South Africa: Built like a BRIC, Or The New Frontier …And OnThe Fear of Becoming Colombia

Two interesting articles on South Africa – one with a bit more of a hard-hitting “realist” examination, but both sure to provide some fodder for thought.

First, via The Financial Post:

There was plenty of grumbling among economists when South Africa last April gained entry into the BRIC club. The four-nation group — Brazil, Russia, India and China — is a collection of what many economists see as the world’s most important emerging markets. Each has a gross domestic product well above $1-trillion and together they make up almost half the world’s population.

By contrast, South Africa is a country with a population of 49 million people and a GDP of $408-billion. Its economy would have to quadruple before it even matched up with the smallest BRIC country, Russia, which has a GDP of $1.8-trillion. And it’s positively dwarfed by China, which has 1.3 billion people supporting an economy worth an estimated $7.3-trillion.

That disparity explains Jim O’Neill’s flabbergasted response to learning South Africa wanted to join the BRIC economic club. Mr. O’Neill, a Goldman Sachs economist who coined the BRIC acronym a decade ago, said there were many other fast-growing countries such as Mexico, Nigeria or Turkey that better fit the bill. “For South Africa to be treated as part of BRIC doesn’t make any sense to me,” he said as the country was seeking membership in 2010.

Many market watchers think having South Africa grouped with the BRIC countries makes even less sense from an investing standpoint.

“South Africa is really in the frontier markets territory,” said Mark Mobius, executive chairman of Templeton Emerging Markets Group and lead manager of Templeton BRIC Corporate Class.

But just because South Africa isn’t a good fit doesn’t necessarily mean it’s a bad investment destination. Many analysts say South Africa can provide indirect exposure to other countries in Africa, particularly countries that are experiencing rapid growth, but are extremely risky and offer little liquidity.

“There are some interesting ways to invest in Greater Africa, if you want to call it that, through South Africa,” said Paul Mesburis, senior portfolio manager of Excel Funds Management Inc. in Mississauga, Ont. “When you go into some of those faster growing markets — such as Kenya, Nigeria or Mozambique — the equity markets are nowhere near as developed as South Africa.”

South Africa’s increasing economic and business exposure to such high-growth countries is what makes the frontier markets label appropriate, Mr. Mobius said.

Frontier markets is an economic term for countries that have less market capitalization and liquidity than more developed emerging markets. Like BRIC, the term was coined by economists in the 1990s. Investors usually associate frontier markets with high rates of returns, as well as low correlation with other markets — in other words, they are less reliant on global growth. What makes South Africa unique is that unlike other frontier markets, which have underdeveloped political and economic infrastructures, it has a much more Westernized business climate.

“South African companies generally, within the context of emerging markets, tend to be well-managed, have good corporate management, hold good corporate reserves and overall are generally stable,” said Philippe Langham, senior portfolio manager for the emerging markets division of RBC Asset Management UK Ltd. in London.Advertisement

Gerardo Zamorano, director of investments at Brandes Investment Partners L.P. in San Diego, Calif., said his fund has had exposure to South Africa for many years. While he’s not bullish on the country’s stock market as a whole, he sees good value in certain South African companies that are consumer oriented and have operations beyond the country’s borders.

One such example is Naspers, a multinational media giant headquartered in Cape Town. After it experienced saturation in its home market, the company used cash flow from existing operations to expand into countries around the globe, providing extra value to shareholders.

Outside consumer-oriented companies, however, Mr. Zamorano is more bearish. While South Africa is home to the world’s largest gold and diamond industries, companies in the mining sector are suffering from worrying levels of inflation and facing financing troubles, a symptom of a broader slowdown hitting the global mining industry. Mr. Zamorano said his fund is avoiding basic materials companies in South Africa for now.

But his pessimism illustrates one downside to investing in South Africa: The choices are limited because mining stocks account for 30% of the publicly traded companies in the country. In many ways, South Africa’s stock market has a similar makeup to Canada’s. Mining companies and financial stocks make up well over half of the Johannesburg Stock Exchange, the country’s main market and the largest one in Africa. Similarly, mining and financial stocks, combined with oil and gas companies, comprise the overwhelming majority of the Toronto Stock Exchange.

“The big question is if I’m going to invest in South Africa and deal with some of the economic and political issues there, and I’m going to buy a gold mining stock, why wouldn’t I own one in Australia or Canada instead?” said Richard Jenkins of Black Creek Investment Management Inc., whose Toronto-based firm has invested in South African companies.

