Local investing

Is it time for equity investors to party like it’s 2002?

Not quite, says Duncan Artus.

Between January 2001 and February 2002 domestic equities and particularly consumer companies suffered significant declines and the rand lost some 63% of its value, stoking inflation and causing interest rates to spike. Investors who were brave enough to buy at these depressed levels were rewarded with exceptional returns in ensuing years.

Given that domestic shares, particularly those with a strong focus on South Africa, have underperformed over at least the last five years, it is tempting to wonder whether the decline in local equity valuations presents a similar buying opportunity to that of the early 2000s.

“We believe it is unlikely that investors buying low today will have as much success as during the previous depressed period, as valuations today are higher,” says Duncan Artus, Portfolio Manager at Allan Gray. “We don’t believe the same conditions that enabled investors to snap up quality stocks at a bargain price in 2002 and generate outsized returns are present in today’s market. However, we are prepared in case a similar opportunity presents itself in the near future, as companies continue to report disappointing earnings.”

Artus says one of the main differences between today and the early 2000s is that government no longer has the financial means to increase the government wage bill and social grants at the same rate, which increased from R140bn in 2001 to R840bn in 2018. This fantastic tailwind for retailers and other consumer stocks is unlikely to occur in the near future given the precarious state of government finances at present.

Nevertheless, Artus does believe there are unique factors about current market conditions that make certain local equities a good buying opportunity right now. However, one such notable difference from the early 2000s is the large number of offshore acquisitions that have been made by local companies in recent years as a means of diversifying away from South Africa-specific risks. Whether one considers Brait’s purchase of New Look; Famous Brand’s buyout of Gourmet Burger Kitchen; or Woolworths’s R21.4bn acquisition of Australian department store, David Jones; almost all of these international adventures have not fared well.

“Local companies in general don’t have a proud track record when it comes to offshore acquisitions, and their share prices have been punished as a result,” says Artus. “This may provide opportunities where the share price has been excessively punished, as we believe is the case for Woolworths, who overpaid for the acquisition of David Jones in Australia, contributing to Woolworths’s share price more than halving.”

Artus says the resultant decline in Woolworths’s share price has made it the “second-cheapest retailer” on the JSE. Its excellent food business, coupled with the fact that there is probably not much more downside left for David Jones, makes Woolworths a worthy consideration. Allan Gray is also keeping a close eye on Pepkor Holdings, which may see a significant portion of its Steinhoff-held stake offered at a discount as the embattled furniture group attempts to pay down debts. On the travel and leisure front, Artus says Sun International is now cheaper in dollars than it was in 1984. Another is Tsogo, which is well-capitalised, well-run and stands to benefit from increased consumer spending should economic growth recover.

“While there are many parallels to 2002/2003, and it is the area absorbing most of our research effort, the valuations offered today are not at the depressed levels on offer back then,” says Artus. “However, we believe there are some opportunities to be found, and the weighting to domestic shares in our portfolios is increasing.”

Duncan Artus presented on this topic at the 2019 Allan Gray Investment Summit. To view highlights from the event visit www.investmentsummit.co.za

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