Has Massmart lost its game?

Walk into a Game store today on an average mid-month, mid-week day, and it’s striking how empty it feels. Gone are the buzzing aisles and the long waits at the tills. Gone is the struggle to find anyone to tell you where to find swimming-pool filters or tumblers in these cavernous, aircraft-hangar-sized shops. There is an echo in the air.

Yet Massmart, Game’s owner, is holding the line, trying to find new avenues to the consumer, keeping its costs tight as always. This is the new context for retail in SA: flat is the new up.

There is, however, a rumbling in the background: how long will Massmart’s owner, the US giant Walmart – the world’s largest retailer by revenue – put up with "flat"? "Flat" was surely not the reason Walmart bought half of Massmart in 2010; the purchase was intended to take part in the new African renaissance, a brand-new one-billion-person growth continent.

Even among its peers, Massmart is gaining a reputation for being something of an underperformer from a share-price point of view.

It has declined about 40% over the past five years, while the retail index has returned 200%. Walmart bought its stake in Massmart at R148 when the rand was trading at around seven to the dollar. Eight years later the share is trading at under R105 and the rand is around R15 to the dollar. And there is also the niggle of the internet threat. Is it possible that Massmart could be "Amazoned", in the same way the US online giant has done the unthinkable by outpacing Walmart in a version of the classic disruption of an established business model by an internet-based start-up?

You will get none of the answers to these questions in Massmart’s trading figures, which until recently were far from poor. Instead, they indicate a lively, active management fighting battles on multiple fronts, some successfully and some less so.

But they also speak to a business model which is struggling to deal with three major headaches.

First, an SA economy which has consistently underperformed every year for almost five years.

Second, a retail context which has changed from being the most resilient segment of the economy to becoming the latest in a long line of underperforming sectors.

Third, a gradual deflationary environment for durable products. With televisions becoming cheaper, to take just one example, retailers have to sell more just to stand still. When that happens across an entire category, the medium-term pain can be harsh.

The resilience of Massmart in this difficult environment has been remarkable — until its most recent interim results, in which headline earnings fell 42.2%, or 20.4% excluding restructuring costs.

In 2009, Massmart’s turnover was about R40bn; it has increased every single year and now it’s about R94bn. But this remarkable record is starting to look toppish, partly because declines in earnings for Massmart are such rare events in its history. The company has never had a decline in turnover, and on a like-for-like basis, turnover didn’t decline this half either — but it was close. On an earnings per share level, Massmart did have declines in the post-global recession period, but the bounceback was fast and even then declines of this scale have not been seen before.

These challenging results are not uncommon in the sector today. Shoprite CEO Pieter Engelbrecht says his company has "been to war", battling among other things the VAT increase, the petrol price rise, the listeriosis outbreak and a spate of robberies. Shoprite recorded its first decline in earnings since 1998.

At Massmart’s results presentation, Guy Hayward, the normally smooth CEO, seemed equally shaken. "The past six months were indeed the perfect storm. I have never felt volatility and uncertainty like this. I do not think this time six months ago any of us expected GDP to contract by 2%."

For Massmart, the GDP figure is a key metric because the company sells right across the economic spectrum from top to bottom, and right across the consumer product rage, from electronics to cement.

Despite it holding its own in a crazy-difficult environment, some analysts are beginning to wonder how long Massmart can hold back the flood. Perhaps the most caustic is Chris Gilmour, who wrote in Business Day that the share has been a "profound disappointment". For all the fanfare accompanying its majority acquisition by Walmart in 2010, Massmart has fallen short of expectations. Relative to other large fast-moving consumer goods (FMCG) retailers in SA, Massmart stands out as the only share to have declined in value since the Walmart deal, he says.

He notes scathingly that in the past eight years, Shoprite and Spar have more than doubled in price, while Pick n Pay is up by 68%. Massmart’s 40% decline over the same period makes it the cheapest of all the large FMCG stocks, trading on a relatively low p:e of 15.7 compared with Spar at about 18, Shoprite on 24 and Pick n Pay on 27.

This is slightly unfair because there was a big run-up in the stock price prior to the Walmart buyout, but Gilmour goes on to say: "There’s a reason it’s cheap: it’s going nowhere slowly."

Hayward, in an interview with the FM, strenuously disputes particularly this last statement.

In fact, Massmart has pushed in many new directions. It has: bought super-cheap chain Cambridge in 2009 to expand its low-LSM offering; brought food into Game; expanded the range of goods and pack sizes in Makro; increased its private label offerings; fought to control costs; expanded in Africa; and has expanded its online and value-added services business.

All these initiatives have been tacked on to a tightly run operation that results, on average, in one of the most profitable retail operations in SA.

But each of the initiatives does come with some questions attached. Take bringing food into Game.

"It has had its detractors," Hayward concedes, adding that the company has from time to time done a poor job in presenting the food offering. But the initiative is working, he says.

