The Foschini Group’s brave move into the Australian market by purchasing menswear specialist retailer Retail Apparel Group (RAG) for A$302.5 million (R3 billion), has raised concerns about its increasing debt levels.
Delving into offshore markets has been a concerted effort by TFG as the purchase of RAG follows its game-changing acquisition of British ladieswear business Phase Eight for £140 million in 2015 (or R4 billion at the time).
RAG is a value- to middle-end retail group that operates 400 stores in Australia under brands including Connor, Johnny Bigg, Tarocash, yd. and recently incorporated women’s sportswear brand Rockwear.
RAG’s brands have a something-for-every-one approach – much like TFG across its brands including Foschini, Exact, Markham, G-Star Raw and others – targeting consumers in different income groups.
The A$302.5 million that TFG will be paying for the deal is based on RAG’s forecasted seven times normalised earnings before interest, tax, depreciation and amortisation (Ebitda) of A$43.2 million (R427 million) in the year ended June 2017.
TFG’s CFO Anthony Thunström said it might purchase RAG at a 6.8 times Ebitda, as existing cash resources and short-term debt will be used to fund the deal.
The introduction of more debt in TFG has made market watchers nervous. Already, TFG’s group gearing (including debt in the UK) sits at 65.3% and debt on its balance sheet is more than R3 billion for the year to March 2017.
“The short-term debt [that comes with the RAG acquisition] would take us to a debt level that we wouldn’t want to sit on for the long term,” said Thunström.
To reduce debt/gearing levels, the retailer plans a rights issue. Before TFG went into offshore markets, its gearing was 36.8% in 2014.
Fashion retailers have been chasing hard-currency earnings through acquisitions in offshore markets over the last three years given SA’s sluggish economy, hard-pressed consumers, rand volatility and political uncertainty.
TFG joins its South African peer Woolworths in Australia, with the latter still battling to turn the fortunes of its David Jones business in the country.
“Clothing retailers by their nature are financially geared businesses because they rarely own their premises – for example, the long-term leases they enter into are a liability that is not reflected on the balance sheet,” said Anthony Rocchi, portfolio manager at Rexsolom Invest. Factoring this in TFG’s case, Rocchi said the retailer’s elevated debt ratio might be higher than it appears, which is “cause for caution”. See below.
Source: Rexsolom Invest
Thunström believes TFG’s Australian strategy will prove itself as RAG is expected to beat its sales forecast. Over the last three years, RAG grew its average revenue by 10.7% and Ebitda by 10.7%. RAG is expected to report double-digit growth in revenue and profit this year.
Thunström said RAG is well placed in the Australian market as it’s headed by “the best management team in the country”. “Half of RAG’s management team are South Africans who have been living in Australia for a long time. They know the Australian retail market well.”
The RAG acquisition will boost TFG’s retail outlet footprint in SA, the rest of Africa, UK and Australia from 3 328 to 3 728.
From a risk point of view, TFG’s expansion into Australia is good given the worrying state of SA’s economy, said Alec Abraham, senior equity analyst at Sasfin Securities. “RAG is acquired at a reasonable multiple and TFG didn’t overpay for it. After all, TFG will have exposure to a higher growth Australian economy.”
Abraham is not concerned about TFG’s debt levels, saying that the retailer will eventually pay down the debt as “retail tends to be a cash generative business”. “TFG is becoming more of a cash sales business than credit sales through its offshore acquisitions. Cash alleviates some of the risks for its debt levels,” he said.
Underscoring this is that cash sales comprised 60.7% of TFG’s group turnover of R23.5 billion in its latest financial year, compared with cash sales making up only 20% two decades ago.