EZA ETF: South Africa's Election Looms

seekingalpha04-18

The iShares MSCI South Africa ETF faces a complex outlook, with various systemic and asset-specific variables playing a role.South Africa's upcoming national election could lead to a coalition ...

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Moreover, we think its dividend profile is latent.Hold rating affirmed.   Jeremy Woodhouse/DigitalVision via Getty ImagesThis article examines the iShares MSCI South Africa ETF's (NYSEARCA:EZA) prospects. We last covered the ETF back in October, assigning a hold rating to the asset on the basis of uncertain interest rate policy and broad-based market volatility. Our analysis today reflects on recent events, with particular emphasis on systematic variables and their potential implications for the EZA ETF's market price. Without further ado, let's traverse into the analysis. EZA ETF's Infrastructure Revisited The iShares MSCI South Africa ETF tracks the MSCI South Africa 25/50 Index, which is nothing esoteric in nature. The index basically consists of about 32 stocks throughout the year, spanning 85% of South Africa's adjusted market float. So, if you've ever taken a statistics course, you'd know that such depth in sampling essentially tracks the broad-based South African stock market, aka the Johannesburg Stock Exchange. As shown in the following diagram, the EZA ETF has tracking risk. The vehicle's tracking risk is likely due to settlement time differences, illiquidity, and imperfect currency hedging. We anticipate tracking errors persisting, along with liquidity premiums and trading costs, leading to benchmark underperformance.   iSharesHistorically speaking, the EZA ETF has underperformed the SPDR S&P 500 Trust ETF (SPY) by a significant margin. However, the EZA ETF's beta coefficient of 0.85 is quite low, suggesting underperformance isn't much of a surprise. Furthermore, the EZA ETF has a trailing dividend yield of 3.12% and a 10-year annualized dividend growth rate of -2.78%, suggesting its income-based features are quite latent. In essence, you're looking at a low-risk emerging market vehicle here. Data by YChartsA sectoral look at the EZA ETF shows that most of its holdings are financial and materials sector firms. This isn't a surprise, as South Africa is top-heavy with mining and banking companies. We'll get into a sectoral and holdings-based analysis later, but I'd like to add for now that we believe EZA ETF's expense ratio of 0.59% is highly impressive given the illiquidity of the South African market and the extent of FX hedging activity required to maintain a U.S. dollar-denominated vehicle. iSharesWith all that in order, let's move on to an analysis of South Africa's upcoming national election and its potential effect on regional stocks. Elections and March Inflation Report Elections – The Just Of It & Our Prediction South Africa is set for its most uncertain election in three decades (on 29 May). The popularity of the ruling party, the African National Congress, has slumped in recent years due to its failure to adequately manage the nation's critical infrastructure and address the central concerns of ordinary South Africans. The riskiness of this election isn't a result of the ANC's demise but instead due to the rise in populist opposition politics. Below is a recent poll conducted by the Brenthurst Research Foundation, followed by a discussion.   The Brenthurst FoundationAs shown in the chart, the ANC is polling at 39%, which is much lower than the 57.5% it received in the 2019 national election. The MPC refers to a multi-party coalition formed by South Africa's second-largest party, the Democratic Alliance, along with the Freedom Front Plus, and other central right (or free market) parties. Furthermore, Julius Malema's far-left Economic Freedom Fighters is polling at 10%, and former South African President (and ANC leader) Jacob Zuma's newly formed MK Party is polling at 13%. Now, we think the ANC will win the election by obtaining votes in the low 40s, allowing it enough parliamentary support to re-elect an ANC member as president. However, we think a low-40s result would lead to an ANC-EFF coalition or an ANC-MKP coalition, allowing it to obtain the majority vote. The MKP and EFF are both pro-nationalization. Thus, their influence would likely lead to a higher probability of land expropriation without compensation (including mineral resources). The ANC isn't opposed to such an idea but has maintained a more centrist view since it assumed executive office - we think a coalition could tilt the balance. Moreover, Jacob Zuma, the leader of the MKP, was part of South Africa's state capture debacle during his term as South Africa's President, which ultimately led to him leaving the party - we think his potential return to parliament would lead to higher nationalization risk due to his cunning ability to formulate political factions. Elections – Potential Influence on EZA ETF South Africa's stock market has faced numerous political woes. However, remember that many of its primary companies are driven by external forces rather than country-specific variables. For example, consider this: Gold Fields (GFI) and AngloGold Ashanti (AU) are exporting companies. Additionally, Naspers (OTCPK:NPSNY) mostly operates in the EU and Asia.   iSharesIn our opinion, of EZA's prominent holdings, the only companies faced by South African demand-side