Trip report: South Africa

Strong and independent institutions are one of the requirements for a country’s long-term success. South Africa undoubtedly faces many severe issues that will continue to be extremely challenging to navigate in the years ahead, and the road to their resolution will be long and littered with pot holes. Nevertheless, for long-term investors, we are positive given that the country is blessed with institutions that have proven themselves to be functional in recent years. 

These institutions have protected the country’s young democracy by standing up to and curtailing the behaviour of Jacob Zuma and his cronies, who may -  elsewhere in the world - have enjoyed greater and more enduring ‘success’. The institutions include a fiercely independent press, a constitution and an independent judiciary that protects it. From an investment standpoint, institutions include those protecting minority shareholders.

As bottom-up investors, these institutions are important to us but we must be very careful not to be over-reliant upon them.  

We saw this in practice in early 2019 when a motion was tabled that would have seen Shoprite dilute its shareholders1 in order to purchase and cancel the super-voting shares held by the company’s founder and largest shareholder, Christo Wiese. These shares were not entitled to profits, were non-transferable, and were non-convertible; they were worthless to anyone other than Wiese. Yet the proposal would have seen minorities diluted by 3.5% in the process, a large dollar amount in the context of a ZAR100bn market cap.2

Fortunately, South Africa’s Companies Act affords minority shareholders significant protection in such situations, blocking them if more than 15% of shareholders oppose the motion. When it became clear that the proposal would be soundly rejected, it was abandoned. A win for minority shareholders that certainly would not have been enjoyed everywhere in the world.

Unfortunately, some of the more shocking attempts to disadvantage minority shareholders are hard to identify in advance and are rarely exposed until afterwards. Two recent and particularly high profile South African cases sadly illustrate this. 

The first and most notorious case was that of Steinhoff3, an acquisitive furniture retailer. The second scandal was at Tongaat Hulett, South Africa’s largest sugar producer. Both involved large-scale frauds. 

Steinhoff’s shareholders suffered a 99% loss of their capital while Tongaat’s shares remain suspended as at time of writing. For both companies, all required corporate governance rules had been followed. The boards were populated with independent directors in possession of impressive CVs and reputations to protect. Independent auditors (Deloitte in both cases) agreed that the financial statements were fair and not misleading and audit committees were comprised of independent directors. Steinhoff’s lead independent director was Dr Len Konar, who had previously chaired the IMF’s external Audit Committee. Tongaat counted Jenitha John as an independent director who held the position of Head of the Audit and Compliance Committee. She was also chief of FirstRand Group’s audit executive – a company we hold in high regard – and has also held positions at other reputable companies.

"how can minority shareholders hope to find companies that are controlled and managed by individuals with their best interests at heart?"

For both companies, all of the governance boxes were ticked yet experienced significant corporate governance failures. Investors in both cases have suffered what is almost certainly a permanent loss of capital.

If such governance checks cannot be relied upon, how can minority shareholders hope to find companies that are controlled and managed by individuals with their best interests at heart? The answer is highly subjective and encompasses many shades of grey. As investors, we need to ensure that when we trust a group of people (which is ultimately what a company is) with our clients’ capital, we do so remembering that investing takes place in the real world. It is not an undertaking easily distilled into spreadsheets, earnings models, quarterly earnings releases, corporate codes or auditors’ reports. The motivations and characters of a group of people are all-important.

Clues to the motivations of a company’s managers and owners are uncovered through a broad process of enquiry. For example, are management driven by a purpose other than maximising their remuneration? Or do they only care about increasing earnings per share or the share price as much and as quickly as possible? Does a CEO encourage and relish challenge from his or her management team? Are investments made patiently and sustainably, or rushed in order to demonstrate growth to the detriment of a sturdy balance sheet? Is the company run for insiders and their own lavish lifestyles, or for all stakeholders? Are the financial statements designed to confuse? 

The clues are numerous and varied. Our job is to collect them and determine whether they fit together into a carefully-constructed jigsaw worthy of owning. In doing so, patterns emerge. Companies that fit the bill are invariably run by individuals with long-time horizons – frequently families or founding entrepreneurs – who emphasise capital preservation rather than growth that is unsustainable or illusory.

South Africa possesses many such companies as we were reminded on our research trip in December. We met a hotel company – City Lodge Hotels – where growth has always been pursued patiently, when it could very easily have been grown faster with less prudence. The company’s hotels are accounted for at depreciated cost4 rather than at market prices, a clear indication of conservatism. Hotel businesses are often vanity projects for egotistical owners and managers, but City Lodge Hotels have always focused their energy on low-key hotels with few frills. The founder and largest shareholder sadly passed away recently but is survived by a CEO who has worked for the company for over two decades. 

Another company we met which displays many desirable traits is Reunert Ltd, a business involved in Electrical Engineering, Information Communication Technologies and Applied Electronics. The company proudly boasts of its net cash balance sheet and has willingly shrunk its business on more than one occasion. It is a rare culture that celebrates such characteristics. 

Remgro, a diversified, conservative and well-managed conglomerate controlled by the Rupert family, is our largest investment in the country. The family has a long history of responsible corporate citizenship, and has always ensured that minority shareholders have benefited from corporate actions. We look for this kind of culture rather than mechanistic governance checklists that miss important shades of grey.


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Footnotes

  1. Diluting shareholders refers to the issuance of new shares which are not offered equally to all shareholders, so that the proportion of shares held by an investor is decreased.

  2. Market cap is the value of a company listed on the stock market.

  3. For illustrative purposes only. Reference to the names of each company mentioned in this communication is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies. Companies mentioned herein may or may not form part of the holdings of Stewart Investors.

  4. Depreciated cost is an accounting policy that reduces the value of an asset every year, even if those assets are increasing in value as may frequently be the case with real estate.