Listen to the show here:
Description:
The GNU dawn is all the rage in South Africa, but what does this mean for portfolio strategies? In this show, Mohammed Nalla and The Finance Ghost add to the market discourse around the South African opportunities with a sobering view on some of the macroeconomic indicators, coupled with highly practical thoughts on what to be careful of in the equity market as part of a broader GNU play.
And of course, there’s a particular sector that the hosts put on the table as a potential winner in a GNU-driven recovery story.
To enhance your understanding of the market and get views that you might not hear elsewhere, this is a great episode of Magic Markets.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
Full transcript:
The Finance Ghost: Welcome to episode 182 of Magic Markets. And as we’ve done on some of our recent shows, I think we’re going to do some quite South African-focused stuff on this show. Obviously we always make mention of international context. I think above all else Moe, that’s our brand promise on Magic Markets, just help our listeners lift their heads to what’s going on in the world around them, because we just can’t stress enough how important that actually is. But today, a little bit of a focus on, I guess, this exuberance around South Africa and how real it is, how to play it, and what some of the things are to look out for.
Mohammed Nalla: Indeed, Ghost, and I think we’re cheekily calling the show New Dawn, or should I call that GNU Dawn? Government of National Unity is a little unwieldy to put out there, but a gnu, I think that’s actually a type of buck. So GNU dawn, if you want to call it that. And Ghost, I’m going to jump in because I want to just offer some high-level insights in terms of the president’s announcement over the weekend, some thoughts on the cabinet and first and foremost, whilst it’s not surprising that the announcement was delayed by about 50 minutes and I’m sitting here, it was a Sunday afternoon for me, just waiting. That’s not a great look. If you want to actually signal that this is in fact a new GNU dawn – let’s call it that – you want to actually start that on the right note. Sticking to your time, that certainly sends a message to the international community and to South Africans in general. So that late start a bad look, but let that not detract from the actual substance.
My high-level thoughts first and foremost is that this is a massive cabinet. I mean, when President Ramaphosa first assumed office, his promises were A, sticking to time. Well, he failed on that one. The second one was looking at trimming down what is probably one of the most bloated cabinets in the world. And unfortunately, now he’s got some cover, right? He can say we’ve got to accommodate a larger cabinet, because we’ve got to accommodate our coalition partners. I still see this as a missed opportunity to try and consolidate some of those portfolios and just placing the right people in charge of what should be much more consolidated portfolios, in my view. That’s not what we saw. Then some high-level thoughts on just some of the appointments. We’ve got Minister Mantashe, who’s still in the mining space. And unfortunately, I’m starting off on this one because he’s been seen as particularly unfriendly to markets. He’s bad for the investment thesis around mining. And so seeing him exist in that portfolio is not a great look for that particular segment of the economy, for that particular industry. I certainly don’t give that a thumbs up. But then some of the things I do give a thumbs up is that electricity as a portfolio. That’s a new addition. I think we’ve got some consistency come through there. And again, based on the results of the last few months, quite surprisingly, I must say, there has been some momentum, there has been some progress. So I give that a tentative, and I say tentative, thumbs up.
We then also have, interestingly enough, the Ministry of Public Enterprises, which is gone. That has now been rolled up into the presidency. And again, based on track record of other functions that have been subsumed into the presidency, I would say not a thumbs up, probably a sideways thumb here. I’m really channeling my Gladiator. It’s either thumbs up, thumbs down. This particular one, public enterprises, is where electricity used to sit. So it does probably make sense to wrap some of that up into the presidency as a transition to actually get accountability at several sub-ministries. But again, let’s see what the track record actually delivers there. Then a thumbs up on finance, we’ve got some continuity coming through there with Minister Godongwana and Minister Masondo coming through, as well as an addition from the coalition partners. So I would say thumbs up on the finance ministry. But in aggregate, this cabinet, not as awe-inspiring as one would have expected. Lots of news flow around it, and this ties into the market reaction. If you have a look at the market reaction this week, it hasn’t been this rampant exuberance. And perhaps some of that is because a lot of optimism was priced in. If you had a look at South African asset prices – not just equities, go and have a look at bond yields, go and have a look at the rand – we’ve touched on that. I cover the rand in particular in another segment that I cover, which is Macrotech Research. And we were actually saying around two weeks ago, some of this optimism looks as though it’s overbaked. That’s starting to bleed back into the market right now. We’ve seen some rand weakness after the announcement, and maybe it’s just the market saying, you know what? Buy the rumour, sell the fact. Not that inspired by it. Let’s see where the dust settles on this one, Ghost. But for me, very tentative thumbs up on very limited aspects of this new cabinet announcement of the GNU dawn, if you want to call it that.
