Do­ing ev­ery­thing right in a dif­fi­cult market

Financial Mail - Investors Monthly - - Analysis - Stafford Thomas

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.

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