BUSINESS NEWS - The festivities are long over, decorations have been packed away and the gyms are full this January as consumers, burdened with a few extra kilos, try to work off the excesses of December. For their part retailers have also packed away their Christmas tinsel, and in due course they too will be shedding unwanted baggage. The inevitable post-season sales should be good, because with a few exceptions retail sales in December were fairly dire and the piles of unwanted stock must be high.
In their trading updates the retailers noted without exception that the trading environment is very challenging thanks to slow economic growth, the Vat increase, rising joblessness and consumer uncertainty.
The coming year looks no easier for retail, constrained as it is by the poor economy and muted improvements in consumer health. Even after the elections there is little to suggest a change in economic circumstances.
Many South African retailers are however remarkably resilient and most have a strategy to cope. Keeping costs down is obviously the first step. Massmart kept its operating costs to below 5%, a good effort in the current environment. Truworths implemented the old fashioned lay-by system, which is how most poor South Africans bought school uniforms in the days before credit, and Clicks continued with its highly successful ‘buy two, get three’ promotion.
That said, what remains evident is that there is a disconnect between results and retail share prices. For instance Mr Price’s earnings are likely to be flat to just positive, yet it sits on a price-earnings (P/E) ratio of 18x. The same goes for Shoprite. At these prices investors should expect earnings growth of 7%. Under most circumstances either the share must derate or earnings must grow, yet the conditions for earnings growth are not visible.
“Share prices have sold off, and we see wild fluctuations in share prices, but investors have not left this sector for dead,” says Wilhelm Hertzog, analyst and portfolio manager at Rozendal Partners.
What should investors do under the current conditions?
The first answer is don’t rush into retail. Speaking about the economy and stocks in general, Hertzog notes that these environments lend themselves to assets becoming cheap – or cheaper – as investors become disillusioned.
The second answer is so obvious it’s almost not worth saying. Not all retailers were created equal.
“Some retailers are in the position they are in because of strategic decisions that went wrong,” says Reuben Beelders, portfolio manager at Gryphon Asset Management. “They have ventured offshore, with varying degrees of success. TFG made good acquisitions in the UK and Australia, yet Woolworths is struggling.”
Read: Offshore markets: Where dreams die for SA retailers
Almost all retailers over-invested at the end of the commodity super cycle. “Retailers saw no tomorrow and,” says Beelders. “The rush for retail space in South Africa is almost without parallel globally. They sit now, with high overheads and not enough feet passing through their stores.”
For investors who are willing to look through the cycle, the stocks to look for are those with strong balance sheets, says Hertzog. While most retailers are in reasonable condition, new reporting standards will force retailers to put off-balance sheet liabilities – such as leases – on the balance sheet.
If you are hesitant about taking a view on how long the down cycle will be, then robust and defensible is what you want. “Food retail at scale is more defendable than fashion and clothing,” says Hertzog. “One would gravitate towards a value offering, one with strong profit margins, and which is a price leader. I’m thinking of Shoprite here.”
Clicks also ticks all these boxes, but both analysts note that it is expensive. The company has delivered and the share reflects that, but the market has not priced in any meaningful reversion in profitability.
An interesting point is that both analysts are keeping an eye on Woolworths, the share that has derated the most, thanks to the value destruction in Australia.
However, as recent results indicate, the food business is robust. Perhaps the market is overly focused on the negative, and underestimating the positive in the food business?
What is evident is that retail investors should be looking for shares that are unlikely to fall further, rather than shares that will shoot the lights out, because those are few and far between.
