I don’t mean to be alarmist, particularly from my perch in Cape Town where we have actual service delivery, but the water news coming out of Gauteng is very concerning. I’m pretty sure that’s how load-shedding started. It’s just a lot easier to create your own electricity than your own water.
The headlines for South Africa never seem to get better, with signs everywhere in local companies that things are tight. This calls for caution among investors, particularly as any equity allocation needs to meaningfully beat the practically risk-free fixed-income returns available.
I’ll start with property, using Growthpoint as an excellent barometer of what is going on in the sector, with an outlook that is about as palatable as the water headlines. Distributable income per share increased by only 1.3% in the year ended June 2023, with the outlook for 2024 reflecting an expected drop of between 10% and 15%. Property is supposed to give you a return somewhere between fixed income and pure equity. Clearly, that isn’t working in a low-growth, high-interest environment.
And it’s not just Growthpoint. Hyprop has reduced its payout ratio and also expects a drop in distributable income per share of between 10% and 15%. Things are tough in general in the property space, with only a handful of counters giving a positive outlook. These include Attacq, Heriot and Vukile.
There’s geographical noise in most of these numbers, as almost all the local property funds have taken capital offshore. In the middle of the lost decade, they could raise hundreds of millions of rands in a matter of minutes with the promise of buying another shopping centre in eastern Europe or industrial properties somewhere in Germany.
Rand weakness is all that has helped prop up the returns from those global capital allocations
With a sharp rise in interest rates in Europe and the UK after the pandemic, property has lost its shine as an asset class. Rand weakness is all that has helped prop up the returns from those global capital allocations, with the price-to-book ratio unwinding in the sector and hurting shareholders along the way.
Property is difficult to justify right now, particularly with fixed-income opportunities giving decent returns as an alternative. Most property funds are struggling to avoid negative reversions (new leases at a lower rate than the expired lease). With net operating income under pressure, finance costs continually increasing and property valuations heading the wrong way, care is required in this sector.
Moving on, I’ve been consistent in my view this year that industrials and services businesses with pricing power offer better places to play than local consumer businesses. Even if you picked Shoprite as arguably the best retailer in Africa, you’re up only 5.3% this year. The pressure is also flowing from retailers into food suppliers.
A different way to sell food to consumers is through restaurants, with Bidcorp sitting at the perfect point in the value chain that gives it pricing power. Bidcorp is negotiating with thousands of small restaurants, not the behemoth that is Shoprite. It also has very little exposure to South Africa, with the share price up 26% this year.
CA Sales Holdings also deserves a mention, showing us that moving goods around can be a better model than producing or selling them. The share price is up 37% this year and the company has strong growth prospects and a sensible, humble management team focused on getting the job done.
If you need any further convincing that this environment requires proper research and an understanding of where the power sits in the value chain, Barloworld just released an update that gives us a reality check.
I realise I’m being cheeky here, and I’m not suggesting this is a perfect comparison, but I can’t ignore Equipment Russia’s achievement in constraining the drop in operating profit to 8.7% — in a country at war and under sanctions — while the consumer-related Ingrain business in South Africa saw its earnings before interest, tax, depreciation and amortisation plunge 19.2%. In case you’re wondering, Equipment Southern Africa grew operating profit by 17.3%.
This environment calls for great caution. If you’re going to pick stocks, pick carefully. Every value chain has price makers and price takers. Wherever possible, focus on the former.
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