The Finance Ghost: I was so excited to tease you for referring to a gnu as a type of buck. But irritatingly, you’re right, because I Googled, it is actually a type of antelope. It’s a wildebeest, right? And actually it’s pronounced “noo”, even though everyone is now saying gnu to try and differentiate it from the new dawn we had last time, where President Ramaphosa was walking around in Sea Point and everyone got stoked, now we have a world where he’s busy appointing ministers and everyone got stoked all over again. And people don’t learn that these things take a lot of time to fix. It is not as simple as you just go and appoint a new minister and now magically we wake up tomorrow and the infrastructure investment is absolutely fantastic and the corruption’s gone. Look, I can’t explain, no one can really explain the electricity. But it seems to all be amazing. Why it wasn’t before, I don’t know. Maybe one day we’ll find out in a book or whatever the case may be. Sucks to be you, if you sell solar panels, you are not having the year that you expected to have at all. It’s nice to be me with no solar panels on my roof. I must be honest, I kind of hoped that this day would come where at some point it would just be all right. So sometimes things are fixed overnight. I guess that is true. Other times they just aren’t.
And I think you raised the important point there, which is the way the market behaves. The market loves buying the rumour and selling the deal. We know this from M&A, we now know this from politics. I mean, as we record this, the JSE’s not had a great day today. You can’t read too much into a one day move, you definitely can’t. But you can read a lot into going and looking longer term. And I’ve written in the past couple of weeks for a couple of publications about how my trip overseas really just helped with some context around what it’s like on the ground for business owners.
The stuff that they are focusing on, the stuff that we are focusing on; they are investing in artificial intelligence and automations, and we have been investing in water and solar and these extreme basics that are basically really just an extra tax on our businesses and our economies. And this stuff, again, does not turn around overnight.
So there is a lot of bullishness all of a sudden around South African stocks. And people love to draw very clever charts about how cheap it all is down here and everything else, but it’s just not that simple. I think you have to be aware of just what’s around you. It’s not difficult. Go speak to business owners in South Africa. Their life didn’t get easier magically in the past week.
Mohammed Nalla: Yeah, indeed, Ghost. I want to get into some of the potential opportunities that exist in South Africa, because I was speaking to someone just a couple of days ago, interestingly enough, this was someone who had externalised their money sitting out here in dollars, and they had said they were looking for compelling investment opportunities and actually returned some of that money to South Africa. I was quite perplexed by this, because that’s usually the other way around when you’re speaking to international investors, certainly South Africans who have been externalising their cash, just looking at what some of those high opportunity segments are in South Africa. And I’ll cover this from a macro perspective, but I want to hear what your thoughts are from a listed perspective, from some of the opportunities you’re seeing on the ground.
First and foremost, I want to always say that agriculture has been a standout opportunity for South Africa, because South Africa has generally good weather. Okay, yes, it is a little bit water-stressed, but I always see South African produce at my local grocery store and it’s great and the quality is fantastic. And then if you have a look at South African meats, for example, those are well-renowned. If you have a look at the quality of our meat, so I would put agriculture fairly high, and I would say not maybe at the top of my list, but fairly high on that list as a potential sector that requires investment in South Africa. Now, you need to get a lot of building blocks right here. There’s obviously lots of question marks around land reform and the like, but as an export industry, agriculture does stand out for me. But it also stands out because it is a sector that absorbs a lot of labor. And that is what South Africa requires. You’ve got to get employment to tick up so that you can actually see the spillover, the multiplier effects come through to the South African economy. Then if we actually dial that up to the next level of the economy, let’s move away from primary industries. I’ll just offer one last comment on primary industries: mining. We’ve touched on mining. That tends to be a bit of a sunset industry in South Africa. A lot of the ore bodies are quite mature. Some of the less mature bodies, for example, if you’re having a look at PGMs, well, PGMs are suffering now because the world has moved beyond catalytic converters. They’re now focusing on EVs, they’re focusing on hybrids that use a lot less PGMs. And this unfortunately takes the wind out of the sails of the one segment of mining that still probably had a bit of potential sitting there.
