South Africa: Global Recession 'Will Cut Profits Sharply in SA'

Source from:  Business Day (Johannesburg) 15 October 2008 10/16/2008

SOUTH African markets have been relatively sheltered from the global turmoil, with shares suffering smaller hits than stocks on the US and European markets. However, the looming global recession is likely to lead to a sharp fall in profits across the board. Although SA is still expected to record positive growth rates of 3%-4% this year and next year, growth in developed countries is expected to come to a standstill, or worse. William Fraser, portfolio manager at Foord Asset Management, says companies listed on the JSE are probably more sheltered from the global turmoil than their overseas counterparts. Public sector spending on infrastructure should help shield corporate SA from the slowdown, but it is unlikely to escape unscathed, he says. "In a global economic slowdown you are also going to get a slowdown in earnings. It's natural. There's higher unemployment, and inflation also rises late in the cycle, pushing up the cost of goods," says Fraser. Alwyn van der Merwe, director of investments at Sanlam Private Investments, says that commodity-based companies would probably be hit worst in the case of a recession. "Commodity prices have fallen rapidly from levels that were arguably high," says Van der Merwe. "If that trend persists, the lower commodity prices in dollar terms will put pressure on the profitability of these companies." Commodities most likely to be affected include steel, iron ore, copper, nickel and zinc. Coal will be affected less due to longer-term contracts and demand from customers such as Eskom, says Van der Merwe. Although share prices of commodity producers bounced in line with stronger equity markets over the past couple of days, Van der Merwe says commodity shares are likely to remain volatile until there is more certainty in the system. He says that banks will not escape the slowdown entirely. They are merely facing the operational challenges associated with a slowing economic cycle. It is very evident that the National Credit Act, high interest rates and indebted consumers are creating tough conditions for banks. "Our financials have resisted the international storm quite nicely. Our financial system has not frozen up," he says. "However, commodity prices cause a deterioration of the terms of trade which normally lean on the local currency." Fraser says that although credit demand is waning globally, public sector borrowing should help sustain demand from South African banks. Among SA's big industrial counters, Van der Merwe says groups such as SABMiller, Richemont and Remgro will be affected to different degrees by the slowdown. "If you think about SAB and their products, traditionally beverages have acted as a defensive product in times of slowdown. They might well weather the storm better than other companies operating overseas," says Van der Merwe. He says Remgro should also do better than some of its peers due to its exposure to British American Tobacco (BAT) as tobacco is also defensive. Richemont has exposure to BAT but also to the luxury goods segment, where there is evidence of business slowing down. Fraser agrees companies exposed to discretionary spending, such as Richemont, might be affected as demand for luxury goods wanes . But this is a short-term slowdown in demand. The super-luxury sector of the market tends to be more resilient than mainline retailers with significant credit books. While Richemont and Remgro should benefit from their exposure to BAT, Fraser says they are in the process of spinning off their stakes in BAT. "At the moment, there is still exposure, but that might disappear next year," he says. Shipping group Grindrod, which said recently it expected earnings to grow 80%-100% this year, was also likely to be affected. "Global freight rates are very important to Grindrod and they have collapsed due to the global slowdown in economic activity," Van der Merwe says. He says the performance of gold, and gold shares, as a result, has been disappointing. "Given the extent of the turmoil, the gold price should have reacted far more aggressively. I would have expected to have seen it above $1000 an ounce. Either the buyers were not as aggressive as they should have been or there was a seller in the market." Enditem