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Author: Abdul Davids, Head of Research at Kagiso Asset Management|

06 August 2012 00:14

Pick n Pay: from underdog to top dog?

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Is Pick n Pay on the cusp of a turnaround, which could significantly improve its long-term outlook?

Pick n Pay, once regarded as the market leader in the food retail sector, has lost significant ground to its competitors over the last few years. The company’s failure to swiftly adapt to the changing food retail landscape resulted in its underperformance. However, we believe that Pick n Pay is currently on the cusp of a turnaround, which could significantly improve its long-term outlook.

Pick n Pay’s ‘golden years’ and ensuing slide

Pick n Pay’s history stretches back to 1968, when it was first established by Raymond Ackerman. The business’ initial success and the innovative retail strategies it pioneered in South Africa ensured strong growth in profitability and market share for around 30 years. During this time, many competitors came and went.

However, Pick n Pay became a victim of its own success as its family-controlled structure seemed to restrict its advancement in the evolving food retail sector. In essence, Pick n Pay became complacent over the last decade. As a result, the business has lost significant market share, mainly to Shoprite, Woolworths and Spar.

Market share loss over the years

Until around 2005, Pick n Pay enjoyed a prolonged period of superior growth in market value and significantly outperformed Shoprite. However, Shoprite’s subsequent stronger profitability growth resulted in its market value exceeding that of Pick n Pay for the first time in 2007 (graph below) and it is now around four times as large as Pick n Pay.

An investment of R100 in Pick n Pay from calendar year 2000 would have grown to R733 (including dividends) by the end of April 2012. In contrast, an investment in Shoprite would have grown to a staggering R2 843 (also including dividends). Due to Pick n Pay’s operational underperformance, its share price has substantially underperformed in recent years relative to Shoprite and other companies in the food retail sector.

Superior operational performance from Shoprite

Shoprite has had a head-start in that it invested in centralised distribution centres and established a presence in Africa much earlier than competitors. This has given the group a competitive edge over other food retailers, especially Pick n Pay.

In addition, Shoprite services a wider range of consumers by targeting low, middle and high-income markets. Pick n Pay, on the other hand, mainly targets the middle and higher-income markets. Shoprite’s exposure to the lower-income group (South Africa’s fastest growing market) has been the largest contributor to its growth in recent years.

Shoprite versus Pick n Pay

In order to highlight some of the important differences in Shoprite and Pick n Pay’s operational performances, we analyse four key indicators.

1.    Operating profit margins

The rapid decline in Pick n Pay’s operating profit margins and revenue growth are largely due to:

  • Management’s fixation with achieving a turnaround for the underperforming Australian business, Franklins. This resulted in considerable management time and attention being diverted away from the key South African operations. 
  • An unwillingness to use the corporate balance sheet to invest and grow the business organically. Instead, Pick n Pay has chosen to pay substantial dividends and grow its franchise store format. 
  • Poor operational management, resulting in the duplication of administration functions across divisions and its legal entities. 
  • The recent high costs associated with the implementation of the Smart Shopper loyalty programme.

In contrast, the growth in Shoprite’s operating margins has largely been driven by higher gross profits due to the lack of a franchise structure. In addition, the company’s successful centralised distribution network and supply chain has improved its operational efficiencies and reduced operating costs.

2.   

Employee costs

As a result of its vastly more generous labour practices, Pick n Pay has been over-staffed over the last few years. The company’s employee costs as a percentage of merchandise sales and its average pay levels have also been much higher than competitors (see graph on the next page).

However, this structural problem is currently being addressed, with management terminating the 1995 ‘Flexibility and Mobility Agreement’, which specified the working terms for Pick n Pay’s employees. This led to the recent retrenchment of around 3 000 employees and the company is reviewing its use of contract labour to ensure a more balanced mix.

As a result, the average number of employees per store is expected to decline from around 117 to 95 by 2015. Furthermore, management has undertaken to reduce employee costs as a percentage of turnover to 7%, bringing this metric more in line with competitors.

3.   

Trading densities

Trading density is one of the most important measures of a retailer’s performance. This is calculated by dividing a retailer’s revenue generated over a financial year by its total store space. A higher ratio implies that the store space is being used more efficiently.

Since Shoprite management does not disclose this data, it is challenging to obtain comparative trade density figures.

For Pick n Pay, a successful rollout of the group’s distribution centres will vastly improve inventory management efficiency. The distribution centres will also free up store space that is currently being used to hold stock in-store. Overall, this will result in improved trading density figures for Pick n Pay as retail space increases and therefore store profitability improves, without any increase in rental cost.

4.    Capital expenditure

Over the years, Shoprite has spent much more capital than Pick n Pay, partly to set up its centralised distribution centres. This strategy has allowed it to aggressively grow its market share. Pick n Pay recently increased its capital expenditure plans significantly and management intends to spend around R2 billion to develop its regional distribution centres.

Pick n Pay’s turnaround strategy

Despite significant challenges, Pick n Pay has developed and begun implementing a turnaround strategy to address the issues that have hampered the company’s growth.

Franklins, the struggling Australian business, has been sold to Metcash Australia and the South African procurement function is being streamlined and centralised to avoid cost duplication. The various employee cost saving initiatives and the benefits of successful centralised distribution centres have the potential to significantly boost Pick n Pay’s margins over the long term. The Smart Shopper loyalty programme is also expected to add to margins by increasing sales volumes. This loyalty programme has been key in preventing larger losses in Pick n Pay’s market share and has given the company useful insights into its customers’ spending habits.

After many years of complacency, Pick n Pay is clearly focusing on reclaiming some of its lost market share. In addition, the imminent appointment of a new CEO and the recent choice of a new Chairman could result in a meaningful change to the company’s operational capabilities. Overall, the outlook for Pick n Pay has improved and we believe that the company’s new initiatives will result in a major earnings recovery.

Topics: pick n pay, Raymond Ackerman




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