Shares to bank on as re­tail cy­cle slows

But food com­pa­nies could still be good

Finweek English Edition - - Companies & markets - SHAUN HAR­RIS

AS­TUTE FUND MAN­AGERS have been buy­ing lo­cal banks, es­pe­cially the big four banks, of­ten at the ex­pense of re­tail­ers. Ris­ing in­ter­est rates sug­gest it’s the right move. But there are longer-term in­vest­ment im­pli­ca­tions to this port­fo­lio ro­ta­tion. And per­haps there’s still space for some re­tail shares, par­tic­u­larly those that don’t work on a credit ba­sis.

Al­lan Gray has been buy­ing fi­nan­cial shares, par­tic­u­larly banks, and has not reestab­lished the re­tail­ers that made up a sig­nif­i­cant por­tion of port­fo­lios from 2001 to 2003. But as a deep value in­vestor Al­lan Gray must be look­ing be­yond ob­vi­ous short-term at­trac­tions. Port­fo­lio man­ager Dun­can Ar­tus says banks’ cur­rent rel­a­tive val­u­a­tions are at­trac­tive and “do not re­flect our ex­pec­ta­tion that their earn­ings should out­per­form re­tail­ers and the mar­ket from cur­rent lev­els”.

Much of the think­ing is based on the way re­tail­ers’ sales and banks’ ad­vances, both ex­cep­tion­ally strong over the past few years as in­ter­est rates de­clined, are trans­lated into bot­tom line prof­its.

For the credit re­tailer, says Ar­tus, the sale is re­flected on the in­come state­ment fairly quickly, as the gross profit (the dom­i­nant con­trib­u­tor) and in­ter­est re­ceived on the out­stand­ing sales amount are mostly re­alised in the year the sale is made.

In con­trast, he says banks’ as­set-backed ad­vances (about 60% of lo­cal banks’ lend­ing) stay on the bal­ance sheet for sev­eral re­port­ing pe­ri­ods (around three to seven years) and con­trib­ute to rev­enue in in­ter­est and fees.

So apart from banks’ as­set-backed lend­ing be­ing more se­cure than re­tail­ers’ credit, the ben­e­fits con­tinue to flow in af­ter a favourable en­vi­ron­ment, as banks and re­tail- ers have en­joyed, starts to slow. Ar­tus points out that due to re­tail­ers’ more cycli­cal prof­its, th­ese busi­nesses tend to be rel­a­tively more prof­itable in the good times and banks un­der­per­form in earn­ings and share prices – hence the at­trac­tive val­u­a­tions now.

There should also be a fur­ther boost for banks. “We be­lieve that as the re­tail cy­cle slows, banks’ earn­ings will be un­der­pinned fur­ther by a sig­nif­i­cant in­crease in cor­po­rate lend­ing,” Ar­tus says.

Many com­pa­nies have en­joyed lit­tle debt and large cash hold­ings, not need­ing ad­di­tional fund­ing from banks. But Ar­tus be­lieves the growth in busi­ness ac­tiv­ity means that many com­pa­nies are op­er­at­ing close to peak ca­pac­ity and will need to em­bark on sig­nif­i­cant cap­i­tal in­vest­ment pro­grammes to in­crease ca­pac­ity and cope with higher lev­els of de­mand. “It’s rea­son­able to as­sume that the banks will fund a ma­te­rial por­tion of this ex­pan­sion in ca­pac­ity,” says Ar­tus.

Other pos­si­ble ben­e­fits he points to from this in­clude in­creased rev­enue streams for mer­chant bank­ing di­vi­sions.

The ar­gu­ment cer­tainly makes banks look like a good in­vest­ment now rel­a­tive to re­tail­ers, and per­haps some in­dus­trial coun­ters as well as mar­gins could come un­der pres­sure due to the lag be­tween in­creas­ing ca­pac­ity and meet­ing de­mand.

How­ever, we wouldn’t rule out the nonor lim­ited credit re­tail­ers, typ­i­cally the food re­tail­ers like Pick ’n Pay and Spar. The prob­a­ble delist­ing of Sho­prite could add to the at­trac­tion of th­ese shares.

BANK SHARES... A GOOD TIME TO BUY

Source: I-Net Bridge

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