Should you buy South African retailers?

It’s not hard to see why investors are uncertain about whether they should put their money into local retail shares this year.

Returns in 2023 were hardly inspiring: from the best performer, TFG, with a  9.8% gain, to the worst, Pick n Pay, with a 59% plunge. Load-shedding continues, consumer debt is cripplingly high and rising, the economy is stuttering — and there’s an election to boot.

But Shane Watkins, chief investment officer of All Weather Capital, is betting on an improvement in the power crisis, which should boost company profits, and on relief from lower interest rates.

“The bottom line is that revenues are going to be higher and some cost items are going to be lower, so the outlook for retail is reasonably good,” he says.

Watkins says the valuation of the sector is “reasonable”, and also lower than its historical average.

“It’s important to note that the sector is probably better managed on average than most JSE companies. For the most part, retailers have competent, experienced management teams and I think the sector deserves to be more highly rated,” he tells the FM.

As for particular stocks, he views pharmacy and beauty retailers Clicks and Dis-Chem, as well as Shoprite, as “probably a bit too expensive”.

“Your opportunities are probably either in recovery stories such as Spar and Pick n Pay, or in the cyclical clothing retailers. Those are the two areas to look at,” he says.

Watkins’s picks are Truworths, “it’s still on a sub-10 p:e prospect, with good [potential] and excellent management”, and Pepkor.

He cites three promising features for the discount retailer: first, that it caters for a very large market segment, offering basics. Second, that its business in South America, Avenida, is doing better than expected “and has a lot of growth opportunities”, and third, that CEO Pieter Erasmus has had his share options reissued at a lower price.

Erasmus’s move, says Watkins, “aligns his interests with the interests of shareholders quite closely. In fact, I have seldom seen a situation where the CEO is so strongly [motivated] to get the share price up in a relatively short time. What is good for him is good for us as investors, and I welcome that dynamic.”

As for Spar, says Watkins, “it’s an interesting recovery opportunity. What it needs to do is sell [its Polish operations] and fix some specific operational problems in South Africa. Those two actions will reduce the financial risk and hopefully increase the loyalty ratio among franchisees, which will result in quite a big turnaround in earnings.”

Casparus Treurnicht, portfolio manager at Gryphon Asset Management, prefers the value retailers, and considers Mr Price to be best placed at the moment. “I would’ve liked to go with Pepkor, but it has been underperforming for a number of periods now, there is something odd about it and the [Avenida] acquisition is taking focus off the main operations,” he tells the FM.

“Truworths is also not a bad option,” Treurnicht says. “It consistently chugs along. TFG made too many acquisitions, and returns to shareholders are going to be on the back foot for now.”

Truworths is also not a bad option — it consistently chugs along. TFG made too many acquisitions and returns to shareholders are going to be on the back foot for now

—  Casparus Treurnicht

Treurnicht says he’d like to recommend Pick n Pay, simply because of its bombed-out share price, “but recent visits do not show any improvement — so we’ll wait for that”.

Watkins sees Pick n Pay as potentially “a big turnaround opportunity”, but only if the retailer, now under Sean Summers, manages to mend its overstretched balance sheet and fixes the myriad problems with its core supermarket brand, which could take 18 months, at least.

For 36One Asset Management’s Ewan Walker, no clear thread has emerged from the slew of retail updates over the past few weeks, though he says the numbers weren’t as “terrible” as might have been expected.

“You still want to be invested in Shoprite, but it’s expensive.” Walker says Clicks and Dis-Chem are good businesses, but there’s opportunity to improve efficiencies at Dis-Chem and both companies will experience the benefit of the single exit-price increases for prescription medicines that were announced by the department of health at the end of last year. 

Walker says there is no clear winner among apparel retailers, given South Africa’s nonexistent growth and rising competition from Chinese retailers in smaller towns. “I can’t call a definitive winner with a three-year view — there are too many moving parts,” he says.

But he reminds would-be investors: “You’ve got to buy when [shares] look overly sold and offload when they’re overly bought. You’ve got to trade on valuation, not fundamentals”.