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Local investing

Finding value in a depressed earnings environment

After a disappointing decade, many are wondering whether the JSE still offers long-term value for patient investors. Rory Kutisker-Jacobson discusses the challenges faced by the local market and shares some of the compelling opportunities in this difficult environment.

In 2023, the FTSE/JSE All Share Index (ALSI) returned 9.3% in rands, while the FTSE/JSE Capped SWIX All Share Index (Capped SWIX) returned 7.9%. Although positive, one could have achieved a similar return from cash while taking on considerably less risk (in 2023, the Allan Gray Money Market Fund generated a return of 8.4%). To make matters worse, in the first three months of the year, markets have given roughly a quarter of this back, with the ALSI down 2.2% and the Capped SWIX down 2.3%.

There have been few places to hide, with 26 out of the top 40 stocks down in nominal terms over the first quarter on 2024, including dividends.

It has not just been a lost quarter or year; the JSE has been a poor place to invest for more than a decade. For a global investor, for every R100 you had to invest in the ALSI at the end of December 2010, you would have approximately R360 today, including all dividends reinvested. In US dollars, a US$100 investment would only be worth about US$126 at the end of March 2024, given that the rand has weakened from R6.62/US$ to R18.88/US$ over this time. Excluding dividends, in nominal terms, the value of that investment would be down in US dollars. In contrast, a US$100 investment in the USA’s major index, the S&P 500, in December 2010 would be worth roughly US$539 at the end of March 2024 – more than four times the return experienced on the ALSI.

The factors influencing performance

Looking in the rearview mirror and taking South Africa’s current political and economic landscape into consideration, it is easy to be despondent about the JSE’s return prospects. This crude analysis, however, is not the full picture and masks some important facts:

Opportunities exist, but careful stock selection matters

In our opinion, the shares listed on the JSE are much cheaper today than they were a decade ago, and we can find a number of attractive opportunities. The opposite is true of many American listed companies.

By way of example, we hold material positions in the global paper and packaging industry on behalf of our clients: Mondi and Sappi. In 2023, Mondi’s earnings fell by roughly 45% as prices and volumes in corrugated packaging and uncoated fine paper came under considerable cyclical pressure. In our opinion, earnings are depressed and current industry pricing is unsustainable. In addition, Mondi has a number of organic projects under development that should see growth in volumes and an improvement in costs. Using what we believe to be conservative normal pricing assumptions, Mondi trades on less than nine times our estimate of normal earnings.

Sappi is a lower quality company than Mondi but also considerably cheaper. At the end of September 2018, the share price was R88.75. At the end of the quarter, some five and a half years later, it was 43% lower at R50.29 per share. Over this period, Sappi’s earnings have been cyclical, but it has grown free cash flow and reduced net debt by roughly a third. Similar to Mondi, we think earnings are depressed at current levels and are likely to rise in the future. However, even if earnings do not recover, Sappi is cheap. It trades at less than seven times consensus earnings for 2024.

While we cannot predict what returns one can expect over the next 13-plus years, we can focus on the factors within our control: buying out-of-favour companies at below fair value.

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