SA pessimism is pricing in worst-case scenarios

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SIMON BROWN: I’m chatting with Sean Neethling, senior portfolio manager at Morningstar Investment Management SA. Sean, I appreciate the time today. We talk around pessimism in South Africa. There’s a lot to be pessimistic about, from greylisting and Lady R, to inflation and load shedding. But really our market seems to be pricing in very much worst-case scenarios, all things considered.

SEAN NEETHLING: Simon, thanks for having me on the show, firstly. I think to your point, just on pessimism, the main point for us is that markets are inherently forward-looking, and a lot of the pessimism we think is baked into the current prices. So if you look at potential risks on the structural side and on the cyclical side, we think a lot of that is baked into current pricing.

So the way we think about it is there doesn’t need to be a lot of change to either these cyclical or structural factors that are driving pessimism.

Because a lot is baked in there we think that, from an expectations perspective, those expectations just need to be a little better than what’s expected, and you’ll probably see a bit of rerating in terms of the market for SA equities and asset classes in general.

SIMON BROWN: That’s a great point. We are not looking for everything to suddenly become perfect and Eskom to work, GDP to be 6%, and unemployment at 6% – just less bad. I know that sounds weird, but ‘less bad’ can be positive for our market.

SEAN NEETHLING: Yes, correct. I think, like you mentioned, markets are forward-looking. Again, if you look at where we’ve come from, there’s a lot that’s gone wrong in South Africa and I think [in] markets, if you look at expected returns, a lot comes from growth. You get a lot of returns from your yield and from valuations as well.

The way we would look at it at Morningstar is we expect growth to be under some strain in this type of environment, but we do think the return that you can get from yield and just from some valuation adjustment could be quite positive for South Africa.

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SIMON BROWN: You also make the point in a recent note you put out that in the region of 69% of revenue on the JSE by those listed companies is actually from beyond the borders of South Africa. We always say the market of Main Street is not Wall Street, or Maud Street is not the JSE, but in the case of the JSE this is even truer perhaps in some other exchanges.

SEAN NEETHLING: For sure. Look, the rand is a bit of a double-edged sword, so from a consumer perspective it hurts. I think from a business perspective there are some positives. If you look just at how businesses have actually diversified away from South Africa, there has been some really astute capital allocation that’s taken place over time.

So the rand depreciation, when you translate that foreign currency back into rand, is actually net positive for a lot of these businesses.

I think South African investors are actually buying a really well-diversified income stream if you just consider the makeup of the JSE. This is in addition to, I suppose, your big secondary listings – your Richemont, your Anheuser-Busch and your BAT.

A lot of local businesses have also set up different business segments to diversify more towards global markets where there is a bit of insulation provided against the rand and SA-specific factors.

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SIMON BROWN: Yes, there are those companies that are diversified, as you mentioned there as well. There are those proper global offshore [ones]. The JSE is a secondary listing to them, and we can get that rand-based opportunity to invest in them. Again, they’re part of our market. They’re in no sense part of our economy. Yes, sure, they sell some of their product locally but it’s not a big part of who [they are] or what they’re doing.

SEAN NEETHLING: Yes. Simon. To your point, those secondary listings, the way we think about them at Morningstar is that these are global conglomerates, really well-established businesses, again with brand appeal, which happen to be listed on the JSE.

So we think the narrative and the pessimism that you spoke about up front tends to be very idiosyncratic in terms of thinking about it from a South African perspective.

But again, it’s important to disentangle, let’s call it, markets from the real economy. So we do think that again – just as an entry point into some of these global businesses – these secondary listings are actually buying into a really well-diversified basket of companies.

SIMON BROWN: And if we go back to the beginning of the conversation – and this does make an attractive market – you mentioned yields upfront as well. We’ve got attractive yields in the South African environment, and decent valuations. It’s kind of that darkness before the dawn, where everything’s terrible, but actually there’s opportunity, and we’ve got to be careful of getting overwhelmed by the terribleness.

SEAN NEETHLING: Yes, a hundred percent. I think we’ve seen that. I think if you go to, I suppose, quarter two or Q2, obviously that was dominated by tech shares and specifically the narrative around AI. But if you go back to pretty much April, there was a lot of pessimism that was back into global markets around a potential banking fallout. And a lot of that actually defaulted into local banks. At Morningstar, again, we look at the fundamental pricing of assets.

We think that financials and SA banks are actually really well priced. You don’t need a lot to go right in order to make some type of return on those. Industrial is somewhat more mixed.

But we do think that there’s a lot of value still on the JSE and, again, being able to build a diversified portfolio is something we think fairly attractive at this point in time.

SIMON BROWN: We’ll leave it there. Sean Neethling is a senior portfolio manager at Morningstar Investment Management SA, Sean, I appreciate the time.

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