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After five years of bumper Christmas sales, analysts expected a subdued season and warned that it would get worse early next year as consumers would feel the effects of recent interest rate hikes.
December 18, 2007

By Tom Robbins Cape Town

After five years of bumper Christmas sales, analysts expected a subdued season and warned that it would get worse early next year as consumers would feel the effects of recent interest rate hikes.

But it is not all doom and gloom. The expectation is that despite interest rates that have risen for longer than expected, the country has not been derailed from its longer-term consumer growth story.

In general the most expensive products categories were expected to be the hardest hit over the festive season but the traditionally stable categories of food and alcohol would prevent a decline in overall retail sales

Barbara Price-Hughes, a research analyst at BoE Private Clients, expected the December sales growth trend to be halted this year. Price-Hughes thought real sales would be roughly similar to those of last year, this after taking inflation into account.

According to Statistics SA, furniture sales have already fallen into negative territory but Price-Hughes did not expect clothing sales to fall, though it was likely that sales growth in this category would continue to moderate.
But Price-Hughes said food sales to the bottom end of the market continued to be strong, as evidenced by the fact that food processors were battling to meet demand.

Abri du Plessis, chief investment officer at Gryphon Asset Management, expected food and alcohol sales to be the star performers, as they benefited from continuing growth in the middle class.

Moreover, Du Plessis believed lower debt levels at the bottom end of the market would help spending on these items.

He expected this to result in real growth for retailers such as Spar, Pick n Pay and Shoprite, but at a lower rate than last year.

Du Plessis expected roughly flat real growth in spending on clothing as consumer spending slowed on discretionary items. But he expected volume sales of popular electronics, such as flat screen TVs, to rise thanks to continuing price cuts, helped by the stronger rand. But Du Plessis said because of this manufacturing deflation, rand value sales would be under pressure.

When Woolworths fell out of the JSE’s blue chip Top40 index last week, the move reflected a cyclical shift in the economy.
December 18, 2007

When Woolworths fell out of the JSE’s blue chip Top40 index last week, the move reflected a cyclical shift in the economy.

The retailer lost its ranking as number 36 on the Top40, at the JSE’s quarterly review of the index. It was replaced by construction firm Aveng, with a market cap of R24.2 billion, a clear indication of where growth is taking place in the country’s economy.

The construction sector is booming, while retailers have been hit by a four percentage point hike interest rates in the past 18 months, which has capped consumer spending.

Woolworths, which joined the list in March, follows retailer Pick n Pay out.

The latter fell out of the index in July and was replaced by newly listed paper producer Mondi, which together with Mondi plc has a market cap of R31.4 billion.

A third retailer holding on to its place near the bottom of the index is Shoprite, number 38 on the list, with market cap of nearly R23 billion.

But whatever the cycle and despite structural changes to the economy, the Top40, which is made up of largest and most liquid companies, is dominated by resources.

Anglo American, with a market capitalisation of R616.4 billion at the time of the quarterly review of the index last week, tops the list, while BHP Billiton is second, with a market cap of R557.7 billion.

Louis Stassen, the chief investment officer of Coronation Fund Managers, said their combined contribution to the 25 percent return on the Top40 shares was 61 percent.
The two companies have been top of the JSE totem pole since the local bourse restructured the index in 2002, in a joint venture with the FTSE as its official index partner.

The two giant mining firms represent nearly 27 percent of the R4.4 trillion combined capitalisation of the Top40 companies.

The dominance of resource stocks has been shored up as commodity prices reached record levels in the past two years, after steady rises going back to 2003.

However, high prices have not encouraged mines to increase production. This is reflected in the contribution of mining to gross domestic product (GDP).

The contribution of mining to GDP has fallen from 20.6 percent in 1980 to 7.7 percent last year and 7.1 percent in the third quarter.

Chris Hart, an economist at Investment Solutions, said that changes in recent years included an increased presence of the financial sector after the listings of Old Mutual and Sanlam in July 1999 and November 1998, respectively, and the rising importance of telecoms and media companies.

Old Mutual is the second-biggest financial company in the index, with a market cap of R127 billion, after Standard Bank with R149.3 billion.

Innovation and the rise of cellular telephony has also left its mark on the index.

And the rise of media companies has put Naspers, with a market cap of R67.3 billion, in number 19.

Mars Africa, the fast-moving consumer goods company, intends expanding its presence on the continent.

Fast-moving consumer goods company Mars Africa intends expanding its presence on the African continent and has targeted five countries to enter.

Mars Africa, part of the global Mars group, contributed about R1bn in revenue to the group last year, 80% of which is earned in SA.

