Invest in South Africa the Easy Way

South Africa gets a bit less attention today than it did in the heady days leading up to the World Cup. But investors would do well not to let the country fall off their radar.

Why? No other country is as widely engaged in the Sub-Saharan economy than South Africa. The country’s economic growth has slowed since the end of the soccer-fueled construction boom, but it’s still chugging along at a 3.2% clip. Its currency, the Rand, has been on a tear the past couple years, appreciating 35% versus the greenback since the start of 2009.

Still not convinced? The smart cookies that manage the Harvard endowment sure seem to be. Their portfolio’s fourth largest holding is the subject of this post.

So, what’s the easiest way for a Yankee to participate in this market? The iShares MSCI South Africa Index (NYSE: EZA).

EZA is an exchange-traded fund comprised of 46 stocks listed on the Johannesburg Stock Exchange. It has performed quite well in 2010, posting a 20.7% return compared to the S&P500’s tepid 3.3%.

Like the other two Africa-focused ETFs (NYSE: AFK and NYSE: GAF), EZA’s holdings are skewed toward the mining sector (24.7% weight), and gold and platinum mining in particular. That’s something to consider if your portfolio is already overweight on commodities, or if you have concerns about the social and environmental impacts of mining. Anglogold Ashanti (NYSE: AU) (6.6%) and Impala Platinum (JNB: IMP) (5.3%) rank among the fund’s ten largest holdings.

The ETF’s largest holding, however, is MTN Group (JNB: MTN), and with an 11.0% weight, its fortunes have a significant impact on the entire fund’s performance. The company is South Africa’s leading cellular provider, but it also operates (or has substantial ownership in) wireless companies throughout Africa and the Middle East. It presently trades at a trailing P/E ratio of 15.9, and it grew adjusted earnings by more than 20% during the first half of the year.

It’s worth noting that the fund also holds shares of one of MTN’s biggest competitors, Vodacom Group (JNB: VOD). All told, EZA’s exposure to the telecom sector amounts to 12.9% of the total portfolio.

Other EZA holdings of note include energy giant Sasol (NYSE: SSL), Naspers (JNB: NPN), a South African media conglomerate, and the large Standard Bank Group (JNB: SBK). These three holdings are weighted 9.6%, 7.5% and 6.5% respectively. Take a look at the entire portfolio here.

EZA trades near its all-time high at the moment, but with a price at 12 times its aggregate trailing earnings, it doesn’t strike me as overly expensive. As with most investments, building a position gradually through dollar-cost averaging makes very good sense here.

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How to Invest in South African Stocks — From Main Street, USA

An African Telecom Stock … Sort Of

It’s difficult to overstate the impact that the cellular phone has had on African economies. The continent’s landline networks are sparse and costly to extend. So, without telephones, most business was negotiated face-to-face.

When the first wireless companies set up shop in the mid 1990s, they couldn’t expand quickly enough to meet the pent up demand. Fifteen years later, most African markets remain far from saturated. Cellular providers continue to grow their customer numbers month after month.

Unfortunately, these dynamic companies remain largely beyond American investors’ grasp. Most of the industry’s major players aren’t listed on the NYSE or Nasdaq. Kenya’s Safaricom is a subsidiary of Vodafone (Nasdaq: VOD) and West Africa’s Orange network is part of France Telecom (NYSE: FTE). But these African firms are dwarfed by their parent companies. Thus, their impressive growth has relatively little impact on the corporate bottom line.

Millicom (Nasdaq: MICC) is the purest African telecom play to be listed on a US exchange. The company derives more than 20% of its revenue from the continent. (The remainder comes from its Central and South American divisions.) It presently operates in Chad, the Democratic Republic of Congo, Ghana, Mauritius, Rwanda, Senegal, and Tanzania.

In most markets, MICC aims to build market share by undercutting its competitor’s rates. It’s been a successful strategy. The company launched its Rwandan operation just 10 months ago, but it has already captured a 15.3% segment of the country’s wireless market. In total, MICC’s African operations netted an additional 2.3 million customers in the first nine months of 2010.

Granted, this kind of growth won’t last forever. The company’s Central and South American subsidiaries have turned to value-added services to boost profits, because mobile penetration rates in the region are much higher. As the marginal benefit of extending its network of cellular towers shrinks, this will surely become MICC’s African strategy, too. It has already launched a phone-based money transfer service in Tanzania.

MICC currently trades at a shade above 20x normalized trailing earnings and a 2.5% dividend yield. That may be a tad pricey, but definitely worth a look for long-term investors who want to participate in the African wireless story. We’ll delve deeper into MICC’s financials in future posts.

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African ADRs

Last week, we took a look at an Africa-focused exchange traded fund. Funds of this sort provide US investors with a convenient entry to African markets. No muss, no fuss.

Unfortunately, most of the stocks that comprise these funds don’t trade on the NYSE or Nasdaq. They trade on their local exchanges or in Europe.

But American stock-pickers aren’t totally bereft of African options. Several African companies trade stateside via American Depositary Receipts (ADRs). ADRs are certificates that represent ownership of shares in a foreign-listed firm. They trade just like ordinary stocks do, and the companies that offer them must pay dividends in US-Dollars and report their financial statements in accordance with US GAAP.

Here are the African ADRs that trade on the NYSE and Nasdaq:

Anglogold Ashanti (AU) – a huge South Africa –based gold-miner that operates on four continents. Most of its proven mines are in Africa, and concentrated in South Africa.

