By now, many of our investors will know that Coronation is fully invested in equities across our range of multi-asset funds. For Coronation Balanced Plus, our long-term capital growth fund aimed at retirement savers, this allocation to equities is at its highest level since the Global Financial Crisis (GFC) (see Figure 1).
However, being this optimistic about return prospects over the next several years does not mean that we are oblivious to the multitude of known and unknown risks, both in South Africa and abroad. As our analysis below shows, after accounting for the various risks as part of our research output, we continue to believe that selected equity valuations are very attractive and offer a sufficient margin of safety. Here’s how we justify our conclusion.
NO TAILWINDS FROM THE SOUTH AFRICAN ECONOMY
There is no doubt that we are paying the very high price of anaemic economic growth for years of underinvestment in our country’s infrastructure. For more than three decades, South Africa’s gross fixed capital formation (currently at <14%) has lagged the level you would expect in a well-run economy, with investment of anywhere between 20% and 25% of GDP required to support increasing prosperity.
Poor management added to the impact of this lack of investment, as is evident in the deteriorating performance of state-owned utilities such as Eskom and Transnet. Eskom has seen consistent declines in its energy availability factor (only 50% to 60% of Eskom’s capacity is currently functioning), mainly due to the lack of planned maintenance sitting at a levels well below what is required just to catch up (10% vs the required 15% - 20%), as shown in Figure 2 below.
In terms of mobility, the scenario is pretty similar to that of our power infrastructure. Transnet too has been underspending on maintenance quite meaningfully. As such, the volume of goods being moved by rail has been declining, and thus shifting significant additional volumes onto our road network which is already under pressure due to the collapse in passenger rail trips (see Figure 3).
Should commodity prices reset, the economy could face a double whammy by way of lower (commodity) prices and lower export volumes should road transport become economically unviable.
SELECTING BUSINESSES THAT ARE DOING WELL, AND WILL CONTINUE TO DO SO
Notwithstanding the above constraints, our analysis shows that many South African companies continue to perform well, with corporate earnings in recent years more likely to surprise on the upside than the downside. While the bulk of our equity market priced at undemanding price-to-earnings ratios of between 6 and 12 times, we believe that stock picking will be key (see Figure 4). Some stocks will naturally disappoint in a weak economy due to market share losses, limited pricing power, brutal cost pressures, nodal declines and the bursting of certain oligopolistic industry structures (e.g. hospitals and life insurance).
As such, our focus is on building portfolios filled with businesses that are performing well and are expected to continue doing well. In other words, those companies that are showing real growth (through market share gains and cost containment without underinvesting in their business) and are allocating capital in a shareholder friendly manner (through buybacks/dividends or being capital light).
MANY GLOBAL RISKS REMAIN UNRESOLVED
With the additional investment freedom brought about by the relaxed Regulation 28 limits on offshore investments, we are able to balance our local stock picks with global businesses which allows us to achieve better risk-adjusted returns within our total equity portfolio.
Again, we are not oblivious to the many risks from 2022 that remain unresolved. While global interest rates have gone up a lot, they are not high compared to history, justifying concerns that rates could continue to rise. Against this backdrop, sovereign over-indebtedness remains a key concern for us (see Figure 5).
If the world tips into recession, and we experience a hard landing, central banks are not in a position to provide the same stimulus that they did during the GFC or Covid pandemic. Furthermore, the risks of investing in China remain heightened as President Xi Jinping tightened his control further in 2022: centralising power and decision making, enhancing state overview of everyday life, and ongoing interference in the economy.
LARGE MARGIN OF SAFETY IN SELECT INVESTMENT OPPORTUNITIES
Against this backdrop, we see us moving into a world that, structurally, will see slower growth. And with the cost of capital having gone up materially, growth is becoming much harder to come by. Investors should therefore become more likely to pay a premium for those businesses benefitting from multi-year structural growth drivers.
However, asset price declines in 2022 were indiscriminate, in response to a classic macro-driven cycle (geopolitics, interest rates and inflation). In our view, this left many diamonds in the rough: businesses whose share prices were derailed simply because they were still in the early stages of their lifecycle (lossmaking and/ or with profit margins not having yet normalised due to investing all free cash generated back into growth).
Our analysis shows that as a result, many quality global growth companies are cheaply priced with the potential to deliver market outperformance over the next several years.
OUR ROLE IS TO MANAGE RISK, NOT AVOID IT
South African shares are screening as very cheap, and quality global growth stocks have sold off aggressively while sentiment was very poor. As long-term investors, this leaves us optimistic about the future long-term return potential from the total equity portfolio in our domestic multi-asset funds.
Our role is to manage the risks outlined above, not avoid it. As such, by having a thorough understanding of the existing and potential hazards and through being selective and diversified in the companies that we add to our portfolio, we believe we can deliver strong returns on behalf of our investors in the medium term.