September 2003
INVESTMENT OUTLOOK
CONTENTS
Over/undervalued JSE Industries
A comparison between JSE and LSE industries in respect of PE ratios
EOH PTY – Star performance.
Dr Gad Ariovich, editor and Investment Consultant
Contributors: Desmond Esakov, Charl Marais
JSE OVER/UNDERVALUED INDUSTRIES *
In the April 2003 newsletter we ran our proprietary over/undervalue models. Our models at that stage clearly indicated that the various industries were all extremely undervalued. One quarter later and the situation has changed dramatically. With a strong run in equities our models appear to have been vindicated. We decided to run these models again to find over/undervalued territories on the JSE.
After being substantially undervalued in April the JSE overall index appears to be currently only slightly undervalued. / The industrial sector still remains undervalued, although to a much lesser extent than four months ago. We believe that there is still money to be made from the blue chip industrial shares such as Bidvest, Imperial and Barlows./ Resources which were also extremely undervalued four months ago now appear to be fairly valued. In fact, resources have been the main driver in the JSE’s recent performance. An important variable in our model is the exchange rate. If one believes the exchange will weaken then resources could well improve further and vice versa. Our research suggests R/$ 8.5 as a fair value.
Gold shares are still slightly undervalued. The Gold index has run up by 32% since April while the bullion price has only increased by around 10%.We however recommend that one exercises caution when buying gold shares at present. / Platinum stocks that were extremely undervalued in April now appear to be slightly overvalued. Therefore we recommend holding or even lightening on platinum shares.
The mining sector as a whole is now fairly valued. / The retail sector still appears to be offering value but again not as much as in April. Retail stocks should benefit from declining interest rates as a result of consumers having more disposable income especially in the emerging black middle class. Our preferred entries are Pick & Pay, Massmart and Nuclicks.
/ Food stocks such as AVI and Tigerbrands which we recommended in April, have moved up strongly since then. We still feel that food stock remain slightly undervalued.
*About our models for revealing Over/Undervalued Models on the JSE
A series of explanatory factors determining the movements of various JSE sector indices have been selected by statistical analysis. The combined effect of the explanatory variables is defined as the simulated line. The simulated line is then compared to the actual values of the corresponding share price index. If the simulated line is above the actual line, the share index is considered to be undervalued and v.v. (In academic terminology – we have devised factor models for various share price indices)
HOW CHEAP OR EXPENSIVE ARE VARIOUS JSE INDUSTRIES FROM AN INTERNATIONAL PERSPECTIVE
Methodology of Study
This study compares the Johannesburg Stock Exchange (JSE) industries with similar London Stock Exchange (LSE) industries in respect of both PE ratios and Dividend yields. Both PE ratios and DY figures can be indicators of relative prices. Thus, we suggest that by comparing the JSE and LSE industries in respect of PE and DY, we could identify relatively cheap or expensive JSE industries from an international perspective. The LSE was selected for comparison to the JSE, as it is probably the most global exchange in the world.
The methodology suggests that if the PE ratio of a certain JSE industries is significantly higher/lower than that of similar LSE industries, it may indicate that the JSE industry is over/undervalued against its LSE counterpart. Similarly, if the DY of a certain JSE industry is significantly higher/lower than that its British counterpart, it may indicate that that the JSE industry is under/overvalued against its LSE counterpart. It is suggested that relative PE ratios will be a better indicator for relative value than DY. Of course, current PEs are not as appropriate as forward PEs in revealing relative value.
For example, the PE ratio of the JSE transport sector is about 7.4 while for the similar LSE industry it is 18.5. Consequently, one may argue that the JSE Transport industry is cheaper than its LSE counterpart. From the point of view of dividend yield, however, the two industries are on par.
One could argue further that the JSE Transport industry is not only cheap in absolute terms but also in relative terms. As the PE ratio for the JSE overall Price index is around 11 and that of the LSE All Share Price index is about 18.4, the JSE Transport sector is arguably cheaper than its LSE counterpart in relative terms as well. This is derived by comparing the relative PE ratio of the JSE Transport Price index with the relative PE ratio of the LSE Transport index.
The following table shows the PE ratios of various industries on both the JSE and the LSE. The last column shows the relative PE between JSE and LSE industries. For example, if the PE of JSE Transport industry is 7.4 and that of the LSE counterpart is 18.5, the ratio is 7.4 / 18.5 = 0.4
Rating of the relative PE – the third column, should assist us in identifying the relative values of the JSE vs. LSE.
