Good news for South African investors 

Peregrine Capital is optimistic about South African equities as Eskom and Transnet stabilise and said undervalued local shares are a key opportunity for investors.

Peregrine’s Investment Analyst, AJ Snyman, said he sees “real evidence” of improvement in two of the country’s most pressing issues. 

He highlighted improvements in Eskom and Transnet, suggesting load-shedding will lessen by 2025.

Snyman believes the market is heavily underestimating the opportunity in local shares, particularly SA Inc. counters.

He pointed out that uncertainty in South Africa had been especially high over the last six to eight months. 

Global insecurity, South Africa’s persistently weak economy, load-shedding, issues at Transnet and the uncertainty surrounding the elections have all severely dampened investor appetite for the local market.

“Most investors think the future doesn’t look all that pretty,” Snyman said.

However, after extensive research and analysis on two of the country’s most acute problems, Peregrine said it has found reasons for optimism. The company also said it has been increasing its long exposure to South African equities. 

“We believe that even though Eskom and Transnet are still concerns, there is real evidence to suggest things are improving,” Snyman said. 

“These two factors have resulted in extremely negative sentiment towards South African equities and therefore very low valuations.” 

“But we have been proponents of buying South African equities and have done that ourselves because we think there are reasons to think the future will be better.”

In particular, Peregrine has found reasons to be optimistic about Eskom’s performance. 

“For the last year or so, we have been saying that towards the end of 2024 and into 2025, load-shedding as we know it will be a thing of the past,” Snyman said. 

He explained that Peregrine has done a substantial amount of work, constructing its own model of electricity supply and demand and speaking to industry experts at Eskom.

“From all the work we did, we believe there is real evidence that load-shedding will be something of the past in the near future.”

Snyman gave three reasons for his optimism about Eskom’s turnaround.

Firstly, he said that the turnaround plan at Eskom is starting to take effect, particularly in terms of planned maintenance.

“Under previous CEO André de Ruyter, they had apparently tried to perform all maintenance in-house, but because they had lost skills, they couldn’t do it,” Snyman said. 

“But now they are starting to bring back those skills through consulting and outsourcing.”

“But more than that, they are bringing in the original equipment manufacturers to do the maintenance alongside Eskom. They have the specialist skills and knowledge required for this.”

He added that they have also worked on incentivising everyone at a station level correctly to make sure that maintenance gets done and unplanned outages are kept to a minimum.

Secondly, a significant amount of supply has now come back online. That has had a noticeable impact.

Lastly, there has been a significant investment in renewable energy with notable effects, he explained.

“In April, there was a cold snap, and despite that, we didn’t have load-shedding,” Snyman said.

“On that day, renewables generated 3000 MW alone. That shows that renewables are taking strain off the grid.”

Unplanned outages have dropped substantially over the past year. And this is not because Eskom is burning huge amounts of diesel in its open-cycle gas turbines. “In fact, their usage has also fallen noticeably,” Peregrine explained.

“So, the improvement is real,” Snyman said. “We’re not saying there won’t be load-shedding in the next few months. But, at most, we think we will only see stage one or stage two during winter.”

In its first Financial Stability Review of the year, the South African Reserve Bank (SARB) also indicated that Eskom’s performance has improved. 

Not only has load-shedding become milder since April, but Eskom’s energy availability factor has also notably improved in recent months. 

“The rapid uptake of alternative energy sources is likely to have contributed to reduced demand for Eskom-supplied electricity,” the bank said.

The SARB explained that this, coupled with broader energy sector reforms and ongoing efforts by Eskom to stabilise the performance of its coal-fired power stations, suggests that electricity supply and grid stability may continue to improve gradually.

“Over time, such improvement should reduce the drag of load-shedding on economic activity,” the SARB said.

Snyman said that where Transnet is concerned, there are also clear improvements taking place.

“I’m not going to pretend it’s on the same trajectory as Eskom, but there has been an earlier recognition by government of what the issues are, and a willingness from government to engage the private sector,” he said.

BMI has previously said that South Africa’s rail network faces complex challenges that are stifling business operations and hampering economic growth. 

These challenges range from ageing infrastructure and rampant theft to broader systemic problems, including underinvestment and managerial shortcomings. 

According to estimates from the National Treasury, the rail and port inefficiencies have cost the economy R411 billion in 2022 alone – almost 6% of GDP.

Snyman pointed out that there had been a change of leadership at Transnet, steps have been taken to fix the balance sheet, and there are moves towards some measure of privatisation.

Structural reforms and recovery initiatives are also underway to stabilise Transnet’s rail and port services and promote private sector participation. 

“Our Infrastructure team believes that if the reform agenda is successfully realised, it will significantly enhance operational efficiency, thereby alleviating a key growth constraint in the sector,” BMI said.

However, Transnet repairs will require a lot of funding. In March of 2023, the chairperson of the African Rail Industry Association estimated that over R100 billion is needed to restore rail track integrity.

“It will be a multi-year story, but at least we’re moving in the right direction,” Snyman said.

In his view, these developments were significant for the South African equity market.

“Eskom and Transnet, among some other things, have led to extreme negative sentiment towards South Africa as an investment destination,” Snyman said.

The average allocation to local equities in South African balanced funds had decreased from over 45% in the second half of 2021 to close to 30% at the end of March this year.

“The changes to Regulation 28 have definitely played into this, but it shows how negative local managers have been on South African equities,” Snyman said. 

“Foreigners have also been sellers, and the rate of outflows has increased.”

“This negative sentiment has manifested in extremely cheap valuations of South African shares. Before we had a little rally recently, we had banks trading on five or six times earnings and dividend yields of 10%.”

He said that there is an incredible opportunity to buy select shares at these kinds of levels when there is good reason to expect an improvement in the backdrop.

“When everything around you is moving a certain direction and shouting a certain narrative, it’s difficult to be clear in your head,” Snyman said. 

“But, sometimes, when that happens, we’ve learned the importance of contrarian thinking and that it’s worth doing the complete opposite of what you feel.”