South African equity market likely to struggle but bargains emerging

22 October 2018

The overall South African (SA) equity market has shed more than 20% from its highs at the beginning of the year in US dollar terms, a similar sized drop to the ‘Nenegate’ slump of 2015.

Even though lacklustre SA earnings growth has been the main drag on equity returns over recent years, bargains are emerging in great stocks that have been thrown out with the bathwater. We’ve had consistent downward revisions to earnings expectations which explains the market’s relatively flat long-run performance. 

This poor performance has resulted in higher dividend yields, making the market seem relatively attractive, but lower earnings growth is likely to hold back any real improvement in price earnings multiples on a forward basis. As it stands, price earnings multiples remain at their long-run historic averages.

For SA investors, however, valuations in some shares look very attractive with some of the Johannesburg Stock Exchange’s leading names trading substantially below long-term valuations. Patient investors can get great stocks at very attractive prices.

Some of these companies are:

Vodacom (VOD): Very negative sentiment has driven share prices down in the SA telecommunications space. The negative news-flow around the earnings consequences of the recent Black Economic Empowerment deal as well as the continued regulatory uncertainty in SA has caused the stock de-rate significantly. In our view, this remains a quality company that dominates the SA market and has opportunities for growth outside our borders. At a forward price earnings ratio of 12x and a dividend yield greater than 6% we think the stock is attractive.

Aspen (APN): The company released full-year 2018 results in September which were below consensus expectations despite reporting a 10% increase in normalised headline earnings per share at constant exchange rates. This disappointed the market and resulted in an aggressive share sell-off which appears overdone at current levels.

In our view, the sale of its infant milk formula business de-gears the balance sheet to some extent and provides Aspen with the opportunity to concentrate on the core pharma business.

And if the rand continues to trade around current levels, it would be a tailwind for them. We also remain constructive on the longer-term healthcare industry fundamentals supported by an ageing population and a higher incidence of non-communicable chronic diseases such as diabetes, obesity and cardiovascular conditions. Aspen trades on a one-year forward price earnings ratio of 9.5x with forecast earnings growth for full-year 2019 at 10%. At current levels, it trades way below its long-term average valuation.

Shoprite (SHP): This quality counter with a strong balance sheet has come under pressure following weak full-year results in a low food inflation environment and a disappointing performance from its African operations. But operationally, the company appears sound. In addition, Shoprite has invested a significant amount of capex into upgrading its IT infrastructure and has also commissioned a new distribution centre. The share has de-rated and now trades on a one-year forward price earnings ratio of 18x. We expect this counter to benefit from a gradual increase in food inflation and a risk-on environment.

Mr. Price (MRP): This cash-based, fast-fashion retailer is strategically positioned to gain market share in the apparel industry and its attractive price points appeal to the consumer through the economic cycle.

Mr. Price has, however, come under pressure in line with emerging markets but the recent sell-off presents an entry opportunity. Investors should be aware though of the impact that currency volatility has on the company’s earnings given that a significant proportion of its merchandise is bought offshore. The share currently trades on a one-year forward price earnings ratio of 19x. Some of the reasons behind the weak local - and other international markets - was the relative attractiveness of US real rates, a strengthening US dollar, a slowing Chinese economy and higher oil prices potentially placing a drag on economic recovery efforts.

We do not expect that the US Federal Reserve will deviate too much from the slow-and-steady approach that has been adopted in their hiking cycle. Nonetheless, this prospect of higher interest rates has spooked investors as they realise that the low interest rate environment that they have been used to for so long will fade.

But it is these times of greater uncertainty that good companies can be bought at attractive prices.