Then let’s look at the secondary sector of the economy. South Africa is noted as being one of the countries globally that prematurely de-industrialised, because the natural progression is you move from primary industries into manufacturing and thereafter into a services economy. And with South Africa, we’ve got the primary industries, then we’ve got a reasonable service economy, but the industrial segment is sorely lacking. And this is a missed opportunity, in my view, because South Africa does have access to cheap labour. Maybe you don’t have access to power, but if they can fix that, and if they can fix the ports, South Africa is primed as a really strong location to actually produce goods at a low cost globally. No, it can’t compete directly with China, but it can become a regional champion. And I see this as a high potential, but currently a missed opportunity.
And then lastly Ghost, services. South Africa does have world class financial services, and we could probably touch on some of that, but that’s usually where you see the impact come through. This optimism filters very quickly through into the financial segment of the market, and then you also see that volatility, and potentially you see some of that coming back if that optimism starts to fade. Ghost, I’m keen to use those as a couple of launching-off points to hear your thoughts on what the on-the-ground experience looks like.
The Finance Ghost: Look, there’s a lot of really good points in there. I think some of the stuff I want to raise is first and foremost, just be careful of rand hedges on the JSE. So you go and plow into these listed equities thinking, oh yes, the rand and South Africa, and then you lose money because actually a lot of these businesses now make more of their money offshore than anywhere else and they’ve actually benefited from rand weakness. So that’s a crummy outcome. If you go and you buy rand hedge by accident because you are bullish South Africa, you’re not going to feel great about your life, unfortunately. And if you’re in an exchange traded fund, if you’re buying the index or whatever, just check the top exposures, because again, you’re probably not buying as much SA Inc. as you think you are, because of what’s happened in the past ten years, where actually the biggest companies on the JSE don’t make much of their money here in South Africa. And that’s how you end up in a scenario where you have very high quality businesses on the local market trading at these big PEs of over 20x. Those are not the sort of SA Inc. cheap, exciting trades that people are talking about in the past couple of weeks and getting excited about. Instead, they are talking about your classic South African small and mid caps, businesses that are operating here and have been trading, generally speaking, at very modest multiples.
And modest is of course a debatable point. People will point to a price earnings multiple of say, ten and say, okay, that looks kind of cheap. That’s a 10% earnings yield. Now, if those earnings don’t grow, you are taking on equity risk to basically get a government bond-level return. So you wouldn’t buy that unless you believe that those earnings are going to grow at a decent rate. So you need to look at this and say, what are the catalysts for growth from here? Now, I’ve obviously listened to a couple of podcasts in the market over the past couple of weeks and read some articles and a lot of the same names come up. People get excited about companies like Afrimat, for example, and Raubex and some of the more real economy, are-we-going-to-be-investing-in-our-country types of stocks. And I think that’s great and I understand the reasons why people are looking at that kind of stuff.
But you’ve also got to remember, if you’re buying it on a relatively high PE already, a lot of stuff needs to go right in order for you to really bank good returns, because the sentiment is going to swing around. And ultimately what matters, is has the company grown its earnings?
So have a look at the business. Don’t just go and blindly buy South African small and mid caps. Go and actually unpack why they make money and how they make money and how will they do better. So for example, one of the local stocks that I punted on recently, which was a bit of a swing trade to be honest, and its worked out was SPAR. I had to be a bit brave because I actually had to buy it twice to get the price that I wanted. But I checked now and it’s up 18%. It’s probably time to let that one go. So that’s a good example of where this increased sentiment has really helped me on a stock that has been in quite a lot of trouble and scored own goals left and right. But now suddenly the market’s quite happy about that. So I’m okay then to sort of take that swing trade. I’ll probably take profit on that and say goodbye.
Something that I’m happy to own for a much longer period of time is a business like Zeda. So not z-e-d-e-r, but rather z-e-d-a as in the mobility business, the car rental thing that was spun out of Barloworld. The reason I bought it is because it is dirt cheap. It is genuinely on a super low earnings multiple. So when we start talking PEs of like three and four, we’re then starting to talk very low multiple businesses. If something’s on a PE of four and it doesn’t grow its earnings at all, it’s still giving you an earnings yield of 25%. Now, I don’t know about you, but a 25% return, that works for me. I’m not going to be too upset about that. If you’re buying on a PE of ten, however, you need the thing to grow. So I’ll stop there, Moe, because I’ve covered quite a lot of ground and maybe you’ve got a question or two on that, but I think those are my main points, is watch out for the rand hedges. If you’re in an ETF, just check your exposure. And then when you are looking at these JSE small and mid caps, just understand what cheap actually means. A ten or eleven PE, it’s not that cheap.
