Should you be shop­ping for re­tail shares?

Finweek English Edition - - News - By Marcia Klein

With con­sumers re­main­ing un­der sus­tained pres­sure, re­tail­ers con­tinue to strug­gle – in most cases re­ly­ing on fes­tive pe­ri­ods to boost num­bers. Are there any in­vest­ment op­por­tu­ni­ties in this sec­tor at the mo­ment? An­a­lysts ex­plain why in­vestors should con­tinue to ap­proach with cau­tion.

don’t let the hordes at the tills on Black Fri­day, or the busy malls in the run-up to Christ­mas fool you. These are just a few high­lights in what has oth­er­wise been a bleak time for cloth­ing re­tail­ers. In fact, many are pin­ning their hopes on these spe­cial events, sales and con­stant mark­downs just to keep go­ing, most no­tably Ed­con – the for­mer dar­ling of the sec­tor – which is now strug­gling to stay afloat.

The sales and earn­ings pres­sure on the ma­jor re­tail­ers and their fight for mar­ket share in an in­creas­ingly com­pet­i­tive and crowded mar­ket are ev­i­dent. Their share prices, al­though un­der pres­sure, re­main de­mand­ing on the whole and not nec­es­sar­ily a good in­vest­ment right now, ac­cord­ing to an­a­lysts.

The prob­lem for in­vestors is that the com­pa­nies that are do­ing well, like Mr Price, are trad­ing on pretty de­mand­ing price-toearn­ings ra­tios (P/E) – in the case of Mr Price a P/E of 22. An­a­lysts also re­main wary about the for­tunes of the rest over the next few years, in­di­cat­ing that their rel­a­tively lower P/Es should not nec­es­sar­ily be seen as a rea­son to buy, nor are they nec­es­sar­ily cheap.

Lat­est fig­ures from Stats SA show re­tail sales of textiles, cloth­ing, footwear and leather goods were up 2.8% in Septem­ber, which pretty much sums up the sec­tor’s lack­lus­tre sales trend over 2018 and sales prospects for 2019 – cer­tainly un­til the elec­tion.

Pro­duc­ing earn­ings to jus­tify a buy call on that kind of sales growth and ex­pec­ta­tions of earn­ings pres­sure is a tough ask. The re­sults of the ma­jor cloth­ing re­tail­ers show just how dif­fi­cult it has been.

In­vest­ment out­look

South African cloth­ing re­tail­ers are well-run and have done well un­der try­ing con­di­tions to get their pric­ing right and man­age sup­ply chains and gross mar­gins, says Evan Walker, 36ONE As­set Man­age­ment port­fo­lio man­ager.

The stand­out has been Mr Price “and I can’t see that chang­ing”, he says. “The share price is re­flect­ing that, and it is not cheap. Mr Price, at a P/E of more than 20, re­flects that the mar­ket keeps bet­ting on qual­ity and it re­wards qual­ity.”

But 36ONE has not been in­vested in the sec­tor. “Earn­ings in the sec­tor have done noth­ing for years, as has the re­tail in­dex, and I don’t know if over the next five years it is go­ing to be any bet­ter.”

He says the sec­tor still has way too many stores for the cur­rent GDP growth, and while re­tail­ers have done “ex­cel­lent jobs” on cost sav­ings, “that’s pretty much in the base now”, mak­ing it dif­fi­cult to keep ratch­et­ing up gross mar­gins.

“I am not sure there are levers to pull any­more,” he says. Walker says cloth­ing re­tail­ers re­main rel­a­tively ex­pen­sive, but there are al­ways go­ing to be win­ners and losers in the sec­tor, and in­vestors may still show in­ter­est in the stronger per­form­ers.

Ed­con’s loss (it is slash­ing store space and los­ing mar­ket share) has been oth­ers’ gain, par­tic­u­larly Pep­kor, Walker says. “Pep­kor is in all the ma­jor and re­gional cen­tres and it is gain­ing share be­cause it is so well-priced.”

Cloth­ing re­tail­ers are also be­ing tested by the growth in on­line shop­ping, some­thing Cas­parus Treur­nicht, port­fo­lio man­ager at Gryphon As­set Man­agers, says they have un­der­es­ti­mated.

Look­ing at what is go­ing on in prop­erty, re­tail­ers are hav­ing to deal with less foot­fall, and strug­gling mar­ginal malls, with more and more cloth­ing re­tail go­ing on­line. Be­tween the growth in on­line sales and con­tin­ued com­pe­ti­tion from global re­tail­ers com­ing to South Africa, re­tail­ers have their work cut out to stay in the game.

If the global growth cy­cle comes down harder than ex­pected, con­sumer stocks can ex­pect a tough ride,Treur­nicht says. Ev­ery­one is strug­gling to keep mar­ket share, and the sec­tor is prob­a­bly over-in­vested.

