From sentiment to strength: the resurgence of the South African consumer

After a sentiment-driven market re-rating in 2024, we believe the next phase of stock price appreciation will be earnings-driven, favouring companies that can convert improving economic conditions into real revenue and profit expansion. Key to this transition will be the resurgence of the South African consumer.

South African equities have performed well over the past two years, largely driven by a market re-rating as sentiment towards the domestic economy improved. The challenge, however, is for companies to convert this optimism into sustainable earnings growth, which we believe will be the primary driver of share price returns in 2025.

The resurgence of the South African consumer will be key in this transition. Our analysis suggests that the environment will continue to be supportive for consumers and that spending will continue to rise. Should this play out as expected, companies that are well-positioned to benefit include Mr Price, The Foschini Group (TFG) and Capitec Bank, which all occupy high-conviction positions in our portfolios.

Historically, local equities have gone through cycles where stocks became cheap due to pessimism and later re-rated as sentiment improved – for example, after a relatively muted 2023, sentiment towards the domestic economy improved sharply in 2024. This was driven by optimism around the Government of National Unity (GNU) and easing economic headwinds, leading to an improved domestic outlook and a re-rating in stock valuations. When looking at the constituent elements of growth over this period (Figure 1), there’s a stark contrast between the main drivers of equity returns over the past two years (which was primarily driven by a re-rating) compared to previous 10 and 25-year periods (which were primarily driven by earnings growth).

Figure 1: Breakdown of ALSI returns over time

Source: Bloomberg, as at December 2024.

Local equities continue to trade at attractive multiples, despite re-rating from exceptionally undervalued levels. Domestic banks and discretionary retailers currently trade at more than 10% below their 15-year average multiples, as measured on a 12-month forward price earnings (PE) basis.

As shown in Figure 2, structural improvements in consumer disposable income are expected to unfold in 2025, fuelled by better employment growth prospects, above-inflation wage growth, lower interest rates, and increased government social grants.

Figure 2: Cash available for retail and discretionary spend

Source: Primaresearch, as at January 2025.

The South African Reserve Bank (SARB) has reduced local interest rates three times since September last year. Our expectation is for further rate cuts – a minimum of 25 basis points (bps) – in the coming months, making borrowing even cheaper for individuals and businesses. Lower debt servicing costs should free up household income, supporting spending on retail, home improvement, travel, and discretionary items.

For the first time in several years, wage growth is expected to outpace inflation, meaning real income growth for South African workers. Inflation, which reached 7.8% in 2022, is expected to stabilise between 4% and 5% in 2025. Private sector salaries have been rising as companies strive to retain skilled workers in a competitive job market, and corporate bonuses and performance incentives are also expected to recover in 2025. Simultaneously, government employees will be receiving above-inflation pay hikes and minimum wage increases are also set to provide much-needed support to lower-income earners. This group typically allocate a higher proportion of their income to consumer goods, benefiting retailers such as Mr Price and TFG.

In 2025, key government support measures including the Social Relief of Distress (SRD) grant will offer additional aid to low-income consumers. Middle-income earners will benefit from increased personal tax rebates and relief measures, putting more money back into household budgets. Additionally, extended energy-related tax incentives will help lower electricity costs and free up disposable income.

COVID-19 saw approximately 2.2 million jobs lost in Q2 2020, the first quarter following the start of the pandemic. The return of the job market to pre-COVID levels has not been a straight line, with a mild deceleration at the back of 2021. Since then, however, employment has grown from 14.5 million to the latest reading of 17.1 million, placing it ahead of its pre-COVID base. This is positive for consumers, as employment growth is the most important driver of the consumer wallet.

After tightening lending conditions in 2023, South African banks are now easing credit criteria as economic stability and wage growth reduce default risks. This has fuelled surging consumer borrowing, with credit applications reaching an all-time high in the fourth quarter of 2024. Personal loan approvals have increased as banks grow more confident in lending to employed consumers with stable income streams, and home and vehicle financing has become more accessible.

Mr Price stands to be a major beneficiary of the consumer resurgence due to its value-driven apparel and homeware offerings. As disposable income rises, middle and lower-income consumers will have greater spending power, driving demand. The company’s cash-based sales model allows it to immediately benefit from higher consumer liquidity.

TFG is also poised to benefit from improving consumer trends, leveraging its extensive multi-brand portfolio and strong online retail presence. The company’s digital transformation has led to a remarkable 47.9% surge in online sales. Meanwhile, TFG’s expanding physical store network, with 4,720 locations globally, enhances its ability to capitalise on rising retail demand. Additionally, the company’s credit business stands to gain from increasing credit approvals and lower interest rates.

Capitec Bank is particularly well-positioned to leverage increased credit availability and consumer confidence. Expected interest rate cuts in 2025 will improve loan affordability, driving higher demand for personal loans, credit cards, and retail financing products. Capitec Bank’s aggressive customer acquisition strategy supports growth in both its transactional banking and credit segments. Additionally, Capitec Bank’s expansion in digital banking and value-added services will enhance its non-interest income.

After a sentiment-driven market re-rating in 2024, we believe the next phase of stock price appreciation will be earnings-driven, favouring companies that can convert improving economic conditions into real revenue and profit expansion. Each of these high-conviction positions possess strong fundamentals and are well-positioned to outperform as consumer disposable income increases, interest rates fall, and employment continues to grow.