Investments Thesis
Shoprite Holdings is Africa’s largest FMCG retailer with operations in 16 countries across the continent. It is also the largest retailer within the borders of South Africa, boasting a market share of approximately 32% of all local grocery spend. The group’s ability to leverage suppliers, its superior distribution capabilities and structurally higher than industry margins, we believe, will translate into higher than industry returns and market share gains over time.
The South African food retail industry
Size and growth potential
South Africa’s formal food retail landscape is an oligopoly with four main operators (Shoprite, Pick ‘n Pay, Woolworths and Spar) competing across the LSM wealth spectrum. The market size is estimated to be around R710bn and is expected to grow over the next 4 years (2019-23) at a compound annualized growth rate of 5%.
Competitive dynamics
Shoprite’s USave and Pick ‘n Pay’s Boxer stores are fighting it out in the lower-end of the market, while the more profitable market segment is a battleground for all four main retailers. Woolworths dominates the higher-end market but Shoprite and Pick ‘n Pay are improving their fresh food proposition as well as refurbing their stores to be more competitive. Muted domestic sales growth due to the weak economy incentivised retail management teams to expand offshore and in the most, these moves have been wealth destructive. To mitigate this, a heightened refocus on scooping gains in South Africa has meant fierce competitive dynamics within the home market. These dynamics together with rising input inflation has shrunk retail profit margins, leading to lower returns on capital as depicted in Figure 4.
Figure 4. Return on capital of SHP and peers. Source: Bloomberg, Northstar Asset Management. May 2019.
Price takers versus price makers
South Africa’s food retail pricing environment is highly elastic (an increase in price reduces demand, or a decrease in price increases demand) with Shoprite, Pick ‘n Pay and Spar displaying limited pricing power in their operating markets. There is however some evidence that pricing power exists in the higher LSM categories with Woolworths displaying relatively inelastic demand against peers – this is evidenced by higher margins, Figure 5, which, as mentioned above, is increasing competition in this space.
Figure 5. Trading margins of SHP and peers. Source: Bloomberg, Northstar Asset Management. May 2019.
Shoprite’s competitive advantage
Shoprite’s operating model is based on achieving high volume growth at lower-than-market prices. Continuous improvements of its centralised distribution network, supply chain and sourcing models, drive scale, growth and enhance margins. The business has a clear strategy based on six core pillars, one of which is to grow its LSM 8-10 share of the wallet by enhancing Checkers’ brand perception. It is achieving this by improving the fresh food offering, expanding its wellness and convenience proposition and driving innovation. Other opportunities include expanding its private label offering as its penetration is relatively low versus peers, capitalising on the recent rollout of the new SAP retail franchise system and achieving scale in its main African operations.
Shoprite’s management
Shoprite’s executive management team is relatively new and untested with PC Engelbrecht having been appointed as CEO in 2017 (previously COO) and A de Bruyn CFO in 2018. Investors are skeptical about the involvement of chair, CH Weise, but overall we believe the track record of the board is impressive. We deem the group’s strategic targets to be sound and realistic, its overall capital allocation strategy to be adequate and its management of the business to be particularly impressive.
Sustainability
Remuneration
Shoprite’s corporate governance is adequate rather than impeccable. The composition and mix of the board is acceptable, however we have question marks over the group’s remuneration policy. We regard both CEO and CFO remuneration structures to be adequate, but question the quantum and mix of remuneration to Christo Weise – our benchmark being JSE Top 40 equivalent companies. Furthermore, we feel that management performance measures tied to incentive structures are vague and not directly linked to the important measures of return on capital employed and cash flow metrics.
Social responsibility
Shoprite is well placed from a human and social capital perspective, the business is South Africa’s largest employer with a staff compliment of 147,478, having grown by 75,000 over the past decade. It spends significantly on learning programmes and bursaries for its staff as well as being involved in several Corporate Social Investment (CSI) initiatives, including fund raising as well as donating surplus food to charity groups. One concern is that the group is only a level 8 B-BBEE contributor, but is increasing expenditure on black-owned suppliers and has a diverse staff compliment, 65% being female, and 97% black.
Valuation
We have followed our normal process of establishing Shoprite’s true worth at a ‘through-the-cycle’ level of profitability. We have also, as is conventional for our process, assessed a bear and bull case for the company. Our belief is that the stock is entering a zone which has potential for improving prospective returns to shareholders but considering the state of the South African economy, it is quite possible that we might enjoy the unique opportunity of buying Shoprite for our clients at our bear case valuation.