MD Ian Burton said the company aimed to earn half of its revenue from the continent and would initially focus on entering five countries. Mars Africa would also focus on developing its categories in the local market.

The company focused on three categories – pet care, snack food and main meal foods – and had no intention of diversifying beyond those categories, Burton said.

The family owned group, which turns over $21bn a year, has five brands worth US$1bn – Mars, M&M’s, Snickers, Whiskas and Pedigree.

Mars Africa’s mid-year name change, from Master Foods SA, formed part of its African expansion plan, which was a key part of its growth strategy, he said.

Mars aimed to develop an official distributor before putting someone on the ground in the five priority countries.

It had targeted Kenya, Ghana, Nigeria, Namibia and Botswana and already had a presence in Kenya and Namibia and would have a representative in Ghana soon. Burton said the company would then set up a sales force in those countries before considering additional investment once critical mass was reached.

Master Foods was incorporated in 1997 after Mars launched Uncle Ben’s as a competitor to Tastic rice in 1996. Subsequently, the company bought Royco and Oxo as it moved to localise its food portfolio instead of just importing its other global brands.

Burton said the company aimed to drive consumption of confectionery by making it more available locally.

It also aimed to grow the pet food category, in which it was the market leader, to garner more sales. Burton said pet food was a growth area for the company.

Burton said there was scope to grow the segment as pet food was relatively affordable locally. In addition, South African pets acquired 25% of their calories from pet food, with the remainder coming from scrap food, for example.

Mars Africa, which has factories in Cape Town and Pretoria, employs 250 people directly and 1000 indirectly.

Rising interest rates are stifling one of the JSE’s hottest sectors — but we will only really see the effects of the retail slowdown after the festive season.

Chris Gilmour, an analyst at Absa Asset Management Private Clients, said recent poor results by retailers have not included the impact of the last two interest rate increases — one in October and this week’s.

“It’s going to be deadly. It’s going to kill consumer demand, especially in certain segments of the market.

“What bothers me is that all of the results are showing consumers are not spending at the retailers. Are we going to have a great Christmas? Probably not — but it’s always difficult to say. People at this time of the year tend to think ‘what the hell’ and get their hangover in January.”

Gilmour expects the middle-income bracket will be hardest hit. “And everyone is talking about another interest rate hike in January. Also, the impact of higher oil and food prices is not good at all.”

Credit retailers were under pressure before this week’s interest rate increase, and the hike compounds challenges facing the sector.

Syd Vianello, retail analyst at Nedcor Securities, said retailers are not opening new accounts.

“Customers are stretched to their limits with existing accounts. That means their incremental spend for existing account holders is not much, probably no more than 6%.

“And if you have a dearth of new accounts it’s difficult to raise turnover significantly beyond these levels. The double whammy of another rate hike and a 6.5% increase in the price of fuel will make the next three weeks particularly tough.”

Vianello’s view is that the first week of December is an important barometer of Christmas trading.

“And the weekend wasn’t great. My biggest fear — unlike what we’ve experienced to date — is that we’re facing retrenchments throughout the economy.”

Vianello explained that if furniture retailers, for example, remain lacklustre they will not take delivery of orders next week. Factories will be overloaded with stock and by January might have to reduce production.

The same applies to motor factories. “If they haven’t pushed all the stock out, they will open next year with no orders and will operate on short time. If fewer cars are manufactured, there is reduced head count,” he noted.

“Retrenchments have a ripple effect through the system. The big telltale sign will be next week — if retailers go on sale next week, then you know they are seriously overstocked.”

Shaun le Roux of Alphen Asset Management said in a recent research note that the fallout on credit retailers and related stocks on the JSE has been significant.

From May 7, when many retail stocks peaked, most share prices have lost in excess of 20% of their value. Over the same period, the JSE All Share index was up almost 4%.

The motor vehicle retailers, which enjoyed boom times in recent years, were the first to encounter tough times.

Next to feel the pain was the durable goods sector, and the furniture retailers have experienced a sharp slowdown in credit sales, coupled with deteriorating bad debts.

Le Roux said JD Group, in its August annual results, reported a 26% drop in headline earnings a share on the previous year on the back of negative credit sales growth and a 65% rise in debtor costs.

The Ellerines share price has not dropped as much as the other furniture retailers because African Bank (Abil) stepped in to buy the business.

“The JD Group share price would be even lower if management had not signalled their intent to split their consumer finance and retail businesses, effectively putting up a ‘for sale’ sign,” said Le Roux.

“It is difficult to see the outlook for retailers and other interest rate- sensitive businesses improving in the near term and, in the circumstances of further upside risks to interest rates, share prices are likely to stay under pressure.”

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