Business Valuations in South Africa’s Stagnant Economy – The Recession Factor

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South Africa has been teetering on the edge of a recession, narrowly avoiding a technical one with a GDP growth of 0.1% in the final quarter of 2023. Despite this, the nation remains in what economists call a “per capita recession.” This unique economic phase reflects the fact that while the population is growing at around 1.5% to 1.6% per year, the GDP growth lags behind, indicating a stagnating economy where individual wealth is shrinking. For business owners and investors alike, the outlook for business valuations in such an environment is critical to understand, particularly as a full-blown recession looms on the horizon.

Stats SA image - Industry growth rates and Gross domestic product 2023 and 2024

The Per Capita Recession and Business Impact

In simple terms, a “per capita recession” means that while GDP numbers may not show a formal recession, the average South African is becoming poorer. GDP per capita fell to $6,190 (Circa R110 750) in 2023, the lowest it’s been since 2005, and projections for recovery are weak, with expectations of only marginal improvement by 2028. This economic reality places significant pressure on consumer spending, business performance, and investor sentiment—factors that directly influence business valuations.

For businesses, the per capita recession creates a challenging environment for growth, especially for those reliant on domestic demand. Companies in sectors such as retail, hospitality, and discretionary consumer goods may see compressed valuation multiples due to the decreased spending power of the population. Investors will likely factor in higher risks when valuing businesses, particularly in industries exposed to local economic conditions. Valuation discounts might become commonplace as expectations for future cash flows and earnings growth dwindle.

Sector-Specific Impact

Certain industries may feel the brunt of these economic pressures more than others. Retail and consumer goods sectors are likely to experience significant valuation declines, as these sectors depend heavily on consumer demand and spending, which are often the first to fall in a recessionary period. The South African consumer base, already struggling with high unemployment, inflation, and rising interest rates, will likely spend less on non-essential goods and services, leading to softer revenues and lower profitability for these businesses.

On the other hand, industries with more international revenue exposure or those serving essential needs, such as healthcare and utilities, could see more stable valuations. These sectors often provide goods and services that remain in demand even during downturns. Furthermore, businesses with robust cost structures and efficient management could be more resilient, making them attractive to investors despite the broader economic concerns.

Changes in Valuation Methodologies

In an economic downturn, valuation methodologies like the discounted cash flow (“DCF”) model, which relies heavily on projections of future cash flows, may produce lower valuations due to more conservative assumptions about future earnings and cash generation. In South Africa’s uncertain economic climate, risk-adjusted discount rates used in DCF models are likely to rise, reducing present value estimates. The price-to-earnings (P/E) multiples may also contract as investors become more cautious, placing lower premiums on future earnings potential.

Comparable company analysis (“CCA”) and precedent transaction analysis might also reflect lower valuation benchmarks as the market becomes more risk averse. Valuators will likely adjust for sector-specific risks and reduce their forward-looking growth assumptions in these comparative analyses, especially for industries that are hit hardest by domestic economic conditions.

How Investors are Mitigating Risk

Despite the bleak outlook, investors can navigate these challenges by adjusting their investment strategies. Diversification is key, as spreading investments across different sectors and geographies can mitigate the risk of a single market downturn. For South African investors, international diversification may provide a hedge against the country’s economic struggles.

Operational improvements in the businesses themselves can also play a role in maintaining value. Investors are increasingly looking for companies with strong management teams that can implement cost-cutting measures, optimise operational efficiencies, and maintain profitability, even in tough times. For businesses, demonstrating resilience through lean operations and flexible cost structures may lead to stronger valuations despite the broader economic challenges.

Opportunity in Recession

Interestingly, recessions also present opportunities for strategic acquisitions at lower valuations. Businesses that can position themselves to weather the storm may find opportunities to acquire struggling competitors or expand into new markets at a discount. Private equity firms, for instance, often thrive in recessions, using downturns to acquire businesses at a lower cost, restructure them, and prepare for growth once the economy recovers.

For South African businesses that can demonstrate resilience, adaptability, and solid financial management, opportunities may arise even in the most challenging conditions. These businesses could not only maintain their valuations but also attract investors looking to capitalise on post-recession recovery.

Conclusion

South Africa’s per capita recession presents a unique set of challenges for business valuations. With economic growth not keeping up with population growth, domestic businesses face significant risks, particularly in consumer-driven sectors. Investors will likely adopt more conservative valuation models, reflecting higher risk premiums and lower expectations for future earnings growth.

However, sectors with international revenue exposure or those that provide essential services may show more resilience. As the economic uncertainty unfolds, businesses that focus on operational efficiency and demonstrate strong leadership may navigate the downturn better than others. While the recession casts a shadow over business valuations, it also offers opportunities for strategic investors and businesses poised to weather the storm.

By understanding these dynamics and adjusting their strategies accordingly, both businesses and investors can successfully navigate the complex terrain of South Africa’s economic landscape.

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