Mark Ingham: The Pick n Pay story – how “high conviction” in Brasher paid off

Independent analyst Mark Ingham was delighted when in early 2013, Pick n Pay entrusted the then struggling retailer’s future to UK import Richard Brasher. He immediately upgraded his call on the stock to a buy with “high conviction”, a view justified by events of the past three and a half years. In this in-depth discussion with’s Alec Hogg, Ingham looks ahead to what can be expected in Pick n Pay’s results for the half year to end August, and considers the stock’s attraction in the light of today’s market reverse – caused by jitters accompanying the latest shocks in the political economy.

This special podcast is brought to you by EasyEquities and my goodness Mark Ingham, have we timed our fortnightly discussion well. News just breaking about an hour ago that apparently there’s been a formal criminal charge laid against the Finance Minister, and the markets have reacted.

Yes, very much so Alec and very much in line with what we were discussing a few weeks ago, with respect to Nenegate and the events there afterwards in August. I think there was probably a lull, if you will, another false sense of calm and, as we discussed at that particular time it’s the interest rate, the stocks, the sensitive stocks that get clobbered. We’re seeing quite a reaction in the market as we speak now across a host of SA folk as companies, with the banks particularly being quite hard hit. Following closely with the consumers.

Why would the banks take a knock, or such a big knock, and we’re talking 5% plus, in some stocks on news like this?

Well I think it goes to contagion, this elevated risk. You see the bond rates react at times like this too, so elevated risk/elevated cost of money and, therefore the present value associated with that has a direct effect on the banks, which are very closely linked, from an evaluation point of view, to those particular metrics and the long bond rate particularly. With the risk once again elevated and we see this every so often now in SA, the banks will be the first to be affected. I think also the fact that they are largely focussed, from a business point of view, on a South African/Domestic market. They’re also very much aligned to that and, therefore probably get hammered the most. We would see for instance mining stocks, or anything that was offshore linked react slightly positively but that would be largely currency related.

Yes, the Rand taking a 35 cents hit against the US Dollar within minutes of the reports coming through. You did say a month ago that we should stay away from interest rate sensitive stocks. Clearly that call has been justified by the reaction today but are they getting to a territory where they’re just too cheap?

Alec, it’s something that I’ve been very cautious of and I think our last chat around this particular topic spoke to that. The binary risk that I referred to at that stage is still very much present in the South African market. It’s unpredictable and as events of this morning has shown us, when you do get these unsettling announcements there is nowhere to hide. Although these stocks are relatively cheap it doesn’t mean to say they can’t get cheaper and if risk elevation is heightened further and we don’t know what the outcome of the announcement this morning will be, with respect to Pravin Gordhan. The unfolding developments around that. We could see these stocks get a hell of a lot cheaper. The fact that they have fallen 4% to 5%, in very short order, is not necessarily a reason to go in and buy them.

Pick n Pay

Yes, but like Nenegate, where you saw a very sharp reverse, although that did stabilise after a period of time. It’s like trying to catch a falling knife, isn’t it?

Yes, I think that’s a very good analogy. When you can’t read the signals. When it’s an unpredictable environment I think we need a period of calm. Unfortunately, I think that alludes South Africa, at the moment.

Looking more broadly, you’ve been a bull of Pick ‘n Pay since the appointment of Richard Brasher. He was brought to South Africa, by the Ackerman family. He used to be involved at Tesco. He was there before all of the shenanigans occurred at Tesco. Since taking over in 2013, more than three years ago, your call has been justified on it. What was it about Brasher that you thought or believed would enable him to get Pick ‘n Pay back on track?

