Beware of the hikes
Strong management has helped with good returns, but investors should note that there are warning lights, writes
January and February are usually busy months for investors due to the volumes of trading updates from listed companies as they prepare to go into their “closed” periods a month before their accounting year-end.
These trading updates prepare investors for what to expect from the imminent release of company results and give a glimpse of how the business has fared over the past quarter, six months or year. Though obviously historical by nature, they often reveal the mood of management over the near term and can be a piece of the puzzle informing your decision-making when looking at a business you are invested in or wanting to invest in.
For those with a particular interest in the retail sector, the recent trading updates from various companies in this sector has been educational.
Combine this company information with economic data releases such as monthly retail sales statistics and consumer price index (CPI) data, which measures change in prices for a range of goods and services, and you start getting a feel for the temperature of the sector over the short to medium term.
SA retail sector management teams have had to deal with the global Covid fallout since March 2020 (with some bizarre restrictions during the initial days of local regulations — who could ever forget walking into a local store and not being able to buy cooked chicken, flip-flops or baby clothing!), as well as the accompanying lacklustre economy with ongoing pressure on consumer spending (though some support from grant payments has eased the pain).
They have also had to deal with the blatant theft and destruction that occurred in July 2021 as a result of the jailing of former president
Jacob Zuma, who refused to obey a constitutional court order (ironically the very constitution he swore to uphold).
The damage caused to the economy by this looting was immense — amounting to about R50bn, excluding the hit to unemployment that has followed as businesses have had to tread water and use future capex spend to rebuild rather than invest and grow (though most listed companies would have had some form of insurance, there is almost always a shortfall).
The impact on the retail sector was swift and severe. Businesses had to deal with huge stock losses as well as physical damage to stores. Pepkor, for example, reported that 549 stores were damaged.
Retail investors who held their nerve and invested through the pandemic and July unrest have been rewarded with some decent share price movements.
And the current batch of trading updates of companies in this sector will give them some more colour and help in making the “What to do now?” decision.
Furniture retailer Lewis, whose year-end is March, released a nine-month trading update for the period ended December 2021.
The group reported that its revenue for the nine months has increased by 8% while its merchandise sales grew by 12.7% (or, ignoring new stores opened during the period, its comparable sales grew by 10.3%).
Keep in mind that the prior comparable period’s base did include six weeks of almost no trading as a result of the hard lockdown.
When you consider that during the current reported period the group had 57 stores looted and damaged in the July unrest, and has been able to get all but three of its stores back up and trading again, this is a remarkable performance.
The group has also continued to improve its debtors book, with the collection rate improving to 79.7%. Improvements here are important when you consider that, as per its first-half results, its credit sales are 50.6% of the total sales mix.
The January trading update builds on the solid first-half results that the group released for the period ended September 2021.
“Despite the rich valuation, we still think Mr Price is a quality counter deserving a place in a long-term portfolio
Though the share price has reacted strongly over the past 12 months, IM has previously written about the company being a consistently good dividend payer and despite the stunning gains in the share price, the company remains cheap on most valuation metrics.
Though increased government grant payments may fall away some time in the future, Lewis will continue to benefit from them for now (and it seems increasingly likely, at the time of writing, that they would be extended at the February 23 budget).
Investors can also take some guidance (and benefit) from management, which clearly believes that the future is still rosy, having spent some R104.5m of cash buying back the company’s own ordinary shares (amounting to 3.3% of its issued share capital) during October and November last year.
Pepkor also released a trading update to shareholders in January, covering the threemonth period ended December 2021.
This update demonstrated the group’s ability to achieve consistent sales growth despite volatile trading environments.
Considering that the group had 549 stores affected during July 2021 and 161 of these had not reopened at the start of the reported quarter (at the time of the trading update 99 stores still remain closed), plus the strong base effect in the comparable period, a 1.3% growth in revenue to R22.8bn for the quarter is not half bad.
What demonstrates the quality of this business even more is that when you compare the recent update with that of the comparable period of 2019 (that is, before Covid), the group achieved sales growth of 10.9%.
Given all that happened between those two years, it could well be deemed a brilliant performance.
For those who took advantage of investing during the peak of Covid and remained invested during some stomachchurning moments, the share price gain of more than 100% has been a spectacular return.
But that’s the past — what about investing new money now?
IM believes that though Pepkor is not the proverbial “dripping roast”, it is also not excessively priced considering its absolute valuation and relative to its peers.
It remains a quality cashgenerating business with a strategy focused on strengthening the balance sheet.
However, despite having proved its credentials of consistent sales growth irrespective of how volatile the trading environments might have been over the past two years, these credentials may be tested again as we move into a higher inflation environment, with wallets under increasing pressure, especially in the lower-income bracket, as interest rates begin to rise.
Mr Price also released a trading update in January, showing that the group had a solid quarter.
Excluding its recent acquisitions, Yuppiechef and Power Fashion, the group grew its retail sales and other income (RSOI) line by 7.2% to R8.3bn.
Including the two acquired businesses, RSOI was up 19.2% to R9.3bn, giving a good indication of what these two businesses can contribute in future.
The group faced some headwinds during the period, which included starting the quarter with 41 fewer stores that had not reopened after the looting in July.
Mr Price did experience short-term market share losses, especially during October and November, as it protected its gross margin (even managing to expand its gross margin by 60 basis points) by focusing on selling more full-price items within a retail environment which was highly price competitive and full of sales and promotions.
The group’s acquisition of Yuppiechef helped grow its online sales by about 51.8% and though online sales are still small (with a 2.7% contribution to total retail sales), e-commerce is an important growth area for the group and it will continue to spend in this area.
In the April 2020 edition of IM, during the height of Covid restrictions, we wrote in our piece on Mr Price that “one rarely finds value and good news at the same time” and for long-term, patient investors, it may be worth looking at a business like Mr Price, “which has a sound balance sheet and an experienced, entrepreneurial and proactive management team, at a discounted price”.
With a bit of luck on our side, that prediction worked out well.
Its share price has doubled since then, so its current valuation may now be leaving little room for error.
Despite the rich valuation, however, we have not changed our view on management and the quality of the business, and still think Mr Price is a quality counter deserving a place in a long-term portfolio (albeit with its weighting adjusted for the recent price increase).
Unfortunately for retail investors (and there is always a cautionary with investing), we are starting to see inflation creep up; the December CPI number was higher than most expected, at 5.9% year on year.
This means that we are in all likelihood going to see more interest rate hikes — like the ones we saw in November and again in January — when the Reserve Bank’s monetary policy committee meets again in March.
Investors will need to take this into account when screening for ideas to invest in and keep in mind that increases in interest rates and the fuel price will start to squeeze consumer wallets, especially in the lowerincome groups.
But trading in this type of environment is nothing new for Lewis, Pepkor and Mr Price, which, with astute management teams and decent balance sheets, may even use a worsened environment to find bolton acquisitions both in SA and internationally.
Any drops in share prices because of the nature of the retail cycle may therefore provide opportunities for patient investors who are prepared to invest through the economic cycle on a longerterm basis.