Margins and interest income prop up OK

At the Market With the Tetrad Group

ON October 21, the day after the third quarter monetary policy statement, we advised that the stock market train was going to be unstoppable. How true! Since then the indu

strial index has gained a massive 72% to reach the dizzy heights of 19 256 830,09 points this Wednesday. Investment analysts and their recommendations had in the meantime become largely irrelevant as all what an investor needed to do was to put all the counters in a box and pick one – raffle style!


If what we have seen so far is anything to go by, the publication of the October inflation rate figure; depressed money market investment rates and the upcoming September earnings season all present an exhilarating cocktail that will certainly drive the market even higher. Those who missed the first leg now have a chance to jump in during the lull that we are experiencing at the moment.


After ZSR’s very respectable interim results last week, another member of the retailing sector released its half-year accounts for the six months ended September 30. OK’s figures were not of the shockingly impressive variety but they were solid nonetheless.


The supermarket chain’s net sales were up 260% to $1,7 trillion, well above the average inflation for the period of 220%. Gross margins went up almost eight percentage points to 25% as the group enjoyed a windfall from a change in product mix away from low-margin basic commodities due to shortages as well as reaping the rewards of a quick shuffle to a replacement cost pricing strategies.


Although operating expenses growth at 287% was above that of the top line, it was not enough to dampen the impressive gross margin performance.

Consequently operating profits recorded a whopping 849% increase to $181,2 billion, with the corresponding margin reaching 10%, an obscene level for the retail sector in the international world.


Finance income of $63,4 billion – $14 billion in 2004 – was a more than welcome boost to the bottom line which came out at $183,5 billion, a healthy and above inflation return of 636% on the prior period. The board remained loyal to its aggressive dividend policy of two times cover, declaring a $26 per share dividend. In these uncertain times where cash reigns supreme is this the result of a mature, cash-generative business or a management team with enough skin in the game to care about the company’s dividend and share price? Or is it plenty of both?


Operationally, management do seem closer to the ball now and off the previous autopilot mode that, while delivering good profits, had seen the Spar brand steal a march on them and the group’s stores losing aesthetic appeal even to the lower-income bracket.


The horrendous shrinkage ratio of 2,1% of sales (all of $9,1 billion) recorded during the same period last year, has been brought under control with the help of CCTV which now covers 29 stores with another six being looked at.


The proportion is now down to 0,80% – a figure more in line with historical and industry norms and at $12,4 billion represents an increase of only 36% in dollar terms. Cash and equivalents stood at $156 billion at the end of September and would have been higher had there not been some $121 billion utilised in increasing working capital ie stocks.


Incidentally, suppliers have long argued that OK’s insistence on long credit terms eg 30 days from statement date is unreasonable and unviable for them in a hyperinflationary environment and has led to the group’s running out of product at a time its management boast of huge bank balances. Rivals, who also sell on cash, quickly adjusted to the new rules of engagement and thus had well-stocked shelves, higher footfall and increasing market share as a result.


For those forward looking investors, what is immediately pertinent is the group’s view on national consumer spending outlook.


Despite an excellent opening month for the third quarter, the management made the point, repeated it thrice, that resistance to price increases is now starting to be keenly felt in the shops with consumers simply opting out of buying commodities which had moved out of their affordability range.

Therein lies the crucial difference with the go-go days of 2002 and 2003 when a buzzing informal sector and all shades of dealers, flush with speculative profits, resulted in robust demand.


The world has moved on since those times – Operation Murambatsvina erased the vibrant grey economy, and favourable changes in the exchange rate regime appear to have eliminated most currency dealers and the accompanying procession of middlemen/brokers/cut-takers.


However, in our opinion, the most important factor has been one which has been predicted for a number of years now but one whose absence, until early this year, had perplexed executive minds in many a company boardroom – the actual onset of simple price-increase fatigue on the part of the ordinary man.


People just don’t have the bearer cheques in their wallets any more to fuel the sprees of yesteryear with the national attitude becoming one of grim resignation – if its too expensive one now opts to do without it instead of attempting to outwit the supplier by buying in bulk. Hyperinflation, retrenchments across virtually all economic sectors and static civil service salaries finally seemed to have put the resilient Zimbabwean economy against the ropes.


The raising of tax thresholds, so often a boon to retailers in the past had, according to OK’s management, no measurable effect on consumer spend at the tills. As implied above, earnings were not helped by government’s newfound restraint with regard to civil servants – they last received a salary increase in January.


Despite the central bank governor and, more recently, the finance minister making sympathetic noises about their plight, it appears that the need to limit the budget deficit (surprisingly) takes precedent. In light of the fact that 2005 is a double-election year, this is a remarkable achievement (so far) for which government has received little credit.


Plans to expand into the region have been put in cold storage as the group limbers up and focus on what looks to be a challenging future on the domestic front. In a fiercely competitive business segment which is being increasingly coveted by heavyweights Innscor, Redstar and CFI and lesser, but equally determined, lights such as Lucky 7, Food Chain Group and Food World, the term cutthroat springs to mind.


Stock turn and margins are a matter of life and death in FMCG retailing – so management’s reluctant admission that volumes are generally lower than their 2003 levels in a situation where price resistance is hardening is an ominous sign for companies which rely exclusively on local sales.

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