On a path leading to the retail disasters club
Edcon is on a trajectory that could soon lead to it joining an unfortunate line-up of disasters in the SA retail sector
S A has had its fair share of retail calamities. Springing to mind are Greatermans, which folded in the late-1980s; OK Bazaars (bought by Shoprite from SA Breweries for R1 in 1997); and now, in its final death throes, Ellerines.
I have a nasty premonition they could soon be joined by another illustrious name: Edcon, SA’s largest apparel retailer through brands including Edgars, Jet, Jet Mart and Legit. Nonapparel brands in its lineup include CNA, Red Square and Boardmans.
Clearly sharing my grave concern about Edcon is the euro bond market, which has ramped up the yield on its €425m notes from an already staggering about-to-go-bust 44% in October to 66%, according to Bloomberg. Maturing in June 2019, the senior unsecured notes were issued in November 2013 at a coupon of 13,375%.
The writing has been boldly on the wall since Standard & Poor’s (S&P) downgraded the notes to a deep-junk CCC+ rating in September last year.
According to S&P, the rating signifies that the issuer is “vulnerable, and is dependent upon favourable business, financial and economic conditions to meet its financial commitments”. They are hardly the conditions facing SA retail in 2015.
The Edcon rot set in after its acquisition by US private equity firm Bain Capital in 2007 for R25bn. At the time, then-Edcon chairman Selwyn MacFarlane boldly trumpeted: “Bain Capital has the commitment and experience to help propel Edcon to new heights.”
Bain has instead overseen Edcon’s downward spiral towards disaster.
As a first step following Edcon’s acquisition, Bain applied the standard private equity formula of adding a big dose of debt to the retailer’s thenungeared balance sheet. In the second step of the formula — grow the business and its profitability — Bain has failed abysmally, to a point where Edcon is technically insolvent.
Telling a tale of operational blunders is Edcon’s total sales growth of only 22% in its five financial years to March 2014.
Its competitors have had a field day at its expense, with the apparel divisions of Mr Price, The Foschini Group, Truworths and Woolworths lifting sales by an average of 73% over the five years.
Adding further to Edcon’s woes has been plummeting profitability, reflected in a trading margin which fell from 12,9% of sales in 2006 to a new low of 4,8% in its year to March 2014. It has left Edcon hopelessly unable to adequately service its debt, which stood at R25,5bn at the end of its half-year to September 2014.
Interest payments in the six months were a hefty R1,56bn, dwarfing trading profit more than three-fold. It left Edcon nursing a net loss of R1,18bn, a total accumulated loss of R15,4bn and equity, propped up by an R8,3bn loan from Bain, at a negative R4,9bn.
It is not a pretty picture and it is now not a matter of if but when Edcon will run out of cash. Some analysts give it 12 months, others only six months.
Either way, drastic measures are called for. Bain could recapitalise Edcon but I doubt it would be prepared to throw more good money after bad.
An asset sale is a possibility with arguably the most likely candidate the 702-store Jet and Legit discount division.
With annual sales of over R10bn and an operating profit of R1,2bn, the division — if debtfree — could sell for anywhere from R6bn to R8bn.
It would be a big acquisition for any SA retailer and if a buyer could be found it would give Edcon time — but still fall far short of solving its debt-servicing dilemma.
Another alternative is for bond holders to take an African Bank-style haircut or swap a big portion of their bonds for equity.
I suspect this is the only real hope Edcon has of survival. But it is a distant hope and already the possibility of Edcon going into business rescue is doing the rounds in the market.
The dire straits Edcon finds itself in bring to mind the first interview I had with Pick n Pay CE Richard Brasher in 2012. “Retailing is not complicated,” he said. “It is just hard to do well.”