Banks and consumer stocks in price of uncertainty

Consumer stocks slipped in the recent equities sell-off, though, yet the share valuations remain high. Leading stocks in the general retailers sector trade on p:e ratings of 17-19. Massmart, Woolworths and Mr Price traded at record highs in the weeks of market volatility since early August.

SABMiller, which is buying Australia's Foster's in a deal valued at almost A10bn, traded last week at a record R272, with its p:e at 25.

The bullish trend in retail and some other consumer sectors contrasts sharply with the continuing weak performance of the large banking groups. The JSE banks index fell almost 45% between November 2007 and March 2009. By March last year, it had recovered from that slide, but it has gone nowhere since then. The sector p:e is conservative, at 11.6.

In some respects the contrast seems odd. If consumer spending is rising, banks should benefit, as many purchases are funded by debt. The prosperity of the bank sector should also be sensitive to economic growth. The expansion may be slowing, but the Reserve Bank is still forecasting growth of 3.2% this year and 3.6% next year. Consumer spending accounts for about two-thirds of SA's GDP.

However, the explanation for investors' wariness of the large banks lies partly in the sector's linkage to the broad economy. Growth is continuing, but it's also patchy, with high unemployment.

When FirstRand reported results for the year to June, CE Sizwe Nxasana said the operating environment was likely to remain difficult. Subdued global conditions were playing out in SA, with high levels of uncertainty and relatively low business confidence. "The potential impact of these conditions cannot be underestimated, given the size of the group's operations in its domestic market and the close correlation between the economic environment and banks' earnings".

As in most domestic upturns, the consumer sector has led the recovery, but even within this sector spending activity has been uneven and could be slowing. Retail sales for the three months to July were lower than in the previous three months. Vehicle sales recovered well but also appear to be losing momentum.

Some consumer stocks have gained from their specific positioning, or from business improvements.

Truworths is particularly successful at fashion retailing. Mr Price, mainly a cash clothing retailer, sells fashion products on price and value. Woolworths has improved its market share and margins, and can still increase efficiencies. It is also improving returns from investments made in the boom years.

Retail stocks tend to do well when interest rates are falling, or are low. Since December 2008, the prime rate has been cut nine times, declining from 15,5% to 9%. Between March 2009 and early this month, the JSE general retailers index rose by almost 180%.

Declining rates have more mixed effects on banks. It depresses their net interest margins because of a negative mismatch between their funding costs and lending rates, known as a negative endowment effect. Lower rates may stimulate lending activity, but recently that's only happened in some markets, such as vehicle finance. Slow growth in overall lending volumes is the biggest problem facing the banks.

Standard Bank economists Adriaan du Toit and Shireen Darmalingam said last week overall credit extension was "listless". Average private-sector credit growth for the year so far, they said, "fails to inspire confidence" in a sustained recovery in household spending.

Mortgage advances, a large credit category for banks, have remained weak. Reserve Bank governor Gill Marcus said last week that in the 12 months to July, mortgage advances grew at a year-onyear rate of 2,9%, consistent with the slow pace of recovery in the domestic property market.

The banking groups have reported sharp improvements in profits from retail banking this year, but this is only one of their main business areas. In its 2011 financial year, FirstRand made 43% of its pretax profit from the retail sector. For Absa, Standard Bank and Nedbank, the retail contributions to headline earnings in recent June interims were 38%, 37% (personal and business banking) and 30% respectively.

Other earnings come from corporate or business markets, and from investment banking, all of them sectors that have lagged behind the broad recovery in the consumer sector. Commenting on FirstRand's outlook, Nxasana said growth in retail and corporate advances would remain low, except in WesBank (the instalment finance business), where a "positive lending environment" was expected.

For some investors, holding SA consumer stocks may be justified on a longterm, strategic view. Favourable forecasts on the consumer spending outlook may have contributed to this.

In a report published at midyear, Merrill Lynch said overall consumer spending was set to increase by 32,8% in the next three years, from R605,5bn to R805,7bn, equating to compound annual growth of 9,9%, up from 9% for 20012010. This month, the firm said the combination of upward surprises to consumer spending and public infrastructural spending should help boost SA's growth to 5% between 2013 and 2016, though it also said growth would weaken without structural reform.

That kind of perspective has encouraged foreign investors to buy SA consumer stocks - though they were net sellers in recent weeks.

If applied to share valuations, a longerterm perspective may lead to different views. Based on p:e ratings and price-tobook values, and on the cyclical outlook, says Coronation Fund Managers analyst Quinton Ivan, bank shares are cheap and most consumer stocks are not attractive. General retailers, he says, are inherently cyclical. Their returns and growth could weaken when rates rise.

On the I-Net Bridge consensus forecasts, FirstRand and Spar Group are rated as buys. Most others in these sectors are holds.

Source: Financial Mail