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Steinhoff Africa Retail:
the return of Pep
Head of Equities
Sep 29, 2017
Since Steinhoff listed on the Frankfurt Stock Exchange in late 2015 to raise capital for its European expansion, investors have undervalued the group’s South African operations, focusing on its developed market assets. To facilitate the listing last week, Steinhoff sold down its stake in Star from 100% to 78%.
Steinhoff management has been looking at ways to demonstrate the value of its South African and African assets on a standalone basis – the primary rationale for the JSE listing. The aim is also to facilitate closer co-operation between the group’s African retail assets and Shoprite. Both Shoprite and Steinhoff have Christo Wiese as their largest shareholder.
At the time of listing, Pepkor (which includes heavyweight brands Pep and Ackermans) will account for 75% of Star’s revenue and 95% of its operating profit. The remainder of the Star mix consists of Steinhoff’s other South African retail assets, split between discount retailers such as Russells, Rochester and Bradlows, and specialty retailers like Tekkie Town, Incredible Connection and Hi-Fi Corporation. These are lower quality assets and therefore don’t command the same high valuation multiples that Pepkor does.
With 4 808 stores, mostly in South Africa, Star has the largest retail footprint in Africa, and is the largest non-food retailer on the continent. The discount nature of Star’s portfolio is appealing, especially Pepkor’s focus on school clothing and basic children’s wear. Pepkor’s South African market share has been steadily rising, from 12% in 2007 to 19% in 2016, largely at the expense of Edcon and independent retailers.
The Pepkor product mix is defensive, with a focus on essential everyday products. Accordingly, Pepkor doesn’t face the same fashion risk as clothing retailers such as Truworths or Foschini. Cash conversion is excellent at more than 100%, which illustrates the quality of the business.
Most investors don’t realise that Pep is the largest airtime retailer in the country. It also sells 60% of all mobile phones in South Africa and 90% of all handsets priced below R500. Pep is shifting towards more direct mobile handset imports, which should have a positive effect on margins.
Pepkor plans to grow its store base by around 6% a year, while driving same-store sales growth through a greater focus on women’s wear. This should result in around 11% per annum revenue growth, which is below the average of around 15% over the last five years. Star’s gross margins of 34% are below those of peers such as Mr Price (39%) and Foschini (50%), which makes sense given the discount retailer model.
The shares listed at R20.50 per share, equating to a forward price/earnings ratio of 18.4 times. On this basis, Star is more expensive than Mr Price, Foschini and Truworths, but cheaper than Clicks and DisChem. In our view, this is appropriate given the differences in growth outlooks and cash generation.
Star has secured options to purchase the 23% of Shoprite owned by Christo Wiese and the Public Investment Corporation at R215 per share (versus the current R209 per share), as well as Wiese’s high-voting shares. This means that, should these options be exercised (which we expect will happen in the next six months), Star will gain control of Shoprite. This will then allow Shoprite and Star to pursue various synergies, ranging from improved bargaining power with property landlords to group sourcing and stores-within-stores.
The purchase price will be settled by issuing new Star shares, and the Shoprite stake will therefore account for 34% of Star after the deal is concluded. Should the Shoprite option be exercised, Steinhoff’s stake in Star will decline to 52%.
Following discussions with management, we’re comfortable that the planned synergies will be realised and that the two groups will fit together well. In the years to come, we would expect Star to try to grow its economic stake in Shoprite, and that Wiese would swap his Star shares for Steinhoff shares.
While Star’s share price doesn’t currently offer exceptional value, we like the group’s exposure to retail growth in South Africa and on the continent, together with the excellent inflation pass-through. This should deliver consistent earnings growth for many years to come.
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