Business confidence on a steady downward spiral
How quickly sentiment changes! It seems like only yesterday we were reporting that South African business confidence was at its highest level ever. And today we have to share that the November 2007 Business Confidence Index (BCI) is at its lowest level since February 2004. The number, compiled by the SA Chamber of Commerce, now stands at 95.8.
Business has plenty of reason for concern at the moment. But we expect the big issue being discussed around boardroom tables at present is the significant slowdown in consumer expenditure. It appears the repeated interest rate hikes are finally taking their toll – with retail and services businesses having to moderate their trading expectations.
Most retail sectors will be hard hit as a series of seven interest rate hikes (with a possible eight later today) severely denting household disposable income. Furniture retailers like JD Group and Lewis have been hard hit – as have clothing retailers Foschini and Truworths. Food retailers (Spar for example) will probably suffer least as they are a largely cash business and an excellent defensive investment. But to really appreciate the impact of higher interest rates consider the story of Edgars Consolidated Stores (Edcon).
Private equity investment suffers as interest rate spirals
Once the darling of the JSE’s local apparel retail sector, Edcon made headlines earlier this year when private equity company Bain Capital bought the group and de-listed it. The problem is that Bain Capital used huge amounts of debt to finance the deal – Edcon’s total debt swelled from R674m in the first half of 2007 to the current R19.2bn. The resultant R1.2bn financing costs (interest payments) meant the company posted record losses of R971m for the half year to September 2007. The number represents the total opposite of the respectable net profit of R678m posted for the same period in the previous year.
The general slowdown in the consumer driven market for clothing will make Bain Capital even more edgy. Edgars Consolidated Stores managed a 10.4% increase in revenue (good considering general market conditions) over the comparable period in 2007. But the quarter on quarter sales growth came in at only 6.6%. That’s a sales growth rate slightly lower than inflation – and we believe the group will struggle to better the result in coming periods
If we were invested in Bain Capital we might be asking some tough questions about the amount paid for Edcon. We would also question the structure and timing of the deal. To lumber a company with such a huge amount of debt in the face of a rising interest rate cycle makes little sense at all.
The consumption investment conundrum
It is now clear that South Africa’s GDP growth will be driven by investment expenditure rather than consumption expenditure in the next decade. This is one situation that has contributed to the Reserve Bank’s difficulty in fighting inflation. Continued interest rate hikes are having a negligible impact on money supply and GDP growth for a number of reasons. First, government and private sector infrastructure investment has to take place regardless of domestic inflationary pressure. This raises a very scary scenario – because it means Mboweni can raise hikes without affecting GDP growth. And if GPD growth remains steady, Mboweni might incorrectly believe that monetary policy is not hampering growth and continue to hike rates. The hidden truth is consumers have already taken more hikes than they can handle.
And second, the interest rate levels have no impact on food and fuel prices which are seen as the major drivers of inflation in the economy. No matter what the Reserve Bank governor does with interest rates – global supply will keep oil prices on the rise. This means South Africans will continue to pay higher prices for fuel – with the concomitant knock-on effect on the price of almost all domestic consumer goods.
Lower business confidence will play out in stock market returns which are likely to fall from around 33% in 2007 to an estimated 6% to 12% in 2008. It looks like the equity market party is over – and that investors will have to be satisfied with the relatively pedestrian returns from bonds and cash in coming years.
Editor’s thoughts:
With petrol up 43c and a 50 basis point hike in interest rates, Christmas 2007 is looking to be a rather bleak affair for South African consumers. Do you believe investors will be satisfied with the returns from bonds and cash given the huge equity market returns they have become accustomed to? Add your comments below, or send them to [email protected]
