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SA retail: Better-than-expected updates, despite the COVID-19 induced lockdowns

09 November 2020

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by Stephán Engelbrecht, Fund Management

Last week was a busy one for the South African (SA) retail sector, with Dis-Chem and Foschini both reporting, Mr Price releasing a profit warning, and Truworths giving investors an 18-week sales update. The market has reacted favourably to all these announcements, although we note that there may also be a bit of euphoria around Joe Biden winning the US Presidential Election in these counters. Below, we highlight the main points coming out of the various retailers’ company updates:

Mr Price: Trading statement for the 26 weeks ended 26 September 2020

On Wednesday (4 November), Mr Price released a trading update in which the company indicated that its diluted headline earnings per share (dHEPS) are expected to be down by between 23% and 28% YoY for 1H21, although Mr Price did not provide any further information. Bloomberg consensus expectations are currently looking for Mr Price’s full-year dHEPS to be down by c. 28% YoY. However, we think that, given the fact that 1H20 overlapped entirely with the lockdown period, this reflects the worst trading environment, and that trading should improve from here. As such, in our view, this trading update bodes well for Mr Price to beat full-year consensus estimates and we expect to see some earnings upgrades over the next few months as consensus analyst forecasts have been EXTREMELY bearish on the SA consumer.

Dis-Chem Group: 1H21 results

Dis-Chem reported dHEPS of ZAc36 for the half-year (1H21) – up 16% YoY, impacted materially by the COVID-19 pandemic and the subsequent lockdowns. Excluding the costs that were directly caused by COVID, dHEPS would have been ZAc39.8 or up 28.5% YoY. Still, overall, the results were ahead of market and our own expectations. The key to the positive surprise was the pace at which Dis-Chem’s Wholesale division achieved profitability. This division reported an operating profit of R41mn vs a loss of R77mn in FY20. Management guidance was cautious, and the company decided not to pay a dividend. We continue to be more constructive on the earnings profile of this company than consensus, but we concede that some question marks remain over whether management can continue to produce positive results. At a forward PE of 26x, the stock is expensive, and we recommend accumulating the share on any price weakness.

The highlights:

  • Revenue growth of 8.1% YoY, with the retail segment growing by 6% YoY and wholesale by 14.9% YoY.
  • Like-for-like (LfL) retail sales were up 1.5% YoY.
  • Diluted HEPS of ZAc36c – an increase of 16% YoY.
  • The retail operating margin declined to 5.1% vs 6.2%% in FY20, due to:
    • Better inventory management and discounts from suppliers, which helped to improve the margin.
    • However, the product mix had a negative impact on margins due to the lockdowns as the Health and Beauty segment, a high-margin business, could not trade under lockdown level 5.
    • There were R45mn of COVID-19 specific costs, much of which should not recur going forward. If we exclude these expenses then the retail operating margin stood at 5.8%.

The positives

  • The Wholesale business turned to an operating profit:
    • Although management did guide that the Wholesale segment would turn profitable in this financial year, we (and the market) were skeptical that this can be achieved in the current operating environment.
    • Ironically, the current environment helped the Group deliver this result, with its external revenue outpacing the growth of its internal revenue as independents and hospitals used Dis-Chem’s systems during this period.
    • Dis-Chem believes that external revenue growth should moderate but will keep pace with internal revenue growth.
    • The positive operational gearing from this division can be material, as it benefits from economies of scale.
    • We believe that this could be a key driver of growth in the next few reporting periods, in much the same way as we have witnessed with Clicks’ United Pharmaceutical Distributors (UPD).
  • We should expect a recovery in operating margins in the Retail segment in the next reporting period and in 1H22. This is as the sales mix normalises and higher-margin products, such as Health and Beauty, make a greater contribution to sales.
  • Acquisitions should start to contribute more meaningfully going forward. We remain constructive on the acquisition of BabyCity and we expect these stores to start contributing to operating profit in 2H21.

The negatives

  • The Retail segment experienced a slowdown in trading over the last few months.
    • Management were very cautious in their outlook for sales growth. The consumer remains under pressure and sales growth decreased to 7% in the weeks since the half-year ended (30 September).
  • Trading densities continue to drop from lockdown peaks
    • During lockdown, Dis-Chem experienced a significant increase in the average basket size as consumers bought more products from its stores. Dis-Chem also gained market share in most household goods categories as consumers tried to limit their store visits to only one store. However, this is starting to normalise as we move out of lockdowns and consumers become more price conscious.

