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Coronavirus and the case for shorting China-exposed South African stocks

By David Whitehouse
Posted on Monday, 24 February 2020 15:24

A worker sweeps in front of the Johannesburg Stock Exchange (JSE)
REUTERS/Philimon Bulawayo

Sharp falls in South African shares as the coronavirus global health emergency worsens are prompting some investors to consider short-selling strategies.

The JSE TOP 40 Index of the country’s largest stocks, many of which have exposure to China, slumped 3.7% this morning.

Jean Pierre Verster, CEO at Protea Capita in Johannesburg, has argued the case for shorting some JSE shares in an interview with CNBC.

If coronavirus takes longer to resolve than the market expects then “valuation levels are effectively too high. There is no margin of safety.”

Verster sees Richemont, Naspers, Glencore, Kumba Iron Ore and Sappi as South African candidates for shorting.

Short selling involves selling shares in the target company and then buying them back with the aim of profiting from a fall in price. The technique has been used to target shares in companies with African operations such as Jumia and Opera.

Correctly predicting short-term price moves in a single stock is one thing.

But calling the impact of a volatile health emergency such as coronavirus, which has the capacity to surprise on the upside or the downside, is quite another. A short seller who gets the direction wrong faces potentially unlimited losses as the price rises.

Lessons from Severe Acute Respiratory Syndrome, or SARS, which killed 774 people in 2002 and 2003, “suggest that market pessimism will be more pronounced when companies and countries publish data that shows to what extent they have been affected,” says Lulama Qongqo, an investment analyst at Mergence Investment Managers in Cape Town. “The impact of the coronavirus on consumer companies’ revenues and profits will be temporary.”

In stock market terms, SARS was a blip that was soon forgotten.

  • But coronavirus has already proved much more lethal than SARS, with a total of 2,626 people already dead.
  • Some Chinese industries are experiencing trading activity levels 20%-50% lower than normal, says Peter Takaendesa, head of equities at Mergence.

Stocks at risk

Izak van Niekerk, a fund manager at Mergence, agrees that stocks with Chinese exposure may take a short-term hit.

  • Richemont sales would suffer; nearly a quarter of Richemont’s sales are in China and Hong Kong, he says, and reduced Chinese travel to Europe will also hurt luxury-goods sales.
  • Glencore would suffer if there is a short-term decline in commodity demand
  • Kumba would be hit by fall in iron ore demand from China’s steel industry.
  • Sappi could also come under pressure, he says, as their dissolving wood pulp, used in viscose production, is sold to China’s textile manufacturing industry, van Niekerk says.

Yet there may also be winners: consumers with restricted mobility still need to make purchases, and entertain themselves, somehow. Takaendesa points to data from app usage trackers such as QuestMobile suggesting that time spent on smartphones and online games went up over 20% during the Lunar New Year period.

  • That’s a supportive factor for Naspers, with its stake in Chinese online giant Tencent, he says.

Retailers may face cost inflation due to disruption to China’s clothing manufacturing industry, Qongqo says.

  • But “considering how short the life cycle of fashion trends and clothing is, we can expect that businesses will rebound quickly” if China does so.
  • “Looking through the noise allows investors to increase holdings in good quality companies that are underappreciated,” Qongqo says.

The unpredictability of coronavirus is such that there’s a good chance that its highly media-tracked progress will cause moments of market overreaction that create buying opportunities in companies that are fully capable of recovering once the virus is brought under control.

Bottom Line: Opportunity may lie in short-term price overreactions to bad coronavirus news that create long-term investment openings.

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