Does the performance of the Johannesburg Securities Exchange reflect the triumph of the national imperative over the shareholder imperatives?


South Africa’s legislative competency in giving life to a national imperative is at odds with the shareholder imperative. That is, the legislative framework lacks the creativity to give birth to South African Dynamism in much the same way as economically vibrant countries such as the United States do through American Dynamism.

Analysis by Elroy Dimson, Paul Marsh, and Mike Staunton of London Business School of 19 major stock exchanges between 1900 and 2011 shows that the Johannesburg Securities Exchange (“JSE”) punches above its weight against 18 Developed Market (DM) stock exchanges. The JSE was in the top three (3) performing stock exchanges in US dollar terms. In the period under review (111 years), the leadership of the 19 exchanges under review alternated between South Africa, the United States, and Australia.

Chart 1: Real equity return (black) and real GDP per capita growth (grey): 1900-2011

Source: Triumph of the Optimists, 2011

It is notable that (i) South Africa registers world leading outperformance of 17 Developed Market exchanges in real terms (that is, adjusted for inflation – higher than Developed Markets by the way) and (ii) the lowest real GDP growth in the group.

The beginning of the underperformance of the JSE relative to developed markets

Since 2011, South Africa’s real GDP has remained painfully anemic, and its returns (both nominal and real) lag those of DMs materially. From January 2012 to February 2024 in USD terms, The MSCI World Index outperformed the JSE substantially, posting 252% compared to 42% for the JSE. In fact, the country’s economic growth on a per capita basis has been in recession since 2011.

Chart 2: South Africa vs. MSCI World (January 2012 – February 2024)

Source: First Avenue, Bloomberg and JSE as at 29 February 2024

While local commentators easily find and lay fault at the hands of the government, we think managements of South African companies have not demonstrated adequate ingenuity to overcome the unintended consequences of the national imperative on generating competitive shareholder and market returns. The following is an illustration.

A national imperative to foster close linkages with the sub region (SADC)

The South African Development Community Free Trade Agreement of 1996, as amended in 2010, is one of the most important legal instruments guiding SADC’s work on trade. It is an agreement between 12 SADC Member States to reduce customs duties and other barriers to trade on imported products among SADC Member States. The SADC Free Trade Area seeks to meet the following needs of the private sector and other regional stakeholders: Increased domestic production; greater business opportunities; and higher regional imports and exports. So, this piece of legislation purports to align the shareholder imperative with the national imperative.

At the expense of creation of economic value in South Africa

In 2017 a leading retailer of mostly imported high end ceramic tiles, Italtile, acquired the balance of shares it did not already own in a manufacturer of lower end floor tiles, Ceramic Tiles, for R3.492bn. In 2018, the company invested a further R680m to both increase capacity and modernize the acquired manufacturing facility to substitute imports with domestic production. The aim was to reduce long lead times, and currency uncertainty, associated with imports. As we all know, out of date stock is as good as a lost sale. Thanks to the SADC Free Trade Protocol, what should have been leadership in short manufacturing runs in response to style trends has turned into a nightmare. International players have set up manufacturing facilities in the SADC Free Trade Area (Zambia) and are exporting product into South Africa. The latest instalment of this is a Chinese manufacturer who has set up similar nameplate capacity as Italtile in Mozambique for the sole purpose of exporting into South Africa’s large consumer market.

These players are arbitraging differentials in labor costs, tax rates, investment incentives, energy costs, and currency convertibility between South Africa and its neighbours in the Free Trade Area. For instance, the Mozambiquan competitor benefits from gas royalties (access to the country’s vast reserves of natural gas at favourable prices) to power its kilns and furnaces. On the other hand Italtile not only pays commercial rates from Sasol Gas (sole importer into the country), but has also recently suffered uncertain supply as disputes on pricing led to Sasol announcing an imminent retreat from importing gas into South Africa. In the absence of another gas supplier stepping into the breach, Italtile may very well have to toggle to the next best option, namely, more expensive coal fired kilns and furnaces. This would not only drive costs of production up relative to its Mozambican (gas) and Zambian (hydro) competitors, but place Italtile at a comparative disadvantage.

The question is why did Italtile not see it fit to set up manufacturing facilities in the most beneficial country in the Free Trade Area to avoid structural disadvantages in South Africa’s operating conditions? Let’s be clear, besides benefiting from South Africa’s consumer market, competitors in the Free Trade Area also benefit from the easy convertibility of the South African rand into US dollars for repatriation back home. The local unit is the third most liquid and convertible currency in the world (after the USD and Euro). In fact, what currently stops Italtile from moving its manufacturing capability to Mozambique under the same attractive terms its Chinese competitor enjoys? Is it the national imperative of keeping jobs in the country? Paying tax to the fiscus in South Africa rather than Mozambique (if any)? Isn’t contributing to lower inflation by importing lower priced goods into the country a national imperative as well? Italtile boasts R1.5bn in cash on its balance sheet. Why not use it to reposition itself in a competitive position? Perhaps, why not unbundle or sell the manufacturing facility and source cost competitively priced tiles from anywhere in the Free Trade Area?

