The key to great retailing: great management

South African consumer-facing stocks, from banks to retailers to schools and distillers have not had a good week. If it was not global and local fears about the coronavirus pulling markets down, then it was their own poor performances that have failed to impress the market.

Results from Massmart, Curro, City Lodge and Distell reinforced a message that investors have been hearing loud and clear – consumers are under pressure, they are buying down, defaulting or not buying at all.

Amid a sea of red in the last week, one set of results stood out, that of Liberty Holdings, though Shoprite’s ran a close second.

The financial services company reported a strong performance for the year to December, suggesting that Liberty is now well on the road to recovery, having completed the bulk of its restructuring a year ago.

Liberty reported normalised headline earnings up 42% to R3.2-billion driven by strong results from its Shareholder Investment Portfolio (the investment portfolio that underpins the life company’s net asset value) and a good operating performance.

“For a consumer-oriented business that is on the blunt edge of discretionary spending this is a good result,” says CEO David Munro.

Of course, the performance of the Shareholder Investment Portfolio (SIP) is influenced by the performance of local and global markets over the last year (and global markets in particular have been storming), but nonetheless the underlying performance of the business has been solid.

“Even if you strip out the SIP result, normalised operating earnings increased by more than 10% which is an excellent result against a very weak economic backdrop,” says Adrian Cloete, a wealth manager with PSG.

A good ratio to watch, says Cloete, is normalised return on group equity value (which is an indication of value added to shareholders over the year). This increased to 11.5% from 3.8% at 31 December 2018 and is now close to the 12% target.

This was mainly attributable to higher investment market returns during 2019 and a substantially improved performance from Stanlib South Africa, the investment manager in which Liberty has a 100% shareholding.

Stanlib SA increased its operating earnings by +30% while its Africa regions increased earnings from R8-million to R54-million. 

“This demonstrates an excellent turnaround in those businesses,” says Cloete.

Overall, the group’s third-party client cash inflows increased to R13.3-billion from R10.2-billion in 2018, supported again by good inflows from Stanlib SA clients.  

Total group assets under management amounted to R738-billion, up from R718-billion in the previous year.

More muted results were experienced in Liberty’s core SA Insurance Operations which saw earnings up just 2% on the comparative period. New business sales of R6.6-billion were 1% up on 2018.

This clearly shows that Liberty’s retail consumers, largely the middle classes, are also feeling the pinch.

“We are seeing very good flows of single premium products, which suggests that when consumers have access to a lump sum, they want to protect it. But we are also seeing a reluctance on the part of consumers to commit to recurring product expense; there is a definite shift in discretionary spend,” says Munro.

Despite this reluctance, the value of new business written by Liberty increased by 10% to R407-million and the new business margin rose to 1%, putting it in the 1% to 1.5% target range.

“Growing sales volumes will remain a priority for management, but this is still a very good sign,” says Cloete.

“The market seems to like the results as well, as it’s one of the few shares that are up today.”

In the red is Massmart, which fell by over 4.5% after the group reported a R1.3-billion loss for the year to December. The company noted that consumers were avoiding big-ticket items, instead spending on food and liquor, which attract lower margins.

Similarly, Distell saw its share fall marginally after the wine and spirits maker reported earnings down by 5% for the six months to December 2019. It was affected by the difficult market conditions in South Africa (its Africa business is performing well) and deep discounting by beer competitors who are “selling beer cheaper than water”.

The company that has arguably been hardest hit in the current climate is City Lodge, which reported a 51% decrease in diluted normalised earnings per share (though this was affected by the implementation of a new accounting standard), for the six months to December 2019. It has seen occupancies decline dramatically in SA, while costs rose above inflation.

Even Curro, the defensive schools group that could not put a foot wrong, is feeling the pinch. Recurring headline earnings per share fell 15% as parents have switched to cheaper schools or emigrated.

Nadir Thokan co-chief investment officer at 27four Investment Managers is sympathetic to a point. 

“There is no doubt that the tailwinds that consumer stocks enjoyed from the late nineties up to and beyond the financial crisis of 2008 has shifted to a massive headwind. This means that companies had to re-examine their strategies and become more efficient.”

He cites Massmart as an example of a company whose strategy could not endure. 

“To earn a 2% operating margin is fine when you are pushing huge volumes, but when these fall off a cliff the outcome is there for all to see.”

World-class businesses, on the other hand, allocate capital efficiently and keep a laser focus on market share, margins and costs. These businesses can deliver reasonable earnings growth under most circumstances.

“There is a reason that Clicks, which earns not one cent of rand hedge earnings, is one of the best performing shares on the JSE over five years.”

Liberty founder Donny Gordon who started the business in 1957 after watching his father labour for years for little financial reward and passed away recently, must be smiling from above. The company is poised for growth.

“It’s just amazing what a good management team can do,” says Cloete. BM