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Edcon - rosy and cautious

01 January 2006 Angelo Coppola

He says that the biggest problem facing any retailer in South Africa at the moment is the rising base effect, due to the strong growth all retailers have seen over the last few years.

Looking at the volume growth which was reported by some of the retailers recently indicates, however, that this is not a showstopper yet. Although volume growth in the Edcon group has slowed down in the first half of the 2006 financial year, it is still sitting at mid-teen levels, down from 25% growth in 2005 (financial year).

Sales growth in 2006 is expected to maintain mid-teen levels.

Edcon is still experiencing deflation in the overall group, although Edgars (including Boardmans) and CNA has seen inflation of 2% and 8% respectively.

Jet experienced deflation of 28%, which can be attributed to management's strategy of lowering the pricing points in certain areas within Jet, in order to squeeze out the competition.

The share price movement at the reporting date clearly indicated the market's discontent with the numbers, with the main disappointment being the decline in gross profit margins from 40% in September 2004 to 38.1% in September 2005.

This change in margins can be ascribed to the bigger contribution from discount chains, such as Jet and Jet Mart, with the contribution from Edgars declining to 53% from 56% previously.

According to Mark Bowers, they are more comfortable with a long-term gross profit margin target of 39%, since they expect the contribution from the discount chains to grow even further. One area in which Edgars has really proven itself is getting the stock turn right.

The more important combination of stock turn versus gross profit margin is a top priority for management and by lifting the stock turnover even more from current levels means that the company can sacrifice gross profit margin percentage points without jeopardizing the bankable profits.

Trading density has improved from R17,390/m to R17,477/m. Further growth in retail space is driven by the fact that trading density in some stores are sitting around R40,000/m, which is risky and unsustainable.

Management seems confident that they can grow the existing retail space or "under-traded" areas without cannibalizing the existing store base. The risk is of course that all of the retail players are taking this view, which could result in an overtraded sector down the line.

Management painted a rosy, but fairly cautious picture going forward, which is the prudent thing to do. Edcon has delivered 45% growth in fully diluted headline earnings per share over the last five years.

We all know the saying that "life is all about expectations" and this is the stage that Edcon has reached as well - under-promise and over-deliver. The company is trading on a 12 month forward dividend yield of 5% and a price-to-earnings multiple of less than 10.

This is not expensive, but any new buying interest is stalled by the negative outlook for interest rates and the impact this could have on the spending power of the consumer.

The interest that Edcon has shown in the Australian retailer, Myer Stores, has raised a few eyebrows, but this is more related to the dismal performance of South African companies in that country in the past.

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