By Nolan Wapenaar and Peter Armitage
For many of us, 2024 ended with a familiar countdown, the pop of a champagne cork and a jolly festive party. A fortnight later, as South Africans dust off our work computers and try to recall our office passwords, we take some time to reflect. The year was a lot better for investors than we had initially anticipated - 2024 was a year when there were many reasons to be fearful, yet everything worked out.
Heading into the new year, it does feel like things are upside down. Domestic politics are relatively calm, while the US is poised for a period of policy uncertainty as President Donald Trump seeks to shift the country's direction. SA is the low inflation jurisdiction, while the US sees inflation that remains higher than desired. Emerging markets (EMs) seem to be low economic growth destinations, while US exceptionalism is expected to continue. Equity markets seem expensive, particularly in the US, while bonds are arguably appealing.
Some things, however, are unchanged. We believe that patience with investments is called for and that patience when making new investments will be rewarded. We continue to advocate for diversification across asset classes and investment geographies.
SA Equities
This year, we continue to see reasonable upside (+14% year on year) for the JSE, primarily driven by a continued earnings recovery for the domestically focussed equities (SA Inc counters). The bottom-up view of South African (SA) equities is broadly supportive of this scenario. Typically, where we find ourselves currently in SA would be associated with the early stages of an upcycle. Inflation (especially food inflation, which eased to 2.3% for October - its lowest rate in 14 years) is moderating, and interest rates peaked in 2024 and are expected to continue declining.
The domestic economy is expected to recover this year to record around 2% gross domestic product growth after years of sub-1% growth. SA banks are also well-capitalised, and their books are reasonably clean, meaning that if we get some demand on the lending side, there should be a nice multiplier effect on the economy.
Some shorter-term, more cyclical dynamics that should support consumption and the retailers, in general, would be the additional cash injection from the two-pot retirement withdrawals. Additionally, loadshedding is seemingly a thing of the past, and some positive, albeit slow, developments at Transnet should add further fuel to the local “things are getting better at the margin” narrative.
Assuming that the global macro backdrop remains stable this year (a big assumption), we expect the improving SA backdrop to translate into continued double-digit to mid-teen total returns from the domestically focused corner of the market. Most banks (a significant component of the FTSE JSE All Share Index) will likely deliver 10% earnings growth this year (Capitec being the exception with 20% earnings growth expected) and trade on high single-digit dividend yields. Assuming no re-rating, one could expect to see dependable mid-teen total returns.
The discretionary retailers, a much smaller component of the local index, will likely experience a much sharper earnings recovery, pocketing a higher proportion of the two-pot retirement withdrawals (estimated at R35bn after tax) with higher operating leverage than the more defensive banking sector. Earnings growth from the discretionary clothing retailers is expected to be around 20% for FY25, coming off a relatively low base from the past few years. Most management teams we have recently interacted with, particularly on the consumer side, have been more optimistic than we have seen in the past. It also appears that the December trading period went well for consumer-focused businesses.
On the industrial side, the messaging has been far more muted. The larger industrial businesses seemingly have not seen much change in their operating conditions, which remain constrained locally. The pickup in domestic activity levels has been concentrated in a gradual consumer recovery.
Looking at the rand hedge shares, it is hard to put the drivers of returns in one bucket, but if there were one, China would most likely continue to have the most significant influence on their performance outcome. The pullback in both Tencent and Naspers/Prosus is a straight derating, and the recent decision by the US Department of Defence (DoD) to place Tencent on a list of companies with ties to the Chinese military is unlikely to have a material impact on the tech giant’s operations.
Trading at 14x forward earnings with defensive double-digit growth in operating earnings has been an attractive entry into Tencent (and, by implication, Naspers/Prosus) in the past. At these levels, we expect Naspers/Prosus to be a material driver of returns for the JSE in 2025, given its relative size in the FTSE JSE All Share Index.
We also continue to like the food distribution business Bidcorp, following a year in which its earnings outlook has not deteriorated, and the stock has de-rated from 18x forward earnings to the current 15x. At 15x, that is the cheapest Bidcorp has ever been (outside of the Covid-19 pandemic), which we find interesting.
In terms of the basic materials sector, the drivers of share price performances over the short term seem to be primarily macro-driven, with the fundamental outlook for most businesses not having changed much over the past few months. From a fundamental perspective, it remains to be seen whether the stimulus measures implemented by China’s policymakers will have a material impact on commodity demand. While, in aggregate, the basic materials sector is generally not a sector we like to be overly invested in, there are certain markers that we look out for when deciding on how much exposure to take in our more benchmark cognisant portfolios. The rate of change of free cash flow (FCF) would feature highly on our list of attributes we would like to see, and at present, the gold sector would screen most favourably.
At the same time, the larger, more diversified global mining houses look to have found a plateau after a few years of consistent downgrades following the euphoria (or actually fear) in commodity markets after Russia’s invasion of Ukraine and the subsequent underperformance of China’s economy from mid-2022. Diversified miners trade on mid to high single-digit FCF yields, which seem reasonable given their moderately flat FCF growth profile. We prefer Anglo American and Glencore within the diversified mining space - the former for the potential value unlock from a restructure and Glencore for its attractive mix of copper and coal.
From a fundamental perspective, the platinum group metals (PGM) sector still screens as the least attractive for us. However, we concede that they are also the most levered to a change in their underlying basket prices (they are close to cashflow breakeven at spot). However, the long-term outlook for PGMs remains the most uncertain in our coverage universe.
We have little doubt that 2025 will be another year filled with surprises. We have new leadership in the US, which will set the global geopolitical tone. We now need a GNU that delivers on the much-anticipated structural reform to keep investor confidence in SA moving in the right direction. One only needs to look at recent developments in Argentina to see what the global investment community can do when confidence grows in a reform thesis – and SA is brimming with potential.
SA listed property
After dramatic falls post-Covid-19, the SA-listed property sector has recovered materially over the past two years, even though the domestic-focused counters are well off their highs. This is primarily due to a material devaluation of office space as workers spread their time between the office and the home dining room or study. The earnings base of the sector is back to a reasonably full level, and growth from here forward is likely to be closer to 5% than 10%. At forward dividend yields of around 9% for local counters, property companies look fairly valued relative to recently increased bond yields. So, it is a case of comparing a 9% yield growing at 5% with a 10-year bond yield of 10.5%, which is not increasing.
Our 12-month forward, total return projection for the sector is 11%, which comprises a slight capital increase in addition to the 9% dividend yield. Property fundamentals appear to have bottomed a few months ago, and vacancy levels are shrinking.
The office sector has long-term oversupply issues, but negative lease reversions have declined sharply as a full rent cycle has almost worked its way through post-Covid-19. So, net portfolio growth is returning, and the interest cost will decline towards the second half of 2024 (unless, like Growthpoint, hedging has delayed this positive impact). Offshore portfolios are performing better, and growth prospects look reasonable. This sets the stage for constructing a reasonable portfolio with a 7%-9% dividend yield and 3%-5% growth.
Nolan Wapenaar and Peter Armitage are the chief investment officers of Anchor Capital.
BUSINESS REPORT