Winners in a cheap credit environment

Economist Mike Schüssler wrote a piece in Moneyweb earlier this month about how the pandemic-induced rate cuts are impacting South Africa.

Read: Economic recovery: Low rates are playing a starring role (May 7)

Taking this further, I am going to build a top-down investment shopping list for those who believe that rates will remain low-for-longer and inflation benign.

Simplistically, low interest rates are stimulative for an economy in that they drive:

1. Credit growth
2. Fixed capital formation, and
3. Risk-taking, while
4. Keeping asset prices buoyant.

These magical ingredients stand to benefit a range of industries, asset classes and, indeed, investors.

Credit growth

The interest margin between our repo rate (the rate at which banks borrow) and our prime rate (the rate at which the rest of us borrow) is currently extremely high.

While prime is typically 3.5% higher than repo, this is a 100% ‘mark-up’ if the repo is only 3.5% (as opposed to only a 50% margin if the repo is 7% and prime is then 10.5%)!

Thus, the winners here are logically the banks, especially if lower rates start to induce more demand for credit. (Yes, yes, we know all the regulatory and other arguments against our banks; that said, they are the single largest extenders of credit domestically, and thus cannot be ignored.)

Other winners from credit growth would be the credit retailers in South Africa (such as The Foschini Group, Truworths and Lewis) and those whose sales are funded by this credit growth (the rest of the discretionary and luxury retailers, the residential property market and the automotive sector, among others).

Fixed capital formation

This is a fancy term for building things.

South Africa desperately needs this, and its beneficiaries are the heavy construction stocks (WBHO, Raubex et al) and the building materials stocks (Afrimat, Cashbuild et al) as well as the supply chains into these and related sectors (such as Hudaco for parts, Barloworld for capital equipment, and Adcorp, Workforce Holdings and CSG Holdings for labour).

Risk-taking

Who benefits from risk-taking? Offerings that give people ways to literally take more risks would benefit, such as casinos, LPM (limited payout machine) operators, stockbrokers and sports betting outfits.

More economically relevant, however, this growth in risk-taking should help a new generation of entrepreneurs.

Thus, beneficiaries could be businesses that offer commercial property (for those starting businesses and needing space), banks (for financing these new businesses) and even developers that offer both residential houses and the ability for individuals to buy-to-let, such as Calgro M3 and Balwin

Buoyant asset prices

Low interest rates lift the valuations of most assets in an economy, thus bolstering balance sheets. This provides positive equity against which credit can be extended.

And, thus, we arrive back at positive credit growth …

In other words, this is a virtuous cycle.

Filtering the JSE

Finally, irrespective of their industries, highly indebted companies are natural beneficiaries of low-interest rates (assuming they have floating debt and/or can refinance at a lower rate).

Taking the above top-down and debt-sensitive aspects into account, I have done the following:

• I have filtered the JSE to show those stocks with the highest gearing (based on debt:equity ratios > 100%);
• After ordering these from highest to lowest, I have further filtered for only the financial, consumer and industrial sectors (in other words, the clear cyclical beneficiaries of the above); and
• Finally, I have cut out many inappropriate stocks (majority offshore exposure, small market caps, and various other subjective criteria).

Other than the stocks mentioned above, the following list may form a ‘lower-for-longer’ shopping list worthy of that rare soul – a bullish South African investor.

Code	Name	Sector	Debt:equity (%)	Market cap (Rm)
SUI	SUN INTERNATIONAL	Consumer	3316,5	4,156.51
MSM	MASSMART HOLDINGS	Consumer	1212,8	11,870.75
TSG	TSOGO SUN GAMING	Consumer	801,1	6,931.24
CLH	CITY LODGE HOTELS	Consumer	435,6	2,646.79
TCP	TRANSACTION CAPITAL	Financials	257,8	23,095.97
DCP	DIS-CHEM PHARMACIES	Consumer	174,1	21,054.87
FBR	FAMOUS BRANDS	Consumer	172,1	5,912.94
BVT	BIDVEST GROUP	Industrials	169,9	58,785.80
TFG	THE FOSCHINI GROUP	Consumer	135,4	39,852.38
CMH	COMBINED MOTOR HOLDINGS	Consumer	128,6	1,514.74
TRU	TRUWORTHS INTERNATIONAL	Consumer	112,3	21,824.84
MTH	MOTUS HOLDINGS	Consumer	109,6	17,426.96
HCI	HOSKEN CONSOLIDATED INVESTMENTS	Financials	105,8	5,137.24
ATT	ATTACQ	Financials	101,6	5,230.80
IPF	INVESTEC PROPERTY FUND	Financials	101,5	8,854.10

Sources: Profile Media and author’s workings, assumptions and subjective deletion of certain stocks.

Finally, in a lower-for-longer scenario, consider how attractive high real yields might be too?

This topic alone is worthy of another article but for brevity’s sake, you can see my JSE Power Hour here on finding income on the JSE.

Keith McLachlan – Integral Asset Management investment officer.