TRADE OF THE MONTH

We suggest a long position in Shoprite and a short one in Pick n Pay

Long Shoprite, short Pick n Pay

OUR trade this month pits food retail giants Shoprite and Pick n Pay against each other. Our selection of a long position in Shoprite and a short position in Pick n Pay reverses what would have been an ideal trade during the first 10 months of 2014, during which Pick n Pay’s share price hit an all-time high, trouncing Shoprite’s, which fell 17%.

This opened up a 20 percentage point performance advantage in favour of Pick n Pay over the period. The performance gap is closing fast and, we believe, will continue to move in favour of Shoprite.

Fuelling enthusiasm for Pick n Pay were its results for the 52 weeks to 2 March 2014. Beating market expectations, headline EPS (HEPS) jumped 43% above the previous year, seemingly confirming hopes that Richard Brasher, CE since February 2013, was fast restoring the retailer to health. But Brasher is a realist not prone to misleading the market. The results, he said, reflected a stabilisation of the business still at the start of its recovery.

A key aspect of the recovery will be to regain market share lost during the years it failed to keep up with new store openings by its rivals. Addressing this through an aggressive expansion of Pick n Pay’s store footprint is part of Brasher’s strategy.

But in an intensely competitive market it will not be easy and, indeed, Pick n Pay has yet to reverse loss of market share.

The 7.1% year-on-year rise in sales it reported in the 26 weeks to August reflects this. Adjusted for its internal 6.7% food price inflation, volume was up only 0.4%. This was in a food retail sector where volumes are growing at an annual rate of some 2%.

Pick n Pay faces tough opposition from Shoprite, which, CE Whitey Basson has declared, will defend its leading market position aggressively. It is living up to that promise. In Shoprite’s trading update for the three months to September, the first quarter of its financial year, it reported supermarket sales in SA up 11.9% year-on-year and total sales up 12,1%. South African food volume growth was impressive, rising a hefty 5.9% after adjusting for 6% internal price inflation.

Shoprite is not the only tough competitor facing Pick n Pay. Woolworths continues to power ahead thanks to its strategy of increasing store space and offering a far wider product range. In Woolworths, year-to-June food sales volume rose a market-beating 6.9%.

Spar is also making inroads. Notable was Spar’s performance in the second half of its year to September, with volume growth coming through at about 3.3%.

Pick n Pay’s share price has eased slightly from its recent high. But it remains priced for perfection on a 38 PE. Based on a consensus forecast by 15 analysts polled by I-Net Bridge, Pick n Pay’s HEPS will rise 27% in its year to April 2015, enough to trim its PE to a still demanding 33. Any sign of a slip would be harshly punished. The risk is that Pick n Pay will have to sacrifice margin if it is to at least hold market share.

It is a high risk, and has seemingly already blunting enthusiasm for the company.

Shoprite, by contrast, is trading at a far less demanding 24.5 PE in line with its mean since the 2009 equity market low. A consensus forecast looks to Shoprite lifting HEPS 12% in its year to June 2015, putting it on a forward 22 PE. On its first quarter showing the forecast appears conservative. Importantly, the aggressive pace of store openings, a big drag on profitability in the first year of operation, has slowed markedly.

Our trade is based on what we view as a high probability that Pick n Pay’s share price will fall on heightened concerns related to market share loss and margins. Strongly in Shoprite’s favour is its ability to grow market share vigorously and a likelihood that its forecasts earnings will be revised upwards.