Retail stocks too expensive?

"Locally, Woolworths' strategy for its clothing business is deeply flawed and how Pick n Pay handled its Australian exit strategy was a disaster," he said.

Comparatively strong

However, he added that the South African retail industry had a good run throughout 2010 and is relatively strong compared to other industries.

"The retail sector was somewhat cushioned by a rise in social spending and BEE that saw many people pour money into the likes of Pick n Pay and Shoprite.

"Some 17 million people are on social spending grants and even though we exited a recession, the sector remains on the whole better than most," the analyst said.

Growing concern

There has however been growing concern among fund managers that shares in South African retailers are expensive.

According to Investec Asset Management Equity research, "free money" in offshore markets has been a driving force in pushing up valuations in emerging markets to historic highs and South African retailers have shared in this largesse and valuations in the food retail sector are at near-decade highs.

Events of the past couple of years have undoubtedly played into the hands of the listed South African food retailers as they used their balance sheet strength and strong cash flow generation to grow market share over the past five years from 62% to 72%.

Negative outlook

Portfolio manager at Investec Active Quants, Grant Irvine-Smith said that the negatives for food retailers are high relative valuation multiples and recent earnings and recommendation downgrades but on the positive side, dividend yields and earnings certainty are above average.

"On balance, however, the quantitative view is decidedly unfavourable, we have negative alpha expectations on the major food retailers over the next year. As a consequence, we have no exposure to this sector," he said.

Contrary views

Earlier this year, in a note sent to its clients, one of Allan Gray's funds, Orbis Africa, revealed that it no longer held any South African retailers.

The report said that there was a much greater chance for disappointment than for positive surprises at current share prices and acknowledged that this is a contrary position to foreign investors, whom it said "seem to have fallen in love with the shares of South African retailers".

The retail analyst said that local managers were looking p:e multiples based on history, whereas foreign investors were looking at South Africa as an open market, and one that tended more to global ratings.

Portfolio manager at Investec Value, John Biccard says that in 2009, the broader retail sector offered other opportunities such as cyclical shares.

Limited exposure

However, during 2010 the retail sector has rerated significantly and multiples are stretched in both absolute and relative terms.

Similarly, Malcolm Gray, a portfolio manager at Investec Responsible Investec Equity says that within the RI equity process on Friday, the fund's retail exposure is somewhat limited.

Strengthening shares

"Over the past couple of years we have been a big supporter of Woolworths, given the relative undervaluation of the stock and the company's responsible approach to sustainability both at the brand and operational level.

The stock has rallied significantly since our entry point and is no longer a top ten holding, due to valuation concerns," he said.

Local retail shares such as Shoprite, Truworths, Foschini, Mr Price and Massmart have recorded strong gains over the past decade.

Orbis Africa tracked the price movements in dollars and noted that Shoprite's (SHP) price increased 27-fold between December 2001 and September 2010, Truworths (TRU) was up 26 times, while Mr Price, Massmart and Foschini grew twentyfold, while Pick n Pay's share price advanced sevenfold.