You're listening to Strictly Business Podcast with Lindsay Williams. With me today is Rohana Khan, who is SA Equity and Multi-Asset at 91 in Cape Town. Now, Rohana, there's several sort of enduring themes that I've been commenting upon over my couple of decades as a broadcaster. One is active versus passive investing, another growth versus value, but there's another one as well. SA, South Africa versus offshore.
And that seems to be particularly pertinent at the moment because it's been very much skewed towards offshore of late. And when I say of late, I mean many, many years. But suddenly, people liking SA. Is that the view from you and your team at 91? Yes, thanks, Lindsay, and thanks for having me. South Africa has been through a massive earnings reset, derating, negative sentiment, as you mentioned. when the rest of the world, especially the U.S., has had opposite fortunes.
So where we stand today, you know, is it enduring from here is the question we're getting asked. We've had this little uptick in South African equities in the last few months post the government of national unity. And is this another one of those false dawns? And, you know, we're going to revert back to the South Africa of old. We do think something's changed here. and that we are set up for something better.
So while the stocks have moved quite aggressively in a short space of time, you've got to realize where they've moved from. So you've just gone from below, way below average valuations to neutral valuations. And the next leg, we believe, is where you get the earnings growth and those earnings expectations improving for the South African companies on a go-forward basis, which will then drive a further re-rating of the names as they grow. for the first time in a long time.
And why can they grow, I guess, is the question. Yes, it is. And before you go on to why they should go and why the earnings should get a re-rating, I think we've got to distinguish between SA Inc. and the JSC Securities Exchange, because there are companies that apply their trade outside of the borders of South Africa, whether it be a resources company or whatever it is, to the ones that really break within the borders of the Republic. So... Maybe we could have a look at that.
It's not a blanket buy, is it? Yes, no, no. So you're spot on. There are three buckets. We look at the South African market. You've got your pure SA Inc. companies, your banks, retailers, insurers, etc. Then you've got your resources bucket, which is the China and global commodity demand angle. And then you have your normal and hedge industrial companies. So where we are excited about, and what I was mentioning earlier, is that SA Inc. bucket.
So the stuff that, you know, the companies that are... are listed in South Africa that make the majority of their revenue and profits in South Africa that will benefit from an improving GDP environment. On the resources side, it's not all doom and gloom, but it still is early days. I think the China angle for iron ore in particular in that resources space is, you know, a lot of that card has been played and now you need the rest of the world to come in with regards to commodity demand.
So China is trying to stimulate in a stop-start sort of way. Everybody's waiting for a big bazooka to come. They keep doing it in a more measured manner. But what that does mean is that there's a kind of flaw for some of these commodities.
And going forward, as we get the interest rate cuts and the new business cycle takes off, an improving demand globally for, you know, a lot of these things, increasing grid spend, electric vehicles, renewables, all these things are very capex-intensive and commodity-intensive, which will support those. over the medium term. So we're becoming cautiously optimistic in that resources bucket. And then you get the ran-edge industrials.
And I must say, in our funds, where we're allowed to hold offshore stocks, we tend to use our offshore allowance versus holding some of the ran-edge industrials in South Africa. Now, sparse and processed, though, we do hold. But the rest of them, like British American Tobacco. and Hauser Busch, those kind of names. I think when we look offshore, we find better opportunities in that particular area versus buying those in the South African equity market.
The South African macro environment has improved, whether it be political with the government of national unity, whether it be inflation, which is coming down, and also therefore interest rates. It does provide rather a nice base for what you've just been talking about. Yes it does and all our own goals we just scored as well right, the transit issues, the electricity issues. And then also like the backdrop of interest rate cuts, right?
So we had the Federal Reserve start to cut rates, which allowed out the South African Reserve Bank to also cut rates as well. You know, declining rate environments really important for that South African consumer because there's a lot of leverage sitting in the system in that consumer, right? So less on interest, more on goods and services, etc. So that's also positive.
But what it has done, because we've scored so many own goals and the growth in South Africa has been so lackluster from a GDP perspective, creating very limited amount of jobs, et cetera, over the last while, you know, companies have been in conservation mode in terms of managing costs to try and just keep the cash flows going and trying to protect margin. But margins have really fallen back a long way.
So when I talk about the earnings reset in a lot of these South African companies that's taken place. You're starting off a very low base from an earnings perspective. What that means is if GDP growth ticks up from the current sub 1% to 2%, the multiplier effect on the earnings basis of an apparel retailer is quite material, right?
Because you get an extra 1% to 3% on the top line, given the fact that the costs have been managed so well and the margins are coming off such a low base, that leads with a multiplier effect to your bottom line. So, for example, with some of these apparel retailers, is... Our analysts'forecasts, if we do a base or a bull case scenario, we are getting like at least 10% upside to market forecasts for some of these apparel retailers. If you spoke to me a year ago, that was not the case.
