In 2013 Spar Group was a formidable Southern African retailer featuring on the list of the region’s top four, alongside heavyweights Shoprite, Pick n Pay and Woolworths. For the financial year to end September 2013 Spar reported revenue of R47.8 billion and operating profit of R1.6 billion – an impressive 3.3% margin. Shareholders did well, with headline earnings of 694.8c a share underpinning a generous dividend of 485c and supporting a remarkable 4% dividend yield. With virtually no debt this generosity was easy to justify.
Other vital signs reflecting the group’s strength were the 39.8% return on equity and 51.8% return on net assets. At the end of September 2013 Spar had a market capitalisation of R20.9 billion.
Fast forward seven years and things have changed dramatically for Spar’s shareholders.
Southern Africa dominates
They remain invested in one of the four top retail groups in Southern Africa, but in addition they now have a hefty exposure to European economies and their currencies. Group turnover has increased almost three-fold to R124.3 billion and operating profit has more than doubled to R3.4 billion. The squeeze on margins to 2.7% is partly explained by the weak performance at Spar’s most recent acquisition, Poland.
Southern Africa contributed 63% (equivalent to R78.6 billion) to the group turnover in 2020, with the remainder coming from Ireland (R30 billion), Switzerland (R13.6 billion) and Poland (R2.1 billion). The regional contributions to operating profit emphasise Southern Africa’s continued dominance of the group with a hefty R2.6 billion (76%) coming from the home region; R978 million (29%) from Ireland; R361.5 million (10.6%) from Switzerland and a loss of R471 million from Poland.
From the perspective of an investor concerned not only about a steadily weakening currency but also the ability of a Southern African investment to continue to generate attractive returns, Spar’s acquisition strategy looks like a winner. It kicked off in mid-2014 with the purchase/rescue of Ireland-based BWG.
Luck of the Irish?
The controlling shareholders of BWG had raised huge amounts of debt to buy the business back in 2006; it looked like a reasonable gamble until the financial crisis hit in 2007, followed by the decimation of the Irish economy. By 2014 it was in desperate need of financial support – so desperate that the initial 80% stake only cost Spar €55 million. But it came with a huge whack of debt.
An indication of how well the BWG business has done since then is that the remaining 20% cost Spar almost €100 million. The increased cost was even greater in rands as a result of the slump in the exchange rate over that period.
That 20% was bought back in two equal parts with the first 10% stake, valued at €41.5 million paid for in January 2020. Spar CFO Mark Godfrey confirms the second stake, due to be paid for this month, was valued at €54.9 million. The SA company now owns 100% of the Irish business – which also has operations in the UK.
Switzerland and on to Poland
Its 2016 Swiss acquisition also needed a bit of nurturing, but recent results indicate it’s now operating in line with management’s initial expectations. “The (Swiss) acquisition represents an opportunity for the company to invest in an established business in a stable market with growth potential,” said the board in 2016. “It will allow the company to enhance its scale and provides further foreign currency diversification benefits”.
Presumably by May 2019 the South African board felt sufficient progress had been made in Switzerland and it could afford to take on another ailing business. In its just-released 2020 annual report, management explains it was attracted by Poland’s macroeconomic stability and expectations that it would suffer the shallowest recession within the European Union. “Despite the Covid-19 pandemic, the macroeconomic picture is positive with ongoing government fiscal stimulus, a low unemployment rate and a positive consumption environment,” explains the company in the overview of its international expansion.
Compared with so many other South African companies that rushed to build up an international asset base during the dark days of Jacob Zuma’s presidency, Spar has done remarkably well. It has not had to take any major write-offs or dispose of assets at knockdown prices. And the reputation of its management team, led by recently-retired Graham O’Connor, has been enhanced.
However, although it has not suffered the sort of value destruction endured by shareholders at Woolworths, Truworths, Famous Brands, Sasol and Brait etc. Spar’s international expansion has not been without its costs.
Taking its toll
It has significantly broadened its geographic exposure and sheltered its earnings from a weakening rand, but it has not been able to sustain the world-class metrics it recorded up to 2015. In that year operating profit margin was 3.1%, return on equity (ROE) was 44.7% and return on net assets (Rona) 68.9%.
In 2020 operating profit margin was 2.8%, ROE was 27% and Rona was 43.6%.
There is also the worrying fact that the group’s balance sheet has been transformed from virtually debt-free to one currently loaded with R6.9 billion of long-term borrowings. Godfrey notes that a large chunk of this – R3.3 billion – is attributable to BWG, which has been on something of an acquisition trail itself over the past few years.
And while the Spar Group’s market capitalisation has increased 75% to R36.5 billion, the end-September 2020 price-to-earnings rating was just 16.7% compared with the September 2015 figure of 19.7%. No doubt the retail sector has fallen out of favour with many investors, but O’Connor’s team might feel a little disappointed that so much management effort has been met with such insipid shareholder response. Perhaps these days investors prefer to implement their own diversification strategies.