MRP is re­garded by an­a­lysts as the stand­out per­former in the sec­tor. In the six months to Septem­ber, head­line earn­ings were up 11.6% and di­luted head­line earn­ings 11.1%.

Chief fi­nan­cial of­fi­cer Mark Blair, who will take over as CEO at Mr Price in 2019, said cloth­ing and home­ware sales were ahead of the mar­ket, in­di­cat­ing it has taken mar­ket share from its com­peti­tors.

These earn­ings were achieved de­spite top-line strain, with to­tal rev­enue gain­ing 7.8% to R10.5bn – al­though re­tail sales growth was 6.6% and com­pa­ra­ble store growth just 3.9%, with the boost to to­tal rev­enue com­ing from fi­nan­cial ser­vices and cel­lu­lar sales. How­ever, cloth­ing sales were rel­a­tively strong, with ap­parel sales grow­ing 6.2%, with growth from Mr Price at 5.9% and Mi­la­dys at 8.3%.

MRP said its re­tail sell­ing price inflation was 4.5% and it sold 100m units, 2.9% more than the pre­vi­ous year, in its 1 286 stores. On­line sales are grow­ing strongly at over 30%.

Treur­nicht says re­sults were rea­son­able

given the state of con­sumer dis­pos­able in­come, but the P/E is de­mand­ing. “At a P/E above 20 we would want to see earn­ings in­creases of at least 10%, and I am not sure we are go­ing to see that [among cloth­ing re­tail­ers] in the next year or so,” he says.

36ONE’s Walker says Mr Price’s out­per­for­mance is ev­i­dent in both the num­bers and share price, and while topline growth is un­der pres­sure, it is in the best po­si­tion among the cloth­ing re­tail­ers in the cur­rent en­vi­ron­ment.

“Mr Price has had one bad year in 20 – that is a phe­nom­e­nal record. It had a brief patch where we thought it had lost its way, but it pulled back so fast and im­pres­sively.”

Gross mar­gins have been held well, he says. Mr Price ben­e­fits from a num­ber of strate­gic ad­van­tages – it has low prices and it is a largely cash busi­ness, with 83.4% of sales be­ing cash. It is also pri­mar­ily fo­cused on South Africa and has avoided the costly mis­takes made by Wool­worths and Truworths in their off­shore ex­pan­sions.

TFG re­ported group re­tail turnover up 28.6% in the six months to Septem­ber, re­flect­ing 8.4% growth in TFG Africa, 50.7% (in pounds) for TFG London and 170.7% (in Aus­tralian dol­lars) for TFG Aus­tralia. In­clud­ing com­pa­ra­ble num­bers for com­pa­nies bought last year, TFG London’s turnover grew 2.3% and Aus­tralia 14.9%, while com­pa­ra­ble store turnover growth for TFG Africa was 4.8%. On­line turnover now con­trib­utes 7.9% of group turnover.

To­tal head­line earn­ings grew by 14.3% to R1.2bn and ad­justed head­line earn­ings grew 8.3%, or by 3.4% ex­clud­ing ac­qui­si­tion costs.

The re­sults were gen­er­ally well­re­ceived by the mar­ket, al­though there

The group launched

the TFG mar­ket­place myTFG­, which will com­pete with fast-grow­ing chan­nels like Takealot and Su­per­bal­ist.

have been some ques­tions by an­a­lysts, in­clud­ing Walker, about its off­shore strat­egy. (See side­bar)

In the year to July, Truworths’ sales dropped 2.7%, or 0.2% on a com­pa­ra­ble ba­sis, while head­line earn­ings were down 7.3%, or 1.3% on a com­pa­ra­ble ba­sis.

Not only were things tough in South Africa, but sales at its UK-based out­let, Of­fice, were down. There is con­cern that man­age­ment’s eye was fo­cused on fix­ing Of­fice at the ex­pense of its lo­cal cloth­ing op­er­a­tions, which seem to be chug­ging along.The mar­ket re­mains wary of Truworths’ abil­ity to make a suc­cess of over­seas ex­pan­sion given its pre­vi­ous his­tory with Sports­girl in Aus­tralia.

Man­age­ment said it be­lieved its new e-com­merce site, in­tro­duc­tion of lay-byes, ex­pan­sion of its Loads of Liv­ing busi­ness and the roll­out of a new store con­cept will en­able it to re­main com­pet­i­tive.

In­vestors have raised con­cerns over its lack­lus­tre re­sults as well as with its man­age­ment team and board, in­di­cat­ing they are long in the tooth and are not adapt­ing to change, in­clud­ing race and gen­der trans­for­ma­tion – a charge which the group has de­nied.

