Pick n Pay bounces back and pleases investors By Adele Shevel

Business Day Live, October 27, 2013

Featuring Roger Tejwani, retail strategist for NOAH Capital Markets

IS PICK n Pay the dark horse investment in the retail industry?

An underachiever for years compared with high-flying rivals Shoprite and Woolworths, Pick n Pay showed the first signs that it may be getting its mojo back with half-year results that suggested its much-touted recovery was actually gaining traction.

Investors were certainly pleased, sending the share price up 13% in the two days after the results — adding R2.6bn to its market value.

But analysts were reluctant to proclaim the recovery a success just yet.

Alec Abraham, retail analyst at Afrifocus Securities, said: “They’re on track but there’s still a long way to go.

“I’m a little surprised by the share-price reaction, considering that the consensus recommendation is hold. I don’t believe the share was undervalued previously, considering its recent past performance.”

After the rally in the stock this week, Pick n Pay shares are now more expensive than those of competitors. It is trading on a price:earnings ratio of 41, while Shoprite is on a ratio of 26, Spar on a ratio of 19 and Woolworths on a ratio of 22.

This has prompted analysts to ask whether the market has not read too much into the results.

Roger Tejwani of Noah Capital Markets said it was a good set of numbers with satisfactory sales growth, an increase in gross margin and strong growth in trading profit and earnings a share. “But the stock wasn’t looking cheap before,” he said.

Mr Tejwani said costs were still running ahead of sales growth.

“We’ve been here before with Pick n Pay, where they have a decent set of results for the first half and then a drop-off. It could still be a game of two halves. There are some encouraging signs, but there’s still a lot which warrants caution. It’s off a weak base, the cost base is still far too heavy, and they are still underperforming the market. It’s on a chunky multiple, and though it was a decent set of six months I would want to see more momentum and a more sustainable performance.”

Still, the results were impressive, illustrating that Pick n Pay had cut costs and appeared to have stemmed its declining market share.

But even CEO Richard Brasher said it was too early to make a call on the situation other than that the retailer was better, stronger and clearer. He said this was not an overnight turnaround. “I’m encouraged but not yet satisfied.”

The retailer has lost market share to competitors, and has been trying to cut costs and drive up sales to regain its former stature as the country’s biggest food retailer.

The slide has been tough for Pick n Pay founder Raymond Ackerman, who said after the results presentation this week to huge applause it had been a very sad time seeing the company slip down. “I’m terribly encouraged by what Richard produced in the last six months … there’s a long way to go.”

“We had a decentralised business, which I was proud of … I used to think you would play harder for the house than the school team … but with Walmart coming and the huge success of Shoprite-Checkers we had to move to centralised distribution.

“I probably didn’t sleep over the past two or three years. It’s worried me … but it’s such an enormous breath of fresh air. I feel very confident of it, but it will take time.”

Group sales grew 8.1% to R35bn. Like-for-like sales growth in stores was 4% in the first half, compared with 3.2% in the previous first half.

Gross margin improved 0.4%, rising to 18.1%, the first time the company reported an improvement in gross margin. Headline earnings a share rose 35.8% to 40.81c.

Pick n Pay will open 64 new stores in the second half, up from 44 new outlets during the first six months. It will also increase its retail space 4.5% this year, but this is still less than Woolworths Food at 9% and Shoprite at 7%.

Brasher said the retailer had to play its own game rather than worrying what competitors were doing. “You can’t turn the dial overnight. I’m not in the space race. We have to find locations and communities to serve better or where we haven’t been before. I’m confident that compared with other operators we can get our share.”

He said there had to be the right balance between improving margin and improving sales. “We have to show good fiscal control and cost management and we have to drive trade. This has to be a sales-led recovery and not just cutting costs. Slow and steady wins the race rather than dramatic change in the six months.”

Analysts have long attacked high head office costs, and about 400 people have accepted retrenchment.

Renaissance Capital said in a report that the pace of recovery remained a key forecast risk. It said top-line sales were improving, and the retailer was likely to lag its peer group for at least another 12 to 24 months.

The brokerage expects trading margin to improve from 1.4% in financial 2013 to 2.6% by financial 2016, largely due to gross profit margin gains and labour cost moderation. “This is still lower than the company’s average of 2.5 to 3.5% in the mid-2000s.”

“It’s half time. It’s nice to go into the second half having done better,” said Brasher, who joined the company at the end of this February. He was on the board of Tesco and worked for the retailer for 26 years.