SA Inc stocks: Has too much bad news been priced in?

JANICE ROBERTS Editor: MoneyMarketing

Too much bad news has been South African companies, often referred to as SA Inc stocks. This is the view of Meryl Pick, Head of Equity Research at Old Mutual Investment Group*. She points out that while a strong rebound has been seen in rand hedge stocks, in Naspers and in resource stocks since the end of March, SA Inc has lagged. “This underperformance is not sustainable,” says Pick, adding that SA Inc companies are remarkably resilient. “These companies have been dealing with a difficult environment for the last five to 10 years, as well as the coronavirus pandemic this year – yet many of them have still been growing revenue, growing profits and finding ways to not only survive, but thrive.”

Pick sees cyclicality as the only thing that is certain in markets. “Every few years a crisis of some shape or form comes along and the market takes a tumble in response. Markets react, but markets recover. The real paradox is that you can’t get the phenomenal investment opportunities without the messiness, the confusion, and the fear. The market noise is the very thing that actually creates opportunity.”

Seeing beyond a particular crisis isn’t easy. “It takes a bit of patience, a countercyclical sort of attitude, and perhaps a bit of imagination,” Pick says.

When she considers SA Inc stocks as a broad sector, she believes that they present some phenomenal opportunities currently, that many investors in the market today haven’t seen in their careers. “Just take the banks, for example: Price-to-book multiples are back to 1980 levels. You’d have to go back pre-1990 to find banks trading at the price-to-book multiples that they are at now – and yet, these businesses are probably stronger and have bigger market share, and more robust balance sheets, than what they did back then.”

Pick adds that when making investment decisions, it’s not only important to look at the macroeconomic environment but also at company specifics and how companies have been responding, either to COVID-19 in particular, or just to South Africa’s lowgrowth environment. “You then make up your mind whether those individual companies, based on their share prices, offer good value and good long-term investment opportunities, despite the macroenvironment.”

She cites, as a good example of how local companies are responding to current circumstances, the case of Aspen Pharmacare, the company that has struck a provisional deal with Johnson & Johnson to manufacture its COVID-19 vaccine candidate. “This will allow Aspen to increase volumes at its Port Elizabeth manufacturing facilities.”

Turning to the construction sector, Pick says that Wilson Bayly Holmes and Raubex, “the last two construction companies in the listed space that have survived since 2010”, both have strong balance sheets. “They’ve cut costs where they could, and they are poised to benefit from government stimulating the economy through infrastructure spending, as well as the pivot to renewable energy.”

Pick notes that Italtile has been rolling out its TopT franchise and consolidating the sale of tiles and sanitaryware in the rural market. “We still have by far one of the lowest consumption of tiles per capita compared to global standards, and we have a large amount of informal dwellings in the country. On a five to 10-year view, there’s plenty of runway for a company like Italtile to consolidate a very fractured sort of market.”

In the telecommunications sector, both MTN and Vodacom have been beneficiaries of the work-fromhome situation that accompanied the COVID-19 lockdown. “Even before thepandemic, both companies cut their costs in response to a low-growth environment – so there’s a weak macroeconomic environment, and there’s a company response,” she adds.

The country’s hospital groups have been facing a stagnant insured population for some time, and COVID-19 has knocked their occupancies. Pick points out that many elective surgeries have been delayed. “Yet their shares are priced as if the current low occupancies and low levels of elective surgeries will continue indefinitely. That is just not sustainable. These are procedures that need to be done.”

She expects volumes to return. “We’ve seen this happening in the UK and we will see that in South Africa.” In addition, local hospital groups are expanding beyond traditional hospital-based healthcare, into primary healthcare and diagnostic services.”

In the retail sector, Pick views Massmart – owner of Game, Makro and Builders Warehouse – as “a very exciting story” as the Wal-Mart parent group, which owns a large stake in Massmart, has deployed Walmart insider, Mitchell Slape, to get Massmart back into shape. “Decisive action has been taken on closing Dion Wired stores and on planning ‘new look’ Game stores. These are all internal self-help measures that companies are using, either to reduce their own costs, or to gain market share, or to tap into other markets.”

For Pick, another good example is Shoprite. One of Shoprite’s main successes has been the rollout of its Sixty60 delivery service app that was still in the early phases of development when the pandemic hit. The app was then accelerated and has become extremely popular, being rated one of the best shopping apps in the country.

EVERY FEW YEARS A CRISIS OF SOME SHAPE OR FORM COMES ALONG

“The Sixty60 app has really taken off during the lockdown,” she says. “In my street, I see scooters dropping off groceries every day as Shoprite gives Woolworths Food a run for their money. The pandemic has driven consumers to a new channel and to an innovation that Shoprite launched last year, with COVID-19 just acceleratingdigital adoption.”

Shoprite is a company that has taken some tough decisions. “I think a crisis does that. It sharpens management’s thinking, and management sharpens its pencil.”

The new Shoprite management has been talking about a greater focus on returns versus purely profit growth “and we’ve seen them take action and not just speak about it, by announcing their decision to exit Nigeria because the returns are just subpar. Shoprite is looking at their property portfolio, their regional footprint, and taking decisions to allocate capital more smartly, to channel into innovations in territories where things are going well, so that they are able to emerge from this crisis stronger.”

Pick acknowledges that currently South Africa’s fiscal issues are top of mind when looking at the markets, and with the Medium-term Budget Policy Statement (MTBPS) having been given a mixed reception. “The COVID-19 pandemic is really a side-show. Over the medium term, we are seeing better growth off a low base supported by low inflation and interest rates. For sustainable growth to really come through, we need reforms.”

There is, however, value to be found. “We certainly don’t think it’s a bull market for South Africa, where a rising tide is going to lift all boats, but there are stock-specific opportunities,” she says.

*Meryl Pick, Head of Equity Research at Old Mutual Investment Group, made a presentation entitled SA Macro vs SA Inc to clients and advisers last month.

Meryl Pick, Head: Equity Research, Old Mutual Investment Group