A late-Oc­to­ber busi­ness up­date said re­tail sales for the 16 weeks to 21 Oc­to­ber had in­creased by 4.5%. Ex­clud­ing Of­fice in the UK, sales were up 3.6% while it ex­pe­ri­enced prod­uct price de­fla­tion of 1.1%, and 70% of sales were on ac­count. Much of the mar­ket’s un­hap­pi­ness with re­tail­ers has been di­rected to­wards Wool­worths, which has dis­ap­pointed with weak re­sults in a con­sumer spend­ing en­vi­ron­ment it de­scribed as be­ing bi­ased to­wards clear­ance and pro­mo­tions.

In the year to June, group sales grew just 1.6% with a con­sid­er­able slow­down in the sec­ond half.

Mar­gins were un­der pres­sure and head­line earn­ings and ad­justed head­line earn­ings dropped by 17.8% and 12.8% re­spec­tively.

Fash­ion, beauty and home sales dropped 1.5%, while price in­creases were held at 0.8%. Com­pa­ra­ble store sales were 4.1% lower, with net re­tail space grow­ing by 2.5%.

Ac­cord­ing to Wool­worths, wom­enswear un­der­per­formed “due to prod­uct misses, par­tic­u­larly in the Edi­tion brand, while

beauty and lin­gerie per­formed much bet­ter”. It has, how­ever, been gain­ing on­line sales, which grew 77%.

The in­crease in pro­mo­tions and mark­downs saw gross profit mar­gins de­cline by 120 ba­sis points to 46.7%.

Wool­worths has been plagued by its David Jones dis­as­ter in Aus­tralia, on which it wrote down R7bn, and there is some frus­tra­tion among an­a­lysts that the group has been slow to turn it around and fix the pric­ing and mer­chan­dis­ing is­sues it has in South Africa.

Walker said Wool­worths has been rolling out big­ger food store for­mats but has not been in­clud­ing ba­sic cloth­ing items, as do some of the ma­jor re­tail­ers. “This was in my view a mis­take. The malls it op­er­ates in have got MRP and Pick n Pay cloth­ing tak­ing sales from it.

“Its big growth in food has been to the detri­ment of cloth­ing, and it has been fool­ish not rolling out lim­ited lines in new stores.

“Ob­vi­ously it has had fash­ion is­sues, but it seems to be third year into the is­sue and it has still not sorted it out. Its ap­parel got too ex­pen­sive rel­a­tive to its cus­tomer base – it did not re-pro­file some price points to take this mar­ket into ac­count.”

The group, pre­vi­ously Stein­hoff Africa Re­tail (STAR), has had to pull it­self out of the Stein­hoff dis­as­ter and Tekkie Town de­ba­cle and try to re­claim its po­si­tion as a trusted in­vest­ment choice in the sec­tor.

In the year to Septem­ber, rev­enue grew 10.9% to R64.2bn. Op­er­at­ing profit be­fore cap­i­tal items and one-off costs in­creased sim­i­larly.

But its ex­po­sure to a cor­po­rate fi­nan­cial guar­an­tee and as­so­ci­ated loans, re­sult­ing in one-off costs of R511m, 882m new shares in is­sue and the ac­qui­si­tion of Tekkie Town and Build­ing Sup­ply Group, among other things, saw its earn­ings slump.

Un­der­ly­ing op­er­a­tions look good. The group re­mains ex­pan­sion­ary, open­ing 428 stores (335 in cloth­ing, footwear and home) and in­creas­ing re­tail space by 3.6%, bring­ing its to­tal store base to an en­vi­able 5 236 stores. PEP and Ack­er­mans sales growth was 8%, or 3.3% com­pa­ra­ble with de­fla­tion at 4.5%.

Now re­leased from Stein­hoff-re­lated guar­an­tees, in­vestors may look at the group afresh go­ing for­ward.

The R18bn re­fi­nanc­ing of the Stein­hoff share­holder fund­ing and re­lease from re­lated fi­nan­cial guar­an­tees will cut it loose from what it de­scribes as “cor­po­rate noise” around Stein­hoff.

How­ever, some of the “noise” is of its own mak­ing. Pep­kor’s ad­mis­sion that it made “in­ad­e­quate dis­clo­sures” in its listing and 2017 fi­nan­cial state­ments, and the restul­tant R5m fine by the JSE, is un­likely to sit well with in­vestors.

Now re­leased

from Stein­hof­fre­lated guar­an­tees,

in­vestors may look

at the group afresh

go­ing for­ward.

Evan Walker Port­fo­lio man­ager at 36ONE As­set Man­age­ment

Cas­parus Treur­nicht Port­fo­lio man­ager at Gryphon As­set Man­agers

Mark Blair Chief fi­nan­cial of­fi­cer at Mr Price

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