South African power cuts
Opportunity overview
The South African economy recorded modest growth of 0.4 percent in Q1 this year, hampered by power cuts and volatile commodity prices. Structural unemployment remains a critical concern, with the unemployment rate at 32.9 percent, close to an all-time high. The ongoing energy crisis, caused by mismanagement of the state-owned utility Eskom, has contributed to significantly depressed P/E multiples on the South African market. On an index of 0-100 over 10 years of P/E data, South African markets are currently trading around 30/100, indicating lower than average multiples.
Recent statements from the Electricity Minister suggest that as warmer weather returns, the daily power cuts may be ending, potentially presenting an opportunity for investors.
Key drivers
Mismanagement of Eskom: Years of mismanagement and financial inefficiencies in the state-owned utility Eskom have led to an inadequate supply of electricity. This has resulted in rolling blackouts that significantly impact the output of South African mining and industrial companies.
Potential opportunities
Mining & industrial companies: As the energy crisis subsides and power cuts lessen, mining companies' output may see a significant boost.
General market discount: The prolonged energy crisis and rolling blackouts have depressed the overall South African market, leading to historically low P/E multiples. As the energy situation improves, investor confidence may increase, leading to gradual multiple recovery.
Risks
There is no guarantee that government guidance on the energy situation is accurate, and power cuts may continue over the mid-term.
Brazil interest rate cuts
Opportunity overview
Brazil's inflation rate fell to 3.16% in June while interest rates remain at 13.75%. President Luiz Inacio Lula da Silva criticized the central bank for keeping rates high despite slowing inflation. Private economists anticipate interest rate cuts, predicting the benchmark rate to end 2023 at 12% with a 25 basis points cut in August followed by three 50 basis points cuts by year-end. This presents an opportunity for investors in the real estate sector and other credit-intensive industries as borrowing costs are expected to decrease.
Key drivers
Inflation-interest rate divergence: The significant drop in Brazil's inflation rate to 3.16% provides an opportunity for the government and central bank to reconsider their tight monetary policy stance. Lower inflation rates create room for interest rate cuts, potentially leading to a more accommodative monetary policy environment.
Potential opportunities
Investing in Real Estate Companies: With the anticipated interest rate cuts, real estate companies are likely to benefit from increased demand for property purchases and investments.
Credit-Driven Retailers: As interest rates decrease, credit-driven retailers may experience a surge in consumer spending. Consumers may find it more appealing to finance purchases through credit, as the cost of borrowing becomes more favourable.
Risks
Interest rate cuts in the face of falling inflation are not guaranteed. The Brazilian Central Bank has stated it is comitted to achieving their 2% inflation target by 2026. The prolonged elevation of interest rates may be part of their plan to achieve it.
Australia retail squeeze
Opportunity overview
Amid soaring costs and a slowdown in consumer spending due to interest rate hikes, Australia's cafe industry has been hit hard, leading to closures and shrinking profit margins. The cost to produce popular cafe items like a steak sandwich or a flat white has significantly increased over the past two years, erasing the typical 10% profit margin in the industry.
However, there is hope that easing inflation in the future could alleviate some of the pressures on the struggling retailers.
This situation may present an opportunity to buy distressed Australian retailers in anticipation of easing inflation.
Key drivers
Easing inflation: The reduction of cost pressures squeezing Australian retailers may lead to improved profit margins and financial performance.
Consumer spending: Slowing inflation may help consumer spending on discretionary purchases rebound. This would positively impact the revenue of distressed retailers.
Market sentiment: If there is a positive outlook for the Australian economy and investors perceive that the worst is over for distressed retailers, they may be more willing to invest, helping depressed retail stocks recover.
Potential opportunities
Turnaround opportunities: Revenue growth and profit margins may recover in a less inflationary economic environment. This may be an opportunity to buy retailers with strong brands and solvency in anticipation of future recovery as inflation eases.
Risks
Economic risk: Prolonged inflation could hamper the recovery prospects of distressed retailers.
Liquidity: Many distressed retailers will be unable to survive long enough to see macro conditions recover. This is evidenced by Australia experiencing the largest number of bankruptcies since the Covid pandemic in May 2023.
*DISCLAIMER: This article is not financial advice. All views are expressed in the context of research and education. Lion Research does not provide recommendations to readers on whether to buy or sell the securities or investments covered.
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