Ben Temkin
27 November 2008
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Johannesburg — IN - at last - focusing on Shoprite, the short report on Tuesday's report that Investec Asset Management is shedding up to 25 jobs to reduce costs is relevant to my analysis.
I wrote yesterday that business can aim to improve its return on assets by improving its asset turn, its ratio of turnover to assets, or its operating margin, by, for instance, by reducing its operating costs. Investec's action to reduce costs is standard methodology.
Investec doesn't rely on plant and equipment to manufacture revenue. Its asset management business derives revenue principally from the inventory of its customers. The value of this produces fees, which depend on the market value of the assets being managed. In a bear market, fees are shrinking. Cost-cutting may ease the pain.
A merchandising operation, such as Shoprite, has more scope than a financial services operation, to manage its assets and to sustain, or even improve, its return on assets, even when market conditions are unfavourable.
The most flexible asset is its inventory. In the year ended June 30 2008, Shoprite's inventory turn -- the number of times it was replaced over the year -- was 9,1. This compared with the 2007 turn of 8,9. It was a significant change relative to Shoprite's average inventory over the year of more than R4bn.
The core of Shoprite's merchandise is staples, mainly food.
In a period of rising food prices, in October last year, it reduced its margins as a weapon in an aggressively competitive market. Its gross margin fell to 19,9% to 20,5% over the year.
The customers liked this. Turnover, the important driver of return on assets, rose 22,3% to R47,65bn from R38,95bn. Consequently, although the gross margin fell, gross profit over the year increased 18,7% to R9,49bn from R8bn last year.
According to Shoprite's performance measures in the 2008 annual report, its trading margin rose to 4,8% from 4,1%. Using the revenue inputs from my model, which include non-core trading income, its operating margin in 2008 rose to 3,63% from 3,54%.
Its asset turn, based on year-end figures, improved to 4,58 from 4,33, an increase of nearly 4%. With improvements in both asset turn and operating margin, Shoprite's return on assets for 2008 was 16,66% compared with 15,32% the previous year.
Consequently, the company was able to report an improvement of 54,1% in diluted headline earnings per share to 298,6c from 193,8c. This performance was notwithstanding the significant slowdown of its furniture operations, which affected not only trading revenue but also income from interest on credit and insurance premiums.
Shoprite's trading update a month ago was positive but made no predictions because of global economic turbulence. With a share price of around R50, the historic price:earnings ratio is 17. However, it looks as if the market has rated its forward price-earnings ratio this year at between 12 and 13 -- bottom-line earnings per share growth of more than 30%.
I would like the company much more if it were not in the furniture business but its share price has been strong in the bear market and the shares are an institutional favourite. It's been upgraded to Jean's and my list of maybes.
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