Evaluation of the use of debt by South African retail firms and the relationship between debt and profitability in these firms

Abstract

This study investigates whether the retail sector responded to the reduction of interest rates in the period 2010 to 2020 by increasing debt utilisation and whether the increased debt utilisation had a positive impact on profitability. The year 2020 was given notable attention as interest rates were at their record low in an effort to stimulate the South African economy. Measures of debt utilisation included the short-term debt ratio, the long-term debt ratio, and the total debt ratio, while profitability was measured through return on assets and return on equity. A total of 57 JSE listed retail firms were used in the study. Panel regression was used to test the relationship between debt utilisation and profitability. The findings indicate that there was an upward trend in debt utilisation over the years with a steeper increase in 2020. Positive financial leverage was only realised up to 2017 and in 2019. Although interest rates were at their all-time low in 2020, retail firms could not take advantage of this as Covid 19 impacted the benefits of cheaper debt negatively. The findings further show that there was a negative relationship between debt utilisation and profitability and that this relationship was consistent for all indicators of debt and profitability. The year 2020 worsened this relationship. These findings imply that the reduction of interest rates may lead to increases in debt utilisation, but the potential benefit of the increased debt may be eroded in adverse economic environments.