In the past decade, the world has changed dramatically for value investors. The rise of the online discount broker and availability of information online has revolutionized the investment landscape for every type of investor. It’s now just as easy to put money to work in Australia as it is in the United States.
So, in this series I’m looking at several different developed, emerging and frontier markets, highlighting their potential risks and rewards for value investors. You can find part one of the series, Is It Wise To Go Hunting For Value In Brazil? Here.
Value investing in South Africa
Africa is often touted as the world’s next high-growth region, following in the footsteps of Asia and South America. And there’s no denying that the region has potential. The continent is home to a third of the planet’s mineral reserves, a tenth of the oil, and it produces two-thirds of the diamonds.
While the continent has been held back by corruption and protectionist economic policies, over the past decade Africa has clocked up an average annual economic growth rate of 5%. Government policies to reform markets and overseas investment have been key growth drivers, but many of the region’s markets remain inaccessible to international investors.
For example, there are 29 stock exchanges in Africa, representing 38 nations. Of these, only 24 exchanges are represented by The African Securities Exchanges Association and only 16 of these exchanges have more than ten securities listed. The region’s three biggest markets are South Africa, Nigeria, and Egypt. Of these three, South Africa is the only market which offers exposure to the whole of Africa, while offering the kind of top ranked audit and accounting standards, a sound banking system, and well-regulated stock exchange that developed market investors have come to expect.

South Africa is still defined as an emerging market by the MSCI MSCI Market Classification Framework, but the country is home to many of Africa’s largest financial institutions. Africa’s four largest banks, Nedbank, First Rand, Absa and Standard Bank are all headquartered within South Africa The smallest of the big four banks, Nedbank, is almost 50% larger than Egypt’s largest bank group, National Bank of Egypt.
Thriving community
The value investing community is thriving in South Africa. In contrast to many markets, most institutional asset managers in South Africa are value-biased, which is both good and bad news. For example, while this concentration on value has created a thriving industry, full of ideas, it has become an overcrowded market and returns have deteriorated as a result. There are around 1,000 companies listed on South African exchanges, which severely limits opportunities — there are over 3,000 companies listed on the US’s NASDAQ exchange.
The relatively small number of listed companies in South Africa means that’s it is difficult for a single value manager to outperform their peer group. What’s more, the region has more than its fair share of value traps.
Africa is a commodity focused-continent, and South Africa is no different. As any seasoned value investor will tell you, due to the lack of pricing power the commodity sector is not an attractive sector for value investors. One sector, in particular, that has caused contention over the past few years is the gold mining sector.
Gold mining in South Africa is a huge industry, and the shares of gold miners have come under pressure as the price of the yellow metal has fallen and costs have risen. As a result, many gold miners are trading at a discount to book, drawing value investors in. Nevertheless, gold miners are notorious for destroying shareholder value. But when the majority of South Africa’s investment industry is chasing value, opportunities like these, no matter how toxic are chased by managers in an attempt to outperform benchmarks.
Deep value investors are more likely to fall into this trap than other classes of investor. As Greg Hopkins, chief investment officer at PSG Asset Management explained to Moneyweb.co.za:

“…PSG has kept its head up well. The value investors that have struggled, however, are largely those at the other end of the spectrum – those with a ‘deep value’ bent. They have bought into companies that they believe will re-rate, but in many cases investors are still waiting for that to happen.
“Avoiding value traps is probably the most important thing to do when you’re buying a business that looks cheap, because it could turn out to be less so in the fullness of time if its earnings continue to deteriorate,” Hopkins says. “So a business that you thought you were buying at ten times earnings really turns out to be trading at 15 times earnings, which would be fair value.”
In South Africa, African Bank was perhaps the most classic example of a value trap in its last few months of trading. Over the last five years, deep level platinum and gold miners have also simply failed to re-rate as it has just become more difficult and more expensive to get the commodity out of the ground.”

Conclusion
What does this all mean for those looking to invest in South Africa? Well, for a start with so many of the region’s money managers chasing value, there’s a shortage of attractive value plays, this is only exasperated by the small number of firms listed in South Africa. These constraints could push value hunters into value traps, not something any value investor would want to find themselves in.
All in all, South Africa is best market to gain exposure to the African economy but it might not be the best place to hunt for value.

The post Is It Wise To Go Hunting For Value In South Africa? appeared first on ValueWalk.
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