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Brightening outlook for SA clothing sector

Mar 20 2018 16:08

Cape Town - As little as six months ago SA's clothing sector was depressed by weak economic growth, subdued consumer confidence and declining earnings. 

But now equity investors see a brightening outlook, according to Overberg Asset Management (OAM) in its weekly economic and market overview.

According to OAM, the consensus view is that the clothing retail sector has taken off over the past six months,  and will continue to rise over the next three years.

But despite this, OAM warns that investors should be cautious of the mixed performance delivered by the big 4 clothing retailers: Mr. Price, The Foschini Group, Woolworths and Truworths.

"The mixed performance of the big-4 clothing retailers clearly requires investors to choose carefully in the sector, favouring a tailored approach," said OAM.

"Operational efficiencies, rising market share, balance sheet health and good cashflow conversion are equally important in making a stock selection within the clothing retail sector."

South Africa economic review

• The RMB/BER Business Confidence Index (BCI) surged by 11 points from 34 in the fourth quarter (Q4) to 45 in Q1. Although still below the key 50-level which signals contraction, the BCI has seldom risen so quickly. Since 1975, when the data series began, the BCI has risen by 11 points on only 15 occasions.

Sentiment improved across the BCI sub-indices with gains shown in manufacturing, retail, wholesale, new vehicle dealers and building confidence. If sustained, the Q1 BCI implies a much-improved economic growth performance in 2018. However, some caution is warranted.

While sentiment has recovered strongly from last year’s lows, this has not yet translated into actual economic activity. Moreover, anxiety over land expropriation may undermine recent gains in policy certainty.

• Manufacturing growth improved in January to 2.5% year-on-year up from 1.8% in December. The gain is attributed mainly to the food and beverage sector, which grew 10.1% on the year contributing 2.5 percentage points to headline growth. The weak base effect caused by last year’s drought boosted the growth figure.

Other sectors showing strong year-on-year growth include motor vehicle and parts, glass and non-metallic mineral products, iron, steel, machinery and equipment, with respective gains of 5.5%, 5.2% and 4.3%. The outlook for manufacturing output has improved, helped by prospects for increased domestic demand, strengthening global growth, and falling producer price inflation.

The Absa manufacturing purchasing managers’ index (PMI) moved above the expansionary 50-level in February for the first time since May 2017, indicating further positive momentum in manufacturing growth in the months ahead.

•  Mining production increased in January by 2.4% year-on-year more than reversing the 0.5% decline in December and beating the 1.3% consensus forecast. On a month-on-month basis mining production increased by 1.0%. Iron ore production grew 25.1% on the year up from 15.9% the previous month, contributing 3.4 percentage points to headline growth.

While making smaller contributions, other non-metallic minerals grew 27.1%, diamonds by 22.7% and building materials by 25.2%. While increased global growth and rising international commodity prices have boosted mining production, the industry has been unable to fully capitalise on the positive environment due to uncertainty over mining legislation.

However, policy and regulatory uncertainty is expected to be addressed by the new Minister of Mineral Resources, Gwede Mantashe, and greater coordination between government and the private sector.

The week ahead

• Reserve Bank Composite Leading Business Cycle Indicator: The Composite Leading Business Cycle Indicator, which dipped slightly in December from 105.2 to 104.6, may have slipped again in January due to uncertainty over land expropriation and unease over global trade.

• Reserve Bank Quarterly Bulletin released on Tuesday: The current account deficit has increased in the fourth quarter of last year to 2.9% of GDP from 2.3% in Q3.

• Consumer price inflation: Released on Tuesday, Consumer price inflation (CPI), which has been on a downward trend over the past year, decelerated further to 4% year-on-year in February compared with 4.4% in January. Inflation is being pushed lower by the stronger rand and the stabilising oil price.

• Retail sales: Due on Thursday 22nd March. Retail sales growth, which has consistently surprised to the upside over the past three months, may again beat expectations in January following December’s stellar 5.3% increase. Consumer confidence has gained amid greater political and policy certainty post the outcome of the ANC elective conference in December.

• Moody’s credit rating announcement: Due on Friday 23rd March. Following Moody’s positive response to February’s State Budget the credit rating agency is expected to keep South Africa’s investment grade sovereign rating when it makes its announcement on Friday.

While unexpected, a downgrade by Moody’s would mean the three main rating agencies would have South Africa at junk status resulting in the country’s expulsion from the Citi Government Bond Index.

Technical analysis

• Having broken key resistance levels at R/$12.50 and R/$11.70, the rand has returned to its appreciating trend, targeting a break below R/$11.00 over coming months.

• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.

• The British pound has broken above key resistance at £/$1.35 promoting further near-term currency gains to a target range of £/$1.40-1.50.

• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.

• The US 10-year Treasury yield has broken decisively above key resistance at 2.5%, targeting the next key resistance level at 3.0%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.

• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 8.6%% indicating a new target trading range of 8.0-8.5%.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.  

• The Brent oil price has broken above key resistance at $60 and likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.

• The break in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.

Bottom line

• Has the tide turned positively in favour of the clothing retail sector? As little as six months ago the sector was depressed by weak economic growth, subdued consumer confidence and declining earnings.

• Despite a raft of earnings forecast downgrades and sell recommendations from analysts the sector has taken off over the past six months. The Big-4 of the clothing retail sector, comprising Mr. Price [JSE:MRP], Woollies [JSE:WHL], Foschini [JSE:TFG] and Truworths, with respective market capitalisations of R72bn, R63bn, R53bn and R45bn, have except for Woollies, shown remarkable share price gains over the past six months.

Over six months, in descending order, TFG, MRP, TRU and WHL have gained 60%, 52%, 30% and 0.6%. Over 12 months, MRP is the leader with 59%, followed by TFG and TRU gaining 31% and 12% while WHL has lost 17%.

• The sector is back in fashion. The outlook for consumer discretionary spending has been greatly enhanced by the shift in political leadership and increased policy uncertainty.

• Improved prospects for economic growth will boost jobs growth and wage growth. At the same time a strengthening rand and falling inflation will facilitate cuts in interest rates further boosting household disposable income.

• Following years of depressed consumer confidence and lacklustre household credit extension, households’ debt to disposable income has reduced to healthier levels providing scope for increased borrowing.

Household credit extension is expected to rise from current depressed levels buoyed by a combination of rising consumer confidence, increased credit demand and a relaxation of lending standards. Banks will be happier to lend in an improving economy.

• Clothing retail earnings are expected to rise strongly over the next two-to-three years. Rising consumer demand will drive revenue growth. Profit margins will improve significantly as revenues exceed the substantial fixed overheads required by retailing infrastructure. With clothing retailers importing the bulk of their merchandise the strengthening rand will add extra margin enhancement.

• The mixed performance of the big-4 clothing retailers clearly requires investors to choose carefully in the sector, favouring a tailored approach. The prospects for a strong rand favour retailers with a greater domestic focus and a larger dependence on merchandise imports.

Operational efficiencies, rising market share, balance sheet health and good cashflow conversion are equally important in making a stock selection within the clothing retail sector.

• MRP is the favourite clothing retail share amongst foreign investors, who own around 50% of the shares in issue. The MRP business model is centred on offering fashionable merchandise at “everyday low prices”. MRP enjoys an exceptional track record founded on bulk merchandising and low pricing, which combined with a reduced overhead structure has resulted in powerful operating margins.

While the share is not cheap on a trailing price-earnings multiple of 26x this rating should unwind rapidly over the next two years. Despite the weak operating environment of the past three years, MRP has one of the strongest balance sheets on the JSE.

For the full report, including a look at international markets, click here.

* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.

Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report. 

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