In­vest DIY Un­der­stand­ing the re­tailer sec­tor

Finweek English Edition - - INSIDE -

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.

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