Invest DIY Understanding the retailer sector
One of the main features of investing is to understand the different sectors, what drives profits in a sector and what metrics are important. While many bits of fundamental data are the same regardless of the sector (such as cash flow, balance sheet, debt ratios and the like), equally each sector also has its own individual data. Over the next couple of weeks I will focus on different sectors, looking at what makes it different and what matters.
This week I want to start with retailers, most have published sales updates for the holiday period and will soon be releasing results that, on the surface, will probably show modest growth.
First and foremost is the same store issue. Retailers are always adding new stores and this boosts growth, so we need to look at same store growth to get an idea if the existing business is growing. Further, we need to remove inflation from this same store growth to see if it experienced real growth or if it was just benefitting from inflation. For example, 15% growth with 9% same store growth and inf lation of 6% actually means 3% real growth. Not bad for a large business but at the same time it’s not setting the world alight. Sure, the 15% top-line growth is what falls down to HEPS and dividends, but we want to get an idea for the underlying strength of the business.
Another very important number is operating profit margin: this is the profit before taking into account interest payments and finance costs and it is the profit made for every R1 of revenue – higher is naturally better and different products will have different levels, for example, food is much lower than clothing. Here we see Shoprite* with an operating margin of 5.8% across the group (the rest of Africa has higher margins than SA due to lower competition) and Woolworths* at 9.8% with its clothing mix at higher margins. Pick n Pay has an operating margin of around 1%. Aside from the low level of profit, it also means that Shoprite has a lot more space to compete against Pick n Pay while the latter is desperately trying to get that number up above 3%.
Inventories is another important number, this is the measure of how much stock retailers have, and they typically have a lot. The old fashioned way of looking at the number is ‘stock days’: how long will the current stock holding last at the current rate of sales. Many no longer publish stock days so we can use current inventories against revenue as a percentage. Here one has to watch out for a rising number that could indicate bad purchasing by the company, the stock of which it is now sitting with, unable to sell it as fast as it would like and with the risk being having to sell at a discount (loss) or even writing it off. The food retailers have their inventory control sorted, but clothing and furniture are a lot more risky as fashions and trends change and if management misread the trends it could be stuck.
We can also run a bunch of other useful stats that help us understand how efficient and profitable a retailer is. For example, sales or profit per square metre and per staff member. In both cases the higher the number the better, and both of these are pieces of data that I pull out of the annual report every year (I have to crunch them myself most times). I compare not only against previous years but also against competition in the sector.
Simon Brown heads justonelap.com, a free resource of financial information and investment education.
*The writer owns shares in Shoprite and Woolworths.