The electronics and electrical equipment sector is at a crossroads, waiting for government infrastructure expenditure to materialise while other markets beckon.

Unlike its close siblings in ICT and other forms of technology, the electronics and electrical equipment sector is generally not perceived as a glamour sector – either in terms of its relative rating on the JSE, or by the analysts and journalists who cover the broader technology space and tend to enthuse more about the much larger ICT sector. But is it a ‘real economy’ sector and deserves more attention, especially the minnows in this grouping.

Much of the business in this industrial subsector relates to basic infrastructure business, such as cables and power-supply systems. The heavier side of these operations tends to be highly cyclical, even during current times when infrastructure-related projects should be all the rage. This is one of the reasons why many larger companies in this arena have diversified their operational bases to achieve a balance between the heavier, infrastructure-oriented side and the lighter, consumer-oriented side such as consumer electronics (for example, satellite television systems and lighting products). There is regular corporate action in this sector as companies buy up local and foreign private businesses which will enhance their operations, as well as enter into joint venture arrangements and partnerships.

As with the building and construction sector, the electrical and electronics sector is at a turning point, waiting for the long-standing government commitment to infrastructure expenditure to materialise. Eskom and municipalities are compelled to start spending on power infrastructure. Eskom’s capital expenditure programme should last for decades and benefit many companies in this sector. But the distribution side of electricity supply is in a far more parlous situation than the generation side.

Mismanagement in the public sector means many municipalities now face a nightmare of crumbling electrical distribution infrastructure. Replacement and maintenance of these systems should be positive for these companies. Eskom expects to spend R26 billion on transmission and municipalities have another R27 billion transmission infrastructure spend backlog.

The heavy side of this sector did quite well in the lead up to the 2010 Fifa World Cup, as a number of projects relating to that event, such as the building of football stadiums and the construction of the Gautrain, required significant inputs of electrical engineering and related work. Since then, the amount of activity has declined markedly, with a concomitant negative impact on earnings growth for these companies.

While infrastructure capital expenditure in SA is now beset by delays and bottlenecks, other parts of Africa are looking at energy infrastructure and fibreoptic network roll-outs, and SA electronic companies are aspiring to participate in this trend.

Big charges

The sector is dominated by two companies, Allied Electronics Corporation (Altron) and Reunert. Altron was established by entrepreneur Bill Venter in the 1960s and for many years its success was derived from supplying telecoms equipment to the South African Post Office telecoms business, which later became Telkom. Today, Altron’s businesses are diverse, encompassing interests in multimedia, telecoms, power electronics and IT. Venter remains chairman and his two sons – Robbie and Craig – head up Altron and Altech (an Altron subsidiary, listed separately in the mobile telecoms sector) respectively.

Reunert has a long history going back to 1888, and was previously a Barlow Rand subsidiary. It owns Nashua, Nashua Mobile, CBI-electric, African Cables and Reutech. Nashua Mobile is a key revenue contributor to the group and the current concern here is that telecoms is now an evolved sector in SA.

While absolutely committed to the continent, Altron has recently gone through pain in parts of its Altech Africa businesses and Powertech Iberia cable business. Operations in Portugal and Spain have seen a fundamental shift in demand patterns due to government austerity programmes.

As Venter Snr put it in the Altron 2012 annual report: “Adverse global conditions have tested our resilience and ability to prevail. Local customers remain highly geared and the domestic housing market continues to be subdued, with the building and construction industry yet to stage a long-awaited and meaningful recovery. A faltering European recovery has had the effect of limiting local business opportunities for international growth, while accelerating the entrance of large global competitors to South African shores.”

Significant impairments have had to be taken in the company’s West and East African books. Experiencing problems in the low-priced paper recharge voucher market, goodwill in West Africa has been written off and the business was put up for sale. Around R500 million of impairments in East Africa are also related to goodwill and asset write downs. The East African acquisition performed well in its first few years, but the most recent has been a pressured trading environment, including currency movements, inflationary costs, and network instability. This regional operation has also been hit below the EBITDA line by interest on borrowings and huge depreciation costs on its network.

Altech is addressing East Africa by putting in a whole new management team, and the Kenyan government has come out with regulation relating to network vandalism, which should help.

