Investment Alchemy series: Will the local retail sector do better in 2024?

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SIMON BROWN: I’m chatting with Arthur Karas, a portfolio manager at Old Mutual Investment Group. Arthur, appreciate the time today. If we look at the retail sector and go back four years – which of course was the pandemic – we came out of the pandemic, we’ve had load shedding, we’ve had high inflation, we’ve had high interest rates. It has been a monumentally difficult four years for the broader sector.

ARTHUR KARAS: Yes, it really has been. We’ve had one thing after another and the list of things that you’ve mentioned isn’t long enough.

More recently all of the stores – quite a few of the retailers – have mentioned issues with the ports, the inability to get stock through the ports and into the shops.

That’s especially important when we have a change of seasons, like we are about to go into winter. South Africans buy winter clothes only for a short time of the year. If those clothes aren’t on the shelves in time, they simply won’t get sold.

SIMON BROWN: Well, load shedding hasn’t gone, but my sense is that Corporate SA is learning to deal with it. The consumer remains under pressure. The pandemic, of course, is in the rear-view mirror. Are we expecting a better 2024 – even if only slightly better?

ARTHUR KARAS: Well, you can add to all of the things you’ve mentioned.

There have been company-specific issues that have affected quite a few of these businesses.

A couple of them have had issues around software rollouts, where they’ve been unable to do business, or struggled with that. That has affected a few of them.

Some of them have had simply had too much stock going into a particular period and [have] not been able to move that fast enough – which is very important in a retail group. Then others have had issues like simply missteps in some of their businesses. Pepkor and the issues that they’re facing in Ackermans would be an example.

We expect some of those issues to abate, making it a bit easier in comparison going forward. So that definitely would be the case. We’d expect things to be a little bit better.

We would also expect the share prices to perform a little out of step with the profits, because we are all looking forward; the stock market tends to discount the future. So we’re anticipating lower interest rates starting somewhere in the latter part of this year, taking a bit pressure off the consumer and typically the more consumer-leveraged companies. Those would be the clothing retailers. They tend to anticipate this, and the share prices tend to tick up long before we ever see that first interest rate cut. So we expect to see some of that and have already seen some this year.

SIMON BROWN: Yes, we certainly have. One that springs to mind, because it’s one I’ve been watching closely, is Mr Price. Would that also then hold true for predominantly cash retailers?

ARTHUR KARAS: It would. If you think about clothing, it’s something you go and purchase when you’ve got the money to do so. If you don’t have the money to do so, you simply wait a few more months or just buy down or the like.

But it would affect the cash retailers. Quite a few of the cash retailers have some credit exposure.

But even if you don’t have an account with a particular retailer, I think you’re spending less on your bond, less on your car finance – and when you put a bit more cash in your pocket, one would maybe see you at the mall over the weekend looking for a new pair of pants.

SIMON BROWN: I take your point. If we look at some individual sectors and quickly focus on food, that’s typically more resilient.

As you said, I don’t need to buy the new T-shirt but I do need to have dinner for my family this evening.

But we’ve seen own-goals there from Spar and Pick n Pay – all sorts of chaos going on there. This should as a rule be a more defensive space, and at the moment it’s Shoprite’s, entirely.

ARTHUR KARAS: It has been Shoprite’s sector entirely. You can also see it in Woolworths, where the food business has been outstanding during this tough patch for consumers. So really at the bottom end and right at the top it’s proving very defensive.

The other two? Spar I think derailed a little bit with its offshore misadventures in Poland, but its local business is still doing reasonably well, even if the offshore businesses have been a bit distracting.

But the real crisis has been Pick n Pay. That’s been brewing for some time. That company is now really struggling. It certainly hasn’t provided any kind of defence for its shareholders.

SIMON BROWN: I mentioned load shedding at the top. It’s still ongoing, though alleviating a little. We are not sort of getting Stage 6, and I touch wood as I say that. But this is something surely the businesses have learned to live with – at a cost. It is not a cheap endeavour at all, running businesses on generators.

