Retailers in South Africa have historically enjoyed good returns on capital, and been somewhat shielded by the kinds of price wars that have reduced retail margins to razor thinness in many developed economies. But competition is heating up at the low end of the sector in South Africa with the entrance of Walmart, and many are curious to see which was things are going to go.
To me, it looks like, if the results companies are presenting for the last year are any guide, Mr Price will remain the undisputed king of the low-end. The innovative retailer has delivered over 20% growth year after year, and in the tough environment of 2013, they managed to grow profits by 22%. It’s an impressive performance by an impressive company, particularly in light of how poorly Massmart has performed since the Walmart deal. –FD
GUGULETHU MFUPHI: Welcome back to Power Lunch. Recently, we saw retailers like Mr Price and Lewis Group publish their full-year results this week. Matthew Warren, the Head of Financial and Retailers at First Avenue Investments, joins us now to take a look at these results and to discuss the impact of the recent GDP figures and potentially, what this could mean for retailers going forward. Let’s pick up on Mr Price. David, as well, mentioned earlier at the top of the show that he’s fairly impressed with these numbers. Can you blame him?
MATTHEW WARREN: Yes, we’re shareholders and I’m still surprised by how good the results are. It’s an extremely tough environment. We know Mr Price is going to stand out compared to their peers because they’re eight percent cash sales and a lot of the pressure’s in credit retail. They offer lower price points across the formats too, so it’s a value type of purchase. We knew they’d do better, but it’s shocking. They have a 28-year earnings growth number of around 22/23 percent. They matched that this year in an extremely difficult environment, so what they’ve been doing is gaining share for three decades, and they’re gaining share even more rapidly at this stage, as things get tougher on some of their competitors.
ALEC HOGG: Twenty-one percent earnings improvement and distribution 21 percent higher. When we were in Omaha, David Shapiro was with us there as well. We went to a Value Investors’ Conference and at that conference, Pat Dorsey – the ex-Morningstar Head of Research – was speaking. From the whole world, he said ‘there’s a pocket you have to look at. In South Africa…the retailers make wonderful return on investment’ and Mr Price is proving that as well. Walmart has come into this market. So far, all we’ve seen them do is get rid of their Chief Executive, Grant Patterson. Are we going to see Walmart shaking up things or are we going to see Walmart going into the flow of this comfortable oligopoly as it is perceived from outside of this country and enjoy the benefits of these high returns?
MATTHEW WARREN: Yes, it’s a good question and one, which we focused on for a bit. Massmart already dominate hardware sales in the country. It’s a near-monopoly in the big store formats. In general merchandise, they’re by far the strongest player. That is bolstered by the Walmart ownership and the supply chain benefits that come through there. In clothing, I think they’re going to add the George brand out of Europe, so they’re going to compete a bit more in clothing, but they’re still a very small player there. They might make some progress, but I wouldn’t expect a huge impact. The potential disruption is in groceries. They’ve really floundered with that strategy so far. Frankly, they’ve opened discount formats, which they’ve already closed some of the stores they just opened. Maybe they’re getting a little better at that now in Cambridge. In Game, they’re adding Foodco, and that strategy worked very well in the States for both Walmart and Target, but it has to have its own parking lot and it has to be easy ‘in and out’. That hardly exists here in Game. So many of them are stuck in malls where it’s difficult to get in and out. They seem to be confused about who their customers are and what their strategy is in Game. Game results are a huge mess and there’s a lot to clean up.
ALEC HOGG: So they’d like to compete, but they have these obstacles, perhaps.
MATTHEW WARREN: Yes, I think the Makro format and the Builders format are doing phenomenally well, but then Games a mess and also the cash business… I think the formalisation retail is just shrinking that business and pressuring it over time.
GUGULETHU MFUPHI:Â Another [inaudible 0:03:40.0] of durable goods comes back to the furniture retailers. We had Lewis out with its results and we know their issues with Ellerines, ABIL, and the JD Group as well.
MATTHEW WARREN: Yes, results slot them in at number two in terms of where they’re ranking right now. Shoprite is by far the leader in furniture right now. They’re rapidly gaining market share with sales up north of ten percent for the last few sets of results here – their opening stores. At the bottom, you have Ellerines and JD Group haemorrhaging sales, pulling back hard-earned credit because the bad debt is so bad. They’re disrupting and deleveraging their store base. It’s a complete mess and without the parent of both those companies, they’d probably be in financial distress. It would have been good for the rest of the industry to see an exit. Instead, we just see disruption and we don’t quite know how that’s going to play out, but shrinkage is happening at those two players. Lewis, on the other hand: you see negative two percent sales, negative eight percent earnings growth…they’re doing better and I think it has to do with the rural footprint and the fact that they’re managing poor location a little better, instead of some overhead/overall corporate strategy that’s just floundering and failing. That being said, if you took the financial revenues and insurance revenues out of their earnings, their earnings would be gone. In my opinion, these are low quality earnings. They’re basically selling furniture as a path to making loans and insurance, and that’s where all their profits are coming from.
ALEC HOGG: But Ellerines did that as well, for years and years. Hence, the attraction of ABIL, but now…
MATTHEW WARREN: Yes. Ellerines want to sell the business, which they haven’t been able to do. I suggest that if you take a close look, maybe it doesn’t look better than what it looks like on paper to analysts like myself. They want to keep the credit book, so they want to control that driver of sales, which is rapidly going backwards. They have no credit appetite right now, so who would want to buy a foundering furniture retail business that’s shrinking rapidly, deleveraging, and losing money. What’s the path to profitability? You don’t even control the credit-granting portion of it. They’re going to have to give up on that idea to find a buyer. I think they’re going to really struggle to find a buyer unless the sales decline bottoms out, frankly. If you look at it now, they’re in a terrible competitive position.
GUGULETHU MFUPHI:Â One wonders if the younger [inaudible 0:06:24.6] is listening.
ALEC HOGG: Matthew’s too smart, hey.
GUGULETHU MFUPHI: Always Alec, that’s why we have him on the show.
ALEC HOGG: Of course. Well, we always have him here, but really Matthew, thank you. That was extremely insightful.
MATTHEW WARREN: Thank you, both.
GUGULETHU MFUPHI:Â I guess with the economic data that we have out as well, retail sales figures were down, and economic growth had a slow pace, so the outlook for retailers is a bit dodgy.
ALEC HOGG: Except for Mr Price – great management – you never can miss.
GUGULETHU MFUPHI:Â Exactly. Well, that was Matthew Warren, Head of Financial and Retailers at First Avenue Investments.
After the break, we take a look at investing in South Africa after the 2014 elections. Do stay tuned.