factors are banks and consumer staples companies. Thus, an argument exists that EZA is mainly driven by exogenous factors such as global industrial demand and tech sector development in the EU and Asia. Although the aforementioned probably holds validity, we think recently developed risks, such as the national election, Eskom's electricity crisis, and decaying infrastructure, enhance internal risk attribution for EZA ETF. Inflation – South Africa's March Inflation Report South Africa's March inflation report landed on Wednesday, revealing that headline inflation softened to 5.3% from 5.5% in February. The report outlines that housing and utilities (up 5.9% year over year), education (up 6.3% year over year), and health care (up 6% year over year) were among the primary influencing variables in the core inflation arena. As for non-core inflation, the food and non-alcoholic beverages basket ticked up by 5.1% year over year, down from its highs of 13.1% in March 2023. Moreover, fuel prices rose by 5.3%, suggesting a potential knock-on effect in broader energy costs. What do these numbers mean for interest rates and EZA ETF's prospects? Starting with interest rates, South Africa's midpoint inflation target is 4.5%, with its upper-level boundary at 6%, meaning inflation isn't out of control, but a near-term interest rate pivot is unlikely on the basis of target inflation. Additionally, the nation's current account is still in a deficit, which could mean that South Africa is keeping interest rates higher to fuel the capital account with short-term funding in an attempt to keep the South African Rand from faltering.   SA Current Account (South African Reserve Bank)Inflation – Potential Effect on EZA ETF The aforementioned data will likely lead to sustained support for South African banking stocks. Elevated interest rates have pushed the repo rate up to 8.25%. Still, an exponential increase in prime rates to 11.75% has led to a spread of 4.5%, concurrently leading to significant profits for South African banks. We think the likes of Absa (OTCPK:AGRPY), Standard Bank (OTCPK:SBGOF), and FirstRand Limited (OTCPK:FANDY) will see sustained benefits from the lending environment, especially with credit spreads widening in recent months. Furthermore, EZA ETF is exposed to insurers such as Sanlam (OTCPK:SLMAF) and Discovery. We believe long-term insurance sales will benefit from South Africa's elevated 10-year yield (about 12.48%). Fixed-rate long-term insurance policies generally prosper when bond yields are high, as policy offerings often provide rates of return pegged to prevailing long-term bond yields. The ETF's materials sector stocks are tough to call. We think sustained U.S. economic uncertainty will add additional momentum to gold stocks such as AngloGold Ashanti and Gold Fields. However, industrial-based miners such as Sibanye-Stillwater (SBSW) and Impala Platinum (OTCQX:IMPUY) are in uncertain territory. Thus, we are somewhat neutral on those names.   Gold and Platinum Spot Prices (Seeking Alpha)Lastly, a quick discussion about Naspers.  We covered Naspers in January 2023, assigning a Hold rating to its stock on the basis of shaky valuations and an underwhelming dividend profile. We maintain a similar outlook on the stock, as we have not witnessed a material change in its influencing variables. In fact, interest rates remain high, likely leading to compressed constituent valuation, while its dividend yield of 0.27% shows little signs of improvement.   Seeking AlphaValuation and Technical Analysis A look at EZA ETF's salient valuation data is up next. In our view, the ETF's price-to-book ratio is pivotal, given its hefty exposure to material and financial stocks. Moreover, the EZA ETF is home to numerous other mature stocks, which allows its price-to-book ratio to speak volumes. At a P/B of 1.5x, we don't think the EZA ETF is undervalued. However, deeming it overvalued would be overdoing it, especially as its price-to-earnings ratio of 11.53x is somewhat moderate.   iSharesLet's move on to a few technical aspects. EZA ETF trades below its 10-, 50-, 100-, and 200-day moving averages, suggesting a downward momentum trend. Moreover, its Relative Strength Index of 43.08 implies that it has yet to reach a resistance level. Although other factors can be considered, we think these variables show that the EZA ETF is faced with technical pricing headwinds.   Seeking AlphaThe EZA ETF's dividends were discussed earlier in the article. However, I embedded the vehicle's key dividend growth and yield metric below for your convenience.   Seeking AlphaFinal Word Our revision of the iShares MSCI South Africa ETF's prospects discovered that its political risk has likely been exacerbated, given the uncertainty embedded in South Africa's national elections. However, keep in mind that political risk in South Africa has become a perpetual phenomenon. Furthermore, we believe the nation's latest inflation report is well-placed, providing EZA ETF's bank and insurance holdings with an opportunity to prosper. Although mining companies are in uncertain territory, EZA ETF's gold exposure seems lucrative for the time being. An analysis of EZA ETF's technical and fundamental pricing points forms a juxtaposition. Considering that and various fundamentals, we assign the ETF a hold rating.  Consensus: Hold/Market Perform","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2428456783"}