Following a rights issue and the successful floating of Boxer’s IPO on the JSE, Pick n Pay Stores (code: PIK) offers an interesting opportunity.
The market has valued Boxer for us and, thus, Pick n Pay’s 65.6% stake in the retailer is worth R19.4bn (excluding a control premium). With Pick n Pay’s market cap currently at R22.8bn, does this mean that we are only paying R3.4bn for Pick n Pay’s own operations?
No, we are paying quite a bit less.
Following its rights issue and the capital realized on Boxer’s placing, Pick n Pay’s balance sheet should have zero debt. Indeed, it should be c.R6bn net cash at this point and we can take that out of the amount we are paying for Pick n Pay’s operations (as R1.00 of cash is worth R1.00 of cash).
Thus, it suddenly looks like we are paying negative R2.8bn for Pick n Pay’s own operations at PIK and BOX’s current share prices (i.e. investors are being paid R2.8bn to hold PIK instead of BOX shares) – see below workings:
Personally, I like getting things for free and I particularly like getting paid to hold something!
But what if Pick n Pay’s turnaround goes wrong? Could PIK actually be worth less than zero?
Anything is possible but, while everyone is focussing on how Boxer is, let’s do some maths to see what Pick n Pay’s turnaround could look like:
In PIK’s segmental disclosure for the 26 weeks to 27 August 2023, the following from note 8 is relevant for only Pick n Pay’s own operations (for the H1:25 period):
- Turnover: R37.7bn
- Trading Loss: (R718.9m)
What is the most likely turnaround strategy here?
Every landlord I speak to that owns retail property exposure says two things: (1) There is a queue for Pick n Pay’s real estate with Shoprite at the front of it and, thus, there should be no reletting risk, and (2) the Pick n Pay stores that they have on their properties trade very well (apparently no one has any bad Pick n Pay exposure?!).
The former point means that landlords could be open to being negotiated out of long-term leases. The latter points implies that Pick n Pay does actually have some good stores in its network.
Both points, though, lead me to believe that using the net cash on their balance sheet of c.R6bn, PIK will buy their way out of some of their loss-making stores’ leases. The landlords should not have too much of a problem with that and the application of the cash in this way does two things: (1) Removes lease costs, and (2) Removes loss-making stores. Both of these add to the Group’s profitability, though sacrifice some revenues and volumes.
Shoprite’s Operating Margin is c.5%, Woolworths Holdings is c.7~8%, and SPAR Group’s lies at the bottom of the peers at a lowly c.2%.
What could a smaller but profitable Pick n Pay achieve? Well, let’s say it loses c.10% of turnaround but that it gets a bottom quartile Operating Margin in place of c.1% (even worse than SPAR).
Previous annual turnover of c.R75bn that was loss-making becomes annual turnover of c.R67bn but generates R670m of operating profit. With no debt (albeit, all the cash spent turning the business around), operating profit less tax (ignoring assessed losses) becomes net profits R180m.
R180m of profit on a 10x Price Earnings (Shoprite’s PE is 25x, Woolies is 17x and Spar’s is 20x, thus 10x is discounted), PIK’s fair value is c.R1.8bn.
This is quite far from the negative R2.8bn the market is currently pricing it at.
Assuming this turnaround takes about 3 years, turning a negative R2.8bn into a positive R1.8n of fair value would add a respectable c.20% return to investors that held PIK shares over this period (yes, there are tons of assumptions baked into this).
But don’t forget, if you hold PIK shares, you also hold BOX shares and, for those 3 years, you also get the growth of Boxer!
Thus, while Pick n Pay’s turnaround has plenty of risks, the first step of recapitalizing the Group has been immensely successful and management are now in a position to execute. The market, though, is betting against them and, therefore, that is where the opportunity may lie for a patient investor.
ARTICLE ORIGINALLY APPEARED ON MONEYWEB
* Keith McLachlan holds PIK shares. Portfolios managed by him and portfolios across the group may also hold PIK shares.