Mohammed Nalla: Yeah, I think some very valuable points there Ghost, because you’ve got to look at what the underlying drivers of the earnings are. I mean, to your rand hedge point, a lot of the companies that are listed in South Africa that might be rand hedges, that have international operations, a lot of them have had mixed success in the geographies that they’ve gone and tried to actually attack. I mean, we’ve had significant headwinds in Australia, you’ve had significant headwinds in the UK, you’ve had significant headwinds in the rest of Africa. And that starts to actually impact what was then effectively a reasonable performance from the underlying South African businesses. So I think your point on rand hedges is definitely well made.
And I would argue that if you’re looking at diversifying away from the rand, make that a distinct investment decision. Diversify away from the rand and then consider international stocks. And again, that’s maybe talking our book a little bit here at Magic Markets Premium where we cover international stocks. But then talking to your point around multiples, yes, when you’re looking at a ten PE, that certainly looks compelling, but then you’ve got to look at what’s the underlying growth. And the fact of the matter is if you actually scratch and look hard enough in the international markets, you can actually find global stocks at similar multiples that the South African stocks are trading at, but with arguably better growth prospects. So those are some of the dynamics that I think are quite important.
What I want to touch on though, Ghost, is – and again, I want to get your view because you’ve given us some interesting pointers in terms of underlying stocks – if I just reflect on some of the other discussions I have in the unlisted space of the market, certainly with investors up here, the emphasis from South Africa’s perspective is going to have to be on infrastructure, because South Africa has to get the building blocks right. It’s not just energy, you’ve got to get logistics right, because you’ve got to actually get the goods that you produce, that you still produce and might produce in the future, you’ve got to get those to ports and you’ve got to get those to export markets. And so I think if I’m going to be looking at this from a macro perspective, some of the metrics I’m going to be watching over the course of the next couple of months, maybe couple of years as well, to see and to gauge the success of this GNU is what’s actually happening on the trade front, because it’s not all bad news. South Africa coming out of the pandemic had some current account surpluses. We actually, that’s largely premised on trade surpluses, now it’s been a combination because remember, it’s how much do you export, but it’s also how much you import. So yes, South Africa imported a lot less. That certainly helped on the trade surplus side of things. But I’m going to watch that in tandem with what you call terms of trade.
Now, terms of trade as a concept is effectively what are the price of the goods that you’re exporting doing versus the price of the goods that you’re importing. And you want to actually see that move higher. And that’s really a product of are global trends helping or hurting you. Because South Africa – let’s not mince our words around this – South Africa is a price taker in pretty much any market that it operates in. It’s not setting the global price rather than taking the global price. So you’ve got to look at the interplay between trade performance that’s just really getting your goods to port, getting into export markets and what’s happening to the underlying price of those goods. And then I want to touch on a very, very important point, because we’ve spoken about the optimism and how it comes and goes. And I see this as the pendulum swing, right, is because people get very excited, then they get disappointed. But when you look at that over the longer term, a lot of your softer data prints your confidence indicators, for example, or the leading economic index, or if you look at PMIs, purchasing managers index, if you look at those, those have not yet reflected some of the optimism that comes through. And as that optimism maybe develops into realism, there should still be some net benefit in terms of just spurring investor appetite, spurring corporate balance sheets into action in South Africa to actually invest in capacity. And this is going to be tied to delivery. So you haven’t yet seen it come through in terms of those confidence indices. But if it does eventually come through, that spills over into consumer confidence, which then hopefully spills over into consumer spend, which is then intrinsically linked to – these things are all linked – if the rand does well, that brings inflation down, it increases disposable incomes, and then only then do you start to see the uptick come through in terms of the underlying consumer, consumer spend and the retail side of the market. So, Ghost, I’m going to leave you with those and hopefully get some comments from you in terms of just a segmental view on how do you see this playing out over the course of the next couple of months based on those underlying segments, export performance, and then eventually the end result being consumer spend.
The Finance Ghost: For sure. I mean, you have to hope that things like industry will start to kick into action again. And where we’ve seen some companies have managed to keep the lights on and do quite well based on their B2B operations and their industrial side, but their consumer durables side has struggled. So what you’d certainly hope to see is if we can get a bit of a kickstart in the industrial side of the economy, that filters into better B2B performance, which then leads into more wealth in general, which then trickles into consumers, which then lands in a better B2C kind of durables play. So that’s the hope of course, is that at the end of the day, you have a better GDP, and that means GDP per capita starts to go in the right direction at some point and perhaps South Africa starts to march towards prosperity.