DRDGold (DROOY) – South Africa’s fourth largest gold-mining firm. Its operations are situated near Johannesburg.

Gold Fields (GFI) – A Johannesburg-based miner that operates nine projects in South Africa, Ghana, Australia, and Peru.

Harmony Gold (HMY) 4.85B – Yet another South African gold miner. It has 11 projects in South Africa and is prospecting for more in Papua New Guinea.

Randgold (GOLD) – A Channel Islands-based gold-miner that operates primarily in Mali and Senegal.

Sappi (SPP) – A South Africa – based wood pulp and paper company. It operates paper mills in South Africa, throughout Europe, and the USA. It sells paper and packaging worldwide.

Sasol (SSL) – a natural gas and chemical company. Headquartered in Johannesburg, it boasts a diverse array of projects across Africa.

As you can see, the list is dominated by South African mining companies. So, it’s not particularly representative of the reasons I find Africa such a compelling investment opportunity. Still there are some interesting stories here that we will explore in future posts.

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The Easiest Way to Invest in Africa

Investing directly on an African stock exchange is an intimidating prospect for someone located an ocean away. It’s a scary thing to send your hard-earned dollars to an unfamiliar place, especially a place that we’ve been conditioned to see as chaotic and corrupt. When this prejudice is compounded by stacks of paperwork or unhelpful brokers, it’s clear why many investors conclude that the continent simply isn’t worth the hassle.

Fortunately, you don’t have to be a thrill-seeker to be an Africa investor. The Market Vectors Africa Index ETF (Ticker Symbol: AFK) brings some of the region’s largest stocks within reach of your online broker. I’m a fan of the fund and here’s why.

Accessibility

As an exchange-traded fund (ETF), AFK trades just like a stock. You can buy and sell it through any US broker at any time of the trading day for the same commission as a stock. You can even sell it short if you so desire. What’s more, its 0.83 expense ratio is a bargain compared to most mutual funds.

Diversification

With 13 countries represented in its portfolio, AFK is Africa’s most regionally diversified ETF. Nearly 80% of the fund’s assets are invested in companies based on the continent. The remainder of the portfolio consists of firms that conduct more than half of their business in Africa. Note that the portfolio is skewed toward South African, Egyptian, and Moroccan stocks, but it does include some token representatives of the Nigerian and Kenyan markets.

Stock selection

AFK holds some fine companies that you simply can’t buy anywhere else this side of the Atlantic.

Bank stocks comprise nearly 30% of fund assets. I like this focus. Compared to their Western counterparts, African bankers tend to be a conservative bunch. By and large, they focus on growing a deposit base and investing in treasuries. It’s not a flashy business model, but it’s a stable one.

Telecommunications companies are also well represented – garnering a nearly 10% weight. Africa’s wireless companies have been some of the world’s most innovative. They’ve pioneered services and pricing strategies that radically changed the way business is done on the continent.

To be honest, I do have misgivings about the fund’s concentration (26%) in mining stocks. The mining industry’s social and economic legacy is a troubled one in many African countries. Moreover, captive as they are to fluctuations in global commodity markets, mining firms are especially difficult to analyze.

Conclusion

While not perfect, the AFK is an excellent way for US-based investors to add some African exposure to a stock portfolio. It currently trades at a slight premium to its underlying asset value (P/NAV: 1.01) and yields 0.76%.

Further Reading

11 Africa-Focused Mutual Funds and ETFs

5 Reasons to Invest in African Stocks

Investing in African stocks strikes many investors as impractical or foolhardy.

Here are a few reasons why it’s the first place I look for investment bargains.

Investing in African stocks strikes many investors as impractical at best and foolhardy at worst. I disagree. Here are a few reasons why the continent is the first place I look for investment bargains.

1. Africa’s where the growth is.

Strengthening consumer appetites, a resurgent demand for commodities, and reduced debt loads have African economies firing on all cylinders. Economists expect 23 African economies to grow by 5.0% or more in 2011. The US’s economic growth will likely fall short of 3.0%.

2. African stocks are cheap.

Typically, rapid economic growth translates into sky-high stock prices. Not so in most African markets. The P/E ratios of the continent’s blue chip stocks routinely fall into the single digits. Zambia’s Lafarge Cement, Kenyan oil marketer KenolKobil, and Ghana’s FanMilk currently sell for 7.8, 4.8, and 9.9 times their respective earnings. The S&P 500 index’s 20.3 ratio is bloated in comparison.

3. African markets have little to no correlation with Wall Street indexes.

Thanks to their small size and low visibility African markets tend to march to the beat of their own drummers. If global markets “zig,” they might very well “zag.” Thus, a few positions in African stocks help reduce the volatility of a stock portfolio.

4. To help develop Africa’s capital markets

Each dollar invested in an African stock helps to build the liquidity of the exchange on which it trades. Rising liquidity lowers risk. Lower risk attracts additional investment to the exchange. Greater investment on the exchange lowers the cost of capital for listed companies. A lower cost of capital leads to increased growth and job creation.

5. African markets are more accessible than ever before.

Africa remains a relatively difficult place to invest, but it’s becoming less so with each passing year. More and more funds, ADRs, and African ETFs are hitting the market. African exchanges have improved their trading systems and governance while brokers are improving their quality of service.

This list is by no means exhaustive, but it captures the essence of what makes African stock markets such a compelling opportunity.

Do you invest in Africa? If so, tell us why in the comments?