At the beginning of 2025 are we almost too optimistic?

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SIMON BROWN: I’m chatting with Rory Kutisker-Jacobson, portfolio manager of the Allan Gray Balanced Fund.

Rory, appreciate the time today. We chatted almost a year ago. It was in the first week of February last year. I’ve got to say, looking back to February last year, there were reasons for cautious optimism but there was a lot of concern. We still had load shedding, local elections, and elections around the world.

We’ve kind of swung the other way on the pendulum, where we sit here at the beginning of 2025 and, certainly looking at some of the returns that we’ve seen in our local equity market last year, we are almost swinging to maybe a little too much optimism.

RORY KUTISKER-JACOBSON: Hi, Simon. Yes, I think that’s roughly right. If you think about where we were last year, during domestic elections there was kind of huge uncertainty around the election outcome – certainly when you had the emergence of the MK party almost from nowhere. Then the polls were indicating that they were going to get anything between 10% and 20% – and they ended up kind of just over 10%.

But I think what the market took extremely positively was the formation of the GNU, the government of national unity. So if you look at market returns within the JSE last year, I think overall the JSE did around 13% in rand. But there’s quite a large divergence in terms of individual sectors and companies.

So you [can] almost break it up into three big buckets; one being mining stocks, another being multinationals that happened to be listed on the JSE – the likes of British American Tobacco, AB InBev, Mondi – and then the third bucket being kind of SA Inc. There I would include most of our large financials, most of the clothing retailers, a handful of the food producers. And that last bucket did incredibly well.

So as much as the JSE did only around 13%, if you look at most of our clothing retailers they did anything [from] kind of 30%. And then at the top end, Mr Price did almost 100%, including dividends, last year. Most of the banks had double-digit returns. Again, the kind of darling was probably Capitec, doing around 60% for the year.

In contrast, what dragged down the overall performance of the market were those first two buckets I mentioned. Multinationals was a mixed bag; some of them did really well, but then some of them did really poorly. And then broadly most of the mining companies underperformed. I think that’s very much a combination [and that] coming out of Covid they did really well. But then secondly, China’s been under pressure and obviously the demand for commodities is disproportionately dependent on China at this point in time.

SIMON BROWN: In a recent note you put out you say you’re not overly negative about the longer-term prospects for South Africa, but has that pendulum on SA Inc swung into much more expensive territory? Have we gone perhaps a little bit far? Not to dismiss the quality of the companies, not to dismiss the prospects, but in the short term it has swung hard.

RORY KUTISKER-JACOBSON: Exactly right. Again, not to kind of pick on Mr Price, I think Mr Price is a really high-quality business, incredibly well run. But if you just use them as an example, at the start of last year the share price was probably around R150/160 a share. It peaked at just under R300/share and now has come back somewhat year to date. But you see growth almost 100%.

As a result the PE multiple went from paying just over 10 times earnings to now paying around 21 times earnings for Mr Price. You would expect to see, given that significant rerating, a substantial improvement in the underlying earnings growth of the company. They’ve actually put out a kind of quarterly trading statement where top-line growth has picked up over the last year, but it hasn’t picked up anywhere near the same extent that the share price suggests. I think their earnings growth number or turnover growth number was just north of 10%.

Foschini put out a similar number. Domestically sales in SA on the Foschini side in the last quarter have grown only 5.2%. So when you’re growing at kind of 5-11%, but your share price is running 40%, 50% faster, we think the sentiment has swung from probably overly uncertain or overly pessimistic last year to some of these counts now [having] significantly more optimism priced in. Now we really have to kind of see that come through and it’s not obvious to us that it will materialise.

SIMON BROWN: That’s just it. Yes, load shedding has for now gone for 300-plus days. The government of national unity is going strong six months in. But the bigger issues –  structural reforms that are needed, infrastructure challenges, unemployment – they haven’t gone. Yes, infrastructure might be moving at a glacial pace in the right direction. The bigger picture still remains ‘challenging’, I suppose is the phrase.

RORY KUTISKER-JACOBSON: Exactly right. So I guess the one thing that we can celebrate that has improved year on year is load shedding; we’ve had I think just over 300 days without load shedding. But if we look at the history of load shedding, I think we first started experiencing it in 2007/2008. Then we had a period absent load shedding, and then it re-emerged again in the early teens, disappeared, re-emerged again. So I’m too sceptical to say we’re completely out of the woods there.

And then if you look at the other parastatals, they are either in need of significant capital investment and/or management changes, and/or the operational performance is nowhere near where it should be.

And then if you look at kind of the fiscal side of it, our debt to GDP continues to grow. We’re sitting at around 75% debt to GDP with interest rates where they are; currently north of 20% of all government revenue is now required just to service the interest on that debt, not even to pay down the debt – just to service it.

And then you reference some of the other structural factors. South Africa has got some really difficult long-term challenges that aren’t that easy to solve, one of which is kind of chronic underemployment. Unemployment levels are north of 30%; over eight million people are economically active but unemployed. Contrast that with the number of actual income-tax payers – around six million people. But even if you carve that up and look at who pays the lion’s share of income tax, I think there are less than two million people paying north of 75% of personal income tax.

I’m not trying to be bearish here, I’m just trying –

SIMON BROWN: I hear you.

RORY KUTISKER-JACOBSON: And the education stats that came out last week – there are some things to be celebrated there. But then of the children who entered Grade eight, 300 000 kids disappeared out of the system in the sense that they never made it to matric for those statistics, which is extremely disappointing and saddening.

And so, as much as one can be positive about the GNU, I don’t think it’s been properly tested with the really difficult decision where you might see real ideological differences emerge between the current parties, and what that may do to the ongoing GNU.

So, tying this all together, I think there’s a lot of things that could happen in South Africa that could be positive and we could see an improvement in growth. But the question is always, well, what am I paying for that today when I’m buying equities? I’m investing in fixed income and buying South African bonds.

And so where we’re seeing opportunities, we’ve been probably at the margin in the last six months, selling down SA Inc businesses and buying more of the underperforming multinationals.

SIMON BROWN: Yes, as you point out that pendulum has swung. There are lots of green shoots, but there are still risks out there, and some of those are big issues that are not easy to solve.

We’ll leave it there. Rory Kutisker-Jacobson, portfolio manager of the Allan Gray Balanced Fund, I appreciate the time.

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