I think he was the right man at the right time. That’s not to say that previous MDs of the company haven’t done a good job but I think the company had reached a stage where it needed a fresh, external perspective and I think Richard Brasher was that man. The company had been steadily losing market share. If you take it over the 2005 – 2016 or so period. Pick ‘n Pay probably lost about 10% market share, and a fair chunk of that went to Shoprite and, to a certain extent, Woolies and Spar. Although Raymond Ackerman invented the modern supermarkets in South Africa, and in fact was a force to be reckoned with for many years. It had reached a stage where it needed a relook and I think Richard brought that. He’s had a very forensic approach to it. It’s very methodical. He knows exactly what he wants to achieve. He had very good experience in the British market, which is one of the most fiercely contested grocery markets in the world. I think with anything Alec, ultimately a company’s PNL is the function of the quality of the people. I think Richard had a good team around him. They just needed the appropriate leadership. I think fortunately, the Ackerman family had got the right man and they pretty much let him run with the ball. Since he took the job with effect from the 23rd January 2013, some very credible changes have been made to the group and they’ve continued. The journey has a while to go but I think and I felt that he was the right man for the job. I think a little bit of a ‘benefit of the doubt’ premium at the outside but I think from what we’ve seen in the last year or two, underscores the confidence I’ve had in my core, on Pick ‘n Pay, and we’re seeing some real P&L delivery. I think importantly some very qualitative differences within the way the business is in fact run today.

I guess many people would be thinking how did they manage to attract a man like Brasher into the fold and reading through your report you make mention of the ‘binary options’. I haven’t seen too many of those being used before. How exactly does it work?

Yes, I think to incentivise management has always been a key thing. There’s the two aspects here. There’s the for-feasible share plan, which is certain hurdles that has to be crossed and I think the aim is that, from a technical point of view, is to be self-funding. There are certain metrics associated with that. The key people who have PNL responsibility largely, have to match. The binary shares were issued to Richard in November 2012, run through to November this year, so it’s a five-year period. There are specific performance metrics also aligned to that, linked to the growth of the Pick ‘n Pay share price and if those conditions are not met then they are forfeit. In a sense you have to earn your bonus, if I can put it that way. He was granted a million binary options, at R42 per share. There is a target of approximately R68 on that and the way things are going at the moment there’s a good chance that he will meet the hurdle. I think given the growth rate that we’re seeing in the underlying operational and earnings performance of the company, and the way the share price has gone. Clearly the incentive, I think, has some way to explain your first question, as to why he’s here. I think it goes beyond that. I think the Ackerman family were looking for the right man. They identified Richard as having done a good job at Tesco. I think Richard, a relatively young man at that stage, early 50’s, he saw it as a terrific opportunity to ply his trade in a new jurisdiction. I also think the challenge of working with what is still regarded, in the grocery world, as a great business. Really turning it around and getting it back to the really, good household name that it had long since become associated with. I think a little bit of slippage there but I think this was an opportunity too good to turn down, and clearly, I think we’ve seen that realised.

We’ve got half year results coming out on the 18th October, that’s just over a week’s time. Pick ‘n Pay is expected to do very well. It’s sitting on a price to earnings ratio of 25 times. That’s not cheap but it’s never really been cheap, almost, since Brasher arrived, has it?

Yes, I think, going back to the benefit of the doubt and expectations. There’s been two schools of thought on this Alec. There’s been fund analysts and fund managers out there, who just simply thought that he would never get it right and that Shoprite would come barrelling down the road, and pretty much sweep all in its path away. But there’s been some very interesting developments. The company is still fairly large. Let’s remind ourselves that its revenue this year, on my predictions, will be about R78bn. You’ll be looking at Shoprite at something north of R100. It still remains a force to be reckoned with Alec, in the grocery field. We’ll see, I think a continual edging up of margins and that largely explains the earnings that you referred to earlier. The trading margin, if we go back to 2014, was about 1.6% overall. This year I’m looking at the margin up to 2.4%, so it’s not as though we’re getting it from the top line, this qualitative, improvements in the way the business is run. There is a whole new approach to the way the stores look. The way the logistics operate. The way the whole chain operates through the whole business, so I think with the improved efficiencies you’re seeing that accelerated to the earnings line. Better space utilisation, new stores are smaller in format but they’re more efficient. There’s been good investment in systems behind the group. Duplication has been eliminated. Buying is centralised and coordinated. In stock availability, which has been quite a [inaudible 0:12:11.6] of consumers, Alec where you go into a store and what you’re looking for isn’t there. In-stocks are very much a focus. You’re getting higher stock turns as well. The fresh produce supply chain is being worked on, so there’s been a lot of remodelling, new-generation stores. Boxer is becoming a national brand, so I think quietly but surely we’re seeing some really great things happening within the group. Although the top line isn’t reflecting it. You’ll probably see about 8% top line growth this year but for the year of February, Alec, I’m looking at about a 20% growth in earnings, which means if that is realised, and we get R1.3bn on the bottom line. That would compare with approximately R0.66bn back in 2014. I think this business, Alec, has the potential, within the next three or four years, to be a R2bn bottom line company for approximately R4 per share, so although, as you correctly point out. The PE may seem a little elevated it degrades quite quickly on a forward view, if the run rate that we’re seeing at the moment, can be maintained.

