Tough times for investors, but there is reason for hope
Delivering exceptional investment performance in current market conditions is no simple task, given that uncertainty and unemployment remain critically high whilst economic growth, liquidity and interest rates remain stubbornly low.
In this difficult environment, shares that were priced perfectly for uninterrupted growth have fallen hard to reality, and companies that appeared cheap a year ago are even cheaper today.
Numerous businesses listed on the Johannesburg Stock Exchange (JSE) have been left debt-strapped, with earnings growth weak or absent, and dwindling share prices. Management teams have very little room to manoeuvre and, within the space of the past few months, a few have even exited.
Many South African investors have therefore been left extremely frustrated by poor returns and a lack of leadership from management teams. The market has been tough, and the reality is that given the fact that the JSE’s All Share Index (ALSI) delivered average annual returns of just 5.6% over the past three years, many investors would have been better off with cash in the bank.
Then, for those lucky enough not to own Steinhoff shares, many would have fallen victim to the other market landmines which have exploded over the past two years, such as Aspen (-74.0%), Brait (-77.9%) EOH (-86.9%), Tongaat Hulett (-88.9%) and even heavyweight British American Tobacco (-33.0%). These previously-loved businesses have reminded portfolio managers and investors of the value of diversification, and reinforce the principle that even angels can fall.
Looking back over the past few years, in the absence of economic growth, it is clear that the market was lofty, price-earnings multiples were priced for a brighter environment, and thin dividend yields had gotten ahead of themselves in valuation. The exact science of hindsight makes it clear that – absent economic growth – pain was coming.
Hard times brings good news for investors
This said, there is some good news ahead for resilient investors.
Shares are no longer trading at elevated multiples and dividend yields have become extremely attractive.
Valuations are one of the most powerful indicators of long-term returns and, while short-term risks are admittedly elevated, the longer-term investment case has notably improved, as the dejected environment has given rise to several great investment opportunities.
Master Drilling is a technology solution-driven company, focused on raise bore drilling services. It operates across multiple countries, with predominantly local currency costs and hard currency revenue.
Essentially, a margin of safety and a strong balance sheet are key and arguably even more so during tough times. Master Drilling offers both, and so much more. The company currently trades on an undemanding earnings multiple of 7.2 times and a 2.5% dividend yield.
This innovative drilling technology company currently has a gearing ratio of only 16.2%, enabling the company to withstand economic downturns. With a healthy order book, disruptive technologies in pilot phase and a strong management team, we believe this business will be able to deliver good results in the future.
While the banks are likely to provide modest asset growth, they remain well-capitalised with their primary focus on costs. Investec is on track with the proposed demerger and separate listing of Investec Asset Management, which should enhance the long-term prospects of both businesses. The group trades on an undemanding multiple of 8 times with an attractive dividend yield of 6.0%. Investec has a high level of foreign earnings, which provides great diversification for local investors. At current levels it is trading around 1.0 times price to book value with a ROE of 11.7% – highly attractive for this bank.
The mid- and small-cap universe, particularly SA Inc, has underperformed over the past three years. We have seen shares de-rate from a nine times earnings multiple to extreme lows of around five times. Santova is one of these companies, and while the local environment remains challenging, for long term investors, these levels are very attractive entry points into great businesses that are well run.
From a ‘one dimensional’ service offering out of a single office in Durban in 2002, Santova today is a multinational global trade solutions business, which we believe is currently deeply undervalued. At the moment, just under half of the group’s profit comes from SA, which has translated into hard yards. We expect the offshore earnings component to grow significantly over the next three years, buoyed by strong franchises in the Netherlands, Hong Kong and the UK.