We had downgrades across the sphere of South African companies. Yes, one of the unique selling points, if I can use that phrase, of 91 is your very close attention to earnings up. upgrades or downgrades? In other words, if someone says, well, the earnings per share look as though they're going to be this, but then they come up with an upgrade and it looks as though it's going to be this, which is plus 15% from our original forecast.
That's what you focus on or one of the things that you focus on. Are you starting to see that at all? Very much so. So this actually started, we started to see green shoots towards the end of last year, where, you know, our analysts were struggling, you know, they have to rank their stocks from... from most to least preferred, depending on the earnings divisions profile, at a reasonable valuation.
And they were struggling to find the stocks they wanted to put at the top of that ranking table because they were just downgrades. And you were kind of trying to find the one with the least downgrades or the one that's not just going to meet expectations. And that started to turn towards the end of last year coming into this year because I think things just got so bad in the country that that final earnings division cut from a lot of the south side or the market forecasters kind of went too far.
And so we started to see that, you know, because we check it, we could see that our analyst earnings numbers for certain stocks were now above market forecast towards the end of last year without the GNU at that point because it was just self-help, right?
And then coming into this year with the government of national unity, understanding that from a top-line perspective, you could get some benefits there and employment growth, et cetera, that just amplifies the ability for those earnings to come through. I'll give you an example. So Discovery is a stock we… like Serene, our insurance analyst, does really good work on the insurance space. And it's a stock she's had on her cell for a very long time.
And at the beginning of this year, Discovery got sold off so aggressively with a negative sentiment. There was a change in accounting standards for insurance companies. And Serene did the work and realized that, you know, the market is completely mispricing the company. The sentiment on the NHI and all those things because of the Discovery health business was being overblown.
Given the fact that this new accounting standard is coming in, the way that that income statement was going to look and the growth prospects for the business were going to look a lot better. And so we piled into Discovery into that negative sentiment. And subsequently, Discovery's numbers have come out and the management have given a guided outlook that was way above market forecasts and even Serene's forecasts, which were above the market. And the shares done quite nicely.
So we are finding those opportunities. And some of it is self-help and some of it is, you know. actually a lot of it at the moment is the self-help part of it and then going into 2025 as the rate cuts come through etc and and the GDP growth starts to pick up the top line should should be the next surprise we think. You've given us a discovery you've spoken about the retailers which have gone from being in the doldrums to being on your radar is there anything else that you like in SA Inc?
Yes, we do. We quite like the South African banks, not all of them. Our LNS Chris Stewart is way above market forecast for Capitec in particular. So Capitec's been one we keep topping up every time we get an opportunity. But now I think the market's caught on to the fact that, you know, the growth vectors for this business are coming through and continue to come through. And that they are, you know, they're growing in insurance.
The business banking, while it's been a little bit slower of late, it is an option for them to increase over time. But the more important part is that when they released the results recently, there was confidence from the management team around affordability and the customer base and a willingness to now lend again into that customer base after very mediocre growth in the credit space. And that's quite telling, right? Because now you start growing your advances book.
It's the credit cycle in South Africa, which, you know, we haven't had a proper credit cycle and growth from that perspective, which then feeds into some of our apparel names that we like.
etc. So quite like banks, our Capitec and Firstrand being our topics in terms of where we are versus market forecasts, the likes of a Firstrand is interesting because this management team has a habit of under-promising and over-delivering and they came out with results and the share came under a little bit of pressure because the guide of the earnings number was like an upper single digit kind of number, was the feeling that the market was getting
and so the analysts were downgrading their forecasts. Chris Stewart, our banks analyst, kind of did the work, kicked the tires with the management team, and he's got double-digit earnings growth. So above-market forecasts that have, you know, just kind of taken what management have said, with Chris realizing through his interactions with the management team that there's a lot of conservatism baked into their guide as they try to over-deliver on, you know, on expectations.
So, yeah, quite like the bank space as well. And then dipped our toe into a few of the property names as well. because, I mean, the property companies have reached a point, a lot of them outside a growth point, where, you know, a lot of the pain's been taken on dental reversions and those kind of things and occupancies are starting to improve. They've also reset their balance sheets for the most part, so the dividend policies now that have been set are more sustainable.
So you're getting a nice dividend yield with, like, 3% to 5% growth depending on which company you look at. So it gives you a nice little, you know, angle in your portfolio to have them because I've... bonds plus growth kind of holdings in an equity portfolio. Rihanna, that is such an encouraging chat we've just had. Thank you very much for your analysis. Rihanna Khan is SA Equity and Multi-Asset at 91 in Cape Town.
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