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Investment Process in Action: the South Africa Diaries

Recently our African investment team visited South Africa as part of their continuing management of existing investments and pursuit of new opportunities. The trip provides a clear snapshot of our investment process in action.

Our unconstrained universe

In January 2016 our fund exposure to stocks in South Africa was 33%, today it’s 60%. We had spotted a deeply undervalued currency and a country concerned about the unpredictable behaviour of President Zuma. Flash forward to today and we find its enduring institutional strength helped maintain its investment grade rating, the currency appreciated over 20% and the external positioning continues to improve with the recovery of commodity prices. Our non-benchmarked approach enabled us to build our position in companies with the potential to deliver great returns over the next 3-5 year cycle, not just from a short-term bounce in sentiment.

Prospects for improving country risk

We assess country risk in terms of economic health and institutional and government quality. It is clear that Zuma has been a disastrous leader for South Africa. However, 2017 holds the prospect of change as the ANC are electing a new chairman. So a real prospect of a positive leadership change, alongside a strong central bank could mark the beginning of a reform driven agenda, triggering a return to faster economic grow.

The “Tail”Winds of Change

As we anticipated, we are now witnessing the headwinds being replaced by cyclical tailwinds with inflation falling, exports rising, and business confidence improving.

At Alquity, we focus on the cycle of profitability with the primary aim to invest in companies towards or close to the bottom of their cycle and where our expectations are significantly greater than the market. One such company is KAP Industrial Holdings, a leading supply chain logistics and manufacturing business. As the South African economy faced headwinds the business maintained its profitability but the market punished its share price, implying a structural change in outlook. As the economy improves, KAP is therefore well positioned to capture growth and increase profitability ahead of market expectations.

Hidden Gems with sustainable competitive advantage

South Africa is a complicated place to do business, which makes it an unlikely destination for direct investments. This allows savvy domestic operators to build world class operations with sustainable competitive advantages. A good example is the clothing & food retail operator Woolworth, that developed its own supply chain and branded food company. Recently it removed all plastic microbeads from its private label beauty and personal care products, making it easier for consumers to avoid being part of an environmental problem that is causing worldwide concern. This reflects their strong supply chain management and responsiveness to consumer trends.

In summary, as a country with strong institutions, great companies and abundant resources it is not surprising that a recent Bloomberg article revealed that South African equities have delivered the highest average return in US Dollars, for any equity market, over the past 100 years.