But of course it’s not that simple. And in the meantime the markets will go up and down. But looking at sectors that I think are worth considering, I really think that the best place to play this could end up being the property sector. I generally like the REITs at the moment. So the yields are pretty good. They are paying you to wait around and take a chance, they really are. And some of them have got some very nice South Africa and offshore combined portfolios. So that’s a nice way to sort of build out a property portfolio, is to include some of that stuff as well. The retail shopping centers, if load shedding well and truly is gone, then all their investment in solar is going to help them out with their operating expenses. But they’re also not going to have this crazy situation where they’re running generators to make up the difference and incurring a lot of costs around that. So that will help. Offices – vacancies are starting to go down, so people are back in the office. We know that we can see it in a lot of trends and numbers, so that helps. Logistics, properties still looking strong. There’s been nice growth in e-commerce in South Africa; that’s been a good driver of demand for warehousing and that kind of thing. And of course, as interest rates hopefully start to come down at some point in the near future, that is good news for the REITs because it means that the cap rate they use to value their property should also come down, and that means the value of the property should go up, which improves their net asset value, it improves their ability to borrow. The cost of their borrowings comes down. All of the stuff that hurts property over the past few years, if that reverses over the next couple of years, property is a nice place to be.
Conversely, banking has benefited from the past couple of years. High rates, high levels of inflation, that’s good stuff for banking actually. As rates come down, not sure what will happen with inflation, I guess time will tell. Yes, you would expect them to benefit from economic growth and maybe a better quality credit book, sure. But on the whole, as rates start to come down, that’s typically not great for banks. And at this point in time, I would pick the REITs. I think the other thing that’s nice is I can do it in my tax-free savings account and just go and buy the exchange traded fund, and then those REIT dividends are tax-free. So you’re banking yields of whatever it is, 8%, 9%, zero tax on that whatsoever, and you’ll never pay tax on any capital gains as well. So my view, I don’t do the whole buy-to-let thing. In fact, I rent the house I live in. So let alone go and invest in a property, I’d far rather buy the REITs. I’d far rather earn those returns, let someone else deal with all the headaches, have a nice diverse portfolio, and of course, a liquid investment in property, as opposed to all the money tied up in one property. In a country where unfortunately, certain areas can decay very quickly and you can end up in a situation where you’ve lost a ton of money in one property, why not buy the spread of properties? So if you asked me to pick just one thing to kind of play this improvement in South Africa, what does it look like over the next year and a half? I think I would buy the REITs.
Mohammed Nalla: I must say, I was initially surprised to hear you say property, but I think you’ve qualified that strongly enough. For me, the high opportunity segments that you’ve seen globally was in the industrial space, logistics in particular. But I think those yields are really compressed. I think there’s a lot of investors chasing that particular segment. And so I understand your emphasis on maybe looking at the retail side of that equation rather than the industrial side of the equation. I think some compelling, let’s call it avenues for further research, certainly from my side, I’m going to go and have a look at some of those ideas you’ve put on the table, and then let’s see if this GNU dawn can actually take hold and if we can actually start to see some results on the macro side, because these things take a long time to actually turn the corner. But interestingly enough, South Africa is currently not the basket case when you look at global geopolitical news flow. I mean, this week we’ve got a UK election and all guesses open in terms of what happens there, but the Tories likely to lose control. You’ve got India that’s just gone through an election that maybe didn’t yield the result that people actually expected. You’ve got the US presidential debates, and we know that’s coming at the end of the year. So lots of global news flow on the political front that maybe shelter South Africa.
If South Africa can just keep to the steady road, not give us any curveballs on the negative side, and just deliver at the margins on some of the stuff, the core building blocks that they need to deliver on, South Africa could go back onto the list as being a reasonable, I don’t say compelling, I say a reasonable emerging market to consider. And again, that would be an improvement that I would happily take. But that’s where we’re going to leave it this week. What do you think? Hit us up on social media. It’s a @magicmarketspod, one word, @financeghost and @mohammednalla on X or go and find us on LinkedIn. Pop us a note and your thoughts on there. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
Magic Markets is your ticket to understanding the global stock opportunities available to you. If our free shows pique your interest, the deep dives and a vast library of research into international companies in Magic Markets Premium will do wonders for your knowledge of the markets. Subscribe for just R99/month at this link with no minimum monthly commitment.
