In 2010/2011, Truworths exceeded even its own stiff targets. This included a 36.4% operating margin, up from 34% in 2009/2010 and above its 32%-34% target range. Foschini, itself one of the world's most profitable clothing retailers, recorded an operating margin of 20.6% in its year to March.
"When our [operating] margin was at 17% 15 years ago, we were also asked if it could be improved," says Truworths CEO Michael Mark. "We did so by enhancing our merchandising, improving store efficiency and harnessing the benefits of IT."
Mark says Truworths will continue to improve its performance metrics but concedes it will be at an "incremental" pace.
Unlike Foschini, which has greater scope to improve stock turn and operating margin, Truworths is perhaps a victim of its own success. With minimal prospects for acquisitions, its growth potential is largely dependent on consumers' ability to continue spending freely.
Over the past decade Truworths and other retailers have ridden high in what has been one of the world's best consumer markets. Creating it was a growing middle class, greater access to credit, sharply lower interest rates and wage increases well above inflation. "For retailers, things are about as good as they get," says John Biccard, manager of Investec Value Fund.
But instead of a strong tailwind, Truworths and other clothing retailers may soon face a headwind. Of concern is the ability of consumers to take on more debt, which, over the past 10 years, has soared from 40% to 80% of disposable income. "It can't go much higher," warns Biccard.
In 2010/2011, 71% of Truworths' R7,86bn sales were credit-based. Of note was a shift from six-month interest-free accounts to 12-month interest-bearing accounts. Mark says the shift was "not dramatic". But it suggests that consumers are under pressure. Add to this a warning from Adcorp that SA could shed almost 500000 jobs in 2011 and 2012 and it is hard not to feel uneasy about credit retailers' prospects.
For investors bent on having exposure to credit-based fashion retailers, Truworths offers the comfort of having too much cash. The retailer's exceptional efficiency has turned it into a cash cow that churned out R1,73bn in 2010/2011, only R186m of which was needed for capital expenditure.
Truworths ended 2010/2011 with R1,5bn cash on its balance sheet, R171m more than a year earlier. "We don't want to build cash any higher," says Mark. It's likely the company will continue with "earnings enhancing" share buy-backs. Also on the cards, he says, are further cuts to dividend cover, now 1.7 times earnings. In 2010/2012 its cover could have been cut to 1.5 times, adding 40c (15%) to its 262c dividend without denting the cash it had at the end of 2009/2010.
For investors looking for a credit fashion retailer with the potential to enhance its operating metrics, Foschini is the one to back. For those looking for a defensive stock in the face of deteriorating consumer spending prospects, Truworths stands out.
Foschini financial director Ronnie Stein acknowledges that Foschini is the more cyclical of the two retailers.
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