The sweet spot of hardware retailers

Why are they resilient despite SA’s retail malaise?
Hardware retailers are punching above their weight despite consumers being under pressure.

SA’s residential market is emerging from its five year funk of slow housing sales and humdrum house price growth.

However, one housing market has seen sustained strong performance since the height of the global credit crisis. As cash-strapped consumers scaled back on the purchase of new residential properties, so they embarked upon home refurbishments.

Industry players report that the home maintenance and upgrades market has vastly improved from 2008/9 levels.  Figures from FNB’s estate agent survey show that 22.5% of homeowners embarked on value-add refurbishments for the fourth quarter from 26% in the previous quarter. Though markedly lower, it’s well up from the 10% recorded in 2009.

The appetite for home upgrades and do-it-yourself (DIY) projects has been good news for retailers Italtile and Cashbuild.

Finding the exact reason behind the resilience of hardware retailers is multifaceted, and continues to puzzle market watchers. Momentum SP Reid analyst Alexander Sprules has his theory: “Consumer spending has remained pretty resilient and government employee salaries increased above-inflation allowing for more spending on consumer products of which hardware retailer’s products have benefitted”.

And retailers have been sharpening their business models to cater to the growing consumer appetite for home improvements. Italtile has been marking its position as a bellwether in the tile and ceramics industry, as it continues to deliver double-digit growth.

Italtile reported a 22% rise in its interim headline earnings per share, with system-wide turnover that grew by 13% to R3 billion.

Asked about Italtile’s secret of posting solid earnings in a tough consumer market, CFO Brandon Wood says it’s all in its brands CTM, Top T and Italtile Retail – which cater to broad consumer segments (LSM 4 to 10).

“We continue to leverage opportunities by stepping up our offering with regard to product prices, availability of stock, improved IT systems and in-store efficiencies,” Wood tells Moneyweb.

Its focus on lower LSM consumers, through its Top T brand, is also proving to be a boon for Italtile, which controls more than 40% of SA’s tile industry. “The lower LSM consumers might buy down, but they are still spending. And we are making sure that we are capitalising on that spend,” says Wood.  

A number of other factors are also working in its favour. While its competitors Build it (owned by the Spar Group), Cashbuild and Massmart’s Builders Warehouse sell general hardware merchandise, Italtile is a specialist tile, sanitary ware, laminated flooring and other related home finishing products business.

This has given it clout in the tile industry. To an extent, Italtile controls the pricing on its products as it’s a major tile supplier in the domestic market.  In recent years, the company bought minority stakes in some of its suppliers like title manufacturers, Ceramic Industries and Ezeetile, supplier and importer of hardwood and laminated flooring Cedar Point – boosting its dominance in the industry.

Another defensive character for Italtile is that roughly 65% of its products are locally sourced, insulating it from currency blows. Smaller peers largely import their products. 

Cashbuild

Another company that continues to perform is Cashbuild.  Since the appointment of CEO Werner de Jager in 2011 to replace industry veteran Pat Goldrick, big changes have followed.

These include sprucing up the retailer’s IT systems to better manage pricing points, promotions and merchandise. Analysts say the retailer’s continued credible performance is widely attributed to changes in leadership.

Perhaps a notable change is that the retailer is concluding more acquisitions – the most recent being the R350 million buyout of family-owned hardware business P & L Hardware.  Says Sasfin Securities senior equity analyst Alec Abraham: “Patrick would never make acquisitions and Werner has changed that. But Patrick was a good operator.”

Also, its aggressive store expansion has seemingly paid off, as it continues to grow its cash-paying customer base of homebuilders, lower-end consumers, contractors, farmers and traders.

Cashbuild operates 228 stores across SA, Swaziland, Namibia and Lesotho.  It also manages ten Cashbuild DIY pilot stores which are of a smaller format. Over time, the retailer is looking to manage 300 stores and there is no doubt it’s heading there, given that P & L Hardware manages 40 stores. Its second-half operating profit shot up 32%, which resulted in an operating margin of 7.3% – the highest in its history.  

Arguably Italtile and Cashbuild don’t have much in common, but both have engineered volume and market share growth by keeping product prices low. 

More pressure expected

Hardware sales still make a minor contribution to overall retail sales. Abraham says over the past ten years, the percentage of clothing sales has been growing while other categories have either slowed or remained flat.  Clothing sales were 19% of retail spend in 2005 but now it is 20.4%; while hardware sales were then 7.5% and are at similar levels ten years later. 

With the hardware industry amassing earnings in excess of R100 billion, the market still remains fragmented with 300 000-odd independent companies trading.  This has created a fertile ground for consolidation – as bigger retailers have acquired their smaller counterparts to build scale.

“A lot of independents are not performing well and are being taken out of business. As market conditions start getting tougher, you are seeing consolidation accelerate,” says Abraham.  The industry is still ripe for more deal-making, he says.

The question now is whether these retailers can maintain their momentum.  If the latest FNB/BER Building Confidence Index is anything to go by it seems not.  The index posted a significant dip in confidence by building materials retailers to 39 for the first quarter 2016 from the previous quarter’s 61. 

Says Sprules: “As consumers come under more pressure, hardware retailers will find it more difficult in the long run. Also, if the government cuts back on salary increases and employment, it might put more pressure on retailers”.

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