Paying a premium for the emerging market story

Paying a premium for the emerging market story

RETAILER NEWS

Reuters - Jan 26th, 09:29

JOHANNESBURG (Reuters) - Buoyed by irrepressible optimism about emerging markets growth, South African stocks have posted a solid comeback since early August, climbing about 18 percent and hitting record highs in the last week. 

The bull run may fade though, as Johannesburg's ballooning valuations prompts local stock pickers to scour developed markets for bargains.

Some of South Africa's best performers are retailers such as Woolworths, Shoprite Holdings and Massmart, all of which have gained nearly a third in the last six months on solid earnings and expectations of further African expansion.

For value investors - stock pickers who look for companies trading at a discount to certain fundamentals - no amount of excitement about African growth can rationalise overblown prices.

"In the short term, the market buys themes and stories... Globally, there is huge appetite for emerging markets. What do you buy in emerging markets? Well, you buy growth," said Piet Viljoen, executive chairman and portfolio manager at Cape Town-based asset managers RE:CM.

"It seems that South African retailers have growth. You can justify that on the basis of the story, but if you look at the numbers it's hard to justify, if you look at the underlying value it's very difficult to justify."

Woolworths Holdings, up 9 percent this year after a 45 percent surge last year, is trading at a price-to-earnings ratio of just above 20, putting it at its most expensive since at least 2001, according to Thomson Reuters data.

Massmart Holdings, the South African retailer majority owned by Wal-Mart Stores is even more expensive, trading at 45 times its earnings.

Therefore Massmart, a discount retailer in a country where household debt levels equal 75 percent of disposable income, is now more expensive than both its parent and bigger emerging market retailers such as Russia's Magnit and Brazil's Grupo Pao de Acucar.

In line with U.S.

South Africa's benchmark Top-40 index, and the broader All-share index, which recently posted five straight record closes, are both trading at PEs of just above 13, or in line with U.S. stocks.

That's a clear sell signal for John Biccard, who runs Investec Asset Management's value fund.

"It's not often that South Africa trades at the same PE as America, that happens once every 20 years and if you sold South Africa and bought the U.S. every time that happened in the last 50 years you would have been right."

With Europe and Japan both cheaper than the U.S., Biccard sees little justification to pile into South Africa.

For instance, he prefers Britain's Tesco, with its PE of 9, to domestic grocer Pick N Pay, which is trading at a heady 35 times earnings. He also likes Japan's battered-down Nintendo, and beleaguered Finnish cellphone maker Nokia.

Investors can get exposure to emerging markets at a discount by buying shares of some multinationals such as Johnson & Johnson and Coca-Cola Co, said Nic Norman-Smith of Johanesburg's Lentus Asset Management.

Norman-Smith also likes U.S. IT firms such as Intel Corp, which he believes are sharply undervalued.

But overseas investors may continue to stomach South Africa's higher prices given the grim short-term outlook for some developed markets.

"Even with the lofty prices, they feel more comfortable with the higher expected growth than the risks in their home markets," said Matthew Kreeve, a portfolio manager at Element Investment Management in Cape Town.

"We can clearly see this 'flooding in' effect in our government bonds as well as other assets. As the rapid sell-off in early August illustrated, when the trend reverses it will be very abrupt."