A Comparison between JSE and LSE in Respect of PE Ratios
FTSE INDUSTRY SECTORS / PE UK(A) / PE SA
(B) / SA RELATIVE to FTSE (B/A)
ALLSHARE / 18.35 / 11.36 / 0.62
RESOURCES / 17.64 / 12.20 / 0.69
MINING / 15.61 / 13.89 / 0.89
OIL/GAS / 18.41 / 5.88 / 0.32
BASIC INDUSTRIES / 13.94 / 7.75 / 0.56
CHEMICLES / 17.59 / 8.13 / 0.46
CONSTRUCTION & BLDG MTRLS / 10.65 / 8.13 / 0.76
FORESTRY & PAPER / 9.18 / 9.35 / 1.02
GENERAL INDUSTRIES / 16.9 / 8.77 / 0.52
ELECTRONIC & ELECT EQUIP / 24.61 / 7.35 / 0.30
ENGENEERING & MACHINERY / 20.04 / 6.37 / 0.32
CYCLICAL CONS GOODS / 13.16 / 12.20 / 0.93
AUTOMOBILES & PARTS / 11.75 / 7.25 / 0.62
HOUSEHOLDGOODS & TEXT / 31.93 / 12.20 / 0.38
NONCY CONS GOODS / 17.21 / 10.20 / 0.59
BEVERAGES / 13.15 / 11.24 / 0.85
FOOD PRODUCERS & PROC / 11.7 / 8.40 / 0.72
HEALTH / 22.39 / 9.90 / 0.44
PHARM & BIOTECH / 21.57 / 12.05 / 0.56
CYCLICAL SERVICES / 20.46 / 11.90 / 0.58
GENERAL RETAILERS / 16.07 / 10.87 / 0.68
LEISURE & HOTELS / 20.7 / 41.67 / 2.01
MEDIA & ENTERTAINMENT / 32.71 / 200.00 / 6.11
SUPPORT SERVICES / 18.22 / 9.01 / 0.49
TRANSPORT / 18.46 / 7.41 / 0.40
NON CYCLICAL SERVICES / 22.87 / 12.50 / 0.55
FOOD & DRUG RETAILERS / 15.51 / 13.33 / 0.86
TELECOM SERVICES / 26.1 / 12.35 / 0.47
FINANCIALS / 18.13 / 10.64 / 0.59
BANKS / 15.14 / 8.26 / 0.55
INSURANCE / 62.14 / 8.85 / 0.14
LIFE ASSURANCE / 42.21 / 26.32 / 0.62
INVESTMENT COMPANIES / 44.74 / 7.75 / 0.17
REAL ESTATE / 24.08 / 16.13 / 0.67
SPECIALITY & OTHER FIN / 17.82 / 7.41 / 0.42
INFO TECHNOLOGY / 72.98 / 24.39 / 0.33
SOFTWARE & COMP SERV / 37.76 / 47.62 / 1.26
The following graph shows the relative PE of JSE industries in comparison to similar LSE ones.
According to the above graph (and in ranking order), JSE industries such as Insurance, Investment Companies, Electronic & Electrical equip, Engineering & Machinery, Oil, Information Technology, Household Goods & Textiles, Transport, Speciality & other Finance, Health, Chemicals, Telecom. Services, Support Services, General Industries, Banks, Non cyclical Services, Basic industries Pharmaceuticals & Biotech are all cheaper than in the UK, not only in absolute term but in relative terms as well.
On the other hand (and in ranking order), JSE industries such as Media & Entertainment, Leisure & Hotel, Software & Computer Services, Forestry & Paper, Cyclical Consumer Goods, Mining, Food & Drug Retailers, Beverages, Construction & Bldg Material, Food Producers and Resources are all more expensive than their similar counterpart industries on the LSE.
If the same methodology is applied to the Dividend yields, the results are somewhat different. The following table shows the DY for various JSE and LSE industries:
A comparison of dividend yields and relative DY between the JSE and LSE are probably less effective in identifying over/undervalued industries from international perspectives. Dividend policies are influenced by other factors in addition to profitability.
Nevertheless the following JSE industries are cheap from the point of view of the dividend indicator (descending ranking order): Information Tech Hardware, Speciality & Other Finance, Real Estate, Electronic & Electronic Equip, Oil, Food Producers, Investment Companies, Insurance, Food & Drug Retailers, Support Services, Life Assurance, Financial, and Engineering & Machinery. The dividend indicator produces results, which are quite near to the PE indicators but by no means identical.
