The Irish are on board

Spar’s European and Africa exposure expected to drive growth.

With the bedding down of Irish operations firmly on track, Spar’s expansion into Africa becomes more important given the tepid retail outlook in SA.

We like the decision to acquire the Irish group, BWG Foods. It will provide earnings stability and boost translated euro earnings, given the rand’s poor running of late.

Ultimately retail supremacy is fashioned by scale, so it makes sense for Spar to accelerate regional expansion. It has a presence in most Southern African countries, hopes to conclude a deal in Zambia soon and plans to expand further into Africa. Scale economies drive up margins as bargaining power with suppliers improves and logistics become more efficient.

But Spar needs to tread carefully so as not to suffer as Shoprite did in Nigeria. Thorough market research is imperative. For example, the growth of the African middle class and rising consumer demand are widely acclaimed. Yet the African Development Bank defines a middle class African as someone who spends between $2 and $20 a day. Also much of the economic growth in Africa comes from mineral resources which have depressed prices at this point. In addition, just a bit of the profits from these mineral ventures trickles down to the mass market.

Spar’s interims results, the first to include Irish BWG group, were in line with expectations.

Turnover, which excludes other income, increased 41% to R36bn with BWG contributing 21%. Operating profit rose 29% to R1.15bn and BWG’s share was 10%. Headline earnings climbed 23% to 455.5c/share with a 34.7c/share contribution from BWG. Although gross margins improved on the Irish influence, the operating margin came under pressure, retreating to 3.2% (1H15: 3.5%) due to an abnormal increase in operating expenses as a result of consolidating BWG. An interim dividend of 239c/share (2014: 195c) was declared.

Stripping out the Irish operations, headline earnings grew 13% (against 9% for Shoprite and 28% for Pick n Pay in their recent results).

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We like Spar’s fundamentals when compared with its peers Shoprite and Pick n Pay. Bar Shoprite’s operating margin, Spar has superior return on equity and dividend yield and its relative valuation, although high, is lower than peers. If the high valuation attached to Pick n Pay comes to fruition through margin improvement, it would not be unreasonable to say the same can happen for Spar since it has a relatively smaller market share. As such there is potential for growth and honing economies of scale.

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Further afield, Spar’s prospects in Ireland look bright as growth of 4% is expected in that economy and employment levels are improving. In addition, management has embarked on a five-year programme to improve operations in Ireland.

However, according to our discounted cash-flow valuation, we think the price of the counter has to a great extent captured the value of the Irish acquisition and is now trading within its intrinsic value range. Against this backdrop we downgrade our previous buy recommendation to hold.

Bull Factors

  • Irish operation provides international diversification and hedges against the rand
  • Continued upward pressure on food inflation could support an increase in margins

Bear Factors

  • Tight competition likely to see continued margin pressure.
  • Uncertain pace of economic recovery and consumer demand.

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Nature of business: The Spar Group Ltd acts as a wholesaler and distributor of goods and services to Spar retail grocery stores, Build it builder’s merchandise outlets and TOPS liquor stores. With distribution centres across SA, Spar also provides goods and services to retail stores in Swaziland, Botswana, Namibia, Zambia and Zimbabwe. The relationship with retailers is of a voluntary trading partnership. It recently added oversees operations through the acquisition of BWG group, Ireland.

DisclosuresThe analyst has no financial exposure to the instrument discussed. The opinion represents his true view.

All graphics sourced from Intellidex.

For Intellidex’s full disclaimer, methodologies and definitions please click here.

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