Just before all hell broke loose in 2020, The Foschini Group (TFG) was trading at R112.
In mid-2021, it was trading above R160. Since then, there’s been a steady decline as interest rates have increased and consumer conditions globally have deteriorated. Trading at just under R100 at time of writing, the decline over 12 months is more than 16%.
If you need a reminder of just how difficult it is for South African retailers, data going back to 2005 suggests a compound annual growth rate (CAGR) over that period of just over 5%. The past decade really ruined it, with a slightly negative CAGR. The dividend barely makes up for this, so your money would’ve been a lot better off in the bank.
The reason for the history lesson is that investors need to understand when they are swimming upstream. Any decision to buy a local retailer needs to be made in the context of the broader macroeconomic picture. There is no point in taking single stock exposure that can’t materially beat the index. When assessing local retailers, you also need to remember that many of them (like TFG) also have offshore operations that need to be considered.
Detailed results for the six months to September are due on November 10. A trading statement guided that HEPS for the period will be between 15% and 25% lower (putting it in line with the first half of 2021 as a best-case scenario), with various reasons for this. There’s a high base effect in TFG London and TFG Australia. We have the obvious problem of macroeconomic pressures in South Africa. Also, the company decided to acquire Tapestry (which sells consumer discretionary items) and take on a great deal of debt into a rising interest rate cycle — a risky play that will hopefully work out over the long term even if there’s pain in the short term.
Tapestry skews the numbers, as any major acquisition always brings loads of new revenue (and costs) onto the financials. At least they do disclose sales growth excluding the impact of Tapestry. TFG Africa sales growth came in at 16.1% including Tapestry, or 9.7% excluding that acquisition. At category level, the Tapestry deal affects only the Homeware category, which is 77.2% larger year on year and now contributes 13.7% to TFG Africa turnover.
Clothing (72.3% of TFG Africa turnover) is still the most important category, growing 11.8%. The overall growth rate was brought down by an unexciting performance in cosmetics and cellphones and a flat performance in jewellery.
It’s also worth highlighting 34% growth in online turnover thanks to the launch of Bash as the new online platform. The group has invested heavily in competing online, something that is unavoidable as consumers become accustomed to doing their shopping at home. It’s an expensive way to service customers.
Cash turnover grew 21.8% for TFG Africa and credit turnover increased by only 2.9%, despite average acceptance rates for new accounts being stable. Cash turnover represents 73.4% of the TFG Africa total.
Though TFG doesn’t run fridges, it’s still difficult to sell clothes in the dark
This sounds OK, so why the problematic earnings performance? Well, the first issue is gross margin, which is down 330 basis points against the comparative period. To drive sales growth, the company needed to be aggressive on price. Inventory is down 4% year to date, so it came into this period overstocked and has paid the price in gross margin.
The announcement doesn’t give any details on TFG Africa store expenses, but one can assume the impact of load-shedding and the usual pressures such as security costs is significant. Though TFG doesn’t run fridges, it’s still difficult to sell clothes in the dark. The gross margin pressure offsets much of the benefit of sales growth, and expense growth may well offset the rest.
Moving abroad, things aren’t heading in the right direction. TFG London’s retail turnover fell 12.4% in local currency, an impact that is cushioned by the rand. The group is focusing on gross margin rather than top-line growth in that business. It’s much the same in TFG Australia, where retail turnover fell 6.6% in local currency. In rand terms, TFG Australia grew 1.7% and TFG London grew 3.7%. They contributed 18% and 14.5% to retail turnover respectively in the 22 weeks to August 26.
Using the midpoint of the headline earnings guidance, the last 12-months is 845c a share. This puts the group on an earnings multiple of 11.7. The inverse is an earnings yield of 8.55%. That’s not enough to justify the risk in this environment.
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