FTSE INDUSTRY SECTORS / DY UK(A) / DY SA
(B) / RELATIVE
(A/B)
ALLSHARE / 3.22 / 3.4 / 0.95
RESOURCES / 3.21 / 3.2 / 1.00
MINING / 2.57 / 3 / 0.86
OIL/GAS / 3.41 / 5.1 / 0.67
BASIC INDUSTRIES / 3.3 / 3.3 / 1.00
CHEMICLES / 3.58 / 4.2 / 0.85
CONSTRUCTION & BLDG MTRLS / 3.28 / 3.7 / 0.89
FORESTRY & PAPER / 5.42 / 2.1 / 2.58
GENERAL INDUSTRIES / 3.76 / 3.1 / 1.21
ELECTRONIC & ELECT EQUIP / 2.92 / 5.9 / 0.49
ENGENEERING & MACHINERY / 3.54 / 4.3 / 0.82
CYCLICAL CONS GOODS / 3.43 / 1.8 / 1.91
AUTOMOBILES & PARTS / 3.65 / 3.1 / 1.18
HOUSEHOLDGOODS & TEXT / 2.35 / 1.8 / 1.31
NONCY CONS GOODS / 2.99 / 3.6 / 0.83
BEVERAGES / 4.17 / 3.7 / 1.13
FOOD PRODUCERS & PROC / 3.23 / 4.8 / 0.67
PHARM & BIOTECH / 2.49 / 1.2 / 2.08
CYCLICAL SERVICES / 2.76 / 2.8 / 0.99
GENERAL RETAILERS / 3.26 / 2.7 / 1.21
LEISURE & HOTELS / 2.92 / 1.4 / 2.09
MEDIA & ENTERTAINMENT / 1.92 / 1.4 / 1.37
SUPPORT SERVICES / 2.84 / 3.8 / 0.75
TRANSPORT / 3.35 / 3.3 / 1.02
NON CYCLICAL SERVICES / 1.93 / 0.9 / 2.14
FOOD & DRUG RETAILERS / 3.04 / 4.3 / 0.71
FINANCIALS / 3.9 / 4.9 / 0.80
BANKS / 4.27 / 4.2 / 1.02
INSURANCE / 2.05 / 3 / 0.68
LIFE ASSURANCE / 4.55 / 6 / 0.76
INVESTMENT COMPANIES / 2.09 / 3.1 / 0.67
REAL ESTATE / 2.85 / 6.4 / 0.45
SPECIALITY & OTHER FIN / 2.8 / 6.9 / 0.41
INFO TECHNOLOGY / 1.13 / 0.6 / 1.88
INFO TECH HARDWARE / 0.57 / 2.5 / 0.23
SOFTWARE & COMP SERV / 1.27 / 0.1 / 12.70
The expensive JSE industries, according to the dividend comparison, are Software & Computer Services, Forestry & Paper, Non Cyclical Services, Leisure & Hotels, Pharmaceuticals & Biotech, Cyclical Consumer Goods and Media & Entertainment. Again, the list of relatively expensive JSE industries, as measured by the dividend indicator is similar, but not identical to the PE method.
EOH PTY – STAR PERFORMANCE
EOH is an information technology company, which we have been monitoring very closely. It operates in three clusters of business units as a fully integrated business: (a) EOH Strategic Solution, which entails IT strategy and Management Consulting. (b) EOH Business System selling business applications e.g. ERP, CRM, Business Intelligence, Advanced Planning, e-Commerce and MES (c) EOH Outsourcing which provides and hosts maintenance and support of IT infrastructure for clients.
We have purchased a full load of EOH shares for both our unit trust and clients with discretionary portfolios about ten months ago at R1.15 per share. The share price is now above R2 rand.
Indeed, the company came out on Monday 15 September with very good set of financial results - revenue up 54%, Cash up 37% and EPS up 22%. The company financial performance is in line with its solid historical performance of earning per share growth rate of above 20% per year since its listing on the JSE five years ago.
In the second week of September EOH announced its merger with KPMG consulting division (submitted to the approval of the regulatory authority). Atos KPMG consulting (Pty) was the consulting arm of the world-renowned Auditing firm KPMG. The Auditing Company had to disassociate itself from its consulting business as a result of tough resolutions by USA regulatory authority prohibiting auditing companies from engaging in consultancy! We believe that the merger between EOH and KPMG consulting arm will enhance both companies. Both companies are similar in size, have complementary business models and similar outlooks for the future. More specifically the advantages are as follows:
· The combined business will probably be a major force in South Africa business and technology solution provider with a staff compliment of over 600 professionals, substantial turnover, offices in five locations in South Africa as well as several operations in Africa and Australia