Should you be shopping for retail shares?
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.
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 myTFGworld.com, 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.
from Steinhoffrelated guarantees,
investors may look
at the group afresh
Evan Walker Portfolio manager at 36ONE Asset Management
Casparus Treurnicht Portfolio manager at Gryphon Asset Managers
Mark Blair Chief financial officer at Mr Price