It is a cliché that supermarket groups, the ‘widow-and-orphan’ stocks of the retail sector, offer shareholders among the most consistent cash returns and capital protection on any stock market. (Of course, critics of this investment philosophy warn that non-cyclical sectors can offer ‘consistently low returns’.) The reason is simple: consumers need staples – come rain or shine.

Globally, after the 2009 recession the big supermarket groups reinforced their standing as a safe haven investment. However, in 2013 they struggled to hold onto this reputation in SA as the cycle of loose lending in the unsecured debt market finally caught up with consumers and lenders, aggravated by issues like hugely inflated electricity costs and high unemployment.

Even as Woolworths Holdings reported in February that first-half profit was up 22%, driven by its luxury food sales outpacing rivals, it was the comments following these results that illustrated the doubts about the future spending of customers.

‘Anxious investors stake glister off Woolies’ shining return,’ was one Business Day headline. This was in reaction to the company’s shares falling 3.9% despite its first-rate grocery and clothing sales performance. The stock was sold because of negative sentiment in the market regarding consumer spending following the unexpected 0.5 percentage point interest rate increase in January. With the rand price of imports expected to rise, economists are predicting there will be more increases to come.

Although not strictly part of the food retailers sector, Woolworths’ upmarket food division has become an increasingly important part of its business. For the record, its food sales were up 15.3% as it almost doubled over four years the variety of items it stocks. The group net profit rise of 22% to R1.61 billion cemented a turnaround of its clothing division, which generates over half of profits. Despite the sudden fright among Woolworths investors, the retailer did not predict any deterioration in turnover growth – forecasting SA sales growth ‘to be broadly in line with the first half’, according to Biznews.

Woolworths CEO Ian Moir highlighted the divergent view of consumer segments at the company’s results presentation. ‘Lower and middle-income consumers are under pressure with confidence at a 10-year low, but the upper-end is more confident and less constrained.’

Precisely how robust the well-heeled consumer proves to be in 2014 is the $64 000 question.

The performance of its rival, the upmarket Checkers chain, owned by Shoprite, confirmed a similar sales trend to Woolies in 2013. ‘The Checkers brand defied the general market trend and reported good growth, increasing turnover by 10.7%. It continued to grow its share of SA’s more affluent LSM10 segment,’ Shoprite commented.

However, the Checkers performance was not replicated at the group’s biggest chain, the middle and lower end Shoprite format.

‘The Shoprite brand’s growth in turnover, which slowed to 7.3%, was severely impacted by unemployment, labour unrest and the indebtedness of consumers,’ the company said.

Overall Shoprite increased total turnover by 12.1% to R92.75 billion in the year to June 2013, lifted by growth of 27.9% in the rest of Africa.

The Shoprite group’s sales growth has since slowed further, the retailer said in a trading statement in January – six month to December 2013 turnover rose 9.6% to about R51 billion. The company said trading in its core SA business ‘remained difficult’ as net profit grew slower than sales. Net profit was up 7.1% to R1.83 billion.

In February Shoprite said it would continue to expand aggressively in the struggling South African market, opening around 100 new stores to add to its existing 1 362 South African company-owned shops before June this year, according to Business Day. In faster-growing markets outside of SA it would open 44 supermarkets before June 2015, adding to its total of 163.

‘[Consumption] should pick up again slowly in the second half as real wage increases keep pace with higher inflation’

PETER ATTARD MONTALTO, NOMURA ECONOMIST

Sector old-timer Pick n Pay, under relatively new management, showed a sign of a profit turnaround in 2013 even if that was not replicated at a sales level. Pick n Pay became more efficient at keeping stores stocked as it continued to implement a centralised warehouse distribution system. The group said while ‘turnover growth remains under pressure’ it had expanded its gross profit margin from 17.7% to 18.1% in the six months to August 2013. 

However, this still lagged Shoprite, which reported a gross profit margin of 21% in financial 2013. For almost a decade analysts have ascribed this margin difference between the two retailers to Shoprite’s leadership in implementing centralised distribution.

Pick n Pay operational profit improved as it grew faster than sales, with trading profit up 15.2% to R318 million, while turnover rose 7.5% to R30.1 billion. However, after adjusting for interest, earned and paid-out net profit was up only 5.8% to R193 million.

Nonetheless, Pick n Pay’s poor performance over most of the past decade has not stopped investors pricing in a return to the good performances of yesteryear. The supermarket group’s price earnings (PE) ratio was close to 40 on 20 February 2014, making it the most expensive pure supermarket investment in the country. By way of comparison, the Shoprite PE was just under 21 and Spar Group at a similar level of about 20. The Woolworths Holdings PE (naturally including clothing) was 18.71.

