SA food retailers looking expensive

"The recent bid for Massmart (MSM) by US retail giant Wal-Mart highlights the search for yield and growth by developed market investors, starved of returns and pessimistic about growth prospects in their home jurisdictions and while the Massmart share price in dollars has increased more than twenty-fold over the past decade, the Wal-Mart share price has stood still,"
it said.

According to Investec, the key question investors in the South African equity market should be considering is whether these seemingly elevated levels have a substantive underpin, for example, a fundamental underlying value and dramatically improving earnings prospects or whether they are merely the outcome of unsustainably loose global monetary policy, and therefore transient in nature.

"We find the argument that South African retailers offer value simply because they continue to trade at lower multiples than certain of their emerging market peers deeply flawed," they said.

"The "less expensive" label will provide little downside protection in the event that monetary conditions stabilise and the search for yield becomes more rational.

Furthermore, markets offer different structural growth opportunities with varying levels of risks,which are typically reflected in diverse long-term ratings," they added.

Events of the past couple of years, according to Investec, have undoubtedly played into the hands of the listed South African food retailers as they used their balance sheet strength and strong cash flow generation to grow market share over the past five years from 62% to 72%.

Market share gains accelerated in the wake of the global financial crisis, as many independents were forced into closure due to banks' tighter lending criteria and constrained cash flows and during 2009, listed food retailers grew sales by 14%, while the remainder of the market was flat.

"The sustainability of ongoing market share gains of this order of magnitude needs to be carefully assessed," said Investec.

Massmart, already a dominant player in wholesale food sales, has growing aspirations in food retail as reflected in their recently launched format, Foodco and the arrival of Wal-Mart as majority shareholder may have a significant impact on the competitive landscape of food retail in South Africa.

"Massmart will be able to leverage the Wal-Mart private label offering, global buying power and implementation of an everyday low price (EDLP) strategy across the business," they said.

"Increased financial muscle will enable Massmart to aggressively roll out its food formats to underserved markets, placing increased pressure on competitors' relatively uncontested rural footprint, for example Shoprite and Spar," they added.

Investec said that an increasingly competitive environment, in conjunction with relatively benign food price inflation, results in lacklustre forecast earnings growth for the food retailers.

"Earnings growth is expected to be lower than the market as a whole and significantly lower than their emerging market peers and we believe that their ratings are demanding and that the risk-reward relationship has moved against the food retailers, this supports our underweight position," Investec said.

It added that its exposure to the retail sector was geared towards companies that offer either a resilient growth story as a result of industry restructuring, like Clicks, superior relative earnings momentum like Mr Price, or company restructuring potential like The Foschini Group.