Declining JSE offshore ownership and coverage weighs on market caps

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The Johannesburg Stock Exchange (JSE) has seen a meaningful decline in offshore ownership over the three years to June 2021, with the top 80 South Africa (SA) domiciled issuers losing c ZAR220bn ownership by market cap to end the period at 36%. Over the same time, according to Refinitiv these companies have seen a 26% reduction in research coverage by analysts, although the weighted average recommendation was upgraded by c 11%, to just below a buy. Despite analyst upgrades and strong growth for most global indices, the top 80 stocks only added 3.2% to their market caps over the period and, excluding the strong recovery in basic resources, have shed c ZAR850bn from their market caps (-15%).

From 30 June 2018 to 30 June 2021 the FTSE/JSE All Share Index (ALSI) fell 3.2% and the FTSE/JSE Shareholder Weighted Index (SWIX) grew by 5.9%. The top 80 companies on the JSE that are domiciled in SA (excluding listings such as BHP and Richemont) represented c 78% of the total FTSE/JSE market capitalisation at 30 June 2021 (ZAR6.3trn). This subset gained 3.2% in market cap over the three-year period, but excluding the very strong performance from the basic resources sector, it lost a large 14.8% (ZAR0.8trn in market capitalisation). In US dollar terms, the JSE (ALSI and SWIX) meaningfully underperformed global indices, with the notable exception of the FTSE100. From 30 June 2018, the ALSI derated from a P/E of 12.0x to 9.3x currently (14.8x at 30 June 2019), which is a significant discount to the S&P500 (25.3x) and the FTSE100 (14.6x).

A key driver of JSE’s underperformance over recent years was a slew of credit downgrades from rating agencies, starting in 2017, during President Zuma’s final years. The period from 30 June 2018 to 30 June 2021 saw SA move from an investment-grade rating by two of the three key ratings agencies to junk status in 2020, and between two and three notches below investment grade in 2021. The downgrades drove a flat market until early 2020, with the exception of the resources sector, which benefitted from a shift in the commodities cycle. During 2020, the market was severely affected by COVID-19, with the financial sectors (banks and insurers in particular) losing almost half of their peak value. The industrial and consumer sectors more than recovered from the COVID-19 dip, driven by increased economic activity, with the resources, chemical and energy sectors benefitting from very strong commodity prices. However, the financial sector remains c 25% below peak levels.

Like the London Stock Exchange (FTSE100), the JSE suffered from country-specific issues (ratings downgrades versus Brexit), but both bourses also lack exposure to the new economy stocks that have been driving global returns, and have not benefited from the meaningful liquidity on offer. In both cases, the bourses and issuers face challenges to convince capital markets that their value stocks deserve attention.

The underperformance of the JSE over the three years from 30 June 2018 to 30 June 2021 (and thereafter) coincided with a marked decline in the offshore ownership of the top 80 JSE companies from 39.5% to 36.0%. This represents c ZAR220bn lower offshore ownership, with most of the decline occurring from June 2020 to June 2021 alone. Over the same period, the PIC ownership of the top 80 companies increased from 12.5% to 13.9%, with other SA investors increasing their ownership by 2.2% to 52%.

Exhibit 1: JSE top-80 offshore ownership
Source: Singular Systems, Edison Investment Research Source: Refinitiv, Edison Investment Research, *: rebased to 1 at 30 June 2018
Exhibit 1: JSE top-80 offshore ownership Exhibit 2: JSE indices relative to global counterparts*
Source: Refinitiv, Edison Investment Research, *: rebased to 1 at 30 June 2018

In total, 14 of the 17 sectors on the JSE recorded a decline in offshore shareholding since 30 June 2018. The three exceptions were banks (a 2.7% increase with strong Capitec and Nedbank movements offset by a large decline for Absa Group), basic resources (a 2.3% increase driven by platinum producers with gold miners generally seeing declines) and food, beverages and tobacco (a 0.9% increase Distell and Tiger Brands gaining most, with Astral Foods and AVI losing). The largest offshore shareholding declines were seen for the energy sector (Exxaro and Montauk), clothing retail (across the board), food retail (Clicks held up well) and telecommunications (MTN most affected).

Although many factors reduced the JSE’s attractiveness to offshore investors, we have seen analyst recommendations steadily being upgraded, highlighting the underlying value in the bourse. Using a one to five scale, where one represents a strong buy and five a strong sell, the weighted average recommendation for the top 80 SA-domiciled issuers according to Refinitiv improved by 11% over the three years, from 2.4 (mid-way between a hold and a buy) to 2.1 (just below a buy).

However, the upgrades to recommendations coincided with a marked reduction in analyst coverage. Over the three-year period, the top 80 companies under consideration recorded a 26% decline in coverage, from 632 analysts at 30 June 2018 according to Refinitiv to only 469 analysts at 30 June 2021.

Exhibit 3: Change in analyst coverage and recommendations
Source: Refinitiv, Singular Systems and Edison Investment Research
Exhibit 4: Relative analyst coverage change
Source: Refinitiv, Singular Systems and Edison Investment Research

The decline in coverage was almost universal, with only the listed real estate sector increasing its number of analysts over the three-year period. On a relative basis, the main winners were real estate, and food, beverages and tobacco, with the main losers being healthcare and chemicals.

Global bourses experienced an initial decline in research coverage with the introduction of MiFID II in 2018. However, this trend was partially reversed as alternative research models, including sponsored research, started to proliferate. JSE issuers have been slow to adopt the sponsored research model, but this service is increasingly on offer, which may help reverse the coverage decline.

The JSE is very dependent on offshore shareholding to support the ratings of its issuers. SA exchange controls and strong domestic investment by the PIC and black economic empowerment (BEE) shareholders create a natural floor in the demand for JSE-listed companies that are domiciled in SA. This amplifies the importance of offshore investors and inbound portfolio flows in driving incremental demand for JSE stocks, hence the rating of the constituents of the bourse. Offshore investors, especially emerging market fund managers, are spoiled for choice when allocating their capital and rely heavily on analyst research among other screening tools in distilling their large investment universe to a manageable portfolio of stocks. The meaningful reduction in JSE research coverage poses a serious challenge for the bourse and its issuers, although alternative research solutions may help to reverse the trend.

This article has been created by our South African partner, Austin Lawrence Gidon (ALG), in collaboration with Singular Systems.

If you would like to find out more about what Edison and ALG can do to promote quality research of JSE-listed companies, please contact Marius Strydom at marius@austinlawrencegidon.com or Neil Shah at enquiries@edisongroup.com.