21 Jun Troubled times
Furniture retailer Lewis is sticking to its guns over its business model, even as investors remain sceptical.
The stock is down 43% in a year, and is now trading on a p:e of just 6 — less than a third of the 21 p:e of the wider JSE.
In January, SBG Securities put out a report arguing that Lewis’s “weak earnings outlook” was not priced into the share price, and its sales growth was expected to slow. SBG, which expects SA furniture volumes to fall by 1% this year, has a “sell” rating on Lewis’s shares and a one-year price target of R44.
Noah Capital Markets recommends Lewis as a “hold”, with a one-year price target of R47.80.
In particular, Noah says Lewis will be hurt by government’s plan to reduce the amount of “credit life insurance” that stores can add to a customer’s bill, to cover the retailer if the customer dies.
Lewis’s credit life is far above the maximum R4.50 insurance per R1 000 spent which government is proposing as a cap.
“We calculate that Lewis would have to increase its gross profit margins to 45%, from the current 36.6%, to compensate for lost insurance revenue to maintain its profit levels. There is a risk that product prices may become too expensive for Lewis’s customers,” say the analysts.
You don’t have to look very far to find a reason for investors’ lukewarm view: consumers have gorged themselves on credit for years, and it’s now come to a grisly end.
Stats SA numbers show that retail trade sales for furniture have been dropping since September last year, plunging 9.9% in October alone.
The Financial Mail’s analysis of the recent annual reports of listed retailers shows that the companies have cottoned on to this, and are scrambling to diversify their revenue.
“There is too much on offer in the industry and a lot of them [furniture retailers] aren’t differentiated in any way,” says Sasfin Wealth equity analyst Alec Abraham. “That’s the main problem in the furniture industry — just too many stores.”
For Lewis, the ailing consumer environment has come with a nasty complication, which helps add to the scepticism over the stock.
Last year, Lewis was referred to the national consumer tribunal for flouting the National Credit Act — doing things like adding “unemployment insurance” to the fine print of credit contracts for people who were already unemployed, or were pensioners. In a show of contrition, Lewis paid back R67.1m of this money, admitting certain cases of “mis-selling,” though that case will be heard in July.
Two weeks ago, however, the national credit regulator hit Lewis with new charges. This time, it stands accused of transgressing the act through the way it provides “extended warranty cover”and “club membership” to its customers.
CEO Johan Enslin says the regulator’s claims are “without merit”. However, he admits that the company’s internal probe — which led to the insurance “mis-selling” being uncovered last year — didn’t delve into whether there were any problems with extended warranties or club fees.
“Lewis believes that its current business model is sustainable and will allow the group to continue to grow market share into the future,” says Enslin. “The model is based on the principle that the sale of furniture and the granting of credit are interdependent, and management further believes that the group’s total cost of credit is market-related.”
It’s a contentious view, given that it was this business model that led to the collapse of Ellerines, as its customers’ staggering amount of bad debt felled even Ellerines’ parent, African Bank.
JD Group, which owns Joshua Doore and other outlets, also came under heavy strain from bad debts.
Still, Enslin is right that there does appear to be some room for growth. The regulator’s own data shows that of the 361 183 secured credit agreements granted in the fourth quarter, 51.71% were in the “furniture and other durables” segment. The R1.8bn in loans granted by furniture retailers even outnumbered the number of loans taken out to buy cars, for example.
It’s not Lewis alone that has earned the regulator’s ire.
Shoprite, Whitey Basson’s retail behemoth, may be better known for selling food, but was also sent to the principal’s office to answer accusations of granting credit recklessly and selling retrenchment cover to pensioners. In Shoprite’s case, those offences allegedly occurred at two subsidiaries — the Shoprite Insurance Company and Shoprite Investments.
In perhaps the most absurd case, Shoprite was accused of selling a retrenchment policy with a waiting period of six months to a consumer who applied for a six-month loan. In other words, that retrenchment cover would only kick in after the loan was meant to be repaid.
Shoprite, of course, has far more strings to its bow than Lewis, which is why its share price has remained static at around R170 over the past year.
Still, Shoprite’s half-year report lamented how its furniture segment had been hurt by the volatile exchange rate and the poor state of the economy. As a result, House & Home, Shoprite’s furniture unit geared towards the upper end of the consumer market, has no plans to open even a single new store before June 2017 at the earliest.
It’s the same story across the board. Wetherlys, a top-end furniture retailer, shut its doors a year ago.
And even the high-flying Steinhoff, which owns brands such as Bradlows and Morkels, said in its half-year report that revenue from its African retail operations had fallen 22% due to “lower market demand” and its move away from “credit-dependent customers”. In other words, it was trying to sell more using cash and less on credit.
This appears to be the way forward, considering that Coricraft, which now has 115 stores across SA in many of the fancier malls, has managed to do well by focusing on cash sales rather than credit.
The credit crunch is exactly why the retailers, including Lewis, began to focus on getting revenue from other sources — including ladling on insurance and “ancillary services” such as monthly fees to belong to a club. Edcon has long followed this practice, and others clearly decided to follow suit.
For a while, it worked.
The Financial Mail calculates that from 2010, Lewis made R15.5bn just from its insurance, finance charges, initiation fees and other “associated services”. This outstripped the R14.2bn it earned from merchandise sales.
At Shoprite, the picture was much the same. The retailer has seen faster growth in its “other operating income” segment — made up of finance income, net premiums earned, franchise fees, lease income, commissions, investment and other income — since 2012, bar one year.
Last year, for example, Shoprite’s “other operating income” rose 20.7%, compared with 11.2% for merchandise sales.
The problem is that this “other revenue” came from the same cash-strapped consumers who had bought furniture and were struggling to pay for the goods — let alone the extra fees which they, in some cases, weren’t even aware of.
Now that the regulator is taking an eagle eye to abuses in selling these add-on services, the signs are particularly ominous for retailers reliant on fine print for profit. (Financial Mail, 5 – 11 May 2016)