This is a tricky time for equity investors in South Africa. Growth is hard to come by in general and almost nonexistent at macro level, so companies with market-leading positions are in most cases watching their margins erode. Costs are eating away at the income statement and top-line growth is asthmatic.
To make it worse, that frightening line called “net finance costs” below earnings before interest, tax, depreciation and amortisation (ebitda) is proving to be the death blow for growth, with bankers getting the juiciest part of the fruit and shareholders left with that soft bit nobody wants to eat.
If you’re hoping to mitigate this by just owning the banks, it’s also not that easy, I’m afraid. The corporate book might be doing incredibly well, but impairments (especially in the retail banking book) are blunting the benefits of this higher interest rate environment. The notable exception at the moment is Standard Bank, thanks to African exposure that is working exceptionally well. We all know how quickly that can turn, though.
The growth potential at Standard Bank is also no secret to the market, which is why it largely ignored the powerful recent trading statement (headline earnings per share up by between 23% and 28% for the year ended December 2023). The share price is up 13% over the past year, so the earnings are catching up to the valuation, rather than the other way around. That’s a dangerous situation for shareholders, as any wobble in the growth story will drive a sharp correction.
It’s difficult to find what to buy. It’s arguably easier to find what not to buy in this environment. The combination likeliest to bite you is a company operating in a market sector under pressure (such as durable consumer goods) with lots of debt on the balance sheet. This means you’re in trouble at operating profit or ebitda level (revenue and margin challenges) and even more trouble at net profit level, once the banks have taken their share of the profits.
Two excellent recent examples are Motus and Super Group, with the share prices down nearly 14% and 23% respectively in the past 12 months.
Business models such as these are hungry for working capital, which creates an unpleasant flywheel effect when sales slow down and inventory can’t be cleared effectively. The operating cash flows don’t come through to fund the balance sheet, so the banks need to be tapped for working capital. As finance costs rack up, even more cash gets used to service the banks. Things can get ugly very quickly unless inventory levels are brought in line.
If the overall market isn’t growing, then you have to win market share to grow
Motus and Super Group are both highly experienced players and will be able to navigate their way through this part of the cycle, but that doesn’t mean the share prices will do well. I suspect they won’t.
Keeping it simple
So, what should you look out for? To justify single stock positions in this environment, you need to find companies that are resonating with customers and winning market share, without making the bankers rich. If the overall market isn’t growing, then you have to win market share to grow.
A bigger slice of a smaller pie is a strategy that worked just fine for Capitec over the past couple of decades. This requires you to look beyond the blue chips and find companies storming their way through the mid-cap tables.
One such example is CA Sales Holdings. The management team is as humble as any you’ll find anywhere, which is half the battle won. The other half is the business model, which is about executing something simple to a high standard. The company isn’t trying to change the world. No, it’s just helping fast-moving consumer goods product manufacturers find a market. By managing the logistics and merchandising side of things, CA Sales Holdings provides a route-to-market solution made necessary by the way in which leading retailers operate. The share price is up 57% in the past 12 months.
Another company bucking the consumer trend is restaurant group Spur Corp. By offering primarily a child-friendly, value-orientated dining solution to battered consumers, Spur is well positioned in this environment. The group isn’t just a one-trick pony either, as it is doing more than just selling burgers next to a play area. The recent acquisition of Doppio is exciting. So are its growth and complete lack of debt, driving the share price 25% higher over the past 12 months.
Will it keep winning, or are there other names you should think about? This question is why we love this game.
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