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The Case for Investing in South Africa (Part II)

In a recent article on Seeking Alpha, I made the case that South Africa presents a unique investment opportunity as it offers the combination of pan-Africa growth and mature capital markets. In other words, South Africa offers investors frontier markets-type growth, but with more liquidity, more mature capital markets, greater data richness and greater transparency. Although markets such as Nigeria, Kenya, and Ghana hold great potential for sustained high growth, South Africa is the most mature stock market on the continent. It comprises nearly 90% of total Sub-Saharan Africa's market capitalization and its listed companies will participate in the upside of less mature markets, making it an ideal entry point for US investors who want to allocate to Africa, as I shall explore in greater detail below.

Gateway to Africa

As capital controls are relaxed through tax treaties and lower barriers to direct foreign investment and profit repatriation, new capital can flow more easily into Africa. South Africa is the primary beneficiary of this development. This should greatly increase intra-African trade, which is currently only 10% of total African trade. By comparison, intra-European trade as a percentage of total European trade is 60% and similar figures for the United States and Asia are 40% and 30%, respectively. As such the potential for increased trade within Africa cannot be overstated, and South Africa, as the most mature African market, is in a unique position to benefit from this increased trade. Examples of South African and multinational companies that have been using South Africa as a springboard into Africa include companies such as Massmart (OTCPK:MMRTY), YUM! Brands (NYSE:YUM), and SABMiller (OTCPK:SBMRY), which can all be bought in the US OTC market. The section on Receding Trade Barriers provides additional detail on the various trade agreements that are being put in place across Africa.

Two-Tier Economy

Although South Africa is technically an emerging market, it is often described as a "two-tier" economy. The "first tier"- consisting of the mining, agriculture, manufacturing, financial services, and retail sectors- is competitive with mature markets in terms of efficiency and level of sophistication. The "second tier" is South Africa's large informal economy that is best characterized as a third world economy. There is ample room for the first tier to grow relative to the informal economy, as South Africa continues on its development path. The informal economy can also be viewed as an untapped labor pool that can keep wage inflation at bay and ensure ample supply of labor as the first tier expands.

High Savings Rate

Gross domestic savings in South Africa in 2010/2011 amounted to 20% of GDP, which compares to 19.5% for sub-Saharan Africa as a whole and 13% in developed countries [2009]. Though not nearly as high as the 54% gross domestic savings rate in China, South Africa's savings rate bodes well for future capital formation and economic growth.

Business Culture

South Africa compares favorably to its African peers with regards to ease of doing business (World Bank), competitiveness (World Economic Forum), and level of corruption (Transparency International).

Ease of Doing Business Rank (out of 183)

Competitiveness Ranking (out of 139)

Corruption Perceptions Index (out of 178)

South Africa

34

54

54 (China = 78)

Kenya

95

106

154

Nigeria

125

127

134

One particularly hopeful data point for South Africa is the progress that has been made with regards to the ease of starting a business and the registration of property, which bodes well for future economic growth.

Stock Market Performance

What is ultimately relevant to investors is whether the aforementioned favorable attributes have translated into positive investment returns. The South African stock market returned on average 12.57% per year from 2002 to 2011, compared to 3.64% for the S&P 500 Index, excluding dividends. Past performance is no guarantee of future results. Investors should however view as positive the fact that those attributes have persisted and improved over time, which should bode well for the future.

Year

MSCI South Africa Index (USD)

S&P 500 Index

2002

23.26%

-23.37%

2003

39.88%

26.38%

2004

40.67%

8.99%

2005

24.03%

3.00%

2006

17.25%

13.62%

2007

14.72%

3.53%

2008

-39.98%

-38.49%

2009

53.39%

23.45%

2010

30.70%

12.78%

2011

-17.29%

0.00%

Although US investors can participate in the greater Africa region through ETFs such as Market Vectors Africa (NYSEARCA:AFK) or iShares MSCI South Africa Index (NYSEARCA:EZA), South Africa offers by far the most opportunities to invest directly in its listed companies without leaving US shores. Retailers MassMart and Shoprite Holdings (OTCPK:SRHGY), SABMiller , and Standard Bank (OTC:SBGOY) are some of the better known names. However, there are also less well-known companies that trade in the US such as Net 1 UEPS Technologies (NASDAQ:UEPS), an electronic payments processor, and Naspers (OTCPK:NPSNY), South Africa's leading electronic and print media company. Additionally, if an investor has access to London's exchanges, the list grows bigger yet.

Source: The Case For Investing In South Africa (Part II)

Additional disclosure: I may initiate positions in Naspers (OTCPK:NPSNY) and Net1 UEPS (UEPS).