Over the latest reporting cycle non-food related like-for-like retailer volumes contracted by 7.3% across pretty much our entire listed retail sector. That is not good, writes KEITH McLACHLAN of SmallCaps.co.za.

listed-retailers

But why is this happening? For a number of reasons, so let me list them for you briefly:

Edgars: Edgars has been losing market share (in the unlisted space) that the other retailers have been picking up (in the listed space). This bleed appears to be over and Edcon is now recapitalised and likely to chug along just fine protecting its market share. In other words, the listed retailers are no longer having their growth subsidised by Edgars’ woes.

Shopping centres: Over the last decade shopping centres have been rolled out at an incredible pace across South Africa. Therefore, periods of soft like-for-like growth by the listed retailers have been obscured by store rollouts and space growth. Consider the fact that the domestic shopping centre boom is pretty much over (read this), and suddenly like-for-like is no longer being subsidised by store rollout.

Credit market dynamics: Unsecured lending (inside and outside of the retail stores) is contracting. This is partially due to the National Credit Regulator’s latest stodgy affordability criteria (amongst other regulatory issues), but it is also due to unsecured lending out of African Bank, Capitec and the other banks contracting. These capital sources all borrowed from tomorrow to buy fancy shirts for today. Eventually, as consumer balance sheets, spending power and credit quality deteriorate, so will the volumes of new credit being pumped into the market. See here for NCR’s latest stats.

Disposable income contracting: Inflation, low growth, limited to dropping employment and the rising administrative costs (administrative costs are a euphemism for various State taxes such as income tax, capital gains tax, VAT, electricity, water, municipal, eTolls, etc) have all led to a flat-lining in South African consumers’ disposable incomes (in real-terms, excluding inflation). When credit markets tighten, then this dropping in disposable income becomes twice as apparent. See here for some data on this. OK, to some degree, disposable incomes have been alright, but household debts have been bad and the bloated government payroll (a massive spender at shopping centres) has been capped. In other words, disposable income going forward is actually likely to be worse…

So, all in all, a combination of factors are converging to make this a very tough retail environment, yet there is an elephant in the room: retailers themselves have been growing their own debt-levels and gearing has been exploding, while their returns on equity (ROE) have been falling. See below:

debt-to-equity

return-on-equity

So not only have retailers been using more and more debt to finance themselves, but they’ve been doing this at incrementally lower returns.

And then, on top of that we start to have falling volumes in even some defensive categories…?

The point is, South African retail is in trouble. This, in a way, is acknowledged by the fact that many of the retail groups are desperately acquiring businesses outside of South Africa. If South Africa was a good retail investment, why wouldn’t these groups deploy their capital in South Africa?

It is simple, we are not. Hence, they are not. Retail REITs (i.e. listed collections of shopping centres) have a historical beta with the listed retailers that approaches 1.0x. In other words, if local retailers struggle, rental escalation cannot be passed onto them, rental holidays appear, vacancies eventually materialise and highly-indebted shopping centres get impaired. And, within highly-geared REIT structures, when net asset value drops then loan-to-values are breached, distributions are the first thing to be cut, and… and… and…. I’m sure you get the picture.

This article was first published on SmallCaps.co.za.and is republished by Sports Trader with permission.