Allan Gray, the privately held asset manager that oversees about R560bn in assets, is worried that certain domestic stocks risk becoming “value traps”.
In a value trap investors buy an asset that appears cheap only to discover instead of appreciating in value, it continues to underperform as the share’s fundamentals deteriorate. That is particularly true for SA Inc stocks relying heavily on the local economy’s performance.
“SA Inc looks really cheap, but the economy is not growing so investors don’t want to assign high valuations to domestically focused stocks like they used to,” Allan Gray chief investment officer Duncan Artus said. “Prices are low but perhaps they are low for a reason — you’ve got low growth combined with a high cost of capital, so many projects don’t happen, and investors aren’t willing to pay what they did in the past. My concern is that some domestic shares end up as value traps.”
The JSE all share index is trading on a relatively cheap price:earnings ratio of 11.8, which compares with a long-term average of 15.4 since 1995. That means investors are willing to pay about 11.8 times earnings on a per share basis to own the typical JSE-listed equity right now, compared with more than 15 times over the longer term.
“When Ramaphoria peaked, people were paying over 20 times earnings for SA retailers, but since then the economic fundamentals haven’t played out due to a lack of structural reform,” said Artus.
With the increased ability to invest offshore and diversify away from SA-specific risks, Allan Gray has upped the offshore exposure in its flagship balanced fund to about 37%, near the regulatory limit of 45% for locally registered funds.
geopolitical environment in which countries such as China and Russia appear to be leading many emerging markets away from an alliance with the West.
“We’re not geopolitical specialists, but the world is clearly splitting in two,” he said. “That can have major implications for investors, especially if sanctions ever come into play. It may have been relatively easy to walk out of Russia, but it’s not so easy to walk out of China if you’re Nike, Starbucks or Richemont.”
That made Artus wary of being too bullish on emerging markets in Asia and US companies heavily reliant on the Chinese economy. He also said over time few emerging market businesses grew their earnings in dollars for extended periods.
So while Allan Gray has been underweight the US market for several years, Artus said one cannot simply write off investing in the world’s biggest economy. That’s despite the S&P 500 trading at a high 18.77 times, while growth stocks such as Apple and Alphabet trade at an even more expensive 27.8 and 23.
“[Sister firm] Orbis is still finding more value in Europe, the UK, Japan and emerging Asia than in the US,” said Artus. “But many of the great companies of the world are listed in the US, which is still the world’s biggest and most liquid market.”
But given that Allan Gray still does a lot of business for institutional clients with domestic only mandates, how does he grapple with investing in a market in a country with little to no growth?
“In the local market we’re looking for companies that have been able to grow profit without relying too much on the economy,” he said.
One of Allan Gray’s better recent investments has been Woolworths, which has rallied more than 30% since the end of 2019 (a few months before the Covid-19 pandemic began negatively affecting the JSE). While the share underperformed for some years prior to that due to its poor investment in Australian retailer David Jones, it had managed to recover strongly since then by stabilising and now selling the Australian department store chain while gradually improving its domestic fashion, beauty and home business.
However, Artus said real positive impetus for the local stock market will only commence when foreign investors again start buying local shares.
“A lot of our stocks don’t have a lot of foreign owners on their share registers any more,” he said. “You need the foreigners to come back and buy — or you need large buyouts like when Pepsi bought Pioneer Foods or Heineken [took over] Distell.”
He said one of the prime targets for a local buyout opportunity could be City Lodge, the budget hotel group that is only valued at R2.4bn based on its market capitalisation. Sun International is another local group he thinks could be ripe for the picking by an astute foreign gaming and leisure operator.
However, he said foreign investors are likely to resume buying SA stocks in any meaningful way only once the country’s fundamentals improve. That includes at least addressing the load-shedding crisis and making it easier to do business in SA.
“Foreign investors will be enticed by the government finally making difficult decisions which require trade-offs but give the economy a much stronger foundation from which to generate growth,” he said. “The other route, of course, is that SA assets just become too cheap to ignore.”
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