More vanilla than bubbly

Pepkor has a strong reputation on the local market. But with a share price return of just 2% since the start of 2019, that reputation hasn’t been earned by making recent investors wealthy.

Among local clothing retailers, Pepkor has been the strongest fish trying to swim upstream in this economy. Since the start of 2019, TFG is down 16%, Mr Price is down 20% and Truworths has lost nearly 40% of its value. Woolworths has been carried by its grocery business, with the share price down about 3% over this period.

There are no winners here. Only different degrees of losers.

Steinhoff still holds just over 50% in Pepkor. An important recent development is that Pepkor has recovered all its exposure related to a financial guarantee that had been provided on behalf of a management investment company that had invested in Steinhoff shares. The implementation of the Steinhoff global settlement put this issue to bed and all related claims and litigation were settled. Having previously provided in full for the guarantee, this R429m recovery equated to a benefit of 12c a share in the six months to March 2022. This is a material number when headline earnings per share (HEPS) for the period were 91.5c.

Looking to the operational performance, Pepkor’s revenue for that interim period grew 3.7% (after adjusting for the disposal of John Craig) and operating profit increased 10.1% on a normalised basis (excluding the Steinhoff settlement). Normalised HEPS increased 12.1% to 79.9c. There are no fireworks here.

Pepkor is dealing with the same supply chain issues that are causing difficulties for everyone in the retail sector. Cash generated from operations fell 19% year on year despite operating profit increasing 17.6%.

Cash sales account for 93% of group sales, higher than Mr Price at 86.1% and significantly higher than TFG at 79.9%. This is important for risk management but it arguably has a downside in a time of consumer pressure.

Pepkor carries a provision in Tenacity (the clothing and general merchandise book) of 21% of the book, slightly higher than TFG’s provision of 19%. With a gross profit margin of 35.3%, this makes credit sales earnings accretive for Pepkor. In other words, credit can be an enabler of growth at a time when consumers are struggling. Within reason, this is a good strategy. Left unmanaged, it can become a disaster.

It’s worth noting that Pepkor’s Capfin book has a provision of 18%. JD Group’s provision dropped from 40% to 33%. JD Group’s credit sales are 12% of that division, as this is core to a furniture model.

Moving on, Pepkor’s clothing and general merchandise segment contributed 65.7% of group revenue and 81.8% of normalised operating profit, so this is the most important part of the business. Revenue increased 4.9% and operating profit 6.1%.

JD Group, which has brands such as Bradlows and Incredible Connection, increased sales 8.8% and operating profit 64.6%. The Building Co (Buco, which Pepkor was blocked from selling to Cashbuild by the Competition Commission) recorded a drop in sales of 1.6% and a jump in operating profit of 26.4% thanks to rationalisation efforts. The fintech segment (Flash and Capfin) reported a drop in revenue based on a change in accounting classification, and a 17% increase in operating profit to R393m, which makes this segment more profitable than JD Group or Buco (R344m and R220m respectively).

With a solid (if uninspiring) performance in the local market, Pepkor is venturing into Latin America in pursuit of growth. Most SA retailers prefer losing money in Australia or the UK instead.

There are sensible reasons why Latin America makes far more sense than either of those choices, especially when Pepkor has structured a deal to buy only 87% of Brazil’s Grupo Avenida, leaving the rest in the hands of the founders and management team. This is a relatively small deal at less than 4% of Pepkor’s market cap at the time of the transaction.

The acquisition was completed in February 2022 and Pepkor is happy with performance thus far.

Pepkor’s share price is down more than 7% this year. It only pays a final dividend, based on a policy of three times dividend cover. If we double normalised interim HEPS and apply that cover, the full-year dividend would be about 53c a share. That’s only a yield of 2.6%, which doesn’t make Pepkor compelling in this environment.

Credit can be an enabler of growth at a time when consumers are struggling. Within reason, this is a good strategy