Fashioning an opportunity

The Foschini Group makes the best of a bad market.

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The Foschini Group makes the best of a bad market.

TFG has responded well to the credit market storm that inflicted pain on most credit retailers in the past two years. It disposed of RCS – its consumer finance division providing credit cards, personal loans and insurance products to the mass middle market – and replaced it with an offshore upmarket cash apparel retailer, Phase Eight.

TFG now generates 46.9% of sales in cash, up from 42.2%. Interestingly, its gross profit margin including Phase Eight shot up to 47.3% (FY:46.5%) compared with 46.7% excluding it. It is plausible to expect this margin improvement to trickle down to the bottom line once Phase Eight has properly bedded down. In addition, Phase Eight provides a natural rand hedge, geographical diversification and also offers a leveraged platform on which the group can introduce its Foschini product range in Europe and Asia. The annualised revenue contribution from Phase Eight is 12%, but this is set to increase in light of the rand’s continued weakness and as Europe starts to benefit from the European Central Bank’s quantitative easing programme.

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Sales turnover grew 13.6% (10.8% excluding Phase Eight) to R16.1 billion from continuing operations, where product inflation averaged 7%. Cash sales accelerated 19.6% and credit sales, which improved in the second half of the year, managed meagre 4.3% growth. Operating profit climbed 10.7% to R2.8 billion with the operating margin (excluding Phase Eight) dipping to 17.7% (FY14: 17.9%). Including Phase Eight it was lower at 17.5% but we expect this to increase to about 18% in the medium term as synergies become entrenched. Headline earnings from continuing operations (excluding once-off acquisition costs) rose 9.7% to 897.9c/share.

Management declared a scrip dividend (with a cash alternative) of 588c/share which is an increase of 9.7%. The scrip dividend is a move by management to reduce the high net debt-to-equity ratio of 77% down to 40% in the medium term.

The consumer market is still cloudy though there are signs of recovery. Transunion national credit numbers reflect the most marked improvement in more than two years but a parallel survey shows consumer confidence is at its lowest point in more than a decade.  TFG’s debtors’ costs as a percentage of debtors deteriorated marginally in FY15 to 13.5% from 12.4% the previous year, but is still far better than FY13’s 28.5%, which was in the thick of the credit crunch. However it is still higher than the 9%-10% range prior to the credit crunch.

It is impressive that debtors’ turnover has gradually improved over the past five years, although the growing cash sales component may be partly responsible for this upturn. In contrast, its stock turnover has slowed marginally during the same period, which has coincided with the encroachment by international competitors on the local market and is also testament to a tougher trading environment.

Given economic stagnancy in SA, management’s drive in FY16 to open more than 250 stores under Foschini and Phase Eight brands as well as growing its infant e-commerce business can be effective in growing sales. Further, this will be augmented by its drive to optimise the supply chain.

To some extent, TFG’s comfortable operating leverage mitigates its worrisome high financial leverage.

At a macro level things are not looking up. Interest rates are set to continue on an upward trend while power outages and poor economic growth are other negative factors for retailers. Furthermore, the regulatory framework has been revised to tighten credit-granting criteria and the credit insurance business model itself is in the spotlight. However, this may have negligible impact as insurance revenue accounts for less than 2% of group revenue.

Having reduced its exposure to the local unsecured credit market and expanded cash sales and its international reach, Foschini is set for better times ahead particularly given the rand’s recent devaluation. Indeed, the group disappointed the market in its FY15 results which were characterised by negative non-continuing elements. This saw its share price coming down after rising to record highs during the year and we believe it is an opportunity to gain exposure to this counter.

Bull factors

  • Robust credit management and focus on increasing cash sales will reduce business risk
  • Entry into Europe and Asia will diversify earnings as well as leverage Foschini’s efforts to introduce its brands in these regions.
  • Rollout of new stores and focus on improving efficiencies should support earnings growth
  • Disposal of RCS has reduced exposure to the unsecured credit market

Bear factors

  • Recovery of consumer spending remains constrained by high unemployment, high indebtedness and threat of higher administered costs
  • Sustained rand weakness likely to undermine margins

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Nature of business: The Foschini Group Limited is an investment holding company with several companies trading in more than 2 200 stores throughout South Africa and some parts of Africa. The recent acquisition of Phase Eight, which operates in Europe and Asia, adds more than 400 stores. The group boasts prominent brands such as Foschini, Donna Claire, fashionexpress, Luella, Markham, Exact!, Sportscene, Totalsports, DueSouth, American Swiss, Matrix, Sterns and @home.

DisclosuresThe analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, please click here.

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