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After showing little to no growth for 10 years, compelling value in the building and construction sector is attracting the attentions of seasoned global peers and institutional investors.
The tide may be turning.
Following a bleak decade of falling investment and declining margins, the outlook is gradually improving, said Overberg Asset Management (OAM) in its weekly economic and market overview.
"Foreign appetite for South Africa’s building and construction sector is motivated by the exceptional value on offer and the opportunity for substantial earnings growth.
"Of all the sectors on the JSE, the building and constructions sector is probably the most cyclical and the most volatile. From current depressed levels the scale of a cyclical upturn could be dramatic."
According to the analysts at OAM, the calibre of overseas investors in the sector suggests significant potential. (See bottom line below for more)
South Africa economic review
• Mining production contracted in April by 4.3% year-on-year following the 8.5% contraction in March.
On a month-on-month basis mining production fell 2.0% after contracting 3.5% in March. For the year-to-end April mining production fell 2.2% on the year in contrast to the 5.0% growth achieved in the same period last year.
Among the mining categories, those showing the biggest year-on-year declines were other metallic minerals, copper and diamonds with declines of 36.3%, 27.6% and 24.1%. Nickel, platinum and gold followed with declines of 17.5%, 6.5% and 5.7%.
The bleak mining production numbers are especially disappointing given the positive global environment for commodity demand and high international commodity prices.
Part of the blame lies with continuing uncertainty over mining legislation and potential land expropriation without compensation. Mining production is expected to recover strongly once certainty is restored to key policy areas.
• Minister Gwede Mantashe released the draft Mining Charter.
Notably, the current draft recognises the principle of “once empowered, always empowered”. The quid pro quo for this concession is that the overall black ownership requirement is lifted from 26% to 30%, although companies have five years to comply.
In a further concession, the requirement under previous mining minister Mosebenzi Zwane that 1% of revenue be allocated to black shareholders, has been watered down to 1% of EBITDA (earnings before interest, tax, depreciation and amortisation).
However, the document received mixed reviews from the Minerals Council South Africa (MCSA). Although describing it a “material improvement” the council criticises the 10% “free-carry” provision on new mining rights, which forms part of the 30% black ownership target.
The 10% free-carry for communities entails zero cost to the proposed shareholders or any participation in capital raising or expenditure related to that holding. The MCSA said the Mining Charter’s 10% free-carry provision “would render uneconomic a significant proportion of potential new projects and would undermine and constrain any prospects for growth in the sector and indeed the economy as a whole.”
Encouragingly, the public has 30 days to comment on the document amid an expressed willingness on the part of government to amend the draft if necessary. Furthermore, government has committed to allow exemptions for junior miners, based on individual applications.
• Fitch credit rating agency affirmed South Africa’s sovereign debt rating at BB+ (sub-investment grade or junk) while keeping its outlook at “stable” indicating no intention to upgrade or downgrade unless there is a significant change. Although lifting its GDP forecasts for 2018 and 2019 from 1.6% to 1.7% and from 2% to 2.4%, Fitch cited low growth, risks to public finances and risks posed by the highest inequality in the world.
Fitch said that despite governance improvements, policy making could be hindered by tensions within the ANC and a preoccupation with general elections, which are due by August 2019.
The rating agency stated that: “Current government initiatives are unlikely to improve trend growth significantly, as their implementation and timeline is uncertain and their impact on growth ambiguous.”
However, Fitch provided reassurance on land reform, stating that land expropriation without compensation will likely be handled in a way that would avoid significant economic damage.
• Retail sales growth slowed sharply in April to 0.5% year-on-year from 4.6% in March.
Part of the blame lies with the VAT increase from 14% to 15% implemented on 1 April. Moreover, the nationwide bus strike and other labour strikes may have undermined consumer confidence. Statistical base effects also exacerbated the weak retail sales data.
The Easter holidays fell in April in 2017 but in March in 2018. By retail category, textiles, clothing, footwear and leather goods contracted 0.5% on the year following growth of 10.1% in March. The best performing categories were the furniture and pharmaceutical sectors which grew sales on the year by 11.0% and 6.2%, albeit a slowdown from respective growth rates of 17.6% and 7.6% in March.
Despite April’s weak reading retail sales for the year to end-April increased by 3.2% on the year, up from 0% and 2.8% in the same periods in 2017 and 2016. A strong recovery in consumer confidence is expected to keep retail sales growth on an upward trajectory into the second half of the year.
• South Africa did not escape the general withdrawal by global investors from emerging markets.
Disinvestment continued in the week to 15 June with South African equity and bond markets suffering net foreign investor outflows of R4.24bn and R1.90bn. Total net outflows for the week amounted to R6.15bn.
