The JSE small-cap index last had a decent run in the post-pandemic period from October 2021 to February 2022. In those golden months the beaten-down segment rallied 85%.
For the next two years the sector trended sideways as interest waned in an economy that was sagging under load-shedding and a tighter domestic environment. Earnings multiples unwound and the depth of small-cap bargains was palpable. Yet few cared.
All the lethargy changed after the May 2024 election, especially on confirmation of the formation of the government of national unity (GNU). Further positivity came from the resumption of uninterrupted electricity, which improved industry productivity, lowered the cost of alternative energy and made production more efficient.
The index, alongside that of mid-cap shares, really turned the heat up in early June.
In the first five months of 2024, the small-cap index was ahead by only 1.7% and that of the mid caps was down 2.7%. The small-cap index turned first, and is now 20.3% up. The mid caps rallied 17.3%. The small-cap index attained a record high at the end of September. If you missed that narrow buying window in June, you’d have lost out on the gains, which, in many cases, have been material.
The stable political outcome delivered a feel-good boost to the economy, which was further enhanced by two events in September.
The first was on September 1, when government legislation allowed retirement fund participants to obtain a portion of their savings via the new two-pot system. There was speculation about the amount fundholders would withdraw, with wild estimates of up to R100bn. To date, industry feedback from the likes of Alexander Forbes, Discovery and Old Mutual states that low- and middle-income claimants were the ones who withdrew funds. The South African Revenue Service says that by the end of September applications for withdrawal amounted to R4.1bn.
The second event that strengthened the economy took place on September 19, when the Reserve Bank cut the interest rate by a modest 0.25%. It was the first cut in four years and took the repo rate to 8%.
With domestic inflation well within the Bank’s band, and many day-to-day costs such as that of food and fuel falling, further interest rate cuts are expected in the months ahead. The next Bank meeting is on November 21.
Judging from the key costs that weigh on consumers, the initial trim of the repo rate will incrementally aid the economy — the saving on a R1m bond amounts to R750. Hardly a Lotto win, but enough to enable many hard-pressed consumers to breathe easier.
Further, a sharp decline in headline inflation to 4.4%, down from 8% at its 2022 peak, also benefited consumers. Thanks to weak global oil prices and a stronger rand since the formation of the GNU, the price of unleaded petrol in the year to date fell 6.5% inland and 7% at the coast. Incrementally, it all adds up.
Many stocks, especially in the infrastructure and property sector, started their renaissance well ahead of the May election, as there was an expectation that domestic interest rates would start to come down and hopes were raised that the government would invest in construction to kick-start the economy.
All this positive news fed its way into the small-cap sector. The index is now running sharply higher than the 11% return from the all share index.
To date the small-cap index’s best performer is Fortress Property (up 176%). National road builder Raubex has been on fire, rising 87%, as has construction stock Wilson Bayly (68% higher).
Property and discretionary consumer stocks were among the best JSE performers, on the expectation that additional cash in consumers’ pockets would see retail tills jingle. Mr Price (up 65%), Truworths (40% higher) and Lewis Stores (rising 60%) were all investor favourites.
The general interest from the institutional market towards small caps has ignited interest across the board — though there’s not much of that yet from retail investors, colloquially called the “easy equities crowd”. Once that floodgate opens the party will probably be approaching its end.
Many stocks ... started their renaissance well ahead of the May election, as there was an expectation that domestic interest rates would start to come down
Concerning also is that, with a sharp rally in what might be considered the quality small caps, the market may start venturing deeper into the second-tier basket, in which low-ball valuations remain but the inherent balance sheet and earnings quality may be lacking. It’s something to watch closely in the months ahead.
In the stocks universe of about 60 shares there have been certain startling moves. Some of this was on expectation of economic uplift, such as Stefanutti Stocks (+258%). Value-based special situations that are grabbing the market’s attention include Argent Industrial (+79%), Bell Equipment (+91%), Nampak (+128%) and Novus Holdings (+55%). Many of these have been recommendations in IM in the past months.
