A decade of difficulty: reasons for South Africa to be fearful and reasons for hope

Tough times

South Africa’s economic performance is highly correlated with that of our traditional economic partners, including Britain, Western Europe the US and Japan. Evidence of the extent of this economic inter-relatedness follows from the fact that each time Europe has gone into recession in the last two decades, South Africa has followed. Thus, whilst internal factors – such as the political landscape, considerations of nationalisation, currency volatility and stability of electricity supply – will matter to South Africa’s economic performance in 2012, external factors will matter at least as much.

The PAFTOTY scenario

Sadly, on the external front, there is not much reason for optimism from our traditional trading partners this year. These historically advanced economies remain mired in structural problems that include huge debt mountains in the private and public sectors; generous social welfare spending commitments that are untenable; demographic decay; and fiscal and monetary policies that have proved ineffective in the aftermath of the global financial crisis. We refer to this quagmire of malaise in which the advanced economies find themselves as a PAFTOTY scenario, where the acronym stands for “pissing around for ten or twenty years”.

The PAFTOTY scenario borrows from Japan’s experience of the last twenty years, which has seen the economy moribund despite furious stimulatory policy efforts. Amongst others things, Japan’s economic stagnation is explained by the same factors that appear in many other advanced economies today: vast indebtedness, demographic decay and policy inadequacy.

At present, 65 percent of the world’s economic footprint is represented by these advanced, but troubled, countries. Thus, as things stand, we are facing a decade or two of “polishing the brass on the Titanic”, effectively going nowhere economically in the advanced world. For those exposed to the South African economy, this is a reason to be worried.

SINFOOH Drivers

Whilst the economic recovery of the developed world over the last two years has been anaemic, many other economies have seen swift growth. China, India and Brazil – the clear drivers of the emerging economies – grew by 7.5% in 2010 and an estimated further 6.0% in 2011. At this rate of growth, these economies are doubling in size every decade. In this vein, the African economy continues to grow quickly, now having grown faster than Asia in eight of the last ten years. This dynamism in emerging markets gives rise to a second acronym – SINFOOH – which stands for “the sky is not falling on our heads”.

The things that matter

In spite of the gloomy outlook for many of the advanced economies in 2012, there is a raft of countries which boast excellent fundamentals in six factors which correlate with socio-economic (rather than economic) welfare.

1. A high savings rate. This funds a high rate of investment in fixed capital that, in turn, translates into economic growth.
2. A favourable demographic structure. If more people are entering the workforce than leaving it, this adds to the nation’s productive capacity and economic welfare.
3. An improvement in the nation’s relative physical health. The state of a population’s wellness, and ongoing improvements in access to healthcare and healthcare infrastructure, lead to further enhancements in socio-economic welfare.
4. Rising education levels with improved access to education and the education infrastructure. The more advanced the education a country’s population, the greater its likely rate of economic growth.
5. Improving quality of a country’s institutions and policy, including monetary, fiscal and industrial policy. Transparent policy-making and policy stability contribute as much to improvements in economic welfare as policies themselves. In essence, a transparent and stable policy setting translates into greater investment certainty.
6. Finally, the degree of economic openness. The extent to which the factors of production (goods, services and capital; people and ideas) are able to move freely between nations plays a role in determining growth and economic performance.

Beyond BRICS

There are at least 20 countries which have these factors in abundance, including all five of the BRICS (Brazil, Russia, India, China and South Africa) which represent a combined population of three billion people. But there are others countries, like Peru, Chile, the Philippines, Vietnam, Iraq, Egypt, Nigeria and, most recently, Mongolia that also are able to tick the boxes. What this means is that, with a richness of success factors and proper application, these factors can be processed into rapid socio-economic advancement. Notably, a region showing signs of improving success factors is sub-Saharan Africa (SSA).

