By Craig Martin
If there was ever any doubt that investors in retailers would be fickle when the news turned bad, then you just need to look at Truworths International Ltd (TRU) dramatic fall yesterday. It had closed at 7450c on 5th of November and was pushed down over 10% to 6700c at once stage, to slightly recover and close at 6900c.
I don’t believe the fall had much to do with the announcement of CEO designate, Jean-Christophe Garbino. Granted, the departing CEO, Michael Mark, has been at the company for 23 years and has often been credited for Truworths success as a world-class clothing retailer, but the market has known about his departure as CEO for many months now. If anything, the statement clarified that he is likely to still remain on the Board, which should have been positive news.
Rather, the aggressive selling had more to do with the poor “business update” which indicated that increases were a mere 4,7% to R3,7 billion over the first 18 weeks. The growth was barely above product inflation which is around 9% per annum.
The second warning in that update was that only 45% of sales were on credit. Truworths has built its business on consumers simply swiping and paying off over 6-months, interest-free. In fact, Truworths incentivises you for using your card, with competitions and discount vouchers. So it is little wonder that historically more than 70% of its sales has been on credit (see table) and this decline could be the evidence that consumer over-indebtedness is stifling new sales.
In an earlier article that I wrote for BizNews on dividends,  I recommended that one could still hold The Foschini Group Ltd (TFG) for dividends, but I had concerns about Truworths, particularly the possibility of them needing to write off debt. Well, TFG published their interim results yesterday and they did offer a nice dividend increase of 8,2% to 263cps – with more than 600c in gross dividends expected from TFG for the year, that places them on a yield of 4,9%. However, I am still of the view that bad debt write-offs at Truworths will surprise the market even more than the slow top-line growth that we saw in this “business update”.
In a previous “business update” the company had indicated that about three quarters of new account applications are declined. This “business update” highlights that even those debtors who made it through their stringent credit criteria were struggling to make repayments. In fact, you will see that from 2013 to 2014 the increase in the number of active accounts was around one percent, with a mere 32 new active accounts been added. In 2011 and 2012, the growth was eleven and ten percent respectively.
Within the “business update” of 5th of November, is another little sign of problems, which many may have missed. If sales for the period was up by 4,7% and 45% of that growth was on credit, then you would expected “Gross Trade Receivables” to have increased by around 2,1%, less payments of accounts, so possibly, GTR would be flat. Instead the “business update” indicated an increase of 9% to R 4.7 billion. Essentially GTR was at R4,7 billion at the end of 2014, so how did the Debtors Book manage to increase by 9%?. The explanation that the company gives is that “account customers transitioned their 6-month interest-free account balances to 12 month interest bearing payment plans.” There is only one primary reason that customers would willingly do that – inability to make repayments.
However, I would like to present a further reason and that is the manner in which Truworths account for debtors who go under debt review. If you read through the commentary in the 2014 integrated financial report, it highlights that “the value of Group accounts under the statutory National Credit Act (NCA) debt review process has remained at similar levels to the previous reporting period. The collection of these accounts is outsourced to specialist collections agencies who ensure regular payments are received from the various payment distribution agencies. Standard write-off policies are applied to accounts under debt review and at period-end.”
Zak King, Editor of Debtfree DIGI commented that “there are challenges when changing interest rates on debtors accounts on most computerised financial systems. They are linked back to a lot of other calculations and tend to have ramifications all over the place. Generally the statements on the retailers and even some banks systems won’t match match the court order, or what the actual agreed figures in terms of the debt review process should be.”
King indicated to me that the “agency” that Truworths uses is called Consumer Friend. According to King, Consumer Friend has “got the best system around for keeping tabs on payments” and they will be able to provide a statement to debtors who request one. However, if you are under debt review and you request a statement from Truworths it will reflect your lower monthly payments as well as “normal interest and possibly penalties.”
Essentially then a person going under debt review would still be show in Truworth’s Gross Trade Receivables, if there account had a normal six-month balance, it would simply move into the realm where interest is charged. These debts are not written-off as the customer under debt review is still making regular monthly payments. In terms of Truworth;s terminology, this customer account simply becomes “non-shoppable.”
In practice, debtors may actually be paying interest as low as zero percent and over a period as long as five years. Yet, Truworths keeps those accounts on their books, charging normal interest, along with its other Debtors, provided that they maintain their monthly payment.
King says that generally “the fight happens at the end of the period” and the Creditors make their final write-downs then. King does hasten to add that “there are so few people in debt review in South Africa that this figure is proportionally just a drop in the bucket.”
Let me add that Truworths are not alone in this practice, and they have indicated that “approximately 66% of the value of accounts under debt review had been written off.” However, my concern is about the 33% of accounts that are under debt review and still on their books. Even if the number is small, these debtors’ accounts are arguably overstating the accrued interest and the value of the Gross Trade Receivables. The fact remains that there is trouble in Truworths trade receivables book and this is very evident from the data.