For the month-to-date total net investor outflows reached R23.82bn with R3.73bn coming from the equity market and the bulk, R20.08bn, from the bond market. Helped by solid inflows earlier in the year, the total net outflows for the year-to-date are less severe at a total of R16.57bn, comprising R25bn from the bond market and a slender net inflow of R9.03bn to the equity market.
The outlook remains clouded by global investor unease over the worsening trade dispute between the US and China.
The week ahead
• Consumer price inflation: The VAT increase from 14% to 15%, implemented on 1 April, which pushed consumer price inflation (CPI) up sharply in April from 3.8% to 4.5% year-on-year, eased against the consensus to 4.4% in May. This was despite the residual impact of the VAT increase and fuel prices climbing 3.5% in May. The consensus was for an acceleration in CPI to 4.7%.
• Reserve Bank Quarterly Bulletin: A highlight of the Quarterly Bulletin will be the first quarter (Q1) current account forecast, which is expected to have deteriorated from a deficit of 2.9% of GDP in Q4 to around 3.5% - 4.0% in Q1. The main culprit is the widening in the income deficit on the balance of payments. A weak current account reading may exacerbate the rand’s recent slide.
Technical analysis
• The rand has broken decisively through key resistance at R13.35/$ indicating further weakness to the R14.00/$ level. However, the rand is deeply oversold at current levels, which suggests a trading range of R13.00/$ to R13.50/$ is more likely.
• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
• The British pound has broken back below key resistance at £1.35/$ suggesting a trading range of £1.30/$ to £1.35/$. The £1.30/$ level is expected to provide strong resistance.
• 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 3.0%, targeting the next key resistance level at 3.6%. 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 above key support levels of 8.6%% and 9.0% indicating a new target trading range of 9.0-9.5%.
• 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 $75 indicating a new trading range of $75 to $85 per barrel. 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 a price recovery and a test of the $1 400 target level.
• Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56 000 and 60 000 in December signals the early stages of a new bull market.
Bottom line
• Basil Read, previously one of South Africa’s blue-chip construction companies, was placed under business rescue on 15 June, prompting the share price to collapse from 21 cents to just 2 cents.
Basil Read, listed on the JSE in 1987, took top position in the Business Times Top 100 Companies Survey in 2008 and 2009, following phenomenal share price growth in the prior five years from 92 cents to R37.00.
• The business failure of Basil Read is indicative of the depressed state of gross fixed capital formation in South Africa. Total domestic order books for the construction industry have shown nil growth in the past ten years, reflecting subdued GDP growth, uncertainty over mining legislation and gridlock in government infrastructure spending.
• To make matters worse, the profitability of order books has declined amid a desperation for survival. Reflecting the depressed operating environment, the rating of the building and construction sector has collapsed.
The market capitalisation of Group Five, for instance, is around a quarter of the value of the cash on the company’s balance sheet. The share price of Murray & Roberts, which increased from R14.00 to R100.00 between 2005 to 2008, is back to its 2005 levels.
• The tide may be turning. Compelling value in the building and construction sector is attracting the attentions of seasoned global peers and institutional investors. Earlier this year, global cement companies and consortia, including Holcim-Lafarge, CRH, and Fairfax, were queuing up to acquire but were ultimately resisted by South Africa’s cement giant PPC [JSE:PPC].
Canada’s Fairfax, likened to Warren Buffett’s Berkshire Hathaway, is on track to build up a 58.7% stake in Consolidated Infrastructure Group. German investment company Aton is making an aggressive bid for construction blue chip Murray & Roberts.
• Foreign appetite for South Africa’s building and construction sector is motivated by the exceptional value on offer and the opportunity for substantial earnings growth. Following a bleak decade of falling investment and declining margins, the outlook is gradually improving.
Greater political and policy certainty coupled with a more business friendly mining charter should boost government and private gross fixed capital formation. As construction orders rise so too will the profitability of the order books, providing a double whammy for the building and construction sector.
• Government policy will tilt in favour of infrastructure spending, either through state-funded initiatives or public-private partnerships. Being labour intensive, infrastructure spending offers one of the easiest and most realistic means for South Africa to achieve an inclusive economic recovery.
Moreover, infrastructure spending would address the bottlenecks which are hampering the country’s productivity and export competitiveness. The building and construction sector is a clear beneficiary of any ramp-up in infrastructure spending.
• Of all the sectors on the JSE, the building and constructions sector is probably the most cyclical and the most volatile. From current depressed levels the scale of a cyclical upturn could be dramatic. While a repeat of the sector’s massive upswing from 2005 to 2009, is by no means a foregone conclusion, the calibre of overseas investors in the sector suggests significant potential.
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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