Overdone or still unravelling?
Pepkor was supposed to be the defensive JSE retailer. But its share price crash in the wake of disappointing numbers is a sign of investor capitulation
Of all South Africa’s apparel retailers, Pepkor was the one supposed to withstand a consumer downturn the best.
Shoppers, the argument went, would hurtle towards value brands such as Pep and Ackermans, but the performance of South Africa’s largest seller of low-income clothing shows that consumers are struggling to buy even the most basic items. Instead, they’re prioritising necessities.
Worse, Ackermans turned in a poor summer season as it got its fashion calls wrong, forcing it to discount more stock. Sales after the six months to end-March were also weak a trend echoed at Tiger Brands, which owns food brands including Koo, Jungle Oats and Tastic. Tiger reported an unexpected drop in sales in the same month, leading to a more than 20% plunge in its share price in the days after its earnings update.
Clearly, defensive isn’t always that defensive.
“Health care was also considered defensive at one stage,” says Gryphon Asset Management’s Casparus Treurnicht. “Well, share prices are never defensive. The lower end of the consumer market is getting most affected by inflation when unemployment is this high. They are buying food with cash and everything else on credit. But only when the retailer wants to grant them credit.”
He expects Pepkor to sort out its internal issues in the next year but, like the market, can’t say when the broader economy might turn. “All I know is that I do not see enough being done to rectify our economy. I would not be too hasty and buy retail stocks for now.”
He is also worried about Pepkor’s Avenida purchase in Brazil. “Time and time again our retailers lose focus of their local core market when they buy overseas.”
How did Ackermans, a brand that rarely puts a foot wrong, mess up its fashion calls so badly? “Especially as the error predominantly occurred in boys wear, which is supposed to be a low fashion and stable category,” says Damon Buss, senior equity analyst at M&G Investments.
“Management has explained the error as the buying team misreading the buying patterns of the substantial number of new customers gained during Covid.” This resulted in the ranges last summer and this winter having a higher weighting to midor high-priced product when the core Ackermans customer is lower income.
“There was a higher proportion of multi-buys [such as three packs] on sale, while the Ackermans customer is cash constrained and normally buys items individually. And the proportion of ‘fashion’ colours was increased well above historic levels.”
Buss says Pepkor’s lead times are relatively long at six to nine months, with limited ability to reduce orders or adapt an order, so mistakes of this nature affect the business for a longer period. He lauds the group for relatively quick action and hiring a new CEO for Ackermans and Ackermans Woman, the other division hampered by fashion mistakes.
“The fresh set of eyes and a return to focus buying for the core customer should result in an improved performance in Ackermans in its summer 2023 range.”
There’s nothing Pepkor can do about the dismal economy. But Buss says Pepkor’s focus on being a cash retailer, offering “exceptional” value, should stand it in good stead. “A nonrepeat of the fashion mistakes will be positive for both sales and earnings.” And completing the supply chain to support a more aggressive rollout of stores in Avenida, Pepkor’s Brazilian business, could improve the market’s confidence in Pepkor’s ability to grow earnings. He also says it needs to build out and monetise the multiple alternative revenue streams it has, such as Paxi, its parcel delivery service, and Flash, its fintech operation that enables small businesses to offer affordable payment options where profit grew 20% over the first half.
In the meantime, consumers are increasingly turning to debt to survive. Debt counselling company DebtBusters has
seen a spike in counselling (up 40%) and debt management (up 92%) against the same period last year.
“People are overstretched because they need to put food on the table. People aren’t going on luxury holidays, people are under a lot of strain. Incomes have not increased in a meaningful way,” says Benay Sager, head of DebtBusters.
The combination of the relentless rise in interest rates and inflation is hurting higher-income groups too, and Sager warns that the full impact of rate hikes and load-shedding still needs to play out. “It’s tough to be optimistic.”
However, he says, “the one thing that stands out in South Africa is the resilience of the people and ability to make a plan, and there’s a huge informal economy.”
DebtBusters says that in real terms, most South Africans had 38% less disposable income this year compared with 2016 due mainly to high inflation, resulting in the need to supplement this income with unsecured borrowing. On average, consumers have 30% more unsecured debt compared with 2016. Those taking home R20,000-plus have unsecured debt levels that are 67% higher than 2016.
Total debt levels (which include secured and unsecured debt) have increased by 17% against 2016, and unsecured debt is being used as a lifeline by many to supplement their incomes. Makwe Masilela, chief investment officer at Makwe Fund Managers, says Pepkor is a clear reflection of the country’s main economy.
“We will have to push our clothes longer than we normally do. But given their [Pepkor’s] balance sheet they will probably be able to survive this period. They managed to take some market share in some key market categories, it’s not all doom and gloom.”
Masilela also likes the fact that Pepkor is a serious player in the mobile industry. “It’s a good business proposition.” As to what could be a catalyst for improvement, he says the group needs to continue to use its influence to introduce structural reforms and improve the ease of doing business. While Pepkor’s earnings were down, the declines, superficially at least, were hardly catastrophic: headline earnings per share fell 11.9% to 80.8c for the interim period to endMarch. Same-store sales increased 0.5%, but average prices were up 5.8%, indicating fewer items had been sold.
Both Avenida and Pep Africa recorded growth; Avenida, now accounting for 4% of group revenue, posted a better than expected increase in sales volume growth of 15.8%.
Still, Richard Cheesman, senior investment analyst at Protea Capital Management, points out that significant items had to be adjusted for, to determine how the group’s core operations performed. Adjusting for a low tax rate and insurance proceeds relating to income lost during prior periods, among others, the group’s underlying performance was meaningfully below the reported headline numbers. Perhaps because of Pepkor’s 20% share price slide this year, buyers are now emerging: investment bank Citi has upgraded Pepkor to “buy”, arguing that the reaction has been overdone.