Best Consumer-Stock Gain Seen Ending on South Africa Valuations

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Bloomberg Businessweek - Feb 6th 2012, 09:15

Jan. 25 (Bloomberg) -- The world’s best-performing consumer stocks have become the lowest-rated by analysts after valuations of South African retailers and food producers climbed to the most expensive levels on record. 

Five companies in the MSCI South Africa Consumer Staples Index including Shoprite Holdings Ltd. and Massmart Holdings Ltd. are rated the lowest among peers in 36 countries, according to more than 3,800 recommendations compiled by Bloomberg. The gauge, which rallied 23 percent in the past six months, may fall 2.3 percent within 12 months, according to share-price estimates compiled by Bloomberg.

While rising food prices helped boost profits and companies accelerated store openings to meet demand, the rally in South Africa is outpacing earnings prospects as the highest unemployment rate worldwide curbs spending and regional economic growth slows, according to Cadiz Asset Management and Investec Asset Management. The MSCI index rose to 20 times projected profits last week, the highest on record and the biggest-ever premium to global peers, data compiled by Bloomberg show.

“The multiples are quite expensive right now,” said Warren Buys, an equity analyst at Cape Town-based Cadiz Asset Management, which oversees about $5.1 billion. “We would be very cautious about buying businesses on the hope that earnings might beat expectations.”

The South African consumer-staples index has outperformed gauges of the stocks in every other developed and emerging market tracked by MSCI Inc. since mid-July, according to data compiled by Bloomberg.

Record High

Shoprite, South Africa’s biggest retailer by market value, and Massmart, controlled by Bentonville, Arkansas-based Wal-Mart Stores Inc., led the advance as food inflation exceeded 11 percent and the companies both announced plans to boost their number of stores by about 8 percent in fiscal 2012. Their gains helped send the MSCI South Africa Index to an all-time high of 871.78 on Jan. 23.

Investors may be overestimating retailers’ growth potential, said Diane Laas, an analyst in Cape Town at Investec, which oversees about $83 billion. South African retail sales trailed the median forecast in Bloomberg News surveys the past two months, with growth slowing to 6.8 percent in November from last year’s high of 10 percent in April.

The World Bank cut its 2012 economic expansion forecast for South Africa to 3.1 percent from a June estimate of 4.1 percent, according to a Jan. 17 report. The Washington-based lender also reduced its forecast for growth in Sub-Saharan Africa to 5.3 percent from 5.7 percent. Shoprite gets about 11 percent of its revenue outside South Africa, compared with 7.4 percent at Massmart, according to data compiled by Bloomberg.

Slower Spending

Fitch Ratings cut its outlook for South Africa’s BBB+ foreign-currency credit grade to negative on Jan. 13, citing unemployment and a weaker economic expansion than emerging- market peers.

Spending growth by households will probably slow to 3.3 percent this year from 5 percent in 2011 as gains in real wages also decelerate, Elna Moolman, an economist at Renaissance Capital in Johannesburg, said in an e-mail. South African unemployment was 25 percent in the third quarter, the highest of the 61 nations tracked by Bloomberg.

“The earnings growth that will come from Africa will be a lot more difficult to come by than foreigners are pricing into these shares,” Investec’s Laas said in a Jan. 10 phone interview.

Profit Growth

Rising valuations for South African retailers are justified because they have “stable” earnings that are more resilient during periods of slowing economic growth than other industries, said Andy Brown, who helps manage about $45 billion at Aberdeen Asset Management Plc in London and holds South African stocks including Massmart. Money managers around the world have favored food companies and consumer-staples retailers in the past six months on concern that the global economy may slow, Brown said.

Earnings in the MSCI South sAfrica consumer-staples index may increase 29 percent in the next 12 months, compared with 15 percent growth for the MSCI All-Country World Index, which is comprised of 10 industries, according to analysts’ estimates compiled by Bloomberg.

“Investors are worried at the moment so they would prefer to hold companies that deliver steady, stable earnings growth,” Aberdeen’s Brown said.

UBS AG’s Darren Cohn is advising investors sell Shoprite shares even as he forecasts profits will jump 33 percent this year. While Shoprite plans to expand its stores outside South Africa by about 10 percent annually during the next five years, the stock’s valuation suggests investors are anticipating “unrealistic” earnings growth, the Johannesburg-based analyst said in a Jan. 16 research report.

‘Huge Premiums’

Shoprite, which closed at 129.95 rand in Johannesburg trading in the latter part of January, may slip to 128.20 in the next 12 months, according to the average of five analyst estimates compiled by Bloomberg this year. The stock has nine ratings equivalent to “sell,” four “hold” and three “buy” recommendations. The Cape Town-based company is valued at 26 times reported earnings, near the all-time high of 27 reached on Jan. 4, according to data compiled by Bloomberg.

Massmart was cut to “sell” from “hold” on Jan. 12 by Nick Higham, a Deutsche Bank AG analyst in Johannesburg, who said the company’s strategy of using “aggressive” discounts to win market share may curb earnings.

The stock may fall to 159.74 rand in the next 12 months from 178.46 yesterday, according to the average of nine analysts’ estimates. The Johannesburg-based company is valued at 41 times profits, a record high and more than double the average of 20 times for global consumer-staples companies, according to monthly data compiled by Bloomberg.

Growth prospects for South African retailers are “more than adequately reflected” in the share prices, Quinton Ivan, an analyst at Coronation Fund Managers in Cape Town, which oversees about $34 billion, said in an interview. They “trade at huge premiums,” he said.