Given this global backdrop, we see some modest tailwinds that have helped the South African economy to achieve reasonable growth in 2011, possibly of the order of 3.0% for the full year. Whilst this is better than many of our advanced counterparts, for South Africa to effectively address our structural unemployment problem the economy needs to grow at 10% per annum, far in excess of recent figures and well-above government’s target of six percent. To move the economy from pedestrian and stale to greater dynamism requires bold policy steps, and vibrant economic partners. The most obvious option in terms of the latter aspect would be for the South African economy to integrate with the SSA region.

Sub-Saharan Africa: filled with hope

In 2000, The Economist ran the now-infamous cover labelling Africa “The Hopeless Continent”. Since then, however, Africa’s progress has been anything but hopeless. Over the ten years to 2010, Africa’s annual output grew by 4.7%, almost twice as fast as the previous decade and much faster than the global average growth rate of 2.6%. In sum, SSA represents an extraordinary partner to help the South African economy achieve much faster economic growth.

The sky is indeed not falling on our heads. Cumulative BRICS growth over past decade totals $12 trillion, equivalent to the size of the US economy. Assuming the same growth rates apply, the BRICS economies would replace Italy ten times or Greece 40 times over the next decade.

What about South Africa?

So what are the implications for South Africa? This country needs to ensure that the six factors listed above are embedded in our society, our economy and our political landscape. We need to be effectively integrated with the rapidly-growing world economies – not just being among them, but working together with them.

We stand on the cusp of 2012 with a new set of policy initiatives launched by the South African government. But in reality we don’t need new policies. As Demosthenes said 2000 years ago, our three most important needs are “action, action and action”. It is critical that South Africa should avoid slipping into a PAFTOTY state – a risk that we run if we continue toying with policy rather than implementing it. South Africa has many positives going for it – a successful tourism industry; the homecoming revolution; superb fiscal and monetary policy discipline; vibrant neighbours; and a windfall from the R1 trillion infrastructure spending pipeline, which has one of the highest job multipliers and substantial spill-over effects. In this setting, South Africa has an exceptional civil society and a world-class private sector.

My three wishes for 2012

So, if I were to be given three wishes for South Africa in 2012, my list would be simple: “education, education and delivery”.

Without education, all else is wasted. We need to start at the very earliest point of education, in the foundation phase, and overhaul the system all the way to Matric. It may take 15 years to achieve, but we will grow a set of world-class matriculants who will change the face of South Africa for ever. We have seen countless examples of countries which have used education to rise above their history; countries such as South Korea, Rwanda, Singapore and Vietnam.

You may not be able to change your past, but you can change your future.

Stocking Fillers

The article below is posted on MoneyMarketing's website today.

4 Stocking fillers from Adrian Saville

Adrian Saville, CIO of Cannon Asset Managers, suggests shares to buy with your December bonus

1. I have been using the Samsung I9000 Galaxy for the past year and I am hooked. Given the incredible agility and resilience of this device, together with its affordability, it is a new must-have.

In a way, the Galaxy represents everything that is right about Samsung, the company, at present. Over the past fifteen years, the company has reinvented itself from producing cheap, second-grade goods in the 1990s to being a leading electronic goods firm today. I predict that the next step for Samsung will be to start writing code, which is likely to be another big industry disruptor.

Chairman Lee Kun-hee, on returning to Samsung following his brief imprisonment due to the Slush Funds scandal, was quoted as saying: “Over the next ten years, expect every one of our leading products to be obsolete.” This attitude demonstrates Lee’s attitude to running the business and the importance he accords innovation. It is how Samsung got ahead and is staying ahead.

This is one reason I believe that Samsung represents a good buying opportunity. In addition, this is a highly competitive company, operating in a highly competitive industry, in a highly competitive region – South East Asia. Shrouded in global competitiveness, Samsung is likely to outperform pretenders to the crown.

