Listed companies feel the effects of power uncertainty

05 April 2023

South Africans have become great event planners. Previously ordinary tasks such as mealtimes, homework and Netflix-and-chill time have become “events” that we plan as we diligently check our load-shedding schedules. We have had to adapt to the intermittent power provision from Eskom’s ailing fossil-fuel generation stock. We have seen a similar trend across the Johannesburg Stock Exchange (JSE).

Despite challenges, there have been some bright spots and South African companies have shown resilience.

INTENSIFYING LOAD-SHEDDING IMPACTS

There has been a negative impact across most sectors from the intensifying load-shedding.

The country’s gross domestic product (GDP) shrank 1.3% year-on-year in the fourth quarter of 2022, led lower by agriculture and mining. Negative growth across these two sectors is concerning, given their high labour intensity – together, they employ more than 1.2 million people. There is a high risk that continued production inefficiencies will lead to cost-cutting and job losses.

Mining and pharmaceutical companies are somewhat insulated at load-shedding stages one to four, however, during stages five and six these companies are not immune to the load reduction measures. The higher stages of load-shedding during the last quarter of 2022 added to the logistics challenges experienced by the coal and iron-ore producers, translating into a 3.2% decline in mining industry output for the period. Other industries are more fully exposed to rolling blackouts.

Mobile network operators and the food supply chain have also been hard hit, both of which have a direct impact on the lives of South Africans.

MOBILE NETWORK OPERATORS HARD HIT

Telco operators face increased diesel and maintenance costs as they run backup generators longer than expected. They have also incurred additional security expenses to secure their alternate sources of power generation at tower sites. Network towers are reliant on electricity supply to operate, and network availability declines as load-shedding intensifies. Telkom noted an increase of 154% in diesel costs and consequent higher roaming costs in their interim result. This contributed to a 17% reduction in EBITDA (earnings before interest, taxes, depreciation and amortisation). Telkom’s network availability drops as low as 70–75% during stages five and six.

MTN’s operations in South Africa have also experienced a negative impact on the group’s topline and costs owing to load-shedding, which reduced the EBITDA by R695 million in 2022, or 3.5%. MTN plans to deploy longer-life batteries and power generation sets to critical sites during the current year. However, this additional capital expenditure was not part of their previous capital allocation programme. Consumers will need to brace themselves, as all three telcos’ operators are set to increase prices in the current year to recoup additional power-related costs.

TOUGH TIMES FOR THE FOOD VALUE CHAIN

Tiger Brands, the owner of Albany bread and several other South African staples disclosed a R27 million additional cost to run back-up generators, partially offset by investments into alternative power in prior years and some local advantages, in the four months ending 31 January 2023. Despite these benefits, Tiger Brands is guiding to R1.5 million in load-shedding costs per day at stage six.

Chicken producers Astral and RCL Foods have been battling higher feed prices since 2022 and rising cost inflation. The situation has intensified with higher stages of load-shedding. Astral reported chicken production costing R2/ kg above the selling price and being unable to pass on the cost inflation to consumers, who are already under pressure due to high cost-of-living increases. Astral’s share price is down 20% over the past six months. RCL Foods spent R96 million in direct load-shedding associated costs for the six months to December 2022 to keep chicken production and bakeries operational. All three companies – Tiger Brands, Astral and RCL Foods – have plans for longer-term backup generation from renewables.

Further down the value chain, the country’s retailers are also finding it hard to deal with the erratic electricity provision. Retailers entered the high trading month of December 2022 amid record levels of load-shedding, which started in the fourth quarter of 2022 and persisted into the first quarter of 2023.

However, not all retailers are impacted equally. Those with perishable offerings are far more reliant on a stable supply of electricity, suggesting a higher cost. As tenants, and not owners of their floor space, retailers face challenges in trying to invest in their own renewable backup power generation at many stores. Shoprite spent R560 million on diesel to run generators in the six months to December 2022. Pick n Pay’s recent trading update guided for an approximately R60 million increase in costs per month on diesel to run generators for the same period. These additional direct costs and indirect increased product wastage costs reduce profits and cash returns to shareholders.

SOME LIGHT IN THE DARK

Despite the gloom, there are bright spots. The transformation from reliance on state-produced power to renewable and alternate sources of backup generation has benefitted some companies. While the latest bid windows (five and six) for renewable energy procurement have experienced challenges, the removal of the 100MW licensing threshold has spurred growth in private sector projects for renewable energy generation.

Media reports note that the National Energy Regulator of South Africa received just over 1000MW collectively, mostly solar power registrations, in February 2023. This is an encouraging figure given that it received only 1664MW for the entire year in 2022.

Additionally, distribution networks owned by Eskom and municipalities require investment to unlock further solar and wind power from key renewable energy locations, to where it is consumed.

SECTORS BENEFITING FROM RENEWABLES EXPOSURE

In the midcap sector, Reunert and Hudaco have outperformed the JSE All Share Index in the year-to-date, increasing 10% and 7% on a relative basis, respectively. Reunert has exposure to turnkey renewables solutions and electrical cables used in electricity distribution. Hudaco’s sales have benefitted from the importation of renewables components, batteries and generators for both residential and commercial use.

In the larger cap space, Bidvest has also made the most of the opportunity, commenting on exponential renewable energy growth in the six months to December 2022. Similarly, banks will benefit from private sector credit extension, as many private renewables projects and some projects from bid windows five and six reach financial close.

Our unloved and forgotten construction sector has seen an increase in requests for renewable project pricing from the private sector, and their order books have seen some benefits. WBHO is investing in an additional precast concrete manufacturing facility for components for the wind energy sector. Energy infrastructure now contributes approximately 20% of WBHO’s South Africa order book. As a labour-intensive sector, the construction sector is poised for increased activity in renewable energy projects, with wide-reaching positive second-round effects and social benefits.

WHERE TO FROM HERE?

The outlook for power security remains uncertain, with negative consequences expected for the entire economy. The additional costs and capital expenditure required to reduce reliance on the national grid appear to be part of the new reality for SA companies. Unfortunately, these costs are likely to increase in 2023.

Energy-related costs, coupled with rising interest rates and inflation, currency volatility and logistics bottlenecks, are a burden for local companies. However, with Eskom tariffs likely to increase by double digits over the next few years, and renewable energy component costs declining, those companies investing in sustainable and reliable alternative sources of energy will benefit from both predictable operations and reduced energy costs in the long run.

At Ashburton Investments, we remain focused on implementing our investment process, which relies heavily on bottom-up valuation and scenario analysis.

We are still finding value in some local companies. Companies, with attractive valuations despite the local headwinds, which are also nimble enough to adjust to the current operating environment and others which can benefit from opportunities brought about by the power disruptions.