Inflated South African retailers poised to fall

Johannesburg: Investors speculating on rising African wealth are driving South African retailers to the highest valuations on record, in a sign to Investec Asset Management and Renaissance Capital that the shares are set to fall.

The FTSE/JSE Africa General Retailers Index has jumped 45 per cent since Wal-Mart Stores Inc. announced plans two years ago to buy Massmart Holdings Ltd., South Africa's largest wholesaler.

The gains pushed the 10-member index to 18.1 times reported earnings, 55 per cent higher than its 10-year average and above the MSCI Emerging Markets Retail Index, which trades at 15.2 times, according to data compiled by Bloomberg.

Just eight months ago, valuations on South African retailers were lower than their emerging market peers.

Exaggerated valuations

Investors are "overcooking" valuations on expectations of an African expansion boost, Diane Laas, an equity analyst at Cape Town-based Investec Asset Management, which oversees more than $90 billion (Dh330.59 billion), said. "I'm not convinced."

Retailers, including Cape Town-based Shoprite Holdings Ltd., Durban-based Mr Price Group Ltd., and Cape Town-based Truworths International Holdings Ltd. plan new stores from Angola to Nigeria to benefit from rising wealth in the world's poorest continent.

Africa's swelling middle class may boost household spending 63 per cent to $1.4 trillion in 2020, according to a 2010 report by New York-based McKinsey & Co.

Aberdeen Asset Management Plc, which has £184 billion (Dh1.07 trillion) in assets, sees further gains for South African retailers.

The Scotland-based money manager has this year raised its stakes in Durban-based Spar Group Ltd, Cape Town-based Clicks Group Ltd, Truworths and Massmart, according to data compiled by Bloomberg. Investec Asset Management hasn't added to its holdings in the stocks, the data show.

In it for the long-term

"Over time, there is an avenue for growth in Africa," Gabriel Sacks, an assistant fund manager at Aberdeen in London, said.

"I know that's a long way away for some of them, but we are long-term shareholders and if anyone will be able to play those markets, we believe its South African corporates."

Foreign investors own about 70 per cent of Truworths, South Africa's largest clothing retailer, from 67 per cent a year ago, and more than 90 per cent of Massmart, data compiled by Bloomberg show.

Almost 60 per cent of shares in Mr Price and 54 per cent of Woolworths Holdings Ltd. are owned by foreign funds, increasing from 51 per cent for both stocks in May 2011. Aberdeen owns about 12 per cent of Truworths and 13 per cent of Johannesburg-based Massmart.

Some South African retailers are cheaper than emerging-market peers even after the rally. Truworths, trading at 14 times its expected earnings for June 2013, compares with 18 times December 2013 earnings for SACI Falabella, Chile's largest retailer by market value, data compiled by Bloomberg show.

Shares of Lojas Renner SA, Brazil's biggest listed clothing retailer, are equivalent to 17 times December 2013 earnings, while Massmart is valued at 19 times June 2013 earnings. Aberdeen also owns stock in SACI Falabella and Lojas Renner, the data show.

If the retailers aren't able to spend their cash on an African expansion or their growth slows, the companies will probably pay out higher dividends, Sacks said in a May 4 interview.

Mr Price, the clothing and linen retailer that trades at 22 times earnings, may fall 23 per cent in the next year to 83 rand, according to Jeanine Womersley, a retail analyst at Johannesburg-based Renaissance BJM, who rates the stock hold.

Woolworths, a Cape Town-based food and clothing retailer, may decline 20 per cent to 40.60 rand, Shamil Esmail, a Cape Town-based retail analyst at BNP Paribas Cadiz Securities Ltd., who rates the stock a sell, said in a March 30 note. "The South African retailers are priced for perfection," Chris Gilmour, an analyst at Johannesburg-based Absa Investments, said by phone.

Style of management

"Even so, there are reasons for the valuations. These companies are managed on a par with first-world peers, but at the same time can benefit from emerging-market growth."

Clicks, Massmart, Woolworths and Mr Price declined to comment on valuations of their stocks, according to e-mailed comment from Woolworths press office and spokesmen Graeme Lillie, Brian Leroni and Lynette Lambert.

Obstacles to progress

Progress in expanding into sub-Saharan Africa is stalled by power shortages, legal and regulatory differences, poor telecommunications and a scarcity of formal retail space such as shopping malls, Truworths CEO Michael Mark said in an e-mailed response to questions on May 11.

Foreign investors are "quite fond of South African retail because of their successful history," Mark said, adding that local investors see the stocks as expensive. "It depends on your perspective."

After opening a store in Botswana more than 20 years ago, Truworths has 21 of its 552 outlets outside its home market, including Namibia, Swaziland and Mauritius. South Africa accounts for 98 per cent of sales, according to data compiled by Bloomberg.

To mitigate risks, Truworths follows an "incremental expansion plan" which allows the company over time to better understand the operating environment and market potential, Mark said.

Africa, the next big thing

Shoprite, Africa's largest supermarket chain with 1,730 outlets, opened its first store in Namibia in 1990 and has 123 stores in 15 countries outside South Africa that accounted for about 10 per cent of fiscal 2011 sales.

Shoprite may spend 1.5 billion rand (Dh664.25 million) over the next three years on Nigerian property to help build sites.

Mr Price said in 2009 it is looking at Nigeria for an expansion and opened a test store in Ikeja Mall in Lagos in March 2012.

"Retailers are tending to look at Africa as the next Asia and considering enormous growth that could come out of there as it formalises," Jeanine van Zyl, a retail analyst for Cape Town-based Old Mutual Investment Group of South Africa, which manages 472 billion rand from Cape Town, said.

Investors "are pricing in Africa way before it actually happens because Africa is a very slow story," she said.

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