How far along the path or Brasher’s plan if you like, has Pick ‘n Pay progressed?

The first plan has been completed very successfully and we’re very much into the second phase of the process, at the moment. The first phase of the turnaround process was stabilising the whole group and recognising the shortcomings and working on that. So we’re very much now into the second phase of that process and in fact, in the last annual report and the last analyst presentations, Richard Brasher has been quite clear as to what he wishes to achieve. The trajectory, as they refer to it as, is in fact accelerating and it’s doing that because they’ve worked on the basics. Therefore, what we’re seeing now is an improvement in the bottom line coming through.

Read also: Sometimes businesses get too big for founding families – like Pick n Pay

Right, so everything seems to be moving in the right direction. You did make it a high conviction call and maybe you can just unpack what that means, and is it still a high conviction call for you?

It was a high conviction call I think we go back to 2013/2014. At the time, as I say, there were divergent opinions I think, in the market as to whether this could be got right. At the time the share price was about R40 or so, it just recently got to R80. It’s come back a bit now, so it’s become less a high conviction call as such I think, and as I mentioned in my notes. This is a travelling trolley now. It’s not something that could potentially deliver. It is actually delivering, so I think perhaps some of the doubting Thomas’ are being won over. I think they’ve also seen a good [inaudible 0:15:26.8] position here of good management, a top CEO who is getting on with the job and the Ackerman family, who are very engaged and still have a significant influence on the business, from a shareholding point of view and from a voting point of view. They’ve pretty much let Richard get on with the job and to claw back lost ground from the competition. It’s been one of the few retail stocks, Alec, that I’ve been keen on. I’ve been very cautious about retail for quite some time, in the last year or 18 month or so, and I think correctly so. We’ve seen quite a bit of market correction in a number of these stocks, Massmart for instance is down, over the period that Richard Brasher has been at the helm. Massmart is down by a third or so. Shoprite is probably level pegging, so there’s no doubt that Pick ‘n Pay, as a stock price, has outperformed its peers, with the exception of Spar. That’s also been one I think I’ve been quite keen on. Alec, I think due to the business model that Spar have, which I think is quite powerful but certainly with the stock having performed very well, I still think there is scope in this. The investment case remains, Alec, and if the projections, which are relatively conservative. I’m not being overly bullish on this, and the one thing I’ve long since learnt as an analyst, is that the only certainty about forecasting is that you’ll be wrong. If you have the right assumptions, then hopefully they would at least be reasonably correct. On that basis, I’ve got my share value at about R70, at the moment. With a target price of R84.

So it’s not too late to invest, clearly, if the price is now in the mid R60’s?

No, and I think any movement downwards. As we’re seeing this morning, back to our earlier conversation, around Pravin Gordhan. We’ve seen a number of stocks that are consumer facing, and that are interest rate sensitive that are coming off. Pick ‘n Pay, Shoprite, Woolies, and a few others, and so forth are in that category. I think any short term weakness associated with macro jitters shouldn’t deflect one from the micro fundamentals of various companies, and Pick ‘n Pay would be one of those. The fundamental is good and if the share price is getting cheaper because of external factors then that means that a lower price is probably a good opportunity for fresh money coming in.

Mark Ingham is an independent analyst and this special podcast was brought to you by EasyEquities.

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