Sound corporate governance, debt ratings crucial

By Edward West Time of article published May 18, 2020

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CAPE TOWN - Moody's Investor Services, Fitch Ratings and Standard & Poor’s: the three global companies that have enjoyed an oligopoly on corporate and government debt market credit ratings for nearly a century, have faced a great deal of criticism in recent years.

In the global financial crisis of 2007/8 they were hauled over the coals for assigning too high credit ratings in the US on what was essentially junk mortgage debt, resulting not in any prosecutions mind, but in additional legislation that is supposed to make the operations of these agencies more transparent.

Much criticism is about the way they make money and the seeming conflict of interest of being paid by issuers to assign credit ratings on the debt of those issuers.

South Africa introduced a Credit Rating Services Act in 2013, much in line with many other countries; and the Financial Sector Conduct Authority has a small department that monitors the compliance to the act by the three agencies.

An internet probe reveals one of the three agencies paid a R300000 fine to the government in 2019/20, but the name of the company or nature of transgression was not disclosed.

Asking National Treasury how much the government pays the three agencies in fees every year for ratings on the government debt issuance, it said the figure could not be provided, because of “confidentiality clauses” with the rating agencies as their client.

FILE PHOTO: The S&P Global logo is displayed on its offices in the financial district in New York City

These agencies play a big role in the South African economy at present.

Credit ratings have become integral to debt issues worldwide. Rating downgrades on South Africa to junk by all three agencies, and the resultant higher cost of government and corporate debt have had severe impacts, including capital flight; currency depreciation; and increasing fiscal pressure.

Fears of misaligned interests aside, the agencies have, nevertheless, been spot on this year, as the Land & Agricultural Bank’s debt default falls squarely within the realms of junk bond credit ratings. The agencies’ concerns about the government’s ability to repay its debt has proved on the mark.

The Land Bank default, and additional risk associated with the credit rating downgrades, have been just two of a number of headwinds that debt issuers have had to face this year.

Massively sliding gross domestic product, anecdotal evidence of the impact of Covid-19 on the economy, and corporate failures such as Edcon, Comair, and Phumelela Gaming are some of the other issues denting investor and debt-issuer sentiment.

Globally, massive fiscal stimulus packages set up by countries to mitigate the impact of Covid-19 will far surpass the stimulus issued for the 2008/9 financial crisis, translating into narrowing rates in global debt markets.

For local and foreign investors, this should translate into a wetting of the appetite to invest in listed shares of growing, financially sound, well-managed and very transparent companies.

On the JSE on Friday, for instance, Richemont’s share price fell 3.42percent to R95.93. The price fell as the JSE opened, two hours after the group announced that Covid-19 took an 18percent bite out of its fourth-quarter sales of luxury watches and accessories.

Asia-Pacific sales fell 36percent, with China falling 67percent. These sales should recover post-Covid-19. The rand hedge and healthy dividend payer was trading at a price:earnings of 23.8 on Friday morning, relatively inexpensive considering the quality.

Cartrack Holdings has consistently delivered double-digit earnings growth since its listing, though the trend might be dented due to Covid-19.

Its business model of mobility-asset-management solutions fits in neatly with the growth of e-commerce, as courier and transport companies seek to improve the productivity of their vehicles. An international suitor is in talks to acquire Cartrack and list it on an international exchange.

Whichever way you look at it, there appears to be value to be had for shareholders. Its share price was 0.87percent firmer at R23.29 on Friday.

Another outperformer is Spear Reit, a relatively small property group that focuses on assets in the Western Cape. Last week it reported a 6.06percent increase in income distribution for the year to February 28, a strong result.

The growth in shareholder returns has outstripped the listed property sector average since 2016. The share price was up 0.73percent to R5.49 on Friday afternoon, trading at a price:earnings of 5.50, which to me represents deep value considering the health of the company, despite the lockdown and the quality of assets that it holds.

Foschini Group’s share price rose by 5.75percent to R65.49 on Friday afternoon, after releasing an update indicating how sales have started to improve following the easing of Covid-19-related restrictions on trading in South Africa, Australia and the UK.

Its price:earnings ratio is low at around 5, but this is probably justified considering the group has been very exposed to Covid-19 lockdown store closures, and that the full impact on Foschini is not yet known.

Still, considering the 10-year headline earnings per share compounded growth rate of 9.7percent, I would say this is another quality share at a low price for an investor willing to see beyond short term.

Impala Platinum’s share price was up a sharp 8.4percent on Friday to R108.82. Last month, it said it had lost 6percent of production volume at its Rustenburg operations after mines were placed under care and maintenance ahead of the Covid-19 lockdown.

The geographical spread of Implats, which also has mines in Canada and Zimbabwe, has allowed mining production to continue at varying degrees during the lockdowns. Excess processing stockpiles were being reduced to secure cash flow.

Auto plants around the world are reopening after the various Covid-19 lockdowns, which should restore global demand for platinum. Fresh air remains high on the agenda. 


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