At R11.8bn, Italtile’s market capitalization today is less than it was in 2017 (R12.3bn) when the company integrated vertically by acquiring Ceramic Tiles. Of course, a material reduction in interest rates could flatter the company’s fortunes (and result in a material rise in market capitalization). But the company’s competitors would enjoy greater profitability than Italtile. Why can’t Italtile put its shareholders in a position to benefit from what shareholders of its competitors in Mozambique and Zambia enjoy?

Disruption of the comfortable kind leads to more pain

Talking of contributing to structurally lower inflation, the clothing retail industry in South Africa is suffering from a similarly debilitating arbitrage from Shein and now Temu, albeit with different fingerprints. The Foschini Group (TFG), Truworths, and Woolworths have all spent billions of rands acquiring traditional brick-and-mortar assets mostly in the United Kingdom and Australia. Pepkor looked to a bricks-and-mortar retailer in Brazil to escape the low growth trap in South Africa. Again, at the time these acquisitions were made, e-commerce as a route to market was a proven capability in the developed world, and rapidly taking root in the Middle Kingdom, China. Today, the cost structure of local clothing retailers is woefully deleterious relative to Chinese e-commerce companies exporting clothes in South Africa. Chinese e commerce competitors are using China’s global comparative advantage to manufacturer textiles and apparel and export to the rest of the world. Try as they might, local clothing retailers cannot come close to both the price points and fashion-ability of products shipped by Shien and Temu.

What could have served as a deterrent (45% import tariff) to cheap imports is the customs and excise tax code. Yet, the excise tax code has a loophole as porous as South Africa’s borders. Shein and Temu ship ordered goods in packages whose weight falls below the threshold for full duties (45%). So, a customer often receives multiple packages under the same order. Practices like this can easily be defended as tax efficiency rather than tax avoidance. The Minister of Trade and Industry acknowledges that Shein and Temu are using lower duties in ways not intended, resulting in an unfair playing field. The onus, however, is on the government to change the tax code to reflect full duty even on a single item. This may take years, if not decades, if challenged at the World Trade Organization (WTO).

The mother of all battles has not even begun

Even if the government enacts a change in tariffs in favour of the clothing retail industry, retailers will only live to fight the mother of all battles against Amazon, the global leader in e-commerce, launching in April this year. One thing for certain, operating margins enjoyed by clothing retailers in South Africa are attractive enough for a company that prides itself, not in arbitraging import tariffs, but in investing cost savings in price to drive volumes to asphyxiate category leaders. If Amazon retail lost money in the US for 20 years straight to establish unimpeachable market share and scale, how long do you think it can do it for in South Africa to bring operating margins of clothing retailers to 5%? After all, Amazon Web Services, Amazon Advertising, and Amazon Freight could very well be profitable during that period as they are much higher margin businesses. For instance, AWS has about a fifth of the revenue generated by retail but produces greater operating profit. That margins for Amazon retail are around 3% should scare local retailers. There is plenty of runway for structurally sound ideas like Amazon, and those “tariff efficient” businesses like Shein, and Temu.

Nearly three quarters of the population of South Africa has internet access, and more people live in concentrated urban areas than in most other nations in the region. Yet e-commerce makes up about 4% of retail in the country, meaning there are potential riches to be won. What is benefiting international operators here is that emerging markets have shown an ability to leapfrog when it comes to technology whether its online banking or insurance. Shein, for instance, is the most downloaded shopping app on South Africa’s Google Play store. Soon will be. The courier company used by both Shein and Temu, Buffalo Express, seamless integrates with the South African customs system, local banking system, and several other express companies for delivery overflow. Buffalo Express boasts a fleet of three hundred self-owned transportation vehicles, and a 25,000-square-meter sorting centre with a 6,000-square-meter bonded warehouse in October 2022. These rival those of local retailers.

There is no such thing as “South African dynamism” to compete in manufacturing the future

It is disappointing that at the core of the complaints by clothing retailers, labor unions, and government officials is a concern about job security. Globalization saw America’s manufacturing base hallowed out by companies that offshored jobs to low-cost geographies (first Taiwan, then China, and now Malaysia and Indonesia) while the American worker moved up the value chain to more profitable areas such as research and development, and industrial design. Rather than resort to complaints, we encourage:

  • Management of South African companies move the enterprises they steward up the value chain to compete for a greater share of the value of global trade.
  • Government incentivizes local industry to invest more in intellectual capital than in basic manufacturing to sustain and grow enterprise value, and the economy.

This way, management teams can decide which parts of the business to outsource to the Free Trade Area and which parts to keep in South Africa enroute to creating high value-added goods for domestic consumption and export. Our diagnosis is that managements of South African companies are too comfortable to radically disrupt themselves.