Steinhoff Africa Retail (Star) is the separately listed business within the Steinhoff International stable that houses Pep, Ackermans and a variety of specialty clothing and furniture retailers. Despite receiving a clean audit for the 2017 financial year, the market wants little to do with anything in the Steinhoff stable and the retail group is trading at a deep discount to its closest peer. Can Star emerge from its parent’s troubles unscathed?
Star, which is 71% owned by Steinhoff, currently has more than 5 000 stores, the most of any South African retailer. The group’s broad business model is based on the premise that low prices attract customers, especially when coupled with an extensive footprint.
Over 90% of the value in Star sits in its two key brands, Pep and Ackermans, both part of the old Pepkor stable, which was sold to Steinhoff in 2015. These businesses have thrived under various owners over decades, delivering more than 10% growth per year over the past 20 years until 2017. They also have great histories of converting accounting earnings to cash, which undoubtedly formed part of the attraction to both private equity owner Brait until 2015, and Steinhoff thereafter.
Pep’s model is designed around servicing lower-end customers, often in South Africa’s more rural areas. The company offers the lowest prices on its products, with best-price leadership on 99% of items. Coupled with ease of access to stores (there are over 2 100 in southern Africa, compared to 1 450 for the entire Shoprite group), the business creates significant loyalty among its customer base.
The primary focus of both Pep and Ackermans is on children’s wear, which makes these operations less sensitive to the occasional fashion misses of Mr Price, Woolworths and Foschini. The simple fact that children grow means that demand tends to be more stable throughout the cycle than at its peers. The corollary to this is that during periods of strong economic growth, Pep and Ackermans generally lag the fashion retailers, an impact then exacerbated by their peers’ higher degree of credit sales.
JD’s return to profitability
The old JD Group – owner of brands like Bradlows, Russells, Incredible Connection and HiFi Corp – forms a small part of Star, accounting for 14% of revenue. Since delisting after being bought by Steinhoff, this business has right-sized its footprint and returned to profitability.
The third piece of the Star puzzle is the mix of specialty clothing and footwear stores, the largest of which is Tekkie Town. Despite the founders’ unhappiness with the Steinhoff shares they received as part of the 2017 sale, the business itself is performing well.
The results for the first half of the 2018 financial year showed a group performing to expectations operationally, but with a substantial charge related to a 2011 management incentive scheme. The original Pepkor shares in this scheme were swapped for Steinhoff shares in 2015 as part of the purchase. This collateral covered the value of external loans by six or seven times when Star listed in September 2017, but the subsequent collapse in the Steinhoff share price means that Pepkor’s guarantee on this loan is now relevant and has been provided for. More relevant is that the lawyers and auditors say there are no other surprises.
Star also recently refinanced its R16 billion of loans from Steinhoff with external banks, which released the group from any guarantees relating to Steinhoff debt. Management assured the market that no further guarantees exist, but scepticism in this regard is only natural.
The market’s key remaining concerns centre around three issues: poor disclosure, potential litigation and ‘unknown unknowns’. While disclosure should improve when the next results are released, the outcome of litigation by Tekkie Town’s sellers and the Steinhoff class action suit will take time, as will showing the market that there are no hidden skeletons.
The above items appear fully baked into the market price, with Mr Price trading at 40% to 50% higher valuation multiples than Star, depending on which metric is used.
The board, led by chairman Jayendra Naidoo, who represents BEE investor Lancaster and is thus aligned with minority shareholders rather than Steinhoff, is pushing hard to distance Star from Steinhoff. The first move is the planned name change to Pepkor. Subsequent efforts will determine whether Star can emerge from the shadow of its tainted parent and spread its own wings.
David Lerche is senior investment analyst at Sanlam Private Wealth.