EVERGRANDE: JUST HOW EXPOSED IS SA?

It was the train wreck everyone saw coming: analysts had been calling the Chinese property developer a ‘sell’ for years. But as its collapse nears, SA is likely to feel some of the secondary effects nonetheless

JSA will feel some hurt, since we’re also an emerging market. But it won’t break us

ean Pierre Verster, one of SA’s canniest investors, puts it best in dissecting Evergrande, the Chinese property developer teetering on the brink of defaulting on millions owed to global investors. “We’re still at the beginning of this movie, and right now it looks like a thriller, but it may turn out to be a horror film,” he says.

If you haven’t heard of Evergrande, you’d do well to acquaint yourself. It has been billed as a firm with the potential to cause the same sort of precipitous plunge in markets (and your pension) as the collapse of Lehman Brothers — the catalyst for the financial crisis — did in 2008.

It all began in 1996, when Evergrande was founded in the southern city of Guangzhou to capitalise on what would become a 25-year real estate boom driven by cheap credit and an emerging middle class. Fuelled by $300bn in debt, it soon became China’s second-largest property developer, and is today involved in 798 projects in 234 cities.

Last October, China’s government stopped the party. It implemented a “three red lines” rule to chill the runaway spike in house prices, preventing developers from borrowing more unless they had enough cash, assets and equity to cover their debt.

Evergrande, the most indebted property company in the world, fell short, which meant it couldn’t borrow more. Which was bad news, since it had taken deposits for 1.5million homes which it had yet to build.

The fallout was ugly: as it battled to slash debt, Evergrande couldn’t pay suppliers, who protested at its 43-floor headquarters in Shenzhen, demanding repayment. In April Evergrande even told its own 183,000 staff to lend money to its investment arm, Evergrande Wealth, or risk losing their bonuses. (In one video that emerged last week, out-ofpocket staff could be heard yelling: “Evergrande, give back my money I earned with blood and sweat!”)

Only, it doesn’t have the money. This week, it is due to make $119m in bond repayments. But, as ratings agency Fitch said last week, a default now seems “probable”.

If it sounds like a localised injury, it isn’t. If Evergrande defaults on repayments (and $850m is due this year), investors will think twice about buying emerging-market debt — like in SA. So how exposed is SA to this fallout?

The good news, says Verster, is that you’re unlikely to find many SA funds with direct exposure to Evergrande; the bad news is, the country will still be hit by the shrapnel.

“There will be significant second-order effects,” he says. “Evergrande was the biggest developer of real estate in China, so its collapse would mean less steel gets bought, which means there’s less demand for iron ore, which is why we’ve seen iron ore prices fall 50% in the past two weeks. And that has an impact on SA’s iron ore suppliers like Kumba.”

(Kumba’s stock has shed 13.7% in the past month, while its parent, Anglo American, has seen its stock slide 16.2%.)

Scepticism towards Chinese stocks, which had already been growing after the ruling party cracked down on technology companies last month, will deepen. Gaming firm Tencent was in the centre of that storm, which wasn’t great news for Naspers, which effectively owns 29%.

As Verster points out, these are the two areas of China’s economy — technology and commodities — where SA is heavily exposed. “It’s no surprise that we find the JSE’s all share index down 10% in the past month,” he says.”

You can see why. Nearly half the value of the JSE’s top 40 largest companies are exposed to China, in some form. This includes mining firm BHP (which makes up 13% of the JSE’s top 40 index), Richemont (which sells luxury goods to China, and makes up 12%), Anglo American (11% of the index), Naspers (7%) and its cousin Prosus (another 8%.)

Yet the apocalyptic headlines — like The Guardian’s claim that this is “China’s Lehman moment” — overstate the case.

The comparison is wildly off-key, says Delphine Govender, founder of Perpetua Investment Managers.

“This is not the Lehman Brothers of China. Lehman effectively came out of nowhere, but this crisis was induced by the Chinese government, which didn’t like the way the property sector was overheating. This is a controlled bleed — and you can be sure that if this spreads to other parts of the market, the government will step in to calm things,” she says.

In other words, China’s government won’t let Evergrande collapse like Lehman did; rather, it will intervene to stabilise the market, in the same way the US did in 1998 when the Long-Term Capital Management hedge fund collapsed.

As Thalia Petousis, a portfolio manager at Allan Gray, points out, the Chinese authorities have already sent in a task force to look at restructuring Evergrande. “Nor is there the risk of offshore contagion like there was with Lehman, since only $15bn of Evergrande’s debt is owed to offshore investors,” she says.

Which is probably a good thing, given the JSE’s exposure to China. “But this moment doesn’t really change that,” says Petousis. “To anyone who’s been paying attention, it isn’t new that China’s property growth was unsustainable. Analysts have been calling Evergrande a ‘sell’ for years already.”

So does this alter the investment case for commodities companies? Or for SA, which relies heavily on China to buy its commodities?

It does, says Govender — but only in the short term. “In the short term, shares exposed to China will trade within a tight range. They won’t fall massively, bar any unknown unknowns, but they won’t rerate back to their highest levels, until sentiment improves — and that won’t happen until the government says, unequivocally, what they’ll accept. This will provide certainty and … a definite positive signal.”

Until then, the JSE will struggle to find direction.

“The era of these Chinese companies generating superprofits is over,” says Govender. “SA will feel some hurt, since we’re also an emerging market. But it won’t break us.”