On 26 April 2021, StatsSA released its first quarter liquidation and insolvencies report. This report is a good measure of economic performance by corporates and household debt strain. It is important for investment practitioners to draw on these statistics for a better understanding of corporate sectoral performance so as to inform their fundamental view on sectoral corporate credit worthiness. In the current economic climate, with enduring COVID-19-induced credit strain, this data offers some insight into the sectors that may be the most affected, and should be viewed with historical context. StatsSA collects its corporate liquidation data from the Companies and Intellectual Property Commission and Department of Trade and Industry.
For a clear economic context, it is worth noting the following:
- The top contributing industries to South Africa’s Gross Domestic Product (GDP) as at 2020 were Financial Services & Real Estate (21.3%), Trade, Catering & Accommodation (13.4%), Manufacturing (11.6%), Transport, Storage & Communication (7.9%) and Mining (6.9%).
- In 2020, South Africa’s economy shrunk by 7% and the year-on-year value-added growth rates of the above industries were -4.4%, -9.1%, -11.6%, -14.8% and -10.9%, respectively.
- The only industries to register a positive economic contribution in 2020 were government services and agriculture, with respective annual growth rates of 0.23% and 13.9%.
- Unemployment is at its highest point at 32.5% in the 21st century, with the country’s gross earnings decreasing by R38 billion in the fourth quarter of 2020 to R740 billion.
Corporate liquidations by sector
The five economic industries in a) above collectively contribute more than 60% to the GDP, in an economy with a heavy slant toward services industries. The low proportion of gross fixed capital formation (GFCF) to GDP (currently at 17.0%) further exacerbates our economic fragility. As a result, economic recovery is expected to be slower in comparison to economies with higher GFCF contribution and more productive industries.
The StatsSA liquidation statistics do not disclose the balance sheet size of the liquidated entities and therefore cannot be used to analyse the full economic impact - but they can be used as an indicator of corporate economic strain. A total of 516 liquidations occurred during the quarter, with 466 filed voluntarily.
Agriculture, Mining and the essential services (electricity, gas & water) have proved to be resilient industries. This can be attributed to the low numbers of SMEs (assuming that most of the liquidated entities are SMEs) in these sectors and/or the industry size relative to the economy. Financial Services & Real Estate and Trade, Catering & Accommodation account for 280 of the liquidations; 26 occurred in Manufacturing; and 135 were unclassified.
These statistics are evidence of our observations of the deteriorating overall credit quality of property companies, and the Financial Services and Tourism & Leisure sectors. But it must be noted that, despite the decline in these sectors, there are certain pockets that we believe will make a good recovery due to their observed balance sheet strength and revenue diversification.
Figure 1: Total liquidations by industry – First quarter of 2021
Source: StatsSA, Futuregrowth
The total number of liquidations was highest in 2018 and 2017. During 2018 this was largely propelled by spikes in the second and third quarters, and 2017 had a high increase in the third quarter. Outside of these anomalies, annual liquidation curves have been smooth across the years (see Figure 2) with marginal increases year on year. As at April 2021, company liquidations (excluding close corporations) are at 267; the highest since 2015 (260). Due to the COVID-19 impact, it is our expectation 2021 figures would be higher than the historical average.
Figure 2: Cumulative corporate liquidations
Source: StatsSA, Futuregrowth
The 2018 total company liquidations were just under 2 750, 1 000 more than in 2017. The annual figure for all other years since 2015 has been just above 1 000 liquidations. It is important for investors to use such data to draw educated inferences for optimal sectoral fund allocations – and to make investment decisions that are informed by both point-in-time and forward-looking views in order to avoid taking undue credit risk.
Conclusion: Full recovery in corporate performance will not be seen in the near term
Futuregrowth’s credit view remains conservative, with some bias towards short-to-medium term investment horizons and high-quality counterparties. As credit investors, our role is to minimise potential portfolio loss in a default scenario. Thus, when the credit cycle is characterised by a high probability of default, it becomes essential to offset this risk through the use of appropriate covenants and secured investments. As a reputable credit investor with proven track record, Futuregrowth realises that the current weak economic environment should not cripple its investment activity, and that robust risk-mitigating techniques must be applied to protect client funds. The liquidation statistics call for cautious asset selection, rigorous balance sheet analysis and an informed sectoral bias. It is our view that a full recovery in corporate performance will not be seen in the near term, and the above investment principles will continue to be important for the foreseeable future. We find sectoral liquidation statistics to be very useful in guiding our use of these principles.