For the three years to the end of September, the FTSE/JSE Mid Cap index was down 12.3% in total. The Small Cap index was down -30.6%.
If these indices are viewed as proxies for SA Inc. stocks, their performance clearly shows the depth of the bear market in some of these counters.
Share prices in this area of the market have suffered heavily in the wake of Covid-19, but their underperformance is not a new story. Fund managers have found it extremely difficult to extract any value from anywhere outside of the JSE’s large caps for years.
Is this time different?
Over this time, there have also been moments when some fund managers have been brave enough to talk up an opportunity that they see in mid-caps in particular. So far, they have been consistently wrong.
Heading into the last quarter of 2020, however, there does seem to be a growing swell of optimism from a range of managers about the prospects in SA Inc. shares. Following the Covid-19 sell-off, the valuations on some of these companies are so low that there is a feeling that the margin of safety has become too wide to be ignored.
Speaking at an event organised by Batseta, Siboniso Nxumalo, head of Old Mutual Equities and co-manager of the Old Mutual Equity fund, said that on an aggregate price-to-book basis, local banks have only ever been this cheap once before.
‘The last time South African banks offered this value was in the 1980s when PW Botha gave the Rubicon speech,’ said Nxumalo. ‘Back then, South Africa had been through an external debt crisis. The country was being boycotted because of apartheid. South African banks are now trading at the same valuations they were then. Does that make sense? The market is saying it is pessimistic about this country, but is it market too pessimistic?’
Better business models
There has been a lot of caution around local banks in particular because of concerns about rising credit risk. The fear is that Covid-19 could lead to a financial crisis.
However, as Nxumalo said, the pandemic hit South Africa more than six months ago. Lockdowns were implemented towards the end of March. There have been no bank failures, and no obvious signs of one.
‘Banks have become better businesses since the global financial crisis,’ said Nxumalo. ‘We see an opportunity here because we think that the market doesn’t see that, compared to 2008, banks have more capital, lower leverage, and they have been making higher returns. They have better business models. They are unlikely to need investors to provide capital.’
Winning in a tough economy
More broadly, he pointed to the fact that a large number of SA Inc. businesses posted strong share price gains in the third quarter of 2020. This is clearly short term and off a very low base, and many of them are still heavily down for the year, but there been significant positive moves.
Shares in The Foschini Group, for instance, have almost doubled from R53 per share in early July to over R96. Motus Holdings is up to R46 from R28 over the same period.
This is not just about valuations.
‘Foschini has done a great job in moving a lot of its supply chain from China to South Africa,’ said Nxumalo. ‘But, also, Edgars has failed. Foschini got to buy some Jet assets at what we consider an amazing price.
‘So as tough as the economy is, Foschini looks like it could become stronger. Hence, we’ve seen a price reaction.’
Nxumalo said this illustrates how the prospects of a business and that of the economy in which it operates are not completely correlated.
‘No matter how tough an economy is, you can’t just judge shares on the economy,’ he said. ‘Even in a tough economy, there are companies that are winning. Those are the companies that you want to allocate towards.’