Doing everything right in a difficult market
Tough times are putting consumer-facing companies’ business models to a harsh test. Even firms with business models as robust as that of diversified consumer brands company AVI find it exceptionally challenging.
“We are hanging in there, but it is not easy,” says CEO Simon Crutchley.
“We are not seeing any topline volume growth.”
In fact, in many areas volumes declined in AVI’s year to June. Among its leading food product lines, tea (Five Roses, Trinco and Freshpak) experienced a 5% volume fall, biscuits (Bakers, ProVita and Baumanns) dropped 3.7% and creamers (Ellis Brown) are 4.6% down.
Crutchley believes the current consumer sector slump is more severe than that of 2008 and 2009, when SA was dragged into recession by the global financial crisis.
“Back then there was still underlying confidence in SA and a lot of consumer credit extension,” says Crutchley. “The country is now facing serious structural problems that were not present then. Confidence is being hit hard.”
AVI did well in its year to increase revenue 8.2% to R13.2bn, an achievement that reflects the generally solid pricing power its strong brand line-up affords it. Also impressive was AVI’s success in lifting operating margins across all three of its broad operating segments: food and beverages, footwear and apparel, and personal care, which respectively account for 75%, 15% and 10% of group operating profit.
The reward was a 10.7% rise in operating profit to R2.39bn and a 9.4% rise in headline EPS (HEPS), a pace that bettered the 7.6% HEPS rise at the interim stage. The total dividend for the year was lifted 9.5%.
The results built on what has been a faultless growth
record stretching back to 2005, the year Crutchley was appointed CEO. Over the 12 years AVI has grown operating profit at an annual average of 15.2% and improved its operating margin from 9.9% to 18.1%.
Along the way shareholders have also been well rewarded in terms of dividends. In the past five years alone AVI has by way of ordinary dividends and two special dividends returned R6.53bn to shareholders, an amount well ahead of its total equity of R4.85bn at the end of June. “AVI is a very shareholder-centric business,” says Warren Jervis, manager of the Old Mutual Mid- & Small-Cap Fund. “It focuses on managing AVI with the best interests of shareholders in mind.”
AVI continues to do all the right things. On the marketing front it last year upped spending by R32m to a significant R760m, or 5.7% of sales. By comparison, Tiger Brands’ marketing spend in its most recent reporting period came in at 2.5% of sales.
“We continuously invest to improve production efficiency and build capacity,” says Crutchley. “Product innovation is also a top priority.”
But while AVI will probably be able to continue tweaking operating margins higher, what is really needed to move the profit needle meaningfully is volume growth. Here AVI finds itself the victim of its own success in having attained major market shares in many of its key product categories.
Crutchley has recognised the need for diversification and in 2005 AVI made its first move through the acquisition of luxury footwear retailer A&D Spitz. Subsequently added to AVI’s line-up as a grassroots development was high-end ladies’ and men’s fashion wear retail business Kurt Geiger.
The two fashion brands proved to be winners for AVI between 2010 and 2013, years when consumer spending fuelled by easy credit roared ahead. For example, in AVI’s year to June 2011 its fashion brands accounted for 38% of the increase in group operating profit and helped drive an overall 31% rise in HEPS.
In the three years to June 2013 AVI’s fashion brands grew their operating profit from R101m to R410m.
Then the brakes started to be applied, as a host of factors, including increasingly stringent credit extension regulations and falling consumer confidence, began weighing on consumer spending growth.
Operating profit from AVI’s fashion brand businesses have declined by almost 11% since 2013, and in AVI’s past year 24% of Spitz and Kurt Geiger sales were by way of lay-byes. AVI’s growth fortunes for now will rest on its food brands.
On a positive note, Crutch- ley says trading in the past two months of AVI’s past year was good, with some categories showing a continuation of this trend into the new year.
It suggests that AVI is positioned to again deliver HEPS growth of about 10% in its current year. With a 4% dividend yield added it would represent a solid 14% total return.
The has been enough to encourage investors to drive AVI’s share price into record high territory and its rating to a 20 p:e. It leaves AVI looking fully priced.