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Spar is a sell

Contrarian view from the University of Johannesburg wins CFA research challenge.

Food retailer Spar Group reported full-year results to the end of September on Wednesday. Turnover up 35% to R73 billion and operating profit climbed 23% to around R2.3 billion. To listen to Hanna Barry’s interview with Spar CEO Graham O’Connor, please click here.

Playing on the branding of the Spar Group, the investment analyst team of the University of Johannesburg issued the recommendation: “Not so SUPER, and sell it KWIK”. This comes as a surprise as Moneyweb’s Click-a-Company indicator shows a Buy consensus view for the wholesaler and distributor of goods and services to Spar retail grocery stores.

The CFA Research Challenge is an annual competition in which university teams research a publicly traded company, produce a coverage report, and present their findings to a panel of experts from financial institutions. Last year, UJ won the challenge with its surprising Sell call on construction company Group Five. Its latest Sell recommendation – this time on Spar – has made them winners once again.

The aspiring fund managers from UJ initiated coverage in mid-September when the share price was at R182.50. The share has ticked up since then, but with a one year target price of R151, they see around 20% downside for this stock, due to stretched valuations, saturated markets and limited organic growth.

Spar’s acquisition of BWG Foods in Ireland was a recurring theme in the presentations from all finalists, including University of Cape Town, Wits, and University of Pretoria.

UJ is not convinced of the revenue generating ability of this foreign purchase, and sees discounters such as Aldi and Lidl as a threat in the European retail market. As a result of the BWG transaction, Spar Group debt ratios are increasing. A depreciating rand is increasing the rand value of the significant amount of euro-denominated debt which now sits on the group balance sheet. This will offset the benefits of euro-denominated revenue and earnings.

The opinion from UJ is that the deal will strain group margins, earnings growth looks set to slow, and cash flow constraints could result in a reduction in the dividend. Operationally, there are retail price wars in play in the UK so the outlook for international margin growth is not encouraging. If the BWG acquisition is to enhance group margins, UJ says that management has to actively grab market share from the very aggressive discounter competition, and focus on better distribution.

BWG was in fact acquired at negative net asset value, but the UJ team would have preferred it if Spar Group had deployed this capital more effectively in other activities. For example, it needs to look at launching online shopping platforms for its retail traders, improving the profile of its shopper reward programmes, and raising brand visibility through advertising and marketing.

Back home, local challenges cited by UJ include skyrocketing food inflation, a lack of disposable income, the perception that Spar products are more expensive, and the threat of spaza shops in rural areas. At the upper product price level, Spar is competing with Woolworths but Woolworths enjoys the better reputation for quality. The team also has a suggestion for management regarding the TOPS liquor outlets – that traders be allowed to open these stores without being compelled to first own a food operation.    

Using several valuation models, UJ sees Spar as expensive, and believes Shoprite or Massmart are better buys for the investor. But ideally, the team recommends staying away from the retail sector altogether.

The other three universities in the challenge all have Buy recommendations on the stock, and in fact rather like the addition of BWG. But they do caution on rising debt levels, increasing interest expense, and lower interest cover. Wits sees this acquisition as a forex cushion for the group, offering revenue growth and geographic diversification, set to benefit from recent EU stimulus policies.

UCT also likes the developed and developing market exposure that the group now has, with the BWG acquisition well positioned to take advantage of the recent recovery in the Irish economy. The Cape Town analysts highlight that Ebitda margins in Spar’s foreign operations have scope for improvement. Companies such as Morrisons and Sainsbury’s post margins of 4.93% and 5.22% respectively. While Spar can never reach those levels, as it is a distributor rather than a retailer, there is definitely opportunity to improve its international margin from 3.47% currently, to 3.92% over the medium term.

Similarly, University of Pretoria points out that while BWG operating margins are higher than those of the South African business, at Ebitda level the BWG margins lag. This metric can be improved by exporting the invaluable supply chain expertise of the South African team to BWG and its recently acquired Londis operations.

With a one year price target of R186.67, Wits likes the defensive nature of the retail sector, the group’s store renovation programme, and the revenue growth of TOPS. But it cautions on competition from Choppies, as well as the entry of Massmart into food retailing. It is also wary that any spike in the fuel price would affect logistics, and of the impact of drought conditions on the food sector. Wits urges Spar executives to exploit their house brands more in order to drive local growth.

University of Cape Town has a one year price target of R215.57 and is complimentary on how Spar uniquely manages to reach across nine LSM groups, and has presence in both rural and urban areas.

University of Pretoria concludes that Spar is undervalued relative to peers. It has a one year price target of R210.50, which gives 11% upside from date of initiating coverage. The UP team ‘kicked the tyres’ during its analysis, drawing up a generic food basket from all SA retailers. This exercise showed that Spar was the most competitively priced in the sample. UP mentioned some problematic issues – namely a weak loyalty programme, and operational efficiencies that need to be extracted. This team also put the spotlight on proposed liquor law amendments that would be relevant to TOPS outlets.

Competition judges were Alec Abraham of Sasfin, Craig Pheiffer of Absa and Mark Butler from Perpetua. Butler describes the university challenge as being invaluable to students about to start their careers in the investment arena. “This project is about real-world stuff. It shows students how competitive and tough the business really is. In this profession, investors will be constantly asking them why certain funds have underperformed, putting their analysis on the spot. And the Spar Group is a good choice at the moment, as many South African companies are going offshore, looking for foreign opportunities.”

This article was published in the latest edition of the Moneyweb’s monthly investment e-mag the Moneyweb Investor. To view the original, please click here.

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LOL – And I suppose PnP is a buy huh? These ‘aspiring fund managers’ are in all probability still living at home, have never been into a Spar lately and mommy dear does the shopping for their daily meals – if they are not using the McDonalds drive-thru.

Was this now sucked out of a thumb between rioting…….?????
I am afraid that having seen the recent behaviour of our future analysts I am finding hard to believe that people that behave like that can make judgment calls on other peoples investments/pension funds.

End of comments.

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