Improving fixed investment is going to be key to any longer-term improvement in South African growth prospects. The dearth of private sector investment since 2013 explains a great deal of the decline in the country’s potential growth rate in recent years. This has been compounded by the virtual halt in investment spending by state-owned enterprises in the last three years, as stretched balance sheets and deteriorating access to debt markets constrained them. In turn, this lack of investment has resulted in significant financial distress in the construction space.
In the last two years, construction companies Basil Read and Group Five have been forced into business rescue due to the lack of major projects in South Africa. Aveng sold its construction arm, Grinaker-LTA, to a consortium in August 2019. All these companies have retrenched staff to cut costs.
The good news is that after a 4.1% seasonally adjusted quarter-on-quarter contraction in the first quarter of 2019, investment expanded by 6.1% on the same basis in the second quarter. This was largely due to higher investment in machinery & equipment, transport equipment and residential buildings.
Surprisingly enough, this is not just thanks to some bizarre quirk of the data. And it should have a bit of momentum. Wilson Bayley-Holmes (WBHO), one of the two remaining sizeable construction companies in South Africa, has seen its share price jump by over 30% in the last ten days. This was from a very depressed price. It also followed a strong improvement in the Australian operations after a once-off write-off last year.
However, the sentiment towards the share improved due to the company’s announcement of positive surprises in their South African order book. After several years during which they were AWOL, WBHO reported that the South African National Roads Agency (SANRAL) has returned to issuing tenders. WBHO also indicated that they have been awarded some of these jobs. As a result, performance in the roads division improved in the second half of their 2019 financial year and the company has guided for further material improvements in the first half of 2020.
Aside from SANRAL, the company reported increased activity from the Airports Company of South Africa (ACSA), which finally issued the tender to lengthen the runway in Cape Town.
These are all small pieces of good news. It doesn’t take away from the damage done by years of inactivity in infrastructure spending. The key is that the incremental improvement continues. For that to occur, continued operational turnaround is needed at the key state-owned enterprises – notably Eskom, SANRAL, Transnet and ACSA.
If government implements some of the less controversial reforms discussed in the National Treasury’s Growth Plan, notably loosening visa restrictions, supporting the agriculture and tourism industries and reducing the regulatory burden on business, it could boost confidence into 2020. Improved confidence is vital to increasing business investment in South Africa. On average, corporates have the financial room to invest in South Africa. What is missing is the confidence to do so.
The lack of confidence has also had a large negative impact on the pricing of South Africa’s financial assets. The current valuations of local banks and industrials are below Nene-gate levels. Excluding Naspers, the JSE All-Share is trading at 1.3 standard deviations lower than its average 10-year forward price to earnings ratio.
The spread between South Africa’s government bond yield and the JP Morgan Emerging Market local currency index is currently at 325 basis points. This has rallied marginally in the last month, but remains more than twice as high as the pre-December 2015 average levels of 150 basis points. South Africa’s 5-year credit default swap rate is 167 basis points. Brazil’s comparable rate is 125 basis points.
When Brazil was downgraded to sub-investment grade by Moody’s in August 2015, the gap was 239 basis points in South Africa’s favour. It is now 64 basis points in Brazil’s favour. After peaking at 500 basis points in late 2015, Brazilian 5-year credit default swaps have rallied consistently as the country has made some incremental positive moves.
Moody’s was relatively supportive at their Johannesburg investor conference this week. They flagged South Africa’s positive buffers, namely low foreign-currency denominated debt, long average maturity of debt, adequate forex reserves and the positive net international investment position.
With a fair bit of bad news priced into South Africa at the moment, any tangible positive developments could result in a sharp rally across domestic asset classes, particularly if these are reforms that support economic growth and keep Moody’s on hold at their November rating review. That is certainly not expected – or priced in.