Cutting their cloth

Mr Price's apparel division (Mr Price, Milady's and Mr Price Sport) grew its retail sales by a robust 19% in its financial year to March. Competitors Edgars and Foschini did not fare as well. Edgars, acquired and delisted by a Bain Capital consortium last year, grew its retail sales (excluding Discom) 6,3% for the year to March. In Foschini's apparel division (Foschini, Markham, Exact and the sports division), sales grew 6%. Strip out inflation and additional sales from new stores, and real sales growth is disturbingly close to zero.

“The buoyant economic environment that retailers have enjoyed in recent years has ended,” says Mr Price CEO Alastair McArthur. “We were able to weather the tougher conditions because of our appeal as a value retailer and our predominantly cash formula.”

Mr Price's group revenues grew 19% to R7,4bn, profit before tax increased from R672m to R770m and diluted headline earnings per share increased from 184c to 210c. Return on equity is a healthy 40% — “the highest in the sector,” says McArthur.

“Being a predominantly cash business has helped Mr Price a lot,” says Gryphon Asset Management analyst Abri du Plessis. A full 84% of sales are cash sales. “But there is a lot of pain in the home division (Mr Price Home and Sheet Street) — and I'm afraid this is just the beginning of the difficulties for that industry.”

A surprisingly resilient performer within the stable has been credit retail brand Milady's, which was the second-best performer in the group. “The average customer is a little older, more conservative and manages her finances more responsibly,” says McArthur. “It's a definite niche.”

Though bad debts on Mr Price's modest debtors' book of R542m have risen to 8,6%, the book is funded out of retained income, says Nedcor analyst Syd Vianello. “This means interest on the yield goes straight through to the bottom line — the only costs are bad debt and administration.”

Says McArthur, “The focus in the next financial year will be on improved collections, not on growing the book”.

Edcon holds a 31% share of the local clothing and footwear market and brands include Edgars, Jet, CNA, Boardmans and Red Square. It reported turnover up 11,2% to R22,5bn. While Edgars did report a loss of R1,3bn, the combination of one-off acquisition costs of R196m, as well as depreciation and amortisation of R458m, reduces this to a more manageable R655m.

When one takes the hefty financing costs out of the picture, Edgars grew its adjusted Ebitda (earnings before interest, tax, depreciation and amortisation) by 10% to R3,1bn for the year to March. “On the surface the loss looks serious and the debt huge,” says Vianello, “but private equity works on the principle that, in the early years, you will make a loss.”

Of course, the financiers probably did not factor in an economic downswing of this magnitude. Though Edgars is carrying a lot of debt, in its favour is the fact that the interest it must pay on its R27,5bn in Eurobonds has been fixed to 2012. In addition, the company has hedged its foreign exchange exposure to 2012 as well. “They must have paid a premium to do this, but it is proving to be a clever move,” says Vianello.

CEO Steve Ross was not prepared to talk to the media, but the group's annual report says sales were dampened by the impact of rising interest rates, escalating food and fuel prices, and the implementation of the National Credit Act (NCA). In particular, the performance at discount brand Jet Stores is disappointing, with the brand losing market share to Mr Price.

Edcon has the largest base of consumer credit customers in Southern Africa, with over 4m active credit card accounts. At least 53% of sales are made using Edgars' private label credit cards. Here, too, bad debts have risen from under 9% in 2006 to 11,6% of the book, which is valued at R9,3bn. However, net profit in the credit and financial services division leapt from R2m last year to R360m this year.

Propelling this increase was the higher interest income earned, because the NCA allows retailers to raise their interest rates on debt. “Our income rose year-on year at 44%, while costs rose at 10%,” explains Edcon's executive manager of investor relations, Tessa Christelis.

“What these results show is the unique trade-off between trading profit and financing profit,” says Vianello. “As long as sales don't fall out of bed completely, you can offset reduced sales with increased finance income. Unlike Foschini and Mr Price, Edcon is funding its book with debt on the balance sheet, but earnings are in excess of extra cost of the debt.”

At Foschini — which last week gave its first annual results presentation to media and analysts in more than 20 years — turnover increased 8,5% to R9,3bn, up from R8,5bn. Operating profit before finance charges was an almost flat R1,9bn, 1% up on last year.

“It has been a tale of two halves,” says CEO Doug Murray, who took the reins from Dennis Polak at the end of last year. “In the first half of 2008 sales grew at nearly 9%, but in the second half they grew by 3,7%. Similarly, headline earnings per share grew 12% in the first half but then fell to a negative 4%.”

Despite the tough trading environment, Murray believes it's the right time to relax Foschini's cautious approach to business. More than 100 stores will be developed in the next financial year, with retail space growing by 9%-10% rather than the previous average of 5%-7%.

“Our competitors are growing at 10% 12% and sometimes more,” he says. “We think some of our brands are underrepresented.”

“What was refreshing was the honesty from this management team,” says Vianello. “They are saying there are problems, but we know what they are and we are working on them.”

Though management at both Mr Price and Foschini are focused on delivering earnings growth this financial year, the road to good earnings growth will be a long one.

Source: Financial Mail

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