African Expansion Critical For South African Companies

Avatar
Written by Anna B. Wroblewska

Of the South African conglomerates, Shoprite has had its eye on the rest of Africa the longest. The company began expanding into its neighboring countries in 1995 and already has 169 stores on the continent. While Shoprite had a difficult year, missing profit estimates owing to problems in the South African market, it is continuing an aggressive expansion strategy.

The retailer is planning to open 30 new stores on the continent by June 2015, committing more than double to new African markets than its home country. By way of explanation, the company’s annual report said, “With economic growth expected to remain below 3 percent there is not much relief in sight for the beleaguered South African consumer.”

It’s not just Shoprite. Africa remains an attractive, and even critical, investment destination for South African firms.

“The South African economy is stagnating… flat-lining if you like,” says Christopher Gilmour, investment marketer and analyst of ABSA Wealth and Investment Management. “The thrust into Africa is not just a nice-to-have, it is essential for future growth.”

Much of this could be attributed to South Africa’s lackluster economic performance, especially in comparison with breathtaking growth rates around the continent. 

Consumer spending, responsible for the bulk of South Africa’s GDP, is struggling for various reasons, including “high levels of indebtedness and moderating demand for credit, highly stretched budgets aggravated by accelerating inflation, as well as weak employment growth,” according to the Industrial Development Corporation of South Africa (IDC). The organization reports that interest rate hikes going forward could further weaken spending.

STANLIB, an investment company, forecasts consumer spending to grow only 1.7% in 2014, down from each of the three previous years.

“Because consumer spending represents more than 60% of the [South African] economy, the relationship between consumer income and consumer spending can be considered one of the most important economic variables in South Africa… Any change in income is immediately reflected in a change in consumer spending, irrespective of changes in consumer confidence or interest rates,” according to the company.

“The core of it,” according to STANLIB chief economist Kevin Lings, “Is that we just don’t have the employment growth necessary to support ongoing expansion in consumption. South Africa is a consumer-based economy but in terms of the growth rate right now it’s fairly lackluster.”

“South African retailers have taken their shopping model in South Africa and literally transferred it to other countries.”

Those who are most successful appear to the be stores targeting entry level and middle-income consumers. Up-market Woolworth’s attempted an expansion into Nigeria but pulled out because “their mix didn’t really work,” while “Pep Stores, which sells low-end clothing, went into Nigeria and can’t keep up with demand,” according to Lings.

Shoprite and Mr. Price Take The Lead

Gilmour brings up the examples of Shoprite and Mr. Price. “[Shoprite] probably has better intelligence and experience on retailing in Africa than any other South African retailer… Mr. Price has been highly successful in expanding in West Africa, notably in Ghana.” Both retailers, again, target the low- to mid-market consumer.

Of course, expansion to the rest of Africa is not a simple matter.

“Africa is a frontier market, rather than an emerging market,” says Gilmour. “It is highly fragmented; it isn’t just a single country… it is a continent of 54 countries with 2,000 different languages and dialects. Logistics are a nightmare for most retailers and lengthy delays at border posts are common.”

Even mighty Shoprite has struggled. Over 80 percent of the company’s goods in other African countries come from non-South African manufacturers, illustrating some of the barriers to trade in the region. Persistent problems with logistics, regulation, and a lack of available retail space have also presented challenges, according to recent reports.

In light of this, it’s no surprise that trade amongst African countries is still remarkably low and surprisingly complicated; the Industrial Development Corporation (IDC) reports that two-thirds of African countries have a harder time trading with each other than with more distant trading partners. Intra-regional trade averaged only 10 percent in the five years to 2012.

Eventually, “you’ll see winners and losers in terms of which countries are good investment destinations,” says Lings. “Many countries look appealing, but I think over time it will probably narrow,” as those countries that look good in theory might not always be profitable in reality.

Either way, such investment efforts remain an important strategy for South African firms.

South African retailers often have what Lings describes “lazy balance sheets,” with low debt levels and strong cash holdings, and there’s a relatively low cost of entry that affords investment without taking on too great a risk. This could be an immense source of value for shareholders in coming years, especially considering how successful the strategy can be.

“Companies who have invested in Africa, when you look at their results and break it down, you do notice that in many instances it’s the ‘rest of Africa’ part of their business that is doing quite well.. it’s becoming more noticeable that those companies that have already invested in the rest of Africa are prospering as a result,” says Lings.

There are local benefits as well.

South Africa has also become an important destination for retailers looking to enter other parts of Africa, according to Gilmour. They come to South Africa “partly [to] offset lower growth in some of their home markets, and most if not all of them extol the virtues of being here. But in reality, the main reason for their presence is as a ‘springboard’ into the rest of Africa.”

This at least provides the benefit of employment opportunities and continued investment in the retail sector. There are also short term benefits for other sectors, like logistics, warehousing, and transport. “A lot of the goods get warehoused [in South Africa],” says Lings, “So our warehouses are doing well, and they get trucked up to the rest of Africa.” Although he points out that infrastructure developments could very well change this.

Overall, however, South Africa’s influence is growing. The country’s importance to the region “has been a well-established long-term trend,” from a trade perspective, said Jorge Maia, head of research and information for the IDC, in an emailed statement. “In 2010, 25.7 percent of South Africa’s overall merchandise export basket was destined for other African markets. By the first have of 2014, this ratio had increased to 30 percent.”

This higher level of trade — and, perhaps, a lower level of complexity in carrying it out the future — could have notable benefits for South African retailers over the long-run.

Uncorrelated Economies

As it stands, African economies are demonstrably uncorrelated on an economic basis, so a greater variety in income sources for South Africa’s corporations could provide smoother earnings, regardless of what’s happening at home. Lower volatility could very well prompt continued investment and development in companies even when South Africa’s economy lags.

While this may not solve inflation or greater economic worries, one hopes that with the proper investments it could perhaps benefit employment rates at the very least.

Either way, for many South African retailers the future looks to be firmly to the north.