top economy
Once again, South African stocks are on a tear.
Drawn by earnings growth, fat dividends and expectations of further Africa expansion, investors — particularly foreign ones — have ploughed into Johannesburg’s retailers, banks and industrials, sending the All-Share Index to another series of record highs.
While Johannesburg is home to at least a dozen companies that boast world-class management teams and an uncanny talent for squeezing out shareholder value, the latest surge in equity prices raises hard questions about Africa’s top economy.
The outlook is tempered by a raft of structural problems: woefully high unemployment, inadequate power supply, a volatile currency and a government that can’t quite seem to quell talk of nationalisation.
It is unclear whether investors have accurately priced big chunks of the equity market — especially recent favourites such as retailers — given the nagging macro risks.
"I think there’s a total mismatch between what’s happening in the country and the pricing," said John Biccard, who runs Investec Asset Management’s value fund.
"The story the foreigners buy is that South African consumer companies are in a structural up market; that there’s been a structural change, which is of course entirely fictional."
Instead, Biccard reckons that the growing spending power of many consumers comes from two places: higher government wages and grants, and the massive increase in unsecured lending to low-wage earners.
And with many reliant on South Africa’s sprawling mining industry for jobs, the outlook for consumers could worsen if commodity prices fall further.
Over the last 12 months nearly 50 shares on Johannesburg’s All-Share index have gained more than 30%, with retailers posting some of the most gravity-defying performances.
Woolworths, which sells clothing and high-end food and is eyeing further expansion in Africa, has clocked a stunning 70% increase, while discounter Shoprite has increased 60%.
Both are trading at heady price-to-earnings (PE) ratios: Woolworths at 26 and Shoprite at 33.
"These businesses are overarchingly being driven by international sentiment rather than domestic economic reality," said Adrian Saville, an economist and chief investment officer at Cannon Asset Managers, about retailers.
But Saville is quick to point out that while portions of the market are at inflated PE ratios, the index itself isn’t.
The All-Share is currently trading at around 13,3 times average earnings, according to Thomson Reuters data, well below its recent historic high of near 18 times in early 2010.
The South African Reserve Bank cut interest rates to a 40-year low last month and trimmed its 2012 growth forecast to 2,7%.
Finance Minister Pravin Gordhan has since told Reuters that growth could come in even lower.
That’s especially troubling when the government says it needs an annual GDP increase of about 7% to make a meaningful dent in unemployment, currently hovering at around 25%.
But even low growth is still growth, and gradual economic expansion usually translates into rising per capita income, more spending and therefore, higher corporate earnings and an increase in stock prices.
And for investors in much of the developed world, South Africa’s slow growth is a better prospect than what they can get at home.
"Whilst growing at 3% is nowhere near what South Africa requires, it’s in the right direction and it’s ahead of population growth," said Saville.
"South Africa hungers for 6, 7 or 8% growth, but global investors will take 3." - Reuters