Viewed as the poor relation of the IT sector in the late 1990s, the electronics & electrical (E&E) sector rebounded to become one of the market's top performers for five years running.
Over this period the E&E index produced a total return of 140%, in sharp contrast to the IT index's 80% slump. But the sector's performance had as much to do with earnings growth as with what investors seek most in uncertain times: value, strong cash flows and dividends. These they found in the sector's four largest companies, Altech, Altron, Reunert and Delta.
Over the past five years, these heavyweights delivered average growth of 15,5%/year in earnings per share and 18,9%/year in dividends. Solid enough, but well below the average 26,1%/year EPS and 23%/year dividend growth of the previous five-year period. Returns on equity also fell, from a 28% average to 22%. Reunert led the field with 29,9%, followed by Altech's 20,4%, Delta's 19,7% and Altron's 17,7%.
The biggest culprit in the slowdown was the rand's gains against the US dollar. Delta, the world's largest producer of electrolytic manganese dioxide (EMD), was hit particularly hard as lower rand earnings sliced a third (R65m) off EMD operating profit and depressed group EPS by 21%.
Currency strength also stalled Altech's growth. "Autopage Cellular and our vehicle-tracking operation, Netstar, had an exceptional year but the rand hit the UEC TV decoder manufacturing operation hard," says CEO Craig Venter. Despite a 39% increase in units sold by UEC, R52m was sliced off Altech's operating profit, leaving EPS in the year to February 2004 11,7% lower.
Slack demand in some key markets added to pressure on E&E sector earnings. Telecommunications, once a source of strong demand, "remains as flat as a pancake", says Reunert CEO Gerrit "Boel" Pretorius.
Capital expenditure by Telkom, the biggest source of demand, has been in decline since it ended its heavy capex programme in May 2002. "This was when its commitment to expand fixed-line services in terms of its exclusive licence ended," says Altron CEO Robbie Venter.
Despite government's arms procurement spending, demand for military equipment presents a similar picture. "Most of the expenditure is not coming the way of local companies," says Pretorius. As a consequence, Reunert has scaled down its defence manufacturing capacity.
"The cyclical nature of demand in various sectors and rand volatility highlight the importance of diversification," says Craig Venter. This limited EPS falls by Altech, Altron and Reunert. Their strong cash flows and robust balance sheets enabled them to sustain dividend growth.
Other companies proved less resilient. A high exposure to telecoms and a big export sales component punished Jasco in 2003, with turnover down a third and operating profit halved. Grintek's telecom operations also stumbled badly in the half-year to December 2003, with divisional turnover down R64m (20%). And its military equipment division suffered at the hands of a strong rand, leaving group operating profit down 60%.
A revival in telecom demand is not assured. The licensing of a second fixed-line operator has been in limbo for two years. Many E&E sector companies are hoping that SA's pressing need to expand its infrastructure, especially in electricity generation and distribution and rail transport, will create and sustain demand.
