Abstract
The South African retail sector continues to experience a decline in sales and returns amidst growing external competition and a drop in consumer confidence stemming from the recent credit downgrades in the country. Yet, firms in this sector appear to maintain high debt to equity levels. This study investigated whether the capital structure practices of these firms influence their profitability. A Panel data methodology, using three regression estimators, is applied to a balanced sample of 16 retail firms listed on the Johannesburg Securities Exchange (JSE) during the period 2008-2016. The analysis estimates functions relating capital structure composition with the return on assets (ROA). Results reveal a statistically significant but negative relationship between all measures of debt (short-term, long-term, total debt) with profitability, suggesting a possible inclination towards the pecking order theory of financing behaviour, for listed retail firms. Additionally, retail firms are highly leveraged yet over 75% of this debt is short-term in nature. Policy interventions need to investigate the current restrictions on long-term debt financing which offers longerterm and affordable financing, to boost returns. While this study’s methodology differs slightly from earlier studies, it incorporates vital aspects from these studies, and simultaneously specifies a possible model fit. This helps to capture unique but salient characteristics like the transitional effects of debt financing on firm profitability. It therefore delivers some unique findings on the financing behaviour of retail firms that both in form policy change, while stimulating further research on the phenomenon.
Highlights
The study adapts this approach in two aspects; firstly, it isolates the various components of debt yet includes them into one specified model in order to assess the explanatory power of the latter, secondly, it lags certain components of debt financing in order to investigate for any possible transition effects in the debt – profitability relationship
Where Profitabilityit represents the performance of firm i at time t, Debtit represents the specific debt employed by firm i at time t and Controlit represents the control variables of firm i at time t
The ROA denotes a measure of the firms’ return on assets, SDA measures the amount of short-term debt, LDA measures the amount of long-term debt, TDA measures the amount of total debt, differenced total debt-to-total asset measure (DTDA) measures the differenced total debt, LSALES measures the size of the firm and sales per year and growth (SGROW) measures growth level in sales terms
Summary
Evaluating the financial performance of retail firms in South Africa occupies a prominent space in the corporate finance literature because current socio-economic challenges in this sector indicate high consumer debt-to-income ratios and rising utility costs that negatively impact the disposable income of households and eventually erode the forecasted revenues of the sector (Euro monitor International, 2017).This First Moving Consumer Goods (FMCG) sector, by its very nature, implies strong links between the acquisition and utilisation of operational debt, with financial performance, which, for this study, raises the empirical question; what form of debt financing is sufficient to sustain profitability and growth in this sector?The debate on firm capital structure and its relevance to financial performance remains unresolved stemming from the 1958 seminal works of Modigliani and Miller (MM) who under perfect market conditions found no relevance of debt to firm performance. Other capital structure theories arising out of empirical contention reject the possibility of a timely convergence towards a target debt-to-equity ratio and suggest, among others, management’s ability to trade overpriced shares in a market-timing fashion, when information asymmetries exist (Baker & Wugler, 2002; Flannery & Rangan, 2006). Such cases indicate that firms rarely converge to absolute target debt ratios (or that the process of doing so takes time!), implying a possible dynamic nature of most firms’ capital structures, with potential advantages and disadvantages for creating value. A significant portion of the sales in this sector are managed by way of credit which exerts pressure on operating cash flows and exacerbates the financing problem
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