Cheap shares on the JSE

There isn’t a rule that shares that have fallen hard will recover, and there is a rule that potentially high returns usually come with a lot of risk.

The level of risk became clear when Moneyweb asked four stockbrokers and portfolio managers for their views on a list of shares that have sunk to multi-year lows …

Read: JSE’s best and worst shares of 2024

Only Chantal Marx, head of investment research at FNB Wealth and Investments, had the courage to go on record with her and her team’s insights.

Obviously

For obvious reasons, the first share on the list is Sasol. The share has been unpopular for years, and every bit of good news is usually followed by some bad news and a further drop in the share price.

The current price of around R84 is just a few rands higher than its recent low of R79.70 and miles away from its 12-month high of R174.

Marx says the share price and Sasol’s financial performance have been under pressure over the last few years because of low chemical prices and oversupply in the market, which impacted revenue and profitability, as well as weak oil prices.

Sasol also had operational issues. The worst of these was at its mining operations, which affected profitability at its Synfuels operations because of the higher cost of mining and the higher cost of buying coal from other miners.

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In addition, write-downs of the asset values of some of Sasol’s major assets worsened its debt metrics and increased its debt-to-book value.

Concerns about gas supply were raised by hostilities in Mozambique and the lack of an alternative feedstock source.

“There is no question – the share is cheap,” says Marx.

“We want to see an improvement in the factors that weigh on the share price before we become meaningfully optimistic about Sasol.

“We may be close to the bottom of the cycle for chemicals and oil pricing. So there could be some reprieve there. The write-downs should slow after management pushed through major asset revaluations in the last financial year.

“Execution on the required operational improvements will be key, particularly at the coal mining operations, as well as positive developments on gas supply alternatives.”

Steel

A share that did even worse than Sasol is ArcelorMittal SA.

It has fallen nearly 90% from a high of above R10 in April 2022 to the current R1.25.

There have been concerns about its profitability for years, and warnings from the international holding company that closing the local steel producer remained a possibility – and the announcement that this is going to happen is the reason for the latest drop in the share price.

Read:

Marx says it is important to remember that ArcelorMittal has two major business lines, being flat steel products and long steel products, and also rolled coil.

“The closures only affect the long steels business, which was loss-making. This means that ArcelorMittal will be more profitable after restructuring and closure costs.

“We were surprised by the market reaction immediately after the closure announcement,” she says.

“Regardless, the company operates in a highly cyclical industry and while this means there will be trading opportunities from time to time, we are unsure if the business can be truly competitive in the global context,” she adds, underlining the risk in the share.

Resources and logistics

Several other resource shares earned the dubious distinction of being on the list of shares with poor ratings. Not only did commodity prices plummet from the highs of 2022, volumes declined as well.

Local producers also had to contend with SA’s electricity shortages and failing logistics infrastructure.

Thus, Exxaro Resources fell by 43% from R274 in 2022 to the current R157, putting the share on a price-earnings ratio of only 4.1 times.

Marx says Exxaro’s stake in Sishen Iron Ore would have had a negative impact, as well as lower thermal coal pricing over the last couple of years.

“On top of this, there is significant boardroom drama ongoing – and we will avoid the share for that reason for the moment.

“Other than that, Exxaro has a relatively decent track record of capital allocation and returning cash to shareholders throughout the commodity cycle.”

Many of the same problems plagued Kumba Iron Ore, but FNB Wealth and Investments seems a bit more optimistic about the share.

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It says Kumba has purposefully curtailed production due to rail constraints, coinciding with the recent downturn in iron ore prices because of economic growth concerns in China.

“A meaningful improvement in profitability will rest on better iron ore pricing and perhaps an improvement in rail performance over the medium turn. However, we prefer having exposure to Kumba via a holding in Anglo American,” says Marx.

Sentiment

Coal shares have been hit hard by negative sentiment, despite good profitability and paying high dividends.

The biggest coal company on the JSE, Thungela Resources, lost more than half of its value since trading at R373 per share in September 2022 and falling to the current price of barely R132.

Marx says Thungela’s recent operational update reported that production for the financial year to end December 2024 would exceed previous estimates, in both SA and Australia.

“Costs were also well managed and was expected to come in below cost guidance, thanks to the group’s focus on operational efficiencies and robust capital management.

“Headwinds persist. Coal prices have been under pressure and the group also sold its coal at a discount to benchmark prices last year,” she adds.

“Nevertheless, the group’s balance sheet remains resilient with healthy cash generation and a good cash balance. This remains supportive of consistent dividend payments,” says Marx.

“Thungela is trading on a forward price-earnings ratio of 4.7 times and a forward dividend yield of 11.8%. This means that near-term cash returns are attractive, but the outlook for global coal demand remains uninspiring and this will have a continued negative impact on pricing.

“There is still significant risk attached to being invested in a company with a declining addressable market over time.”

Pick n Pay

And then there is Pick n Pay, with the experts at FNB pointing out that:

While the share price had a good year last year, it is currently still 44% down on a total return basis relative to its April 2018 highs.

“A return to those levels will require the share price to more than double,” says Marx.

“This means that profitability will have to improve substantially, and trust will need to be restored with shareholders.

“This is not completely impossible, but there is major execution risk in a turnaround of its SA supermarkets business – and a highly competitive environment to boot.

“There is some upside. Our valuation model gives a target price at about R34 over 12 months, equating to a return in the mid-teens,” she adds.

However, there are risks. “Just like there is execution risk in its operations, there is forecast risk in estimating Pick n Pay’s profitability near term.”

Read:
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Marx does however add: “A stronger balance sheet and better valuation of Boxer after its listing on the JSE mitigate this somewhat.”

And so, where to put one’s money?

Looking at the list of recovery shares again – there are others like African Rainbow Minerals and platinum shares – brings to mind the investing principle that returns also depend on whether you want to sleep well or eat well.

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