At Sanlam Private Wealth, we have maintained a stake in Pepkor – South Africa’s largest non-food retailer – in our clients’ portfolios for several years, adding to the share in May 2024. In our view, it remains a quality business with an encouraging long-term growth outlook. Why then did we trim our holding in the clothing retailer across some of our client portfolios in December? The answer lies in the fundamentals of portfolio construction and managing position sizes.
In May last year, we decided to increase the size of our Pepkor holding in our portfolios after election-related concerns had driven the share price down to compelling levels. South Africa’s elections proceeded smoothly, leading to the formation of a government of national unity. Loadshedding remained in abeyance, inflation cooled, interest rates declined, and South Africans gained access to a portion of their pensions via the new two-pot retirement system. Together, these developments bolstered both the willingness and ability of consumers to spend.
This combination of positive factors – particularly beneficial for lower-income consumers – propelled the Pepkor share price more than 50% higher between mid-May and mid-December, outperforming the All Share Index by more than 30% over the same period.
As our outlook for South Africa improved, so too did our expectations for Pepkor’s medium-to-long-term growth potential. This lifted our December assessment of Pepkor’s fair value to around R27 per share, 18% higher than our view back in May – driven largely by a higher projected long-term growth rate.
With the price having moved by more than 30% relative to our fair value, not only had the margin of safety between the share price and our intrinsic value closed, but the excellent share price performance meant that the weighting of the Pepkor holding in our portfolios had increased significantly.
POSITION SIZE
When we added to our position in May, we raised the holding to 5.2% of our South African equity portfolio, a size that reflected our positive outlook on the share in the context of a concentrated 24-stock portfolio. By December, however, the position had grown to beyond 7% while the stock’s expected returns had moderated, even after accounting for the improvements to the environment mentioned above.
This presented us with a great opportunity to bank some profits and reallocate some capital to relatively more compelling opportunities elsewhere.
We continue to hold a meaningful position in Pepkor, which we still view as a quality business with long-term growth potential. While Pepkor likely won’t exhibit the same leverage to a consumer rebound as its credit-retail peers Foschini and Truworths, we think it provides the right type of through-the-cycle consumer exposure at what we consider a fair price. We require an annual return of around 13.6% from our Pepkor holding, and we remain confident in the retailer’s ability to deliver in this regard.