But even outside the troubled mining sector, investors need to pay attention to corporate valuations, analysts say. Because South Africa is a more thoroughly developed emerging market than others on the continent, stock values have become inflated in the past few years.

“We’re underweight on South Africa in our emerging market fund because we think valuations are a touch high,” said Mr. Mesburis of Excel Funds.

South African stocks are currently trading at a price-to-earnings ratio, based on 2012 forward earnings, of about 11 times, which is equivalent to valuations in the developed world. The S&P/TSX Composite currently has a P/E of 13.77, while the S&P 500’s is 13.25.

But it is the future that presents the biggest opportunity for investors who opt to park their money in South Africa, Mr. Mobius said.

He predicts the rapidly growing countries north of South Africa will offer many businesses a quick way to expand into new markets. Currently, the majority of South African firms have their operations exclusively within the country’s borders. But with neighbouring countries such as Mozambique and Botswana, which posted GDP growth of 7.1% and 6.2% in 2011, respectively, South African businesses will likely begin to cross borders, said Mr. Mobius.

Such decisions will be a potential catalyst for stronger investor returns over the next decade and vital for the growth of South African business. The country has little, if any, natural population growth, due in large part to the AIDS crisis that has ravaged the country, and its economy is lagging other emerging markets, posting only a 3.1% GDP increase in 2011.

“Increasingly, we’re putting more and more companies in South Africa in the frontier markets arena,” Mr. Mobius said. “We expect to see more and more of that as South Africa benefits from the tremendous growth to the north of it.”

Second, courtesy of  Why Nations Fail:

South Africa didn’t collapse economically after the end of Apartheid. In fact, following the tails of a long decline from the mid 1970s, its rate of economic growth picked up after the transition in 1994 and has been positive, though moderate, ever since. Despite how modest progress towards a different society has been, South Africa has not veered to populism, though as we saw in our last post there have been some threats.

But perhaps populism is not the main threat to South African democracy in any case. Perhaps the real danger lies elsewhere.

In Why Nations Fail we tell the story of how Latin American societies became highly unequal and extractive during the colonial period. Though they gained independence 200 years ago, most of Latin America, for example Colombia, continued along this path, with the traditional or new elites firmly remaining in control despite electoral democracy taking root. Though electoral democracy and other reforms removed the de jure control of these elites, their de facto command remained largely unchallenged.

Could it be that the endpoint for the transition in South Africa is a transition from Apartheid to a Colombian model?

Here is why this scenario is not so far-fetched: in Latin America, the elite managed to keep de facto power in attendance because it still controlled the main economic assets and wealth, and could capture and co-opt the new political elites. The situation is similar in South Africa. Economic assets and influence are still hugely concentrated. In the face of the economic power of the economic elite, the ANC leaders found themselves with both serious constraints on their behavior and new lucrative economic opportunities. Legitimately they feared the economic collapse that might have followed from the implementation of too radical a program. So they went slowly. But slow progress left economic power, opportunities and decision-making where they had been before. The once radical ANC began to empathize with the problems of business; they worried about the bottom line of businesses — after all, wasn’t business confidence crucial for the new South Africa? Private sector banks were involved with the attempt to build houses for the millions of black people living in shanty towns, but banks worry about collateral and profits, not about the positive externalities and the social transformation that would follow from an integrated society. The ANC started sympathizing with the banks, perhaps even forgetting about that social transformation.

In the meantime the reality of Apartheid fell into the past. People, especially new generations, started to get used to inequality. Perhaps with Apartheid gone, inequality appears less unjust, less rigged today.

The bottom line of this is that a clear trajectory for South Africa is not as a NIC or a BRIC but as a NLC, a Newly Latinamericanized Country, one with high inequality and persistently poor economic performance as a result of the fact that the vast majority of its population will still be poor and excluded from economic opportunities. Some people, of course, will be doing extremely well.

It is interesting that the German state after World War II, though devastated by the war and de-Nazification, was still able by the 1960s to largely re-build the infrastructure which the Allies had pulverized in the closing stages of the war. In contrast, the South African state has been unable in the same amount of time to get the poor people, who fought for the end of Apartheid and voted for it, out of shacks and shanty towns.

This entry was posted on Tuesday, July 31st, 2012 at 8:17 am and is filed under South Africa.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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Wildcats & Black Sheep is a personal interest blog dedicated to the identification and evaluation of maverick investment opportunities arising in frontier - and, what some may consider to be, “rogue” or “black sheep” - markets around the world.

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