6 (More) Reasons to Invest in South Africa

Yesterday, Jan Schalkwijk, CFA, of Africa Capital Group began to make the case for investing in South Africa. Today, he bolsters his argument with six additional reasons to be a South Africa bull.

Why else should stock investors consider South African stocks?

1. Link Between Africa and the BRICS

South Africa is an attractive market for investors who wish to gain exposure to African growth but wish to avoid the pitfalls of less mature markets in terms of liquidity, trading costs, limited data, and transparency. African GDP is forecasted to reach $2.6 trillion by 2020, up from roughly $1.6 trillion today. South Africa is well positioned to play an integral part in this growth, with its mature and competitive industries and proximity to African markets.

Additionally, South Africa will benefit from the growth of its biggest export market: China. As such South Africa – uniquely positioned at the confluence of the “Africa” and “BRICS” themes – offers a compelling case for investors with a long-term horizon and the patience to see these opportunities materialize.

2. Unemployment Slowly Easing

The combination of low labor cost pressure and competitive sophistication has benefited South African companies on the global stage. However, the benefits to South Africa’s economy would be greater with lower unemployment and thus higher domestic consumption.

Photo by Kicki Holmen

South Africa’s unemployment rate is stuck at 25% and will require high economic growth to alleviate. Though the rate is high by global standards, the 10-year trend shows a gradual reduction in joblessness.  The pent-up economic activity that is unleashed when the unemployment number comes down, bodes well for South Africa’s economic future. Also note that the informal economy in South Africa is quite large, so labor force participation and purchasing power are likely understated as much work goes unreported.

3. Inflation Held In Check

Inflation is currently at 6%, which is close to the country’s 10-year average inflation. It has peaked twice in the last decade; once at approximately 13% in 2002 and at 14% in 2008. The 2008 peak was substantially driven by commodity price inflation. Despite a 6% rate of inflation, the rand is worth the same in dollar terms today as it was in March of 2003. On balance, however, high inflation is a negative, as it leads to uncertainty for businesses and introduces volatility in the conversion of short-term investment returns earned in local currency.

4. A Diversifying Economy

The main sectors of the South African formal economy are financial services, consumer products, and mineral resources. On the resources side, South Africa is the largest producer and exporter of gold and platinum as well as a top exporter of diamonds. Chinese, Western, and Russian companies are all vested in South Africa’s mineral wealth. If managed well, South Africa will be able to parlay this dependence into further diversifying its economy so that the resources do not become a curse but a catalyst for broad economic development.

Jan Schalkwijk, Portfolio Manager at Africa Capital Group

This is beginning to happen in the diamond industry. Diamonds are a girl’s best friend, but not always a country’s best friend. It is probably fair to say that diamonds and precious metals have been more of a curse than a blessing for Africa. Though certainly they have created wealth, the benefits have not been widespread. Now, some of that wealth might find its way into the broader economy. Recently, the Oppenheimer family of South Africa sold its 40% remaining stake in DeBeers Diamonds for $5.1 billion. Some of this wealth will likely be redeployed in consumer goods and agriculture companies, a focus of the family’s investment arms.

The reinvestment of capital gains from the diamond trade into sectors that have greater economic multipliers is a positive for (South) Africa and should provide meaningful economic impact in the short-term.

5. A Healthy Banking System

South Africa has mature risk control, foreign exchange control, and settlement systems, which has greatly aided international investment and banking. Net interest margins for the country’s four largest banks have recently been in the 3.5% to 4.5% range, nowhere near as high as what you might find in frontier African countries but healthy nonetheless.

Furthermore, loan-to-deposit ratios in the banking sector are healthy at around 90% on average for the big banks. By contrast, loan-to-deposit ratios of mature European banks are generally over 100% and US banks, not eager to lend, are currently at 80%. One might conclude that the South African banking sector is mature from an infrastructure standpoint and healthy from a financial standpoint. Coupled with the growth of financial services and the broadening reach through micro credit and mobile banking, South Africa’s financial sector would seem an attractive destination for investment dollars.

6. An Emerging Middle Class

The consumer industries comprise the third pillar of the South African economy. The thrust of this paper has been a discussion of the economic opportunities that abound in South African and the continent at large. Ultimately, these opportunities all lead to the same place: the emergence of an African middle class. Therefore, consumer companies are at the core of a successful Pan-African investment strategy.

South Africa has several publicly traded companies that are currently focused on the African consumer. Most known perhaps is Shoprite Holdings (SRHGY), a supermarket chain that operates close to 400 stores in 16 countries throughout Africa. Its economies of scale allow it to be a price leader and it has branched into value added services such as ticket sales, pharmacies, liquor stores, and financial services. Though a leader, other companies are sure to follow.

Africa’s Turn to Shine

The promise of Africa is the alignment of favorable macro opportunities that will finally make the continent an economic power in its own right and deliver prosperity to a growing share of its people in the 21st century. Much in the way that investors were rewarded for early investment in Japan in the 1960s and emerging markets in the 1980s, Africa represents an opportunity for above average returns in the decade(s) ahead.

What keeps investors from participating is very similar to what may have kept them out of Japan 50 years ago and Southeast Asia 30 years ago: lack of familiarity, misconceptions about political and economic risk, lack of rich data, and limited liquidity. Incidentally, these same factors are part of the reason excess returns can be achieved with a prudent and disciplined investment approach.

Focusing on South African companies as the gateway to investing in sub-Saharan Africa will mitigate some of the risk factors associated with Africa while still allowing for participations in the continent’s growth prospects. As the story of Africa matures, one’s Africa exposure should mature with it to include stocks listed in other countries in order to maintain exposure to above average growth.

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