2. The BMW Group – one of Germany’s largest industrial companies – is a successful car and motorcycle manufacturer. It also represents an interesting investment opportunity. Financial stress in the euro zone has resulted in investors reacting negatively to the German-listed BMW. The share has slipped from a peak of €74 in mid-2011 to €43 in October 2011. It has since recovered to about €50, but that still is 30% off the high. On a 6.5 times trailing price:earnings ratio and trading at a little more than book value, a company of this stature is extremely appealing.

Apart from being exceptionally well-established as a brand, BMW is attractively priced, has a robust balance sheet, good cash flow, pays dividends and has a world-class management team that has taken the firm through good and bad economic times. During 2011, BMW sales into North America rose by 17%, in part due to the relaunch of the X3. In the Asia-Pacific region, vehicle sales are 45% up on 2010 figures. Having overtaken North America in terms of sales, it is likely that in the next 24 months, the Asia-Pacific region will overtake Europe (excluding Germany) to become the most important market for BMW.

Although a European company, over 50% of BMW’s revenue is derived from other markets, which investors need to take into account.

3. Metair is an investment vehicle with a portfolio of companies that manufacture and distribute products destined, predominantly, for the South African automotive industry.

Over the last ten years, while earnings have been volatile, Metair has grown operating profit at an average of 15% p.a. – not glamorous but a steady march upwards over a decade. The quality of the company is further underscored by a return on equity in excess of 20%. Moreover, with retained earnings exceeding shareholders’ equity the implication is that the company’s balance sheet has been funded by historical profits as opposed to debt or other outside capital.

The stock is trading on a trailing price:earnings ratio of 8 times and a dividend yield of 4% with a balance sheet that is exceptionally strong. The company has no long-term debt and has more than R300m cash on the balance sheet. In the difficult economic setting, it also is comforting that interest cover is 30 times and the company is a consistent payer of dividends.

Aside from the intrinsic value of the operating businesses that Metair owns, we also see exceptional value in the balance sheet of the business. Metair owns industrial property of some 227,000m2 that we value at as much as R750 million. This is a material component of Metair’s market capitalization of R2.7 billion.

One guide to prospective returns is to know what insiders are doing. Of the last 120 director dealings, 106 represent directors buying i.e. 88% of the deals by those close to the business have been to purchase the shares.

4. Our final stocking filler is Anglo American (Anglos) which has been undergoing thorough corporate streamlining that is progressing well. On this front, Cynthia Carroll is proving to be very effective is getting the firm leaner and more focused. She has demonstrated effectiveness and ability in managing the company. In 2009, she saw off the audacious Xstrata bid for Anglos. More recently, she has negotiated a sincerely good deal in acquiring the Oppenheimer’s 40% stake in De Beers for $5.1bn.

Notwithstanding the failed Xstrata offer, Anglos remains a promising take-over target particularly as the company should soon be net cash positive. All debt should be extinguished by the sale of a 24.5% stake in its Chilean copper unit, Anglo American Sur (Sur), to Japan’s Mitsubishi for $5.4bn. And at this price, it places a value on Sur of $22bn, which is equivalent to 42% of Anglos’ market capitalisation.

Just the holdings of Sur, Anglo American Platinum (79.7% held) and Kumba (65.3%) explain Anglos’, market capitalisation. This means that an investor will acquire all its other holdings “for free”, including the coals interests, which accounted for 22% of revenue in 2011, and Anglos stake in De Beers.

If the advanced world does slip into recession, this would pose a greater threat to the oil industry than to other commodities, which would imply that BHP Billiton would be more vulnerable than Anglos. In addition, it is unlikely that China is going to experience negative economic growth in the near future, which provides a safety net for the base metal market and thus Anglos. Specifically, iron and copper account for some 50% of Anglos’ revenue.

In sum, there are good reasons for Anglos to be on your shopping list. It is a world-class resource player which is attractively valued. The company is well positioned for a world which is migrating from traditional developed markets to the emerging markets and recent investor anxiety around resource companies places the business on an extremely attractive through-the-cycle valuation multiple.