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[TOP STORY] Is the South African consumer in a perilous position?

Evan Walker of 36ONE considers the high ratings of Clicks, Shoprite/Checkers and Dis-Chem – and the possibility of shorting the shares as scarcities loom.

SIMON BROWN: I’m chatting now with Evan Walker from 36ONE Asset Management. Evan, I appreciate the early morning. We chatted twice last year around the local consumer concerns that you had. There was certainly some early weakness, but they were hanging on and the R350 grant was extended. But now, looking at where we are in June 2022, [with] transport costs, food inflation, interest rates rising – the consumer must by this point be in frankly a perilous position.

EVAN WALKER: Simon, hi, good morning. Yes, it doesn’t look like it’s getting any better, there’s no doubt if you look at global dynamics now. I just happened to read this morning that even in the UK consumption levels are falling quite dramatically even in sort of non-discretionary items such as food, etc, inflation is kicking in across the globe.

We are not in isolation. It’s an entire global crisis brought on about by *** costs, spurred obviously higher by this Russian/Ukrainian war, and obviously global dynamics at this point which are having a huge impact on global consumerism.

SIMON BROWN: The obvious hit here is retailers – and I want to touch on food separately in a moment, but I’m thinking of the fashion retailers and the like. There’s a bunch. I even wonder about the likes of Clicks, which yes, has a great operating model, but is sitting on high ratings – and consumers’ discretionary spend is just vanishing.

EVAN WALKER: Yes. Those ratings have dumbfounded us, Simon. It’s been an unbelievable business. It really has compounded over the last 15 years its stellar returns for investors, but it’s an exceptionally high-rated stock on a global comparative basis. At some point we think that rating has to come down.

It’s done an exceptional job of growing earnings for shareholders, but to us it’s just too expensive relative to the outlook going forward.

In this country we had up until 2020 significant tailwinds from public-sector wage increases, etc, in this country, but those tailwinds have come to an end and unfortunately now we need to normalise and their stock levels certainly haven’t normalised.

SIMON BROWN: Yes. Clicks is a great operation, but is still on a historic PE of around 35 times. That is onerous.

You mentioned food. I would have thought that perhaps more non-discretionary. Certainly food [which is] non-discretionary would be more robust – particularly [for] the likes of Shoprite, who are great operators, who have the different brands for different LSM points. But perhaps there’s some weakness coming there because, again, Shoprite is not quite a Clicks in terms of a rating, but it’s not a cheap share.

EVAN WALKER: No, it’s not cheap, but it has shown itself to be very resilient. It’s also shown itself to migrate very fast to its online capabilities and take significant market share in that space. We think the likes of Spar have been left behind from a market-share perspective just in that territory, not being able to keep up with the likes of Checkers and Shoprite, and certainly taking share away even from the big guys, the likes of Makro, etc, in this environment where online has become so prevalent – and obviously is still accelerating in the local dynamic.

The jury is still out over the next 12/24 months as people are returning to work and convenience comes back a little stronger, and online drops off a little.

So we’re not quite sure what that dynamic will look like, but there’s no doubt that online will incrementally continue to grow in the South African environment and Checkers has done a phenomenal job of taking share. So we still think that’s a good share. We still hold that share in our portfolios.

We still think it’s leveraged to relatively high inflation [with] continual strength coming from market-share gains. And then they’ve done an exceptionally good job, both exiting areas of the world where they don’t think they can add value, and bringing capital back to South Africa – which has been long overdue from South African retailers – and they continue doing an exceptional job in the South African environment. So that’s a share we still do hold, Simon, in the portfolios.

SIMON BROWN: I saw a comment a week or so ago about the likes of Shoprite. The comment was that they have absolute pricing power unless there are shortages. Until there are shortages they are the pricing power. Broadly, if we look at some of those retailers who are expensive, who are looking at risk, are you and your team looking at shorting opportunities here, or is this just a case of ‘let’s avoid them at this point in time’?

EVAN WALKER: It’s difficult to short very good shares until you see a crack in the system. We haven’t seen a crack yet. Even for the likes of Clicks we’ve got single-exit pricing from the drug side still coming through quite strongly. We are obviously going into the back-to-work environment, where people through the winter will get sicker again. Kids are back at school. There’s still this back-to-work initiative coming through at the front end of these businesses, so we are a little scared to short it still. We think they’re expensive. We’re not long on these stocks. Dis-Chem is another one, which is a highly rated share in this environment. But still, the turnover growth in the last trading update was pretty good, running at about 14/15%. These are good numbers coming for retailers still.

So we are reluctant to short shares until we see a definitive crack coming. That crack will come at some point at a margin level to us. Not so much at a turnover level, but certainly at a margin level.

Our big worry, funnily enough, jumping back to the food retailers, as you said, would be shortages. We haven’t seen significant shortages yet in the South African environment. It’s a thing playing out now globally, but yet we’ve yet to see that from our supply chains which have been quite resilient, but there could be some pretty big shortages coming down the way in the next six to eight months.

SIMON BROWN: We’ll leave that there. But I like the point there – there’s no crack yet. Don’t try and get ahead of it. As Evan Walker of 36ONE Asset Management says, keep an eye on those margins. That’s going to be the point.

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