Analysis of the Johannesburg Securities Exchange
Investors at the Johannesburg Securities Exchange (JSE) have realized sweet ROI in the past 5 years despite the tremendous challenges. On the other hand, the GDP growth has experienced a bumpy ride, moving to a high of 5.1 in 4Q of 2013 before falling to a significant low of -1.4 in the 1Q of 2014. This was attributed to the volatility before the general election. Since then, the economy has recovered and investors are anticipating sweet returns in future. In this analysis, we will look at the sectors and companies that investors need to look at (and avoid) when considering capital allocation.
The Market Snapshot
In the last 5 years, the South African market has outperformed its global counterparts. This is clearly seen in the chart below which compares its performance against the Kenyan, Nigerian, and the S&P.
Chart from Bloomberg.
This growth has been attributed to a number of factors including a peaceful political environment, strong monetary fundamentals, company performances and increase in FDI inflows. In 2014, South Africa was ranked as the 4th country in FDI appetite behind Nigeria, Kenya, and Angola. However, the country continues to face multiple challenges with energy being a major concern among investors.
Broadly, JSE is made up of 3 sectors: Resources (Oil and Gas and Mining), Financial, and Industrial. In this part, I will analyse the sectorial performance of the 3 sectors, identifying opportunities and challenges.
Source. Financial Times
The history of the JSE would not be complete without mentioning the resources sector. The sector is one of the main drivers of the exchange with an estimated market capitalization of more than R2.82 trillion. Additionally, the mining industry accounts for 4.9% of South African economy.
However, as seen in the chart above, investors in this segment have suffered immense losses because of a number of reasons. One, the industry is heavily reliant on energy which is a big challenge in South Africa. Eskom, the country’s power distributor proposed a 25% increase in power prices in March which threatened the resources industry.
The resources industry being an energy reliant industry has been affected by unreliable power supply which has reduced the margins leading to poor investor appetite.
Another main issue affecting the resources sector are the common wage demands by unions. Recently, the unions in the coal sector demanded for 15% wage increase despite the global coal prices taking a dive.
Finally, the global prices of the main resources has gone down. Gold has fallen from a high of $1850 in 2011 to a low of $1100 in 2015. A large percentage of South Africa’s mined products relies heavily on the global prices which presents further challenges in the sector. In this period, AngloGold Ashanti Ltd, has lost more than 70%, Kumba Iron Ore has shed 86% and Anglo American Platinum has shed more than 65%.
Under the current circumstances, the segment will continue to lose money for investors because none of these downward trend factors has been completely mitigated. For instance, the global gold prices will continue to fall based on views from 35 analysts. Analysts also believe the price of iron ore will continue to fall which will have significant losses for iron reliant companies. Workers will also continue demanding more money and the problems with Eskom will not end soon. The verdict for this situation is to sell and avoid resources.
Industrial 5 year chart by Market watch
Despite having similar challenges with the resources segment, the manufacturing sector investors have realized sweet returns in the last 5 years. This is attributed to a number of factors including a conducive business environment, a good rate of economic growth, a widening middle class and government policies boosting business growth. According to World Bank, South Africa is ranked the second best African country in their ease of doing business survey. British American Tobacco has gained more than 250%, Tiger Brands, 60% and the famous brands has gained more than 400%.
While the growth in this sector is encouraging, challenges such as power and wage issues will continue to dominate the sector. For investors, the long term opportunity will be to identify undervalued companies and invest their money in them.
The financial sector in the JSE has been the best performing in the last 5 years. According to EY, the South Africa’s financial sector has become very successful and sophisticated. The country has done extremely well despite the challenges brought by an increasing rate of unemployment and a staggering economic growth. As reported by PwC, the industry growth rate of more than 10% will continue to increase with financial institutions becoming relevant to the rural population.
In the last 5 years, Fortress Income Fund has risen by more than 1342%, Investec by 38%, Old Mutual by 232%, Coronation Funds by 800%, and TrustCo by 900%.
This growth leads to a number of questions. One, will the growth be sustained? What are the key drivers to this growth? Is this growth related to the intrinsic value of the financial institutions? To answer the final question, let us compare the growth with the current PE ration which is noted respectively: 16.68, 21.18, 16.9, 16.77, and 8.3. The unscientific average is 15.96 which means that investors expect good ROI.
The financial sector will continue doing well as the industry leaders expand in stable and emerging economies in Africa. A good example is Old Mutual which has been in an aggressive move to the East African market through acquisitions. For long term investors, the financial sector will remain sweet.
Investors have learnt bitter-sweet lessons in JSE. Investors in the manufacturing and financial sectors have made a killing while those in the resources sector have been killed. I believe the market will continue to do well but measures must be put in place. The South African government must put in place measures to encourage investors. This will be achieved by aggressive investment in the infrastructure sector especially energy and transport. In addition, the country must ensure that risks being faced in other African economies such as security are mitigated. Finally, I expect to see an increase in M&A deals especially in the mining and financial companies. This will be inevitable if the current growth will be sustained.