Leading JSE-listed groups ‘not hoarding’
• While narrative might serve some, the evidence tells a different story
An analysis of cash holdings over the past 10 years of the 85 largest mining and industrial companies on the JSE found that this group had increased its cash holdings from R154bn in 2007 to R765bn in 2016, Intellidex said after conducting research into cash hoarding.
This reflects a compound growth rate of 17.4%. However, some context shows this is not hoarding. As the price of firms’ outputs and inputs increase, so does the cash they need to hold. After adjusting for inflation, cash holdings grew 11% a year.
Another factor to consider is the depreciation of the dollar. Most of these 85 companies have significant overseas operations and therefore a lot of their cash is held in hard currency.
The market capitalisation of the JSE also grew 250% during the period. Total assets held by the top 85 nonfinancial companies more than quadrupled over the same period.
There are claims that South African companies are hoarding cash as a protest against the ANC government’s policies or lack of policy.
A recent report by the University of Johannesburg’s Centre for Competition, Regulation and Economic Development found that cash reserves by the JSE’s largest 50 companies increased from R242bn to R1.4-trillion between 2005 and 2016. It says that companies are accumulating reserves and not investing in the economy.
But is the analysis of trends in nominal cash holdings sufficient to conclude that companies are hoarding cash? Hoarding in this context is when a company holds cash more than it requires for its day-to-day operations.
To test the claim, Intellidex undertook a study into cash holdings. In theory, a company’s optimal cash level occurs when the marginal cost of a cash shortage equals the marginal cost of holding cash. In other words, companies balance the costs of raising new cash through debt, sales of assets, or from shareholders against the cost of holding cash.
Cash is expensive as it usually earns a lower return than equity. To boost shareholder returns companies are better off with less cash.
We assessed cash holdings of the 85 largest mining and industrial companies on the JSE (we excluded financial firms as their cash levels effectively doublecount those of companies) over the past 10 years. We found that these companies had increased their cash holdings from R154bn in 2007 to R765bn in 2016. This reflects a compound growth rate of 17.4%. However, some context shows that this cannot be considered to be hoarding.
Inflation has to be factored in. As the price of companies’ outputs and inputs increase, so does the cash they need to hold. After adjusting for inflation, cash holdings grew 11% per year.
Another important factor to consider is the depreciation of the dollar. Most of the companies we studied have significant overseas operations and therefore a lot of their cash is held in hard currency.
The three largest cash holders are BHP Billiton, Anglo American and Richemont. In 2007 the rand was R7.29 to the dollar; by 2016 it had depreciated to R16 to the dollar. This means that every $100 of hard currency holding would have increased from R729 to R1,600 over the period, an annual growth rate of 8.18%.
Growth in cash holdings should also be examined in the context of growth of other assets and the overall sizes of a company. The market capitalisation of the JSE grew 250% during the 10 years to the end of 2016. Total assets held by the top 85 nonfinancial firms more than quadrupled over that period.
The best way of making sense of cash holdings is to look at cash as a percentage of total assets. That strips out the effects of inflation, exchange rates and growth of operations.
Over the past 10 years this figure has fluctuated between 6.4% and 10.2% of total assets, and in the most recent year was at 7.8%. In a global context this is actually quite modest, with one study of European companies finding that their cash holdings are in the upper teens, and another of US companies finding the ratio to be about 20%.
While it suits some to talk of cash hoarding and investment strikes, the evidence simply does not support this.
Our study also rebuts the notion that capital expenditure has been declining. The 85 firms collectively invested R694bn in the 2016 financial year, with the amount invested in the last five years being considerably more than in the preceding five years.
In general, holding cash is costly for firms. If a firm chooses to hold cash and near-cash securities rather than invest, it generates opportunity costs. It is effectively earning less than it could from investments. Return on equity for industrials has largely been above money market yields with an average spread of 20% post the 200809 economic crisis.
Given such a spread between the two options — holding cash or investing — it would be irrational for firms to hold surplus cash on their balance sheets.
Companies with surplus cash can distribute their cash as dividends or pay off their debt. But data show that companies have not been doing that either. Dividends declared by companies as a percentage of cash have declined from 80% in 2008 to about 20% in 2016 and the ratio of debt to total assets increased from 75% to 100%.
Mining firms face a further dilemma: for the past eight years their market value has been lower than their book value. In such a situation it is irrational for companies to convert cash into other assets — it destroys shareholder value.
Return on equity for mining companies has also been below the interest mining companies can earn on cash, so the balance of their assets are delivering a very low return. As it is, the amount of cash mining companies are holding is almost equal to depreciation rates of their assets. So it is sufficient to replace equipment to maintain operations, but no more.
To the extent that there is variation in cash holdings of companies, this is strongly correlated with the economic cycle. Cash levels as a percentage of assets do rise during periods of adverse economic conditions as they brace for poor sales.
They have been trending upwards since 2012, just as growth has been slowing. This ensures companies don’t find themselves with a cash shortage just when it is most expensive to try and raise cash. Such actions should be applauded as they effectively protect employees and suppliers from credit risk.
Investment rates will increase if the opportunities for profitable investment increase. The mining sector cannot invest profitably. This is mostly a function of poor policy, given the decade-long government indecision over amendments to the Minerals and Petroleum Resources Development Act and further uncertainty around the Mining Charter.
Investment rates will increase if there is an improvement in economic conditions and the potential returns firms can earn from investment. When economic prospects are good, shareholders invest in companies and bid up their share prices. That makes it cheaper for companies to raise money from shareholders.
When the levels of shareholder funds increase, it becomes cheaper for firms to also raise debt as they are less risky overall.
The investments they make would be profitable, generating further cash that can be used for further investment, and a virtuous cycle ensues.
SA’s economic growth has clearly decoupled from growth in the rest of the world. Global growth has trended at about 3% for the last five years, while SA’s growth has sharply slumped since 2013 to the point where the country has been in recession. That performance cannot be blamed on global economic conditions — it is our domestic policies that have damaged economic performance.
GIVEN SUCH A SPREAD BETWEEN THE OPTIONS … IT WOULD BE IRRATIONAL FOR FIRMS TO HOLD SURPLUS CASH
Business and consumer confidence are at record postdemocracy lows. Progrowth policy delivered in a reliably sustainable way would boost company investment rates. Pointing to companies’ cash levels, without seeing them in context, does nothing to improve the country’s growth prospects. If anything, it merely confirms the impression of poor political judgment and insight into the conditions facing South African companies.