‘Compelling opportunity’ in South African assets

PSG Asset Management believes there is a compelling opportunity for strong returns in some South African stocks, which are severely undervalued due to the headwinds the country is facing. 

Head of equities at PSG Asset Management, Justin Floor, and fund manager Dirk Jooste outlined why they are allocating more of their clients’ savings to local equities. 

In response to the country’s major challenges of load-shedding, infrastructure deterioration, and high interest rates, many local assets have become substantially undervalued. 

The equity market is priced at historically low valuation multiples, and companies are acutely undervalued relative to their prospects for growth and shareholder return. 

In addition to equities, South African Government bond yields are hovering around 12%, one of the highest real rates globally. 

The rand has also been weak and has underperformed the currencies of many other emerging market countries.

Most importantly, the rand has significantly weakened versus a strong US dollar, with Floor and Jooste noting that emerging and commodity markets seem particularly sensitive to this. 

According to them, we may enter a dollar down-cycle where emerging market assets will benefit. History suggests this cycle could gather momentum and last for many years. 

Periods of dollar weakness can be a significant tailwind for investment returns in emerging markets, including South Africa.

Floor and Jooste said some domestic headwinds are starting to abate and may turn into tailwinds, which will compound the effect of a weaker dollar. 

Firstly, the Reserve Bank has brought down local inflation to within its target band, but pockets remain. 

There is a good chance of interest rates starting to fall later this year and into 2025. However, the cutting cycle will be short and shallow, with interest rates only decreasing by 1% to 2%.

This minor change will result in a substantial decrease in the base cost of capital in the economy, benefiting consumers’ disposable income and reducing company interest rate expenses. 

Moreover, it could have a positive impact on equity valuations and bond prices.

Floor and Jooste also think the country’s infrastructure challenges are set to improve. Load-shedding will likely be less frequent in the next few years as the private sector invests heavily in electricity generation. 

In addition, private sector resources have been deployed to Eskom’s generation fleet, and the large Medupi and Kusile units are coming online. 

More reforms are needed, but the current direction of travel will be evident in economic growth and the earnings and cash flows of affected companies.

There are also signs of improvement emerging at Transnet and the ports, alongside increasing private-sector involvement. 

The last five years have seen a vicious cycle of foreign equity and bond outflows from the relaxation of prudential offshore limits and local and foreign institutional investors reducing allocations to local assets. 

Many large South African funds are close to maximum offshore capacity and may need to start directing funds back to rand assets, Floor and Jooste said.  

A further sign of a bottom in the market is that private capital is buying and delisting South African companies.

The companies that will benefit the most from this are those in the construction industry and the tourism and leisure industry.

“We aim to identify companies with agile and entrepreneurial management that consider how to protect and grow the value per share of the companies they manage,” they said.

“We are also closely watching the increasing trend among companies to repurchase their undervalued shares on the market, as this can be a sign of strength and may benefit shareholders.”