The Foschini Group: 1H20 results

The period under review (1H20) was difficult for The Foschini Group (TFG), with the company reporting a 1H20 loss per share. All its business units were severely impacted by the lockdowns in their respective jurisdictions. However, we believe that these results will form a base and that the tide will start to turn for TFG. In fact, in our view, there may have been some aggressive markdowns by TFG to clear out inventory in order to start the post-lockdown period afresh. The Jet transaction continues to look like a great opportunity and should start to contribute to the bottom line from day-one. We are, however, concerned about the UK business, with a second lockdown again adversely impacting trading. To compound that, TFG’s retail brands are very exposed to business-, formal- and event wear. We believe that these categories will take longer to normalise post the lockdown. The positives of Jet and the continued momentum in athleisure are counterbalanced by the struggles in the Group’s other business units. At current price levels, the risk/return profile is balanced in our view.

The highlights:

  • Group turnover was down 26.1% YoY.
    • TFG Africa (accounting for 66% of total turnover) recorded a 22.1% YoY turnover decline, while TFG Australia’s (18.5% of sales) turnover was down 26.9% YoY in Australian dollar terms. TFG London’s (15.5% of sales) turnover fell by 56.2% YoY in pounds.
    • Cash turnover (77% of sales) declined by 23% YoY and credit turnover fell by 35% YoY.
    • Online turnover grew significantly in Africa (+116% YoY) and Australia (+67% YoY). However, TFG London is still struggling, as department stores and their online offerings remain under pressure. In the UK, TFG’s online sales grew by only 1.6% YoY in British pound.
  • The gross profit margin decreased by 8% for 53.2% in FY2019 to 45.2% in FY2020
  • Trading expenses were well controlled and fell by 22.8% YoY.
  • Operating profit, before acquisition and finance costs, declined by 88% YoY.
  • The Group reported a headline loss per share of ZAc90.8.
  • No dividend was declared.

The positives:

  • The Jet acquisition continues to look like a great deal, in our view.
    • The transaction was concluded on 25 September 2020.
    • Jet currently has 382 stores and management stated that all these stores are profitable.
    • The final purchase consideration, after accounting for the inventory (that is clearing better than management had anticipated), was R333mn.
    • Jet should start to contribute to the bottom line from day-one.
  • We believe that Jet will enhance TFG’s offering by providing it with access to the value-orientated customer.
    • This could not come at a better time as the depressed economic conditions are forcing more customers to focus on buying perceived value offerings.
  • Athleisure struggled during the lockdowns as it was initially unable to trade and later its products were low on the consumer’s priority list. However, as SA entered level 2 and 1 of the lockdowns, this category has recovered rapidly.
  • TFG continues to invest in its online offering and this sales channel continues to surprise management on the upside.
    • We believe that out of all the SA retailers, TFG is probably the best placed to benefit from the continued switch to online retailing.
  • The credit impairment was better than expected.
    • The Group pulled back aggressively on granting credit with an acceptance rate of less than 10%.
    • TFG’s current accounts keep on exceeding expectations, with customer repayments trending better than expected.
  • The rights issue has significantly reduced the debt levels of the company, with the debt ratios now far more palatable.

The negatives:

  • TFG London continues to struggle.
    • The struggles of department stores in the UK still hamper this division.
    • TFG London is also very exposed to formal, work, and events wear (even more so than TFG Africa and Australia). These categories also continued to struggle post the hard lockdowns as social events and working from the office were discouraged in all jurisdictions.
    • The division is reducing space aggressively (-11.3% in the half) and will continue to do so, which will put a drag on any sales growth but should help longer-term profitability.
  • Credit applications fell by 55% over the half-year period. Management are blaming this on lockdowns, but this trend has not been as severe at Truworths or at Mr Price.
    • We note that this lack of account applications can be due to TFG starting to attract more higher-LSM customers, who prefer to pay cash or, on the negative side, that customers are getting better terms at other businesses (banks or retailers).
    • Credit has always been a real enabler of sales growth and we are slightly concerned about this trend and will keep a close eye on it.

Truworths: Business update for the first 18 weeks of FY21

Truworths provided an 18-week sales update on Thursday (5 November). Group sales decreased by 10% YoY and Bloomberg consensus forecasts are looking for FY21 sales to be flat. Truworths Africa experienced a 9% YoY sales decline, with cash sales (-0.1% YoY) outperforming account sales (-13% YoY) over the period. Account holders able to purchase, improved from 77% at the end of FY20, to 83%, indicating an improvement in the book quality. Office sales declined by 26%.

We note that the sales decline has been moderating in both Truworths Africa and Truworths Office since the company’s nine-week update provided at its last results presentation. At its FY20 results presentation, the company said that Truworths Africa experienced a sales decline of 11% YoY, meaning that the next nine weeks saw a sales decline of 7% YoY. At the results, Truworths’ Office segment experienced a sales decline of 30% YoY (in British pound), meaning that the next nine weeks saw a sales decline of 22%.

We do not believe that Truworths’ business model of credit-induced sales of higher-margin and more expensive products will thrive in the current economic environment. The share may be cheap, but we continue to prefer the value fashion retailers, with greater cash-sales exposure.

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