South Africa definitely has issues right now. Unemployment runs close 24%, official inflation is over 5%, and economic issues have led to strikes, unrest, and violence in many parts of the country, not to mention weaker consumer and business confidence. Against that backdrop, it's not so surprising that The Foschini Group (OTCPK:FHNIY), one of the larger retailers in South Africa, is having a tougher time of it, with the ADRs down 40% over the past year and the South African shares down about half as much (down 21%).
There are definitely things that Foschini needs to work on, including comparatively unimpressive inventory turns and a high reliance on credit sales, but there are also some worthwhile positives in the company's favor. Foschini is positioned towards the higher end of South Africa's "mass-middle market" and has nearly 20% share in a market where the informal sector still has about 40% overall share. What's more, the company has already begun to expand outside of Africa and has been targeting logical growth opportunities. The Foschini Group does not look hugely undervalued to me today, but it does look like a good option for playing a relatively bullish thesis on the South African consumer, if your interests are in that direction.
Retailing And Finance
The Foschini Group goes back almost 100 years in South Africa, and the company operates around 1,900 stores in the country with brands like Foschini, Markham, and exact!. In regards to merchandise assortment, Foschini is basically similar to companies like Kohl's or J.C. Penney in the U.S. - about two-thirds of the merchandise assortment is apparel, but the company also sees meaningful sales in areas like jewelry and housewares. Unlike U.S. retailers, cellular is a meaningful category (close to 10% of sales) for Foschini as well.
Foschini sources about two-thirds of its merchandise locally, and has partial ownership of some of its production. Foschini's brands skew to the higher end of the South African retail market, with Truworths (OTC:TRUWY) a little more high-end and Edgars, Woolworths (OTC:WLWHY), and Mr. Price further down the price/image curve.
Financing is a significant part of the Foschini story. The company's TFG Financial Services segment handles its in-store credit card program and over 60% of the company's sales are made on credit. That's not as high as Truworth (which is around 70%), but it is quite a bit higher than Woolworth (around 30%) and Mr. Price (sub-20%).
Foschini also owns 55% of RCS Group, a consumer finance company that operates in South Africa, Namibia, and Botswana through offering both credit card and consumer loans.
Challenging Conditions For Now
South Africa has lagged its African peers in terms of GDP growth over the past decade (2.8% growth versus 4.8%), but I don't believe that tells the whole story. South Africa started from a higher base and still scores better than most (but not all) African countries in measures like the Human Development Index. Economic growth in the post-apartheid years has not been easy or smooth, though, and the country's Gini coefficient (a measure of income equality) is one of the highest in the world.
It's not all bad news for Foschini, though. First, the economy is increasingly shifting from an informal economy to a formal economy; ten years ago about half of retail sales were estimated to occur in the informal economy versus around 40% today. As incomes improve and shoppers become more accustomed to conventional stores and malls versus stalls and market centers, it will work in the favor of Foschini.
For now, though, times are getting tougher. Consumer credit levels are high in South Africa and recent interest rate hikes are leading to lower consumer spending and higher consumer credit defaults. Roughly 22% of Foschini's debtor book is in arrears and credit sales are starting to tail off noticeably. Foschini has also had a difficult time selling its stake in RCS Group; management has talked about reducing its position here (wholly or in part) for some time, but the difficult market environment is not making it easy. Even so, I believe sentiment toward RCS is having a disproportionately negative impact on Foschini and selling at almost any reasonable price will be seen as positive.
Through the third quarter of fiscal 2014, Foschini reported same-store sales growth of 4% on a 3% volume decline, with clothing up 3% and jewelry up about 2% (cellular was up close to 6%). Truworths, which again gets about 70% of sales from credit, saw same-store sales rise 1% on a 6% decline in volume. Woolworths saw an 8% gain on a 4% volume improvement, while Mr. Price saw a 10% sales increase on flat volume. To highlight the impact of credit a bit more, while December monthly sales were up 5%, cash sales were up more than 18%. Making matters worse, inventory turns have not been great and rising consumer defaults threaten to hit the company's profits.
Short Vs. Long
Every country has its ups and downs, and while emerging market countries like South Africa tend to have more pronounced swings, I do not believe that the country is a perpetual basket-case in the making.
I am also bullish on the company's long-term expansion plants. Management wants to have over 200 stores outside of South Africa in the next three years (doubling its current store count), and already has a significant presence in Namibia. Expansion into markets like Nigeria, Ghana, and Angola makes a lot of sense to me, as does avoiding Zimbabwe for the time being. Many of these markets are similar to how South Africa was a decade or so ago, with a large informal retail sector ripe for the picking for a company that can deliver quality merchandise and a consistent shopping experience with acceptable prices.
Considering the prospects for better economic performance in South Africa down the line and the ex-South Africa expansion, I believe Foschini Group can grow revenue by more than 10% a year for the long-term, with more than half of that growth from store growth. I believe restructuring (getting rid of RCS) and improving store operating performance (better inventory turns, more sales and profits per sq ft) can unlock significant margin expansion, leading to FCF growth (over 30% a year, albeit from a very low base).
The Bottom Line
On a DCF basis, I believe Foschini is worth almost $18 a share today. Looking instead at a P/E approach and giving the company a 10x multiple to FY15 EPS estimates (in line with the revenue growth rate and sell-side EPS growth expectations), I come up with a very similar number.
Neither of those fair value calculations makes Foschini a must-own for me, though I do like the idea of companies exposed to rising consumer incomes in Africa (which is why I own MTN Group (OTCPK:MTNOY)). For now, I'm more interested in more undervalued names in Brazil and Mexico, but I wouldn't sleep on Foschini - if management can sell RCS and start improving store-level metrics, I believe the long-term rewards could be solid or better.