Spar Group, as a grocery distributor to independently owned Spar-branded stores, has always operated a centralised distribution system. Spar produced the best investment performance among food retailers as management consistently delivered both profit and dividend growth over the last five years. Spar’s industry-leading, one-year return to 20 February was 8.85%, according to Bloomberg. Pick n Pay was second over the same period with a 1.6% return, Woolworths third at -2.91% and Shoprite last at -18.5%.

Spar said it ‘experienced a challenging trading period’ for the 17 weeks ended 25 January 2014, with turnover at R16.9 billion, growing 7.4% on a comparative basis against the prior year.

The group highlighted that sales volumes were up, not just the rand value of sales – in a climate of rising food inflation fears. ‘This performance continues to reflect positive volume growth and low levels of food inflation,’ Spar said. It’s recent 7.4% sales rise reflected slowing turnover growth at the firm after sales climbed 9.8% to R47.4 billion in the year to September 2013. Spar profit growth was ahead of sales growth with net profit up 12.4% to R1.19 billion.

Like other companies in the sector, Spar is looking to growth on the rest of the continent. Last year it announced it would develop its logistics systems to supply new stores in Angola, following other SA retailers (Shoprite and Pepkor) into sub-Saharan Africa’s third-biggest economy.

Initially foreign retailers had not been tempted by Angola’s big economic growth rates due to political risk, and contract insecurity. It is not clear what changed the risk-reward equation for SA investors in Angola but media have noted the government’s early successes in diversifying the economy away from a total reliance on the oil industry.

Taking a calculated chance to establish a presence there has paid off for some – in January the country was the biggest foreign revenue generator for Shoprite.

Media has noted the [Angolan] government’s successes in diversifying the economy away from a total reliance on the oil industry

Spar said the investment would be alongside an unnamed Angolan partner but didn’t quantify the investment or the speed of the store rollout. ‘We decided some time ago that in taking our business model to Africa we needed local expertise or we were wasting our time,’ Spar group finance director Mark Godfrey told Bloomberg.

‘Our African expansion is deliberate. We supply Spar stores in Botswana, Namibia, Swaziland and Zambia and have a 35% share in Spar Zimbabwe,’ according to Spar’s 2013 annual report.

Zambia was the first country where Shoprite, the SA industry leader in African expansion, built a significant presence. In 2013 Shoprite had 21 same-name stores there and had established a distribution system as effective as that in SA, according to the group. But despite the relatively low political risk in Zambia over the last 15 years, there have been disruptions.

Last year the Zambian government reportedly told Shoprite to pay 3 000 striking workers ‘far above the minimum wage’, Business Day reported. Shoprite responded by firing the workers and the government threatened to revoke its trading licence, illustrating that stability in the country is yet to be completely cemented. In the end the dispute appeared to be settled through negotiation less than a week later.

But it is the situation south of Limpopo that has analysts cautious. While food volume sales have rarely turned negative in SA (helped by population growth), for months in 2013 they were barely positive.

Traditionally at this point in the economic cycle, where interest rates start to rise off a low base, it has been spending by the mortgage-free majority, the lower end of the market, that has started to make up for the fall-off among home buyers who curtail spending to pay their bonds. This mass market, which is less interest rate-sensitive, then begins to benefit from job creation in a growing economy. The problem is the SA economy isn’t growing, certainly not fast enough to create widespread employment. Production is sluggish and imports are still high while the rand is weak. Adding stress to the mass market is that it is already constrained by high interest, low-value, unsecured loans with banks wary of granting new credit.

Emerging markets economist for Japanese investment bank, Nomura, Peter Attard Montalto, told the media: ‘We see consumption stalling through the first half [of 2014] as rate hikes begin but also, and we suspect more importantly, credit growth to households continuing to slow.’

‘It should pick up again slowly in the second half as real wage increases keep pace with higher inflation. As such, we see growth in consumption of only 3.5% for the full year after 2.8% in 2013, still much lower than the 4.9% seen in 2011,’ he said.

The conventional investment wisdom is ‘a bit of inflation’ can benefit food retailers as the rand value of profits is boosted. But this depends on two related factors: firstly that supermarkets are able to pass on price rises to shoppers and secondly this does not cause the volume of product sales to fall. Despite the weekly supermarket shop being the last purchase households cut back on, some analysts have questioned consumers’ ability to absorb price rises this time round.

Speaking on Talk Radio 702’s markets show, Chris Steward, head of equity research at Investec Asset Management, said the jury was still out on the impact of higher inflation on food retailers. Steward cautioned investors not to be overly optimistic about supermarket profit expectations.

‘We shall see, but it’s a tough consumer environment out there and I think the consumer is not going to be able to take huge amounts of price increases,’ he said.

By Tom Robbins
Image: Gallo/GettyImages