Investing in the JSE. A look into Shoprite Group

My terrible memory growing up forced me to rely on analogies when trying to remember information for exams. I'd often use a tennis match to remember chemical reactions during my chemistry classes. It also made revision fun. Analysing Shoprite Group reminded me of Lewis Hamilton during the British GP.

He started the race well ahead of team Ferrari but midway, he stopped in the pit. Three cars overtook him, and everyone thought he couldn't come back. However, in the last ten laps, other racers slowed down, and Hamilton came out on top due to his fresher tyres!

Shoprite's Growth pedal is back on! We knew we couldn't solely rely on the financial statements to conclude on the SA Food Retail industry, so we implemented other strategies.

1st half of the Race (Early days till 2017)

Between 2008 and 2018, Shoprite's share price accelerated from R43 to a peak of R252 in March 2018. At the end of the 2017 FY, its EV/EBIT traded at 15.48 and its Return on Invested Capital (ROIC) reached a peak of 19.44%. 

The normalised net income grew by 13.58%, and its free cash flow (FCF) was at a peak R5 billion in 2018 FY. No wonder headlines introduced Shoprite as the Walmart of Africa (Even though Walmart owned a South African brand, Massmart). But what could go wrong?

Pit Stop

Uhhhh… All good things must come to a pause. At least when you have Spar Group, Pick n Pay, Massmart and Woolworth behind you. Some analysts blamed Shoprite's expansion to the rest of Africa as the leading cause of its growth pause. Sales in Angola and Nigeria took a U-turn as the oil exporters went through an economic crisis.

Currency devaluations, challenging economic conditions saw customers come under significant financial pressure. Non-RSA recorded a 13.3% decline in sales and contributed about 15% to the group's total sales.

The big dent to the share price was the profit warning in early 2019. Interim headline earnings per share (HEPS) fell up to 36%, and shares fell by 17% within a day. In South Africa, when a company announces a profit warning, you run because everyone overreacts to the news.

Shoprite also had a change in management as Whitey Basson, who founded Shoprite in 1979 and grew it to a market share of 34% had just retired (2016). I naturally prefer founder-led businesses, so when you hear the founder is retiring one always has to rethink their investment.

As one can see, problems for Shoprite were piling up. Rivals were also winning market share. Spar Group performed reasonably well in its European stores and investors preferred exposure to Europe than the rest of Africa. Pick n Pay also offered cheaper food products in comparison to South Africa. It began stealing more market share from lower-end consumers.

The icing on the cake for Shoprite's woes was the sharp increase in pessimism for the whole retail sector. The growth of e-commerce, fewer consumers going to malls began pricing into the retail index as it fell by 21.88% in 2019. 

However, if you focus on just food retailers, people are always going to buy groceries, and the African consumer is still far off from ordering products on Jumia. At least for now.

The comeback? 

So we've explained how Shoprite got beaten down. By August 2019, Shoprite's share price traded at R110, from a peak of R252. I then had to ask myself a few questions:

• Is Shoprite still a good business with a competitive advantage?
• Do we trust the management team?
• Is the price we have to pay much cheaper than our intrinsic valuation?

After reading its last three annual reports, I couldn't conclude on my pick. That's where the Scuttlebutt technique comes in.

Scuttlebutt - Thank you, Phil Fisher

Phil Fisher, one of the fathers of investing, extensively wrote about his Scuttlebutt method. An analyst will conduct his due diligence by talking to all kinds of people like customers, vendors, trade associations, competitors etc. I excluded employees because I didn't want to have any insider knowledge. Remember, insider trading is illegal!

After gathering as much data and information as possible, it seemed Shoprite's growth pedal was back on. Stores were getting smaller, but more items were actually in these stores. Its investments in its supply chain and relationship with farmers seemed to pay off too. After my due diligence, I only had two more worries before finalising Shoprite as my pick:

• Will Shoprite improve its inventory control and levels?
• Will Shoprite, including Checkers group scale back on Capital expenditure in 2020?

Its CEO, Pieter Engelbrecht, announced he would scale back on the rest of Africa expansion and focus on current stores in Angola. For me, this was a confirmation of an improved CapEX for 2020.

Other JSE food retailers were also overpriced while Shoprite was trading at a record low EV/EBIT of 9.72 and a P/B ratio of 2.95

2020 H1

After assessing the H1 2020 report, it's clear Shoprite's growth pedal is back on. Other retailers except Woolworth are currently struggling to achieve Sales growth in SA. Shoprite announced a sales growth of 9.8% in SA, its free cash flow is back to positive figures (R5.4 Billion) and the impact of the IFRS 16 wasn't as severe in comparison to Pick n Pay.

So who wins? 

Fundamentally, Shoprite is my winner. A value and growth opportunity, a robust competitive advantage driven by its brand perception in Africa and a management team with an appetite for continued sustained growth.

The stock market may not reflect this because there's much pessimism for the rest of Africa retail sector, especially Angola. Woolworth may also finish the year advancing more than Shoprite. 

Nevertheless, Shoprite remains my pick in the food retailer industry in South Africa.

*Disclaimer the writer owns shares in Shoprite and is not an investment professional. Please consult your own advisors before making any investments.