Lewis could be in for a big earnings windfall

Furniture retailer Lewis may have earned 50c a share worth of additional income because of up-fronting of insurance recognition or a massive increase in insurance income, an analyst said yesterday.

The group provides insurance to customers buying on credit, and this is deferred over the period of the contract. Over a two-year contract, 55% of the insurance revenue is recognised in the first year, instead of 50%.

Lewis is able to do this through a reinsurance deal with its 100% owned insurance company Monarch Insurance.

Nedcor Securities analyst Syd Vianello said that while the effect of this on two-year loans had been disclosed at the presentation, the effect on three-year loans had not, and Lewis was writing off more as competition in the sector increased.

Based on Lewis' accounting policies, Vianello said this could be as much as 50c a share in upfront earnings, as 60% of the premiums for the three-year contract seemed to be recognised in year one.

However, CEO Alan Smart denied that the group recognised 60% of three-year contracts in the first year. He said the group recognised 40%.

African Bank, which recently bought Ellerines, said this month that it had overpaid by R450m as a result of upfront recognition of premiums, adding an extra R1,4bn to income that had been recognised early.

JD Group, which has yet to report results, recently amended its accounting policies on how it reflects insurance income. The group reported revenue of R3,6bn in the year to March, a 8,2% increase on the previous year's. Operating profit improved to R930,4m from R859,9m and headline earnings per share improved 6,9% to 689,8c.

Vianello said Lewis' insurance income rose from R465m to R565m during the period, on a 1% increase in credit sales, indicating that either premiums increased about 20% or more had been up-fronted, he said.

However, he said furniture companies had leeway with accounting policies, and each had a different method of dealing with issues such as bad debt write-offs.

The only way to analyse a furniture company properly was through its cash flow, Vianello said.

Taking into account a share buyback and an early tax payment, the group's cash flow was “very good” and stable, he said, despite increasing its debtors' book and improving its dividend cover.

This indicated that the group was trading better than its competitors were and had produced a “very credible” set of results.

Smart said the group was pleased that its business model had proved sound in tough times. The group's bad debt provision was lower in percentage terms than a year ago, having gone down to 13,5% from 14,9%.

Lewis may also benefit when competitors Ellerines and JD Group closed stores as it could buy up the sites, expanding its footprint, Vianello said.

He said more competition was expected to enter the market shortly, as Mr Price stepped up its furniture offerings and Massmart and Steinhoff seemed serious contenders for the space.

However, as long as Lewis stuck to its model, the group should prosper, as it had during the previous year, he said.

Source: Business Day

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