ARTHUR KARAS: It has been a very expensive exercise. I think the way that we look at it is to say that about a year ago, if you went to an investor conference and spoke to a lot of the retail-facing companies, all they were talking about was how many days of trading they’d lost to load shedding, the cost generators and the like.

This year around there’s not much of an update on that. In fact that wasn’t really a topic of conversation. Now the costs are in the base, and any kind of easing of load shedding means a little bit of saving on that score.

Some people still mention that load shedding affects consumer sentiment; it tends to depress people. So to make you cheerful you want to go to the shops.

But it’s not a minus. It’s in the base and things eventually get better. You could expect that to be a positive.

SIMON BROWN: I take your point, again with Shoprite, because I know the number they’re spending – almost a billion rand a year – on diesel. If load shedding were to disappear tomorrow, that billion would drop to the bottom line.

ARTHUR KARAS: Yes. I think at the moment we’re a little concerned about when that’s going to happen, when it could be a saving the companies could make.

SIMON BROWN: Are there any in the broad retail spaces we look at? Shoprite’s absolutely one of them. We have touched on that. Others that have really navigated what, as we said at the top of the show, has been a really, really tough four years for the sector?

ARTHUR KARAS: I mentioned two of them. Truworths – Truworths is a company that has stuck very much to its credit retail business in South Africa. It has not navigated away from that, the way that some of the other clothing retailers have.

A few years ago Truworths purchased a shoe-retailing business in the UK called Office, and that was about 10% of their business. It’s a lot bigger now because the shoe manufacturers have kind of restructured where they sold their products in the UK – leaving a lot more space for the resellers, the likes of an Office – rather than their own stores. So that business has grown extremely well and has seen its margins go up a lot. So that is a business that has done really well out of that.

In the past 12 months Truworths is up some 46%. So the market is recognising the benefit of this business that it bought overseas and which has performed better than most people expected.

The other one [is] the pharmacy chains, especially Clicks. They’ve really still got a long runway ahead of them in terms of rolling out pharmacies in most countries.

Independent pharmacies that aren’t part of a chain make up about 10% of the market globally. In South Africa I think that’s still well above 30%.

So there’s still quite a bit of room for these corporate chains to roll out pharmacies and take market share from the independents that way. I think that means that there’s still years of growth ahead.

The business model is a good one. The companies are able to fund their own growth, pay out a decent dividend to their shareholders and still be able to buy back some of their shares on top of that, while not having to build up any debt. So a really strong business model in action there.

SIMON BROWN: As you’re saying, Clicks, and I’m thinking about their ClubCard – a quick last question: the loyalty programmes we’ve seen from most of the retailers, do they make a seriously marked difference, or is it just more PR and marketing, or can they make a real difference to the bottom line?

ARTHUR KARAS: I think you get people who love those products – or love the loyalty cards – who will base their spending plans around where they can get points, or who offers the best scheme. I think if you’re a retailer you have to have something like that. You can’t ignore it.

But I think what it also does, it provides the retailer with a lot of information about their clients. It tells them who you are, where you live, what kind of things you buy, what offers you respond to, and the like. So they can tailor your offerings to you.

There’s a story I heard many years ago that’s an example of retailers knowing people better than you think.

A young lady in America got a letter from Walmart saying ‘Congratulations on your coming baby’. They could tell that she was having a child based on the products that she was purchasing at Walmart, even though she hadn’t yet told her parents that she was having a child.

That’s an example of the kind of information you can get from these customer loyalty programmes. That’s long before the advent of something like AI and the amount of data-crunching we’re doing today.

SIMON BROWN: I take the point. It’s around that behaviour.

We’ll leave it there. That’s Arthur Karas, portfolio manager at Old Mutual Investment Group. Arthur, I appreciate the time.

This podcast series, Investment Alchemy, is brought to you by the Old Mutual Investment Group. In relentless pursuit of investment excellence.

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