Warning Signs: Retailers, Shopping Centres & Retail REITs (Part 1 of 2)

OLD ARTICLE – Original posted on November 22, 2016

Following an exchange with Byron Lotter on Twitter (see here) after what I believe (and the market believes) was a very poor trading update from Woolies (WHL).

But Woolies is not alone in this regard.

Here are the key listed retailers, their like-for-like same-store growth, inflation and the resulting indication of volumes at store-level:

	Like-for-like (Food)	Inflation (Food)	Volume (Food)	Like-for-like (Non-food)	Inflation (Non-food)	Volume (Non-food)
Woolies (South Africa)	4.9%	9.2%	-4.3%	0.8%	7.0%	-6.2%
Mr Price	–	–	–	-3.2%	11.4%	-14.6%
Lewis	–	–	–	-9.2%	6.0%	-15.2%
Shoprite (South Africa)	12.40%*	7.2%	5.2%	9.10%*	6.0%	3.1%
Pick ‘n Pay	3.5%	5.5%	-2.0%	–	–	–
Spar (South Africa)	7.9%	6.2%	1.7%	–	–	–
Holdsport	–	–	–	3.3%	8.6%	-5.3%
The Foschini Group	–	–	–	2.1%	9.0%	-6.9%
Truworths	–	–	–	-5.0%	16.0%	-21.0%
Average	2.0%	3.1%	0.1%	-1.4%	7.1%	-7.3%

So cyclical, discretionary non-food related like-for-like retailer volumes contracted by c.7.3% over the latest reporting cyclical across pretty much our entire listed retail sector.

That is not good.

But why is this happening?

A number of reasons, so let me list them for you briefly:

1. Edgars: Edgars has been losing market share (in the unlisted space) that the other retailers have been picking up (in the listed space). This bleed appears to be over and Edcon is now “recapitalised” and likely to chug along just fine protecting its market share. In other words, the listed retailers are no longer having their growth subsidized by Edgars’ woes.
2. Shopping centres: Over the last decade shopping centres have been rolled out at an incredible pace across South Africa. Therefore, periods of soft like-for-like growth by the listed retailers have been obscured by store rollouts and space growth. Consider the fact that the domestic shopping centre boom is pretty much over (read this), and suddenly like-for-like is no longer being subsidized by store rollout.
3. Credit market dynamics: Unsecured lending (inside and outside of the retail stores) is contracting. This is partially due to the National Credit Regulator’s latest stodgy Affordability Criteria (amongst other regulatory issues), but it is also due to unsecured lending out of African Bank, Capitec and the other banks contracting. These capital sources all borrowed from tomorrow to buy fancy shirts for today. Eventually, as consumer balance sheets, spending power and credit quality deterioriate, so will the volumes of new credit being pumped into the market. See here for NCR’s latest stats.
4. Disposable income contracting: Inflation, low growth, limited to dropping employment and the rising administrative costs (“administrative costs” are a euphamism for various State taxes, like income tax, CGT, VAT, electricity, water, municipal, eTolls, etc) all have led to a flat-lining in South African consumers’ disposable incomes (in real-terms, excluding inflation). When credit markets tighten, then this dropping disposable income becomes twice as apparent. See here for some data on this. OK, to some degree, disposable incomes have been alright, but household debts have been bad and the bloated Government payroll (a massive spender at shopping centres!) has been capped. I.e. Disposable income going forward is actually likely to be worse…

So, all in all, a combination of factor are converging to make this a very tough retail environment, yet there is an elephant in the room: retailer’s themselves have been growing their own debt-levels and gearing has been exploding while their Returns on Equity (ROE) have been falling (see below; click graph to expand):

So not just have retailers been using more and more debt to finance themselves, but at incrementally lower and lower returns.

And then, on top of that we start to have falling volumes in even some defensive categories…?

The point is, South Africa retail is in trouble. This, in a way, is acknowledged by the fact that many of the retail groups are desperately acquiring businesses outside of South Africa.

If South Africa was a good retail investment, why wouldn’t these Group deploy their capital in South Africa?

It is simple, we are not. Hence, they are not.

I’ll write a bit later on the full effects of this, but consider the following: Retail REIT (i.e. listed collections of shopping centres) have a historical beta with the listed retailers that approaches 1.0x.

In other words, if local retailers struggle, rental escalation cannot be passed onto them, rental holidays appear, vacancies eventually materialise and highly indebted shopping centres get impaired. And, within highly-geared REIT structures, when NAV drop then LTVs are breached, distributions are the first thing to be cut, and… And… And… I’m sure you get the picture. This is a lot of doom and gloom, but consider this parting thought: have your shopping habits changed in the last year or two? Think about it…