The valuations in 2024 might not be overextended. Despite sizeable rallies in many stocks, it highlights just how unloved and underappreciated the sector was. It needed just a spark for stocks to move higher. It is difficult, though, to recommend those that have run hard, as the easy money, one might say, has been made.
However, in the current economic dispensation there remain legs to the sector, barring any geopolitical calamity, of which there are many simmering, or the sudden breakup of the GNU.
The following stocks remain part of IM’s small-/mid-cap portfolio on a medium-term perspective. Despite the rally, some have missed the gains and may play catch-up, while others may allow a second bite at the cherry.
Afrimat (R66) — The management of the diversified mining counter is seen as consisting of master capital allocators and turnaround specialists. Every deal since the company’s 2006 IPO has grown earnings, making Afrimat one of the best-performing stocks on the JSE.
In 2024, a perfect storm of deal regulatory delay, weak global iron ore prices and domestic issues hit the counter, and it issued a rare first-half 2024 profit warning. The stock barely budged, as the market expected a 2025 recovery.
There are no problems in the business and IM continues to rate the stock a solid long-term holding.
Argent Industrial (R26.96) — This small-cap stock has been the darling of the sector, yet few have recognised its transformation from a domestic to an offshore earnings–focused business. Eleven consecutive increases in earnings have seen this lowly rated counter soar in value, yet its earnings multiple remains at about 5.4.
With about 75% of earnings offshore and a strong NAV, this small-cap counter should continue to deliver.
Cashbuild (R168) — The company’s best recent period was after the pandemic, but earnings have slid sharply since then as a weak consumer economy and some missteps have hit the business. However, it remains a leading nationwide provider of building and DIY products.
With lowering interest rates and the two-pot system injecting cash into the economy, IM believes Cashbuild must be an eventual beneficiary. Well below its highs and in trough earnings, there is scope for a material earnings and share price recovery.
Combined Motor Holdings (R35) — The motor retailing, services and car rental stock is ahead 32% in the year to date, but just back to the record high it attained in 2018. With 50-year-experienced owner-managers, the business is well positioned in retailing a range of affordable motor vehicles and has a strong percentage of profits from tourist-related inbound travel.
Earnings have been hit by the economy, but this cash rich, conservative stock should bounce back in a lower-interest-rate environment and its low p:e supports.
Famous Brands (R63.99) — The fast-food stock has been out of favour for so long that its recent uplift has perhaps gone unnoticed. Management missteps have irked the market and its own franchisees. After a disastrous foray into the UK in 2016, funded by hefty debt, the business is now throwing off the shackles of its past misadventures.
As the 800-pound gorilla in the sector the group is reviewing its portfolio, and IM believes management just needs to find its past mojo. With food price inflation subdued and consumer sentiment ticking up, the stock looks interesting.
Invicta (R31) — The distributor of spare parts and widgets has held its own in difficult times, eking out modest single-digit growth. Its share price has been in a rut for three years. With a much improved business and balance sheet, any uplift in the South African economy should spur demand for its industrial and mining products.
With a fat NAV of R51.64 a share and an earnings multiple of six the stock has been cheap for years and just needs a spark to move it higher.
Nampak (R42.56) — It was a brave investor who, like IM, backed this recovery stock in 2023, given the depth of work that was needed to restructure its business and weak balance sheet.
Since the 2024 first half results, Nampak has soared as asset sales, debt reduction and operational and margin improvement in the beaten-down business occurred under the eye of CEO Phil Roux.
Despite the heady share gains, IM believes there is more to come as business optimisation, further cost efficiencies and the regaining of lost market share rebuild earnings.
Southern Sun (R8.47) — The hospitality group, which is part of the Hosken Consolidated Investments (HCI) portfolio, has had a strong start to 2024 as improvement in hotel occupancy and margin, and an increase in travel, especially inbound, has washed over the hotel and leisure sector.
HCI CEO Johnny Copelyn fizzed at the AGM when he discussed the group’s prospects. A positive recent six-month trading update was well received, and Southern Sun’s usually better second-half season lies ahead.
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