CREDIT CONTROL

Is JD Group set for a bad debt shock?

JD GROUP increased its impairment provision in August from R557-million to R966-million. Turns out it might not be enough.

This is a crucial point for the retailer, which owns brands such as Joshua Doore, Russells, HiFi Corporation and Incredible Connection, considering that nearly onesixth of its revenue comes from “consumer finance” — the interest it charges on loans given to clients to buy its furniture and appliances.

It’s also crucial, considering how African Bank, which plays in the same LSM sandpit as JD Group, was caught short recently with CEO Leon Kirkinis offering himself up as a target for furious shareholders to throw things at.

While Abil bumped up its impairment provisions to 63.6% from 59.2%, it turned out it was far too little, far too late. Without a more than R5-billion share issue, the company would be bankrupt.

It might not be fair to compare JD Group with Abil since their credit criteria and debtors profiles are different, but essentially both companies invest in people in the lowerincome bracket by lending to them for a fee. It is that income bracket that takes the brunt of price inflation while being worst affected by soaring unemployment.

But shareholders who have seen African Bank’s 58% plunge in its share price over the past year, as it fessed up to its bad debt woes, will be keen to ensure JD Group avoids a similar fate. This is especially so because JD Group’s stock has already fallen 38% in that time. And even though it looks cheap on a price-to-earnings ratio of 7.6, analysts don’t seem that impressed by its growth prospects as most of them rate it a “hold”.

The risk factor has been the steep rise in JD Group’s debtors over the last year. Despite the stress in the economy, JD Group’s total debtors book grew by nearly a third over the past year, adding more than R2billion to a book that has now topped R8.2-billion. It might seem like great news, until you see that more than R2.1-billion of that — about 25% — is in the hands of people who are more than five months in arrears.

Even though JD Group has now bolstered its impairment provision by nearly R400-million, only about 11% of that debt is covered.

The provision even seems remarkably slim when compared with that of rival Lewis, which also sells furniture on credit but which FOCUS: JD Group has conflated operations of Incredible Connection and HiFi Corp and used them to drive down the cost of stock set aside an impairment provision equal to 17.4% of outstanding debt. A 17.4% impairment provision for JD Group would push its cover up to R1.3-billion — around R300-million more than where it is now.

Although JD Group’s results were for the 12 months to June, compared with those of only 10 months the previous year, there was no masking the fact that it was a tough year.

The company, which serves the “value-conscious mass-middle market” peddling furniture, consumer electronics, appliances, building materials and DIY, has been through a high-profile three-year re-engineering project to contain costs and drive sales.

This included retrenching 750 of the 22 000 people employed throughout the company and ratcheting up cost-saving initiatives like conflating the back-office operations of Incredible Connection and HiFi Corp and using the combined weight of both to drive down the cost of stock.

In the midst of the re-engineering project, Markus Jooste’s Steinhoff took over 50.1% of the company in a share swap that saw it only actually pay cash of about R250-million for a company worth in the region of R49billion. Jooste’s furniture retailer is the second largest in Europe.

Quite whether JD Group’s bad debt provisions are adequate came under the spotlight at JD Group’s AGM this week when Theo Botha, the relentless shareholder activist, asked whether the amount set aside for bad debts was not understated — especially as debt

The directors are comfortable about the necessary vigilance

owed by customers who had fallen into arrears by more than five months had now eclipsed a worrying R2.1-billion.

CEO David Sussman responded that: “The company [was] ... comfortable with the level. The directors are comfortable about the necessary vigilance.”

This is debatable when you consider that these customers now face a mountain of debt five times higher than they intended to pay every month, and the provision of R966million is only half of the R2.1billion they owe. Especially when people who shop at JD Group’s stores typically buy things on credit because paying cash upfront is financially impossible.

“It would be wrong to say we aren’t concerned,” Sussman said after the AGM. But he played down the risk.

Sussman said some of his customers — though he couldn’t say what historical percentage — did pay back the chunk of cash that had accumulated after they’d missed payments for a number of months.

In fact, he said, customers even more than five months in arrears sometimes got back on track.

Sussman said people in this LSM band often had all-consuming oneoff financial burdens that have to be dealt with — school fees, a funeral, a retrenchment — and once the burden had been managed the instalments kicked off again.

But even so, why not increase the impairment provision to a level at which JD Group can be better shielded from the economic storm?

Chief financial officer Jan van der Merwe responded that the provision was not something that could be manipulated— it was generated by “certain IFRS8 methodologies” which involved complicated algorithms and was endorsed by auditors Deloitte.

However, that version of the international accounting standards is based solely on historical data. It does not accommodate a changing economic context, such as a slowing economy with increasing joblessness, or even mining strikes that directly affect a large portion of the company’s customer base.

Van der Merwe said the new accounting standard, IFRS9, would be adopted at some point, and that would allow some measure of forecasting to be adopted in the calculation.