Altron management describes Africa as having great potential for growth, while being a difficult market with unique regional challenges. Knowledge of local markets and a good choice in partners are very important, but conditions on the ground can be difficult. Being a high-profile listed group with standards to adhere to, Altron has had to turn its back on opportunities where business practices are somewhat ‘different’.

Altron’s Netstar has also ventured into the continent, recovering stolen vehicles and offering fleet-management services to the mining sector. The aim is to globalise Netstar, using its proven and locally developed and owned intellectual property in a global context.

Both Netstar and Autopage Cellular are now regarded as being in the mature phase in the SA market – so these operations would need to tap into emerging markets that offer greater growth opportunities. Altron is hoping for a pick-up in construction spend and is looking to grow capacity in the telematics markets. This segment of the group is signing up subscribers at a rate of around a thousand a month, with the aim doubling this rate by the end of 2012.

Netstar recently hit a R1-billion revenue milestone and is looking at acquisitions in Latin America, walking away from a few in which the due diligence process revealed some unacceptable risks.

Autopage’s ARPU has been under pressure, but this is being mitigated by cost savings, more value-add services and increased data penetration. Similarly, as margins come down, Reunert’s Nashua Mobile strategy is becoming more about client retention than winning new customers. In 2011 it acquired ECN Telecommunications to fight against declining ARPUs – but this deal has turned litigious as the previous ECN CEO subsequently launched a competitive product.

Ellies Holdings is a new kid on the block in terms of listing, even though it has been around for more than 30 years. Its staple products of plugs, adaptors and antennae are well known, but it has broadened its base in recent years to offer a significant range of commercial products and applications. Ellies has recently benefited from infrastructural electronics, with the majority of its business being done outside of SA, with its sights on the African mining sector.

There has also been a focus on sustainability and Ellies is working with Eskom on energy-saving devices. Its wholesale consumer product environment is being knocked by the falling rand, increased dollar prices and a scared consumer. To fund projects, Ellies has undergone balance-sheet restructuring, particularly the conversion of short- into long-term debt, thereby building growth through higher gearing, although still at acceptable levels.

Several companies in the sector should benefit from the long-awaited switch over from analogue to digital television. In line with most other countries, SA has committed to switching terrestrial television broadcasting from analogue to digital to liberate much-needed bandwidth. This process has been agonisingly slow, with much vacillation from government and the SABC.

Analysts have not been happy with corporate governance in this sector. Altech was plagued by the loss of COO Jeffrey Hedberg a few months after his appointment. Altech CEO Craig Venter explained that Hedberg came in from the outside, previously in CEO positions with Telkom and Cell C – so the transition to a different role, particularly within the unique Altech culture, was not likely to work out. Over the past few years, there have been departures of a number of other key (and very long-standing) executives in the group. Reunert has also come in for criticisms on its leadership and the 2011 CEO comings and goings.

In the mix

The sector additionally has some small but exciting players. South Ocean (a small market cap) manages commodity price moves, particularly copper. Analysts see some pricing power opportunities here, meaning large-margin expansion and earnings growth, riding off Eskom and government infrastructure projects. The Radiant Lighting Division is considered to be a consistent performer with massive growth opportunities into Africa.

Market commentators are also complementary about Consolidated Infrastructure and consider it to have good management, with potential to be a meaningful player in sub-Saharan Africa as well as in the renewable energy space. Jasco offers a range of solutions in telecoms, manufacturing and domestic products and security to a range of industries.

With a presence in 56 countries, Digicore is investing heavily in the long-term future with big research and development expenditure. It has piloted tap-and-go payment cards to be used in the taxi industry and provides telematic solutions to Discovery’s short-term insurance operation. Its significant upfront investment means Digicore must now focus on bridging the gap between its revenue and profit trends, and getting the bottom line up.

Other companies in the sector include Amecor (which provides electronic security and power solutions), Control Instruments (which services the automotive industry), ARB (a distributor of power cables, overhead line conductors, light fittings and lamps) and Zimbabwean-based Cafca (a cable manufacturer and part of the Reunert group). Some of these small players – especially those with a reach into Africa, and/or with stable annuity income streams – could well see themselves as part of future corporate action as they offer appealing operational leverage opportunities.