For the past two years the company has been trying to be more efficient, and it has managed to keep expense growth between 1% and 2%

The intention is to achieve the same kind of synergistic interaction that Woolworths gets from its food division; you are providing for different customers who have different customer missions, but each works to boost the other.

Massmart can see it working because it has been in the process of gradually including food into its Game stores at the rate of about 10% a year. At the moment about 70% have been converted, so the change has resulted in real test samples.

Food now consists of about 20% of sales at Game stores, but crucially, on a like-for-like basis, sales of durable items in the non-food sections have increased.

The effort comes with a problem too; the margins in the food sections are lower than the margins in the durable goods section, so though overall sales have gone up, the rate of profit has come down.

Still, Hayward says, "we have higher sales and more customers and that is what we wanted and expected".

The overall offering is narrower than supermarkets, which typically offer about 20,000 items. Game offers about 5,000 food items, and Hayward says the aim is to provide everything food shoppers really need. Tricky, you have to say.

There is another problem here: as Game has entered the food market, supermarkets have gone the other direction, offering many items that used to be the preserve of durable goods stores. Categories are beginning to merge in both directions. Hayward says Game stores are very competitive on prices and are priced below the majors.

Another of Massmart’s major thrusts is the expansion of its private labels, which is not confined to the M brand label in Makro stores. Not many people know it, but the Campmaster tents and sunshades are a Massmart-owned brand, as are Logik televisions, Trojan workout products and a host of others

They constitute about 8% of Massmart’s products in food and 14% in durables. Just on a comparative basis, there is still lots of room for growth in this division. In the UK, private labels constitute about 40% of sales in food, and in the US the figure is about 25%.

But again, it’s tricky. Hayward says you have to be respectful of the main brands because often they create the category, and if you don’t have them, you can hurt the whole category. "Not without risks, but you do capture the supplier margin."

Something else not often mentioned in relation to Massmart is cost control. A big part of the decline in headline earnings this past half was a big restructuring charge, but analysts are laudatory about Massmart’s cost controls.

Massmart has been an efficient business, and its operating costs have been the lowest in the SA retail sector. "We need to be because we trade at lower prices," says Hayward. For the past two years the company has been trying to be more efficient, and it has managed to keep expense growth between 1% and 2%. "We are closer to the end of that journey than the beginning," he says.

As for being "Amazoned", Hayward says this is where the local store has learnt a lot from Walmart. Buyers gradually becoming online shoppers was once viewed as a kind of existential threat to traditional retailers, but big stores have gradually built their own online offerings that are fast gaining traction.

In Massmart’s case, online shopping from the company’s own websites has increased between 60% and 70% over the past year, and online penetration — the proportion of those products offered online against total sales of those items — is now about 1.6%. That seems low, but in some categories it can constitute half of the total sales.

The company needs the SA economy to recover if its own results are to improve

—  What it means

And traditional retail hasn’t been affected anything like other "disrupted" industries. For all kinds of reasons, people still like to shop by going to the store and walking around with a shopping trolley. Amazon itself implicitly recognised this reality by buying Best Foods last year.

One other strength in Massmart’s favour is that it has been a relatively slow store opener. Massmart has grown its store portfolio by only 3% a year over the past five years. "We are probably understored rather than overstored," says Hayward, "but if you have subpar stores in your portfolio you have a real problem.

"Mall owners are feeling the pressure, and traffic is down. There probably are too many malls, and there are definitely too many b-grade malls." What people seem to want is strip-malls; somewhere you don’t pay for parking and where you can get in and out quickly.

Massmart has also been conservative in opening new stores elsewhere in Africa. Only around 6% of sales come out of the African portfolio, but some stores have been fantastic successes. For many years, the Builders Warehouse in Maputo was the best store in the division. Not many African countries are doing well because of the dollar’s strength, but the growth is there, particularly in Zambia, Kenya and Ghana.

Massmart does operate in Nigeria and will be opening new stores. "Nigeria is so big you have to be there, and we have been opening stores there carefully and steadily." It’s "difficult but not impossible" to operate in Nigeria. The country is strict about what you can remit, but "we do get our money out," Hayward says.

It was always thought that Walmart bought Massmart as a vehicle to move into the rest of the continent, but just after the sale, Walmart went through its Mexican scandal, in which backhanders were allegedly paid to government officials for building permits. The stories worried some African governments, so in the end, it’s possible Walmart itself complicated Massmart’s African expansion.

What is Massmart’s near-term future? Analysts are generally respectful of the quality of the business but not ready yet to endorse its growth prospects. That sense is reflected in the company’s rating: almost every analyst covering the company suggests Massmart is a share to hold, but not to buy or sell.

It’s worth noting that in the US, Walmart’s share price has been growing strongly, and that reflects the overall growth of the US economy. Massmart can battle the currents all it wants, but what it needs above all is a growing SA economy.