Before the bad news on sovereign debt downgrades started coming in, South Africa restructuring specialists had a positive outlook for the economy.
Results from Deloitte’s fourth annual South African Restructuring Outlook 2017 survey showed a significant improvement from 2016, with most respondents of the survey expecting an improved economic environment in 2017, in line with the wider trend seen across developing economies.
An important caveat is that this positive sentiment likely weakened in the wake of South Africa’s sovereign debt rating downgrades by S&P Global Ratings and Fitch Ratings, which occurred shortly after the survey was conducted.
“We surveyed a cross-section of restructuring specialists in South Africa to obtain a better understanding of where the industry is now and what their expectations are for the next 12 months,” says Deloitte associate director of restructuring services, Daniel Terblanche. “Respondents represented a selected mix of commercial banks, development finance institutions, lawyers, business rescue practitioners, academia and other key professionals.”
Key themes that emerged were:
* 66,7% of survey respondents expect an increase in activity in their restructuring teams in the next 12 months, following on from 55,6% over the last 12 months.
* Sectors identified to be most at risk of being distressed in the next year were retail, agriculture and construction.
* The results highlighted both the importance of identifying distress early and the risks of value erosion that business rescue can bring if not managed carefully, such as the discontinuation of supplies into a business or higher employee attrition rates.
* Protecting the business is still ranked as the number one priority of a restructuring project, with the preservation of employment becoming increasingly prominent.
* Early identification of financial distress remains one of the main areas where restructuring professionals believe the local restructuring industry could be improved.
“An increase in volatility can be expected across the South African economy and the ability to identify financial distress early by management and boards of directors, accompanied with the imperative need for restructuring practices, both informal and formal, to develop and become more dynamic, is more critical now than ever before,” says Deloitte’s head of restructuring services, Nisha Dharamlall.
“While the potential of increased volatility can be daunting for companies and organisations alike, it most notably calls for a renewed focus, agility and proactivity by all stakeholders in order to be able to identify, address and manage the uncertainties surrounding businesses in South Africa.”
Respondents believe that the retail sector is the most at risk of distress in the next 12 months, followed by the agricultural and construction sectors. This marks a change from previous years when the resources sector was cited as being the most at risk.
The increased focus on the retail sector follows the highly-publicized restructuring and the ongoing business rescue of well-known house brands in the local market. Low growth, high (imported) inflation caused by the weak rand in 2016, increases in the repurchase rate since 2014 and higher income taxes have reduced the spending power of South African consumers. This, coupled with increased competition from overseas retailers, has made for challenging conditions in this sector.
Agriculture is forecast to be the next most-at-risk sector, having been chosen by 53,6% of respondents, even after the El NiƱo drought came to an end in the summer rainfall region. While the rains in this region might have helped growing conditions, the appearance of “zombie companies” as conditions improve remains a risk. Forecasters predicted a return of adverse weather patterns in the 2017/18 season, which would cause serious concerns again for this sector.
The construction sector remains one of the sectors most at risk of financial distress in the next year, retaining its top-three position for the fourth year running. This has been attributed to the lack of government spending on infrastructure, which consistently falls below the 30% of GDP target as outlined in the National Development Plan. Ongoing tight margins and liquidity challenges for operators in this sector are also contributors to the weak outlook for the construction sector.
Resources remains a concern for 42,9% of respondents as a result of market prices remaining relatively low compared to the commodity price boom of 2000-2014. The lack of competitiveness in sectors such as steel globally was identified as a concern in this area.
Solvent restructurings are expected to be the most common route to rescuing a company in distress over the next 12 months, with the injection of new equity via the sale of the business, a new equity raise or the sale of nonperforming assets being the preferred route. Finding a solution for a company in distress that avoids a formal process such as business rescue or liquidation is often the best way to preserve employment and value for creditors.
Business rescue, now entering its sixth year since the implementation of the Act in May 2011, is expected to be the next most used mechanism. The industry is starting to reach new levels of sophistication and is gradually becoming more robust and effective.
An interesting finding is that 27,3% of respondents have experienced a success rate of less than 15% in business rescue cases, compared to 4,5% for informal restructurings.
A total of 81,9% of respondents had experienced success in more than 50% of the informal restructurings that they have been involved in, compared to 63,7% of business rescue cases.
Business rescue in certain circumstances can be a useful way of assisting with the implementation of a transaction involving new equity. It provides an opportunity to achieve a better result rather than opting for liquidation.