The El Niño weather phenomenon can’t end soon enough for South African clothing retailers. The reduced demand for winter clothing resulting from warmer southern hemisphere winters has been a major driver of underperformance in the sector for the past few years. We do believe clothing retail shares are starting to look interesting again from a valuation perspective, but investors should note that it’s still a beleaguered industry and there may be more upside potential in other sectors – such as banking – if there’s a recovery in consumer confidence.
El Niño isn’t the only culprit in clothing retail stocks’ fall from grace. People also change their wardrobes in response to what’s in vogue and clothing retailers worldwide are lamenting the lack of significant changes in fashion trends over the past few years. The last major change – the skinny jean – has been in fashion for more than a decade! It seems shoppers are in dire need of some fresh ideas and novel trends to pique their interest in apparel and accessories again.
Another thorn in clothing retailers’ side is that in markets such as the UK, consumers are shifting their spending away from material goods such as clothing and luxury products towards ‘experiences’ such as fine dining and travel. This is probably not such a big issue in South Africa, where shoppers are generally highly fashion-conscious – with ‘investing’ in clothing being near the top of the priority list.
The major challenge for South African retailers is consumers’ declining disposable income, aggravated by the weak rand, which has materially increased the selling prices of imported clothing. Consumers are having to make trade-offs in their monthly spending patterns, with less income going towards buying clothing.
The entry of international fashion retailers into South Africa has received a lot of attention of late, with the likes of H&M and Cotton On in particular finding good early traction on our shores. The base is probably too small to have hurt local players yet but the growing presence of these foreign retailers shouldn’t be ignored.
What has been the impact of these trends on South African clothing retail stocks? With the exception of the Foschini Group, which had a relatively weak 2015, many retailers performed poorly in the year to date: Woolworths -19%, Truworths -18%, and Mr Price -20%. Interestingly, South African clothing retail shares didn’t fare that badly compared to our global counterparts: H&M -20%, Marks & Spencer -40%, and Zara -1% – all in rand terms.
Since the start of 2013, the sector has underperformed the JSE All Share Index by about 25%. At Sanlam Private Wealth, we’ve maintained an underweight exposure in our house view portfolio since then. In our view, clothing retail shares are now starting to look more interesting, however, after their prices fell below our estimate of their fair values. The average price-to-earnings (P/E) ratio fell from a high of about 25 times in early 2015 to 14.4 at present.
Investors should take care, however, not to anchor their expectations to past share prices, as the sector is in fact now only trading in line with its longer-term average P/E and is still some way above bottom-of-the-cycle levels of around 8.5 times P/E.
While value has started to emerge in clothing retailers, there’s a much stronger valuation case in another locally focused and consumer-dependent sector – South African banking stocks. South African banks have a lower downside to historical trough levels, so from a portfolio management perspective, we have over the past year preferred to add to our exposure to banks, which in our view have offered more upside in the event of a South African consumer recovery.
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