Tasneem Samodien, Research Analyst at Private Clients by Old Mutual Wealth
South African asset managers have commonly referred to the years following 2010 as the “lost decade,” characterised by a decline in economic growth and hindered potential due to state capture. In this challenging economic climate, businesses and investors seeking opportunities in the local market face hurdles, as economic growth is a crucial driver for sustainable long-term sales and earnings growth for companies.
While it’s been a challenge, South Africans and their corporate counterparts are known for their resilience. Many local companies have managed to grow despite the lacklustre economic growth, with one industry particularly standing out for its ingenuity – local retailers.
Despite operating in an economy that has become “poorer” and is dogged by corruption and load shedding, certain local retailers (across both food and apparel) have managed to grow their earnings in multiples.
“South African retailers have demonstrated their ability to generate earnings growth even amidst various economic and market cycles. Their strategies of differentiated market positioning, acquisition, and diversification have contributed to their success,” explains Tasneem Samodien, Research Analyst at Private Clients by Old Mutual Wealth.
When evaluating potential investments, earnings growth is a key consideration, but the value paid upon acquisition is equally important. Overpaying for growth can be as detrimental as investing in poorly managed companies.
“We utilise various valuation models to assess potential investments. For example, we focus on an easily observable market-related valuation metric, forward earnings per share. While the absolute level is important, the level in relation to the historic average holds significance. As of the end of June 2023, food and apparel retailers are trading at a discount to their average multiples,” adds Tasneem Samodien.
Amid concerns about risks faced by these companies, such as load shedding and inflation that might be challenging to pass on to financially constrained consumers, Samodien points out that these challenges are not new. South African companies and management teams have been navigating these obstacles for over a decade.
“While earnings are under pressure this year due to unfavourable macro-economic factors, we, as long-term quality investors, look beyond short-term fluctuations. We believe in the power of compounding, and time in the market is far more critical than trying to time the market,” asserts Samodien.
Amidst fierce competition for a share of the shrinking consumer wallet, retailers’ earnings growth stands as a testament to their successful implementation of targeted growth strategies, led by adept management teams.
Some highlights into certain retailer’s growth strategies
MR PRICE: The preferred operator in the apparel retail sector, Mr Price, balances consumer desires for current fashion trends and quality with limited discretionary budgets. Its prudent capital allocation and focus on the local market have contributed to superior profitability. While peers have made large bets with offshore expansions, they’ve made smaller bets. Their prudence paid off with a superior growth profile as management had more time and capital to invest in the local market.
PEPKOR: Positioned as the leading local value apparel retailer, Pepkor caters to budget-conscious consumers, employing dynamic pricing policies and focusing on basic staples. In serving the largest and fastest growing income segment, growth is often driven by merchandise volumes. The company has made significant strides in improving its balance sheet and focusing on cash as opposed to credit sales, thereby improving the overall quality of its business model.
TRUWORTHS: Known for its relaxed credit granting policies, Truworths appeals to cash-strapped consumers, charging a premium to cover the costs of this strategy, as reflected in a gross margin of 54%, well ahead of peers. This has turned out to be a successful strategy in SA where the consumer has been under immense financial pressure with salaries recently failing to keep up with food and fuel inflation.
SHOPRITE: Leveraging efficiencies through scale, Shoprite’s centralised supply chain and supply chain management system underpin a responsive and agile supply chain, providing a competitive advantage, one which competitors have found difficult to replicate.
WOOLWORTHS: Successful execution of the Woolworths food offering has propelled Woolworths’ growth, positioning them as a market-leading brand targeting the affluent consumer. From private label penetration to Café NowNow, Woolworths Food has been the growth engine of the group, its success eclipsing that of their legacy business, fashion, beauty and home. Woolworths was the only retailer bold enough to focus on sustainability, wellness and quality, targeting the affluent consumer, and their strategy has paid off with a market leading brand value of US$1.2bn in 2022, ahead of peer Shoprite at US$801 million (according to Kantar BrandZ report).
The Foschini Group (TFG): Pursuing diversification, TFG has acquired brands and launched its own, operating across product categories and income segments to reduce reliance on any single income stream.
The current valuation discounts present an attractive entry point into a sector that has proven its relevance and resilience in the South African context.
“In line with our quality-focused investment philosophy, our top picks are value fashion retailer Mr Price and market-leading grocery retailer Shoprite,” concludes Samodien.