Tough times ahead for SA-based companies, say analysts

The odds are stacked against SA-based companies as consumer spending remains under pressure while operating costs continue to rise.

The immediate future does not look good for small cap companies and some underperforming mid-sized stocks, according to experts who spoke at a Nedgroup Investment summit on Thursday, who anticipate that their profit margins will remain under pressure.

“I’ve said it to many investors for a long time: times have been tough for small businesses and they will remain tough,” said Anthony Sedgwick investment manager and director at Abax Investments.

Small cap companies make up 2% of JSE’s market capitalisation and include the likes of steel company ArcelorMittal and private education group AdvTech. Small cap companies have been underperforming for a while, falling 10.9% in the past five years, while the all share index rose 12.6% over the same period.

But given the double-digit discount at which they trade relative to their net asset value, some investment managers still consider them as a good buy. But experts at the summit were worried that the rising costs of doing business in SA, coupled with depressed consumer spending which resulted in the GDP contracting 3.2% in the first quarter, overshadowed the discount in these stocks.

The concern now is whether SA-based companies can grow their earnings given concerns such as frequent interruptions in water and electricity supply. Their cost base is also constantly rising. For instance, in 2005 municipal charges made up 44% of local property companies’ total operating costs. In 2019, this has increased to 63% and looks set to continue climbing, said Iain Power, partner and senior fund manager at Truffle Asset Management.

“Unfortunately companies are unable to control these costs. They just have to accept it,” he said.

Sedgwick said investors should tread carefully around small caps for now, even though their share prices remain attractive. “In the medium term I think, yes, South African businesses and entrepreneurs are very innovative and will find ways to do well for us as investors and to grow their profits. But for the time being, I don’t think you need to rush into it,” he said.

But what about medium cap SA-based companies? Neil Brown, fund manager at Electus Fund Management said SA Inc, which includes all JSE-listed companies that generate their revenues locally, is not yet broken. But, the key is being able to separate the “good” companies from the “bad”.

The bad include mostly mid-sized companies whose performance over the past few years has been undermined by acquisitive sprees, increasing costs in an economy that is no longer growing as it used to. Among the good, said Brown, are companies like Capitec and FirstRand in the banking space and Shoprite and Mr Price among retailers.

But even among the good, local financial services companies are in a better space than retailers, despite the increasing competition in the banking space because the local economic climate does not weigh as heavily on them as it does on other industries, said Brown.

“The key difference is that retailers, every day, have to make a sale. Banks and insurers have in-force books. Every month, people are paying premiums, are paying back their mortgages. There’s annuity revenues which should smooth them relative to other companies like retailers.”

buthelezil@businesslive.co.za