Local retailers overvalued at current prices
Fund manager looks north for opportunities
The spate of global retailers entering the South African market as a result of the strong profits achieved in this sector over the past decade adds further credence to value based asset manager, RE:CM’s, view that share prices of local players are expensive and offer very little value for investors.
According to Wilhelm Hertzog, Portfolio Manager at RECM, the recent entries of the likes of Walmart, Zara, Cotton On and Topshop will likely result in increased competition and potentially lower returns being generated by local retailers than what we have seen for the past few years.
He says that while South African retailers are typically very strong businesses with world class management teams, the share prices of these companies currently price in almost no potential for less than perfect long term outcomes. “An example of this is the Datastream SA retail index, which is trading on all time high price to book values and P/E ratio one standard deviation above long term average, with operating margins at close to all time high levels.”
Hertzog says instead, RE:CM currently favours offshore retail shares such as Carrefour, the second largest retailer by sales globally, and the largest in France. It is also one of the leading retailers in Spain, Italy, Belgium, Brazil and China. Food constitutes about 80% of Carrefour’s sales.
“European retailers in general are going through a difficult time, given the macro-economic environment in the Eurozone. As often happens, the poor recent results and weak short term prospects for these business have resulted in share prices being driven down to levels that increasingly look like attractive value to us.”
He says that due to strong bargaining power with suppliers and economies of scale in distribution, food retailers with large market shares in the markets in which they operate have historically generated very good returns on capital. “Because of the negativity prevailing in Europe, it is now possible to buy a high quality business like Carrefour for a substantial discount to just the value of the properties that the company owns, with the retail business being assigned no value by the market.
“Although the short term profitability of the company is currently under pressure, given its strong market shares, we believe the favourable long term economics of the business is intact.”
He adds that due to the depressed state of current earnings, RE:CM believes measures like enterprise value (market capitalisation plus net debt and capitalised leases) to sales, or enterprise value per square meter of trading space, is a better indicator of how cheap Carrefour currently is.
“Carrefour is currently trading at about 0.25 times enterprise value to sales. The comparable metric for similar retail businesses in South Africa ranges from about 0.5 times for Pick n Pay, to more than 1.5 times for Woolworths. On an enterprise value per square meter of trading space basis, investors are currently paying just more than $2,000 per square meter for Carrefour, compared to anywhere from $4,000 (Pick n Pay and Massmart) to $10,000 (Woolworths).”
Hertzog says Carrefour is the single largest investment in the RE:CM Global Fund currently.
Hertzog adds that the sell-off of Australian retailers over the past 18 months has also caught RE:CM’s attention. In particular, it favours Harvey Norman - a listed discretionary goods retailer - which is one of the top holdings in the RE:CM Australia Equity Fund.
“Harvey Norman is by no means perfect but we believe that it is relatively well positioned to survive the current downturn, and emerge stronger for it. It is our view that - in an interesting mirror image of Carrefour - at the current traded price, one is paying fair value for the underlying franchisor/retailing operation, and getting Harvey Norman’s considerable property portfolio for free. These are odds we like very much,” concludes Hertzog.
