Market gloom opens opportunities
The tough local environment is a challenge for most companies, and many local investors are feeling the pain after a somewhat demoralising third quarter.
Despite a bumper start to the year for local markets, South Africa’s stop-start economic growth, and mixed signals from government on policy reform, saw business confidence hit an all-time low in August, while the JSE All Share Index ended September in the red for the third consecutive month.
Then, further compounding the general mood of despondency, negative sentiment, policy uncertainty and Eskom-related anxiety saw the World Bank cut its 2019 growth forecast for South Africa by half a percentage point to 0.8%.
However, in some good news for investors, difficult local conditions have led to a material de-rating in equity valuations, creating several enticing opportunities in higher-quality companies that were previously expensive, or were trading on historically demanding multiples.
While local industries will likely continue to be challenged by the weak environment, select companies that are supported by higher quality or defensive attributes are also set to fare relatively better as we inch towards a brighter setting in the economic cycle. These attributes include stable business models, above-average returns on invested capital (ROIC), industry prominence, balance sheet strength and high cash generation, amongst other factors.
In our view, some of the attractive companies on offer include:
RMB Holdings (RMH)
Source: Iress, 2019
Since its listing in 1993, RMH has provided shareholders with a vehicle to co-invest with the founders of FirstRand (which makes up 99.3% of RMH’s intrinsic value). RMH’s discount to net asset value (NAV) is currently around 11%, thus offering an attractive investment into FirstRand. This compares to the three- and seven-year average discounts to intrinsic value of 6.8% and 3.3% respectively. With quality management behind the group, the business’ strategy to deliver superior earnings, dividend growth and sustained long-term capital growth will also appeal to many investors.
The primary asset, FirstRand, is a high-quality banking and financial services operation that has historically traded at a material premium to its peers. FirstRand has momentum behind its franchise, and its strong core operating performance looks set to continue, albeit at a lower level of growth. Return on equity (ROE) is likely to moderate from the current level (22%), but we believe that ROE can be supported within management’s target range of 18%-22%. And, while the group continues to trade at a premium to peers, the stock has de-rated, providing an attractive entry point.
The current price-earnings (P/E) multiple is 12.8 times, with an attractive dividend yield of 4.6%. This is made further enticing through RMH’s discount to NAV.
Given the structural nature of South Africa’s challenges, companies will have to execute appropriate strategies in order to produce growth, and we believe that RMH should be able to deliver on this promise with its current portfolio.
The MultiChoice Group (MCG) is a pay-TV operator with 15 million subscribers, a 30-year track record and a presence in 50 countries across Africa. The MCG group comprises:
- A South African pay-TV asset (67% of revenue), which has a relatively mature growth profile and a strong track record of free cash flow generation;
- A loss-making, but high potential rest-of-Africa pay-TV portfolio (28% of revenue); and
- Irdeto, a platform for digital security.
The share price has recently come under pressure, largely due to headline risks around its rest-of-Africa strategy, premium subscriber erosion in South Africa and concerns over its broad-based black economic empowerment (B-BBEE) transaction.
MCG announced the details of the “flip-up” transaction prior to its listing, and as such this transaction is not a surprise. Phuthuma Nathi (PN) shareholders (who currently own 25% of MultiChoice South Africa) are being offered shares in MCG at an exchange ratio of 0.97. The price MCG is offering PN shareholders is significantly below what we would consider to be fair value.
In our opinion, however, the recent sell-off is overdone, and the price (R120 per share) offers an attractive entry point into this high-quality investment. The group has operational leverage thanks to several cost-optimisation strategies, as well as the ability to grow market share in the middle and mass markets.
Source: Iress, 2019
Mr Price (MRP), a former market darling, has experienced soft sales and margin pressure in an increasingly competitive sector, but part of the retail group’s challenges was self-inflicted owing to an inappropriate product mix. Additionally, like most South African companies, MRP is at the mercy of low economic growth, indebted consumers and rising unemployment. The share has de-rated considerably (shedding 30% within a year), as deteriorating earnings and growth expectations are priced in.
Consequently, we believe the current valuation is now attractive, with a P/E multiple of 13.3 times and dividend yield of 4.6% – as compared to its historical five- and ten-year average P/E multiples of 21 and 20 respectively. And while the company may still experience challenges over the short term, this business is a high-quality asset, with net cash of R3.1bn on its balance sheet, and some of the highest ROIC in the sector.
Source: Iress, 2019
Retail specialist AVI is home to a diverse range of businesses and recognised FMCG brands, which produce goods from sweet and savoury snacks, hot beverages and frozen foods to personal care products, cosmetics, clothing and footwear.
AVI’s trading environment is expected to remain difficult as a result of constrained consumer spending, and the company is likely to experience low or even negative growth rates until there is a meaningful improvement in the economy.
Notwithstanding this, all AVI’s businesses are targeting profit growth in the next financial year, and it represents a well-managed company with a resilient business model. Furthermore, with a P/E multiple of 15 times and a dividend yield of 5%, it is currently trading on the most attractive valuation multiple we have seen in the past five years, given its average P/E multiple of 20 times.