Massmart Annual Report 2008
Shelves being packed at Macro Woodmead, the Makro store with the second highest sales in the Division.

"The economic cycle was clearly gaining downward momentum, but we proved that the Group is able to ride through the troughs."

A customer loads goods to restock shelves in her small trading shop in rural KwaZulu-Natal.

The economy over the year

Last year was a turning point for the world’s recent economic performance. It marked the end of five years of sustained upward momentum in the global business cycle with growth, underpinned by India and China, providing a rising tide for world prosperity. South Africa had reached an economic growth rate of 6% per year.

However, 2007 was to be the year that would mark a change in economic fortunes. The global credit crisis, which had begun to take hold in 2006, recently reached perilous proportions with the collapse or near collapse of several major international investment banks and other financial institutions. Debt markets, from which a wave of cheap credit had emanated over the previous five years, suddenly seized up as investors panicked about their risk exposures. Monetary authorities, particularly in the US, responded swiftly by pumping liquidity into their economies through lower interest rates and a variety of mechanisms to provide cheap credit to their financial systems. But their determined efforts at times appeared not enough to stave off a global slowdown in economic growth and, in the US, perhaps even recession.

South Africa’s performance

Prime overdraft interst rate %

Prime overdraft interst rate %

In South Africa, however, the monetary cycle was moving in the opposite direction, in our opinion correctly so. Interest rates had begun climbing in mid-2006 after staying flat for over three years. By the start of Massmart’s 2008 financial year, the prime overdraft rate had risen by 2,5 percentage points to 13%. By the end of the financial year, another 2,5 percentage points had been added. The intention of increased interest rates is to slow consumer and business spending by making borrowing more expensive. Consumers borrow less, but the cost of their existing borrowing also goes up. Repayments on home loans and other finance absorb more personal after-tax earnings. The net impact is to reduce private consumption expenditure, which reduces overall demand in the economy and so relieves inflationary pressure on the prices of goods.

CPIX metro and other urban
areas, year-on-year % change

CPIX metro and other urban areas, year-on-year % change

The need to slow demand was triggered by a sustained increase in inflation during the year. Controlling inflation is the main policy objective of the Reserve Bank and it uses interest rates to try to do it. The Reserve Bank is required to keep inflation, measured by CPIX, in a target range of 3% to 6%. By the start of Massmart’s financial year, inflation had just breached the upper range of the target, but during the year inflation would increase significantly, reaching over 11% by the end of it.  

The difficulty is that there is a lag effect between interest rate increases and changes in actual consumer behaviour. This exists because consumers and companies have resources available to them other than debt, from which they can draw before monetary policy actually changes their behaviour. Generally, the lag is from 12 to 18 months. So the slowdown in consumer spending takes some time to be realised.

Personal consumption expenditure
on durable goods, seasonally
adjusted annualised % chanrge

Personal consumption expenditure on durable goods, seasonally adjusted annualised % chanrge

Private sector credit extension
year-on-year % change

Private sector credit extension year-on-year % change

BER consumer confidence index

BER consumer confidence index

Retail sales figures year-on-year
% change current prices

Retail sales figures year-on-year % change current prices

A weaker Rand also fed into inflation, helping increase further the Rand cost of imported goods, particularly petrol. During the financial year, the Rand-Dollar exchange rate was an average of R7,28 compared to R7,18 the previous year. However, this masks the significantly higher exchange rate in the first half of 2008, at an average R7,65, closing the financial year at R7,96, which helped push up inflation further.

Consumers under pressure

Given this environment, certain goods have seen a marked slowdown in consumer spending. New car sales and sales of durable goods, such as kitchen appliances and televisions, have declined. As the graph on the previous page shows, growth in durable goods spending showed a marked decline, falling into negative territory in 2008.

The slowdown in durable goods consumption has been driven by higher interest rates, although this has not been as significant a cause as monetary authorities might have hoped. In fact, despite the interest rate increases, private sector credit extension has continued to grow. At the end of the financial year, lending to consumers and companies was still around 20% higher than a year earlier, although this rate had fallen from 27% at the start of the financial year. It seems that this growth has been driven mainly by companies that have been accessing overdraft facilities, but consumers also seem to be accessing credit through available overdraft, credit card spending and homeloan access bonds. This is even as higher interest rates and the tougher lending criteria of the National Credit Act have taken effect. This may lead to greater consumer stress down the road once facilities are exhausted and consumers face higher debt service costs. This is exacerbated by the property market, which has seen the value of properties decline recently as new mortgages have become more difficult and more expensive to obtain.

Consumers are certainly worried about their positions. The Stellenbosch Bureau for Economic Research consumer confidence indicator has shown consumers to be very positive about their prospects since the strong bull market began in 2003. But that changed dramatically in early 2008, with consumer confidence falling into negative territory. That means that respondents to the survey on average see their prospects over the next year negatively. The result will be an unwillingness to invest, further hurting the housing market and durable goods market.

High inflation, high interest rates and declining expenditure have all resulted in a decline in sales by retailers in the SA economy. The graph alongside shows the percentage growth in real sales compared to a year earlier. It shows that sales grew from 2003 until 2008, but have recently begun to shrink. This by definition reflects a tougher environment for retailers in South Africa.

Expectations for the next year

We should expect the scenario to change only once interest rates reach their peak and begin falling, so restoring consumer confidence. This is likely only sometime in 2009, and depends substantially on world oil and food prices coming off their highs. Even once the cycle turns, consumers will still take some months to regain confidence and start spending, but an asset backlog will likely have developed by then, so a recovery could be significant.

The impact on Massmart of the consumer spending scenario during the financial year was mixed. Massmart’s reputation as a high-volume, low-margin retailer attracts consumers who ‘trade-down’ as a response to the tougher environment. This effect could lead to Massmart increasing market share in durable goods, such as the general merchandise sold in Game and Makro stores, even as overall durable goods sales shrink. Food sales are inelastic – meaning consumers must buy food even if prices increase – so Massmart’s wholesale food businesses did not suffer and may also have benefited. The higher inflation environment will, however, increase revenues even while volumes come under pressure.

This report was prepared in conjunction with Intellidex