Gone to the Dogs

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

2012-01-24T15:09:00.005+02:00

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.

A high savings rate. This funds a high rate of investment in fixed capital that, in turn, translates into economic growth.
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.
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.
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.
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.
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

2011-12-14T09:55:00.002+02:00

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.

Name the world's fastest growing economy over the past decade (it’s not China)

2011-11-28T16:20:00.003+02:00

Almost ten years since the Angolan ceasefire, the country’s economy has risen like the proverbial phoenix from the ashes. The article below sets out some of my views and thoughts on Angola’s economic performance since independence, the economy's remarkable rise over the past decade and the country's economic prospects as the tenth anniversary of the declaration of peace approaches in April 2012.

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When Angola gained independence from Portugal in the mid-1970s, the country was the fourth largest coffee producer in world. Alongside coffee, this large, fertile country exported other cash crops, including sugar, cotton and more than half a million metric tons of maize a year. Angola had become the fourth largest diamond producer in world by the early 1970s while oil production, which started in 1955, was ramped up by large offshore reserves that came online in 1970. In addition, a small, but diverse and modestly successful manufacturing sector had developed since the end of World War II.

Despite these signs of success, by the turn of the century, Angola’s economic engine had been obliterated by four decades of strife: a 14-year war of independence against its former Portuguese masters was waged until 1975, followed by a civil war that continued for 27 years.

By April 2002, when the civil war ended with a ceasefire after Jonas Savimbi’s death, the Angolan economy had been shredded and the country devastated. The population of 10.5 million lived in appalling conditions: 80% of all schools had been destroyed during the war, and a whole generation had missed their education; three-quarters of factories had been wiped out; 60% of hospitals lay in ruin; and land mines meant that Angola, along with Cambodia, had the unenviable record of having the most amputees per capita. To make matters worse, at the end of the war some seven million unexploded land mines remained in the interior of the country.

During the war, the country’s woes were compounded by a flight of skills: 300,000 Portuguese fled, depleting Angola’s managerial and technical skills. Coffee production had fallen from 220,000 tons in 1974 to just over 1,000 tons in 2004 and Angola had been turned from a food exporter into a food importer. The country’s per capita income of $550 in 2002 was one of the lowest in the world.

But an economic miracle has been taking place in Angola since peace was declared in 2002. Under Jose Eduardo Dos Santos, the resource-rich economy has gone from strength to strength and the socio-economic fabric has begun to repair. Over the 2001-2010 decade, the Angolan economy grew by 11.1% per annum, making it the fastest-growing economy in the world (the second fastest, China, grew at 10.5%). As a result, per capita incomes have risen steadily to reach $5,608 per person, a figure ten times that of just a decade before.

This trend of rising per capita incomes seems set to continue as high fiscal deficits of the 1990s had been turned into budget surpluses by 2005. This year’s government’s budget of $43bn, which is 75% oil derived and based on oil prices of $65/barrel, seems set to produce further high windfall gains given current oil prices. Importantly, the government sector represents about one-third of economic activity.

Whilst Angola is benefitting materially from economic reconstruction, it would be naïve to suggest that the country is rebuilding in isolation. Since the end of civil war, Angola has successfully attracted foreign direct investment (FDI) into the country, especially into the oil sector. From 1993-1998, the estimated investment in that sector was $6.8bn, but in 2009 alone Angola received $13.0bn in FDI for the sector. In some ways, this result is unsurprising: Angola’s proven oil reserves stand at about 13.bn barrels – or 40% more than the United States’ estimated reserves of 9.5bn.

Beyond oil, the agricultural sector is being revitalised while the small manufacturing sector is also recovering, aided by investments in ports, roads and railways. Angola feels like a gigantic building site, as roads, ports, railways, hotels, shopping centers, hospitals, universities – even whole new towns – rise up out of the bush. Luanda has changed out of all recognition, as the dilapidated red-tiled colonial buildings and encroaching slums make way for a forest of elegant high-rise hotels, offices and apartment blocks.

From history, however, we know that a key driver of sustained economic growth is international integration: the extent to which capital, goods, services and people move across borders and between countries. In this regard, it is noteworthy that data obtained from a global payments and technology company show that Angolans are spending increasingly in other countries, which points to rising economic integration.

Given historical ties, it is unsurprising that the data point to high levels of spend in Portugal. But interrogation of the data also highlights other features: utilisation of credit and debit cards by Angolans in other countries rose by more than 50% in dollar terms over the past year and almost doubled over the past 18 months. This figure represents a growth rate in spending by Angolans that is more than ten times the global average growth rate over the same period. This data reflect strong economic growth and rising economic integration. Importantly, this pattern is reflected in the 91% increase in spending by Angolans in neighbouring countries, including Namibia, Mozambique and South Africa, over the past 12 months. This underlines an even more important aspect of Angola’s economic miracles, namely that the miracle is taking place in the context of rising regional collaboration and economic integration, which augers well for all of the economies involved.

As Angola approaches the tenth anniversary of the 2002 peace agreement, the country has rebuilt much of its economy and social fabric and looks poised to fulfill the IMF’s expectation of 7.1% per annum economic growth from 2012 to 2016.