Bottom up investing in South Africa

Part of the reason we built this site is because of the historical divergence in equity markets. Developed markets, led by the US are historically expensive. In contrast, emerging markets and frontier markets are historically cheap. There are several ways to take advantage of this historical opportunity. One way is through a top down approach, buying emerging market ETFs. Another way is to apply a bottom up approach to picking stocks in markets that are historically cheap. Desert Lion Capital demonstrates this approach in South Africa. In their 2020Q2 quarterly letter they discuss how expensive the US market is, and how cheap South Africa’s market has become.

In this piece I highlight some of Desert Lion’s insights on South Africa stocks.

Country risk does not impact all stocks equally.

South Africa’s economy looks disastrous from a top down perspective. It had an aggressive lockdown. Unemployment is over 30% and GDP is contracting rapidly. The budget deficit and Gross National Debt to GDP are all nearing record levels. The government is corrupt, and it fails to provide basic services to people. Consequently capital has been flowing out. Yet a messed up country doesn’t mean that all companies on that countries stock exchange are bad investments. In fact, often great companies are hidden on the exchanges of disastrous countries. South Africa is icky, and thats what makes it interesting.

That said, icky is good. I like icky. Icky means less competition, higher inefficiency, more mispricing, more great businesses at cheap prices. Yes, there is a lot of worthless ore on the JSE, but the JSE can be a gold mine for the knowledgeable investor, especially in a zero-interest rate world.

For companies with most of their revenue outside South Africa, all the problems in South Africa matter a lot less. Desert Lion’s key insight:
It is a fallacy to think all JSE listed companies’ fortunes will move in lockstep with SA’s fortunes.

Bottom up investment research in South Africa

Desert Lion sifts through South Africa listed companies one by one looking for opportunities.

There are about 325 companies listed on the JSE. Many of them do not depend on the country to perform to deliver us exceptional performance. Yet, most all of them trade at cheap valuations just because they are listed in SA.

Desert Lion highlights a handful of specific companies

Naspers is a global tech company which holds large shares in a lot of world famous companies in fintech, cloud, gaming, online classified, food delivery, travel, online retail, and various early stage venture companies. Perhaps its most famous holding is a 72% holding in Prosus, which in turn owns 31% of Tencent- the company that owns the famous WeChat app, among other assets critical to consumers and businesses in China. Naspers trades at over a 40% discount to its underlying assets. The Economist recently highlighted Naspers.

Cartrack gets over 50% of its earnings from Europe and Asia Pacific.
Argent is an industrial company gradually transforming its revenue base without getting much stock market attention. They’ve been divesting South African assets to invest in high return niche industrial businesses in the US and the UK.

Captec is the fastest growing bank in South Africa. Its not dependent on local economic growth, instead its focusing on expanding market share and product offerings. IT has a better Capital Adequacy and return on equity than the “big four” banks in South Africa.

Desert Lion’s letter is a primer on how to use bottom up research to find opportunity